Articles

Mutual Fund Share Classes Defined

Fri, 09 Jul 2010 00:00:00 GMT

There is much confusion among mutual fund investors regarding various "share classes” that mutual fund companies create. For many mutual funds, there are more than three share classes for each fund within a mutual fund family. In every case, a different share class represents a different method of calculating the fees in which mutual funds levy on investors. The most common share classes are as follows:

Class A share mutual funds generally assess an upfront (one-time) commission that is paid to the broker (4.75% to 5.75% is the range). In addition, there is a lower ongoing annual fee (12b-1 fees) that is paid to the broker to service the investment.

Class B share mutual funds do not charge an upfront load (commission), but rather have higher annual expenses and charge a contingent deferred sales charge (CDSC) if shares are sold within a certain period of time (usually 3 to 7 years). When the CDSC period expires, Class B shares "convert” to lower cost Class A shares. At the point when Class B shares convert to Class A shares, deferred charges are not assessed when the fund is sold.

Class C shares generally do not assess an upfront load, but will assess a 1% load if you sell the fund within one year. After holding the fund for one year, there is no fee to exit the fund. However, the ongoing internal cost of class C share mutual funds are generally higher than other share classes of mutual funds.

Class D and Class F share mutual funds are usually no-load mutual funds. While no-load mutual funds do not charge "commissions” upon their purchase, there are ongoing expenses that are assessed to investors. These ongoing expenses vary for each fund. Class D and Class F share funds can be purchased at most discount brokerage firms through their "mutual fund supermarket” platforms. Many D and F share class funds pay an annual 12b-1 fee to the brokerage firm (not the advisor that may recommend the fund).

About Beacon Financial Strategies

Beacon Financial Strategies is a Registered Investment Advisory (RIA) firm, located in Raleigh, NC that specializes in providing comprehensive financial and investment advice to clients through a fee-only (no commission) framework. Beacon’s investment philosophy is grounded on the tried and true premise of asset allocation, while also minimizing the investment and tax related costs that tend to reduce investor’s long term rates of return. For more information, please contact Beacon Financial Strategies to request an introductory packet.

Is a Defined Benefit Pension Plan Right for your Business?

Thu, 01 Jul 2010 00:00:00 GMT

For business owners, there are many alternatives when it comes to establishing a retirement plan. While 401(k) plans are a common choice that can enable contributions of up to $22,000 in 2010 (for those age 50 and over), what about those people who would like to make more sizable tax-deferred contributions into a retirement plan? For these individuals, a Defined Benefit Pension Plan (DB) should definitely be considered.

A defined benefit pension plan is a qualified retirement plan whereby a specific annual pension payment is guaranteed to an employee or business owner at retirement. While larger corporations have been phasing out pension plans recently, small or closely-held businesses can benefit immensely by establishing and funding these plans.

Because funding requirements are based on a projected annual benefit level, deferrals into defined benefit plans can be quite substantial. In fact, often times employers can make tax-deferred contributions in excess of $100,000 annually. This high deferral level can enable those with defined benefit plans to create a substantial retirement fund in a relatively short period of time.

While any employer can establish a defined benefit plan, it is most suitable for businesses that have a small group of highly compensated owners and very few (or no) employees. A DB plan is most advantageous for an employer who wants to maximize tax-deferred benefits and can afford to make large contributions. Here are a few of the key strengths and tradeoffs when considering a defined benefit pension plan:

Strengths

With less time until retirement, older participants are allowed to have greater contributions made on their behalf
The plan is structured to provide a guaranteed pension benefit based on annual earnings levels
Contributions are tax deductible to the business and investment earnings are tax deferred
When the plan is suspended or terminated, the plan can be rolled into a 401(k) plan or an IRA

Tradeoffs

The plan must be funded regardless of how the business is performing
An actuary must be utilized to determine the annual contribution requirements
DB plans are generally subject to ERISA rules and to "top-heavy" legal requirements
The plan is not allowed to discriminate in favor of highly compensated employees
Underfunding of the plan may require additional outlays of cash

While an actuary is required to determine the annual contribution amount, the formula is generally based on compensation, age, and length of service with the company. The retirement benefit is calculated to be the lesser of $195,000 or the average of the three highest earning years. As a result, if an employee is approaching retirement, the contribution levels could be significant.

While this type of plan sounds complicated and costly, there are companies that specialize in offering DB plans specifically for solo or small businesses. If you are a business owner who would like the ability to increase your retirement savings, while simultaneously reducing your income tax liability, a defined benefit pension plan may be a suitable alternative. If you have questions about your retirement savings strategy, or would like to explore the appropriateness of a defined benefit pension plan for you, please contact our office to schedule a meeting.

About Beacon Financial Strategies

Beacon Financial Strategies is an independent, fee-only financial planning, tax and investment advisory firm located in Raleigh, NC. Beacon works with clients on a consultative and objective basis to help them achieve their personal financial goals. Beacon professionals specialize in the following areas of financial planning: retirement feasibility planning, estate planning and coordination, investment management, tax minimization strategies, and other wealth management services.

Second Quarter 2010 Market Review

Thu, 01 Jul 2010 00:00:00 GMT

When will the financial storm clouds lift? Even the most disciplined investors are asking themselves this very question, as they continue to endure a seemingly endless supply of bad news.

High unemployment, sovereign debt fears, health care and financial reform, budget deficits, an uncertain tax code, a massive oil spill and political bantering are all creating a perception of uncertainty and chaos—especially in the financial markets.

During the second quarter, the equity markets reacted adversely to the realization that global economic growth would not experience the rapid recovery that many had hoped. Although corporate earnings improved somewhat, job creation in the private sector experienced only modest gains.

The fixed income markets (bonds) continued to advance, as investors’ appetite for "safe-haven” investments strengthened. As we have noted on a number of occasions, we believe that bond investors’ willingness to accept low yields in an exceedingly low interest rate environment will prove to be a perilous decision when interest rates adjust to more normalized levels.

We believe that the headlines will likely remain negative for some time as the global economy evolves. However, those investors who can separate themselves from the crowd by making investment decisions that ignore—and are actually contrary to—the popular sentiment, should be rewarded by superior investment results.

As a reminder, making important long term financial decisions requires the discipline to ignore the noise of the moment in order to recognize the opportunity of the future. While there are certainly challenges that lie ahead (and there always will be), we believe that an investment approach formulated within the context of a comprehensive financial plan will provide the peace of mind necessary to ensure a favorable outcome.

Please do not hesitate to contact our office if you have any questions or would like to discuss your financial circumstances in more detail. Have a great summer!

About Beacon Financial Strategies

Portfolio Accounting Methods: Which is best?

Thu, 01 Jul 2010 00:00:00 GMT

How do you track the cost basis on investments held in your taxable portfolio? What portfolio accounting method does your broker, custodian or advisor report to you or your CPA? This is a decision that, for some investors, can save thousands of dollars in taxes and ultimately make a significant difference in the after-tax rate of return of your portfolio.

Managing the tax impact when selling an investment in your taxable portfolio is a critical component of a tax-efficient investment strategy – especially with those investments whereby dividends are reinvested or there are a series of purchases (i.e. dollar cost averaging). The following are descriptions of the portfolio accounting methods available to investors:

Average Cost Method

As its name implies, the average cost method keeps a running tally of the average cost of mutual fund or stock shares that are purchased or sold over time, including reinvested dividends. The average cost accounting method is the most commonly used method by mutual fund companies.

First in First Out (FIFO)

The FIFO method assumes that the shares sold were the first shares purchased. This method realizes the maximum capital gains when an investment has appreciated throughout its holding period. The FIFO method is the "default” method for many brokerage firms.

Select Lot (or Specific Lot) Identification

The Select Lot method allows an investor to identify the shares that are sold. This is the most flexible portfolio accounting method and allows the investor to have maximum control of any gains or losses generated when selling an investment.

Last in First Out (LIFO)

The LIFO method assumes that the shares sold were the last shares that were purchased. This method can result in higher short-term capital gains or losses. Short-term capital gains are generally taxed at higher tax rates than long-term capital gains.

High Cost

The High Cost method assumes that those shares sold are the highest cost shares. This portfolio accounting method can result in minimizing capital gains or maximizing capital losses.

The IRS is indifferent as to the accounting method that investors utilize. However, the IRS has indicated that investors should maintain consistency in whatever accounting method is chosen. In other words, investors choosing the average cost method cannot subsequently decide to convert to the LIFO portfolio accounting method.

About Beacon Financial Strategies

Beacon Financial Strategies is an independent financial planning, tax and investment advisory firm located in Raleigh, NC. Beacon works with clients on a consultative and objective basis to help them achieve their personal financial goals. Beacon professionals specialize in the following areas of financial planning: retirement feasibility planning, estate planning and coordination, tax minimization strategies, and wealth management services. Beacon Financial Strategies provides both one-time and ongoing financial planning, tax and investment advice to clients and operates in a fee-only, fiduciary capacity.

Tax Considerations for Executive Stock Option Plans (ISOs, NQ's and RSUs)

Wed, 16 Jun 2010 00:00:00 GMT

Disclaimer: While the following article addresses many of the common issues relating to executive stock option plans, there are a number of considerations that can be specific to your employer’s plan or, more importantly, your personal tax or financial situation. We would suggest that you contact Beacon Financial Strategies or your tax advisor prior to making any decisions relating to your executive stock option exercise strategy.

There are a number of tax and other financial planning considerations for those who have been granted executive stock options. The following article discusses the most common types of executive stock options and their tax implications, including possible exposure to the alternative minimum tax (AMT).

Non-Qualified Stock Options (NQs)

Generally, the taxation of non-qualified stock options (NQs) is considered less advantageous than their counterpart, the incentive stock option (ISOs). Non-qualified stock options give an employee the right to purchase company stock at a specified price. Usually, an employee is granted the option of a certain number of shares. These shares gradually vest over a period of time (normally several years). Non-qualified options generally expire no more than 10 years from the grant date. Employees have the ability to exercise their vested stock options at any time until the expiration date. The tax implications of non-qualified stock options are as follows:

When the options are exercised, they are also sold on the same day. The difference between the exercise price and the price on the date of the exercise is considered compensation income and will be reported on the employee’s W-2. Because this income is considered compensation, the income will be taxed at ordinary income tax rates.
In most cases, the employer will withhold taxes on the income from the option exercise at a standard tax rate. Tax withheld includes, not only federal and state withholding, but also Medicare and Social Security.

While the employer does withhold taxes from the option exercise, we have found that in many cases the withholding levels are inadequate. Remember, the tax liability generated from the transaction is dependent on an employee’s specific tax bracket and not the employer’s standard withholding schedule.

Incentive Stock Options (ISOs)

Incentive stock options are similar to non-qualified stock options in the way they are granted to employees and their vesting schedule. However, those individuals with ISOs should carefully consider their exercise alternatives and the inherent tax implications when developing an options exercise strategy. The taxation of ISOs, depend on whether the options are exercised and the stock is immediately sold or if the stock is retained. Consider the following:

Option is exercised and shares are immediately sold

An employee can choose to exercise the ISO and immediately sell the shares. In that case, the difference between the exercise price and the market price would be taxed to the employee at ordinary income tax rates (the same as a non-qualified stock option). Generally, the employer is not required to withhold taxes on this type of transaction.

Option is exercised and shares are held

An employee can also purchase the shares at the specified option price and hold them for as long as they choose. The following are tax considerations when ISOs are exercised and shares are held:

Taxation on the options exercise date:

Regular Tax: There is no income tax reported for regular tax purposes.
AMT: When the shares are purchased, the difference between the exercise price and the market price is a preference item for AMT (Alternative Minimum Tax) purposes. As long as the preference item does not trigger AMT, the purchase transaction would not trigger any additional tax.

Taxation when shares are sold:

Regular Tax: When the shares are sold, a capital gain is reported as the difference between the exercise price and the sales price. If the shares were held for at least one year, long term capital gains rates would apply.
AMT: When the stock is subsequently sold, there is a negative AMT adjustment equal to the difference between the exercise price and the market price on the date of purchase.

Restricted Stock Units (RSUs)

Restricted Stock Units are a relatively new form of stock compensation. Basically, a company grants a specific number of shares to an employee with a future vest date (generally 2-3 years away). On the vesting date, the stock is valued at the current stock price. The total value of the stock on the vesting date is reflected in the employee’s compensation and therefore taxed at ordinary tax rates. A portion of the shares are sold to pay for the withholding for federal and state income tax as well as Medicare and Social Security tax. The remaining shares are issued to the employee.

The remaining shares can be sold at any time after they are issued to the employee. At the point shares are sold, any gains would be taxed at long term capital gains rates if shares have been held for at least a year. The capital gain is calculated as the difference between the sales price and the price on the vesting date.

Example: An employee is issued 150 shares of restricted stock units that will vest in two years. On the vesting date, the stock price is $10/share. Therefore, $1,500 is included as the employee’s compensation. Withholding for federal and state income taxes and Medicare and Social Security is assumed to be $500. Therefore, 50 shares are "sold” to pay for the tax withholding and the employee is issued 100 shares of stock.

One year later, the stock price is $14/share and the employee decides to sell the 100 shares of stock. The proceeds from the sell are $1,400 and the capital gain from the transaction is $400 ($1,400-$1,000).

For those executives who have been granted stock options, there are a number of financial planning and tax implications to consider. Beacon Financial Strategies has extensive experience in helping clients understand their stock options and develop a tax-efficient exercise strategy. For more information, visit www.BeaconFinancialStrategies.com or contact our office at (919) 321-8625.

Tax Considerations for Employee Stock Purchase Plans

Wed, 16 Jun 2010 00:00:00 GMT

Disclaimer: While the following article addresses many of the common issues relating to employee stock purchase plans, there are a number of considerations that can be specific to your employer’s plan or, more importantly, your personal tax or financial situation. We would suggest that you contact Beacon Financial Strategies or your tax advisor prior to making any decisions relating to your ESPP investment strategy.

Employee Stock Purchase Plans (ESPP) can provide both executives and rank-in-file employees with an effective method of investing in their company’s stock. However, understanding the potential tax implications of this transaction is a critical component of implementing a successful ESPP investment strategy.

Employee Stock Purchase Plan (ESPP)

With employee stock purchase plans, employees are given the opportunity to buy company stock (usually at a discounted price). Generally, an employee chooses the amount they want to contribute each pay period and the employer deducts that amount, after tax, from the employee’s paycheck. Money withheld from the employee’s paycheck will accumulate until the end of the offering period when it is used to purchase shares of the company’s common stock.

Some companies offer a "lookback” period, so that the price the employee pays is based on the price at the beginning or the end of the offering period, whichever is lower. With this type of plan, the employee could receive an extra benefit, if the stock price appreciates during the offering period, as they would buy in to the stock at lower levels.

Usually, when the shares are purchased, the employee has the ability to sell the shares at any time. However, income tax liabilities are deferred until the shares are sold. The actual income tax payable on this transaction are dependent on how long the shares have been held.

Disqualifying Dispositions

The taxation on the sale of the stock depends on whether or not the transaction is a disqualifying disposition. A disqualifying disposition is when both of the following are true:

· The shares have been held less than one year since the purchase date AND

· It has been less than two years since the beginning of the offering period.

If the sale of the stock is considered a disqualifying disposition, the difference between the purchase price and the market price on the date of the purchase (the discount) would be added to an employee’s compensation. The disqualifying disposition is reported on the employee’s W-2 and would be taxed at ordinary income tax rates.

The remaining gain or loss on the sale is taxed based on the holding period of the stock.

Short Term Holding Periods

When a stock is sold less than one year after the purchase date, it is considered a short term capital gain (or loss). The tax rate for short term capital gains (or losses) is considered to be the employee’s ordinary tax rate.

Example: Joe purchases his company stock shares at $7.50 when the price of the stock is $10. He holds the shares for six months and sells them at $15 per share. Compensation of $2.50/share ($10-$7.50) is added to his gross pay and reported in his W-2. In addition, he would also report a short term capital gain of $5/share ($15-$10) on his tax return. The $5/share gain would also be subject to Joe’s ordinary income tax rate.

Long Term Holding Periods

A long term holding period is considered to be at least one year after the purchase date. Even though an employee holds the stock for one year before the sale, the transaction can still be a disqualifying disposition because as shares may still be held for less than two years after the beginning of the offering period.

With long term disqualifying dispositions, the purchase discount is taxed as ordinary income. However, the remaining gain (or loss) from the sale would be taxed at long term capital gains tax rates which are currently lower than ordinary income tax rates.

Example: Jim purchases shares at $7.50 when the price of the stock is $10. He holds the shares for just over a year and sells them at $15 per share. Compensation of $2.50/share ($10-$7.50) is added to his pay. In addition, he would also report a long term capital gain of $5/share ($15-$10) on his tax return. The maximum rate (under current law) for capital gains is 15%.

A Scenario to Consider

There is one particular situation in which the holding period is very important. Consider the following:

If an employee has a sizable benefit at the time of purchase, but the stock price declines sharply afterward, the employee can actually pay tax on "phantom income” if they make a disqualifying disposition.

Example: Sue purchases $10,000 of stock during an offering period and the stock price rises dramatically. The stock is valued at $25,000 at the end of the offering period. She holds onto the stock and the price falls leaving her with shares worth just $8,000. In this situation, a disqualifying sale will require her to report $15,000 of compensation income. She will also have a $17,000 capital loss on the sale. Unfortunately, because of the capital loss limitation she may only be allowed to deduct $3,000/year.

By contrast, if Sue held the shares long enough to avoid a disqualifying disposition, she would subsequently report no compensation income in this situation. As such, she would only have to report a capital loss of $2,000.

Qualifying Dispositions

A qualifying disposition is when both of the following are met:

· The ESPP shares have been held more than one year from the purchase date AND

· It has been more than two years since the beginning of the offering period.

Because with all qualifying dispositions, the shares have to be held at least one year, the transaction automatically qualifies as a long term capital gain. In that case, the taxpayer would report a capital gain (or loss) on the difference between the sales price and the purchase price. Because capital gains tax rates are lower than ordinary income tax rates (assuming a stable or rising stock price), a holding period of more than two years would presumably provide most taxpayers with the most favorable tax treatment.

Example: Larry purchases shares at $9 when the price of the stock is $12. He holds the shares for three years and sells them at $15 per share. Because this transaction is considered a qualifying disposition, there is no compensation reported on the sale of the stock. Larry would report a long term capital gain of $6 per share ($15 - $9). The maximum rate (under current law) for capital gains is 15%.

Lowering the Cost of Long Term Care Insurance

Mon, 10 May 2010 00:00:00 GMT

Most would agree that long term care insurance planning should be an integral component of a comprehensive financial plan. Given the increasing cost of long term care insurance, we have developed a list of alternatives that may help reduce your cost of coverage. Please note that there are a number of risks involved in employing these strategies and they should only be considered in the context of your overall financial plan:

Lower the monthly benefit level

While nursing home costs on a nationwide level are exceeding or quickly approaching the $200/day mark, it may not be necessary for your long term care policy to cover a $6,000 per month benefit. Depending on your personal financial situation, it may make sense to partially insure the cost of long term care. That is, instead of buying a policy with a $6,000 per month benefit it may be best to reduce the amount of long term care insurance to a $3,000 per month benefit. The idea is that in the event you do require long term care assistance that your LTC insurance can cover part of the cost and you can pay the overage out-of-pocket.

Increase the elimination period

The elimination or wait period is the amount of time you must qualify for long-term care insurance prior to receiving a benefit. While receiving care during the time of the elimination period, you will pay for the care out-of-pocket. The elimination period is the equivalent of a deductible with health insurance. The longer the elimination period the lower your premiums will be.

With some long term care insurance policies, one day of home health care assistance can satisfy an entire week of the policy’s elimination period. Since home health care services are generally cheaper than ongoing assisted living care and people often utilize home health care services prior to entering a facility, it may make sense to have an elimination period of six months or more on your policy.

Reduce the benefit period

Reducing the benefit period can be an effective way to control the cost of LTC insurance premiums. Instead of buying a policy that offers a five year long term care benefit, reduce the benefit to two years, with the idea of paying for any additional long term care coverage with your assets.

Consider policies that allow spouses to "pool” LTC insurance benefits

Some LTC insurance policies allow spouses to pool their LTC insurance benefits. That is, if each spouse were to purchase a LTC policy with a 2 year benefit the total benefit period is 4 years. If only one spouse were to require LTC assistance, he could utilize the entire 4 year benefit period (leaving the second spouse with no coverage or partial coverage). Pooling LTC benefits is an effective rider to utilize in conjunction with reducing the benefit period.

For more information, please contact Chip Hymiller, CFP® or Erin Campbell, CPA/PFS, CFP® with Beacon Financial Strategies at (919) 321-8625.

Estate Planning: Do you need a Trust for your children?

Mon, 26 Apr 2010 00:00:00 GMT

Most parents take certain steps to protect their children in the event of their premature death. Drafting a will or other estate documents, designating a guardian, obtaining life insurance and naming appropriate beneficiary designations on IRAs and 401k plans are all important components of an effective estate plan that serve the purpose of protecting your children. However, most parents should take additional measures to provide guidance on how their financial assets are managed for their children’s benefit. In the event of your death, consider the following:

Would you like to avoid the potential financial pitfall of your children inheriting a sizable sum of money at an early age?
Would you like to have some control over who manages your children's financial assets?
Would you like to provide guidance on the types of expenses your assets should be used to cover?
At your death, would you like to gradually give your children access to their inheritance based on their age or other benchmarks (like graduating from college)?

If you answered yes to any of these questions, you should consider incorporating trust provisions into your estate plan. A properly drafted Trust that can help protect your children and preserve your assets.

What is a Trust and how are they funded?

In a general sense, a Trust is simply a document, or a provision in a document, that outlines how certain assets are to be managed and ultimately distributed. Trusts can be funded in a variety of methods including titling property in the name of the trust, naming a trust as the beneficiary of life insurance policies or retirement plans or they can be funded through the probate process by provisions in a will.

What are common components of Trusts that are specifically designed for the benefit of children whose parents are deceased?

The Trust names a trustee.

Through the drafting of a Trust, the grantor (in this case the parent), identifies a trustee. The trustee has a fiduciary obligation to manage and disburse trust assets per the terms of the Trust. Oftentimes the trustee of the Trust is also the child’s designated guardian. However, this is not always the case as sometimes the guardian may not be financially savvy enough to handle all of the financial requirements of being the trustee.

The Trust gives guidance to the trustee on appropriate uses of Trust assets.

Trust provisions can be as accommodative or as restrictive as the grantor prefers and the situation warrants. Some Trusts specify that assets be used as the trustee sees fit, while others earmark trust assets only for health, maintenance and education of the beneficiaries (in this case the children).

The Trust spells-out a final distribution arrangement and ultimate Trust termination.

Trusts generally set forth a timeline as to when children would ultimately receive their inheritance. Most parents would like to ensure that their children are mature enough to handle money effectively before they receive a sizable sum of money. Therefore, Trust provisions may specify that children would receive laddered distributions. For example, their child would receive 1/3 of the Trust at age 25, 1/3 at age 30 and the final 1/3 at age 35.

Is an attorney needed to draft Trust documents?

Estate planning is a complex and dynamic component of the financial planning process. There are many financial, legal and practical matters involved that we believe warrant the use of a qualified estate planning attorney.

Beacon Financial Strategies has an extensive list of qualified attorneys and other professionals that we depend on to help our clients. If you would like to discuss your situation in more detail, please feel free to contact our office to schedule a meeting.

About Beacon Financial Strategies

First Quarter 2010 Market Review

Sun, 04 Apr 2010 00:00:00 GMT

Where are the jobs? That’s the question that many people are asking. After enduring the worst recession since the 1930s, recent employment numbers are finally starting to indicate modest job growth.

Figures released by the Labor Department estimated that the economy created 162,000 jobs in the month of March. While any job growth is a welcome change, it may take years to recover the 8.2 million jobs that have been lost since 2008.

In fact, it has been estimated that the nation will need to experience 5% GDP growth in order to reduce the unemployment rate by a mere 1%. With most economists predicting GDP growth in the 3% range, unemployment is likely to remain elevated for some time.

The financial markets have continued to shrug off a challenging economic environment and focus on the possibility of a brighter future. Major stock market averages have advanced nearly 50% in the last 12 months. In fact, since March 9, 2009 (doomsday), the Dow Jones Average has bounced 65.8% from its twelve year low of 6,547.

With a very predictable Fed interest rate policy, bond investors are enjoying stable returns. However, we continue to be cautious in our outlook for bonds—especially as the Federal Reserve Board begins the process of hiking interest rates to more normalized levels.

So, where are the markets headed? And, after such a rapid advance have stocks moved too far too quickly? We believe it is impossible to accurately and consistently predict the direction of the market over shorter time periods and attempting to time the market is a losers game.

We choose, instead, to adhere to an investment strategy that has withstood the test of time—in both good and bad markets. We believe that making investment decisions formulated in the context of a financial plan, controlling portfolio risk through asset allocation and ignoring the "noise” that can lead to investment mistakes is the most effective long-term investment strategy.

We look forward to helping you make informed financial decisions and continued progress toward your personal financial goals.

Spring Cleaning Your Financial Files

Mon, 29 Mar 2010 00:00:00 GMT

We often receive questions about how long certain financial records should be retained. The IRS, through Publication 552, offers some guidance with regard to record keeping for individuals. Their recommendations are based on the following deadlines:

The IRS has 3 years from your filing date to audit your return if it suspects good faith errors. This deadline also applies if you discover a mistake with your return and decide to file an amended return.
The IRS has 6 years to challenge your return if it suspects that you under reported your gross income by 25% or more.
There is no time limit if you failed to file your return or filed a fraudulent return.
With the IRS limitations in mind, here are some general guidelines that can help you confidently shred those useless financial records.

Tax Records

We recommend that you permanently retain your actual tax return. However, many of your supporting documents including canceled checks, receipts, etc. can be shredded if they are older than 7 years. It’s time to shred your pre-2002 supporting documents!

401(k) Statements

Maintain your quarterly statements until you receive an annual summary. If the quarterly statements reconcile with the annual summary, shred the quarterly statements. Confirm that the annual statement matches the deferrals listed on your W-2 form. Retain the annual summary until the account is depleted or transferred. Permanently retain the final statement to provide a paper trail that the account was depleted.

Bank Records

Upon reconciling your bank statement you can immediately shred the returned checks that are of no importance. Retain the checks (or the statement) that will be used as support in completing your tax return. There is rarely a need to ever retain bank statements, returned checks, carbon copies or your check register for longer than 7 years.

Brokerage Statements and Trade Confirmations

Brokerage statements and trade confirmations are used to determine your investment gain or loss on a particular stock or mutual fund. These records should be retained for seven years after the sell of the investment.

Household Bills

In most cases, household bills can be shredded when proof of payment is received. You may choose to retain old bills for one year to help with household budgeting.

Credit Card Bills and Receipts

On a monthly basis, you should reconcile your credit card receipts with your monthly statement. When the two match up, you can shred most receipts. File your receipts for deductible expenses in your current year tax file.

Paycheck Stubs

Retain your paycheck stubs until you reconcile them with your current year W-2 statement. If everything reconciles, your pay stubs can be shredded.

House Records

Permanently retain all closing and settlement statements to your home. Retain the records that document the costs of permanent improvements (additions, remodeling, etc.) for seven years after you sell your house.

Please feel free to contact our office if you have any specific questions regarding your household files.

When it Comes to Life Insurance - Know Your Options

Mon, 22 Mar 2010 00:00:00 GMT

The idea is simple—get enough life insurance to protect your family from the potentially devastating impact of a death. While the concept is straight-forward, as with many components of financial planning, deciding on the appropriate type and coverage level of life insurance is not quite that easy.

Beacon Financial Strategies ’ Philosophy Regarding Insurance

At Beacon Financial Strategies, we believe that insurance is a necessary component of an effective financial plan. However, in most cases, we do not believe that insurance should be considered an investment or a "forced savings.” As such, we generally suggest that clients obtain adequate insurance coverage at the most cost-effective price.

How much life insurance is necessary?

The amount of life insurance needed varies for each individual or family. However, there are a number of considerations when deciding on the level of coverage necessary including the following:

Current assets that could be used to cover living expenses for the surviving spouse (this would normally not include retirement assets due to adverse tax implications on withdrawal)
Current debt and income levels
Projected income and expenses of the surviving spouse (including Social Security survivor benefits)
Reasonable inflation and investment rates of return estimates

What type of life insurance is most appropriate?

In general, there are two types of life insurance as follows:

Temporary (or term) life insurance is the most straight-forward type of insurance coverage to obtain. Term life insurance coverage is generally purchased for a set period of time (5, 10, 20 or even 30 year periods). During the coverage period, premiums and the death benefit are remain stable. If the insured dies within the coverage period, the beneficiaries of the policy are paid the death benefit. If the insured survives the coverage period, the insurance policy usually expires (or premiums rise dramatically).

Permanent life insurance generally consists of two components, an insurance component and an investment component (often called the cash value). As its name implies, permanent insurance is designed to provide life insurance coverage for the insured's entire life. The most common types of permanent life insurance are universal and whole life policies.

For more information regarding various types of life insurance, please reference our article "Life Insurance Alternatives.”

In most cases, we generally recommend term over permanent life coverage for the following reasons:

We believe the "need” for life insurance coverage diminishes with time as assets grow, debt levels decline and children become independent.
Term life insurance is generally cheaper than a permanent policy—particularly in the early years of a policy when the life insurance coverage required is the highest.

Are you confident that you have adequate life insurance coverage? If you would like to discuss your current coverage level in more detail, feel free to contact our office. Remember, we do not sell life insurance or represent any insurance companies—so you can rest assured that you will get unbiased and objective advice you can count on.

Is It Time to Consider a Roth Conversion?

Mon, 21 Dec 2009 00:00:00 GMT

Is it time for you to consider a Roth Conversion?

Through the years we have often touted the benefits of Roth IRAs to Beacon clients and suggested financial planning strategies for utilizing Roth IRAs. Given the current economic conditions and likelihood of rising income tax rates, we believe that everyone who qualifies should consider a Roth conversion this year.

A Roth IRA refresher

Before considering the merits of a Roth conversion, it is necessary to discuss the benefits of Roth IRAs in general. The following are several advantages of Roth IRAs:

Qualified distributions from Roth IRAs are not subject to income tax (as they are with 401(k) plans and traditional IRAs).
Investment earnings are completely tax exempt.
There are no required minimum distribution (RMD) requirements at age 70 1/2, allowing these accounts to grow tax-free indefinitely.
Original Roth contributions, including conversions, can be withdrawn prior to the age of 59 ½ without penalty.

When is a Roth Conversion Appropriate?

For 2009, only taxpayers who have a modified adjusted gross income level below $100,000 are eligible to make Roth conversions. With that in mind, here are several scenarios that may present a perfect opportunity for a Roth conversion.

You are over the age of 70 1/2 and normally take required minimum distributions (RMDs)

As a result of battered investment portfolios, Congress decided that in 2009, required minimum distributions from IRAs should be suspended. So, for those taxpayers who do not need their IRA to fund living expenses, it may make sense to take an IRA distribution anyway. IRA holders can pay taxes on the distribution and convert the IRA proceeds into a Roth IRA.

Most brokerage firms (including Schwab) allow their clients to simply move shares of a stock or mutual fund directly into a Roth IRA to facilitate the conversion. By transferring an investment directly, at depressed values, you would essentially have transferred (and paid the taxes on) a depressed asset with the thought that you, or your heirs, would never pay taxes on that investment again.

You temporarily expect to be in a lower income tax bracket in 2009

For many, 2009 will prove to be a year in which income levels decline. In some cases, high income earners have been laid off or have taken a significant pay cut. Suddenly, they may find themselves in a much lower tax bracket.

For people in this category, converting an IRA to a Roth could essentially allow normally high-bracket taxpayers to maximize the lower tax brackets in a low earnings year.

There is a possibility that you will have unused itemized deductions

Some people find themselves in a situation where they have sizable itemized deductions, but their income is so low that some of these deductions go unused. Examples could include, high medical expenses, mortgage interest, property taxes or state income taxes.

For these taxpayers, it may make sense to convert a portion of their IRA into a Roth. This tax planning strategy essentially creates additional income, which enables the taxpayer to make full use of their itemized deductions. Additionally, taxable IRA proceeds are then converted to a Roth IRA and never taxed again.

2010 Roth Conversion Opportunity

In the past, only those taxpayers with an adjusted gross income of $100,000 or less were able to convert existing IRAs into Roth IRAs. Congress has suspended the adjusted gross income limitation for Roth conversions for the year 2010. As such, taxpayers at any income level have the ability to convert their IRAs into Roth IRAs. While this may represent a golden opportunity for some, there are a number of issues to consider prior to making the switch including the following:

What will be the tax cost for the conversion?
Will the additional taxes from the Roth conversion be paid from the conversion itself, through paycheck withholdings or through other means?
Will a Roth conversion create adverse tax implications like the deductibility of medical expenses or increased costs of Medicare Part B premiums?
Does it make sense to execute a Roth conversion into multiple Roth accounts, to take maximum advantage or the possibility of recharacterizing the conversion at a later date?

We believe that tax rates are likely to rise somewhat over the next decade. Executing a Roth conversion now, while tax rates are low, can represent a significant future tax savings to you and your family. Of course, every situation varies so it is essential to fully consider the tax and non-tax implications when converting IRA proceeds into a Roth.

If you would like to discuss the pros and cons of a Roth conversion given the details of your specific situation, please feel free to contact us to schedule an appointment.

About Beacon Financial Strategies

Considerations When Investing in Bonds

Fri, 20 Nov 2009 17:47:00 GMT

Bonds are fixed income securities which pay investors a set interest rate for a pre-determined period of time and then return the original principal at their maturity. There are many different types of bonds. Corporations often raise money by issuing bonds in addition to selling stock. Governments often use bonds to pay for their ongoing operations or specific projects, such as highways or new construction.

Though bonds are not risk-free (e.g., a bond issuer could default on a payment or even fail to repay the principal), bonds as a whole are considered somewhat less risky than stocks. Here is a brief description of a few types of bonds and distinguishing attributes of each.

Corporate Bonds are issued by corporations and typically pay a fixed interest rate usually every six months. The interest on corporate bonds is taxable at ordinary income rates by federal and state governments.

Mortgage Backed Securities (MBS) are debt obligations that represent claims to the cash flows from pools of mortgage loans. Mortgage backed securities pay investors interest, but as mortgages within the pool of loans are refinanced, investors can also receive return of principal payments.

Municipal Bonds are issued by state and local governments. Interest from municipal bonds are generally federally tax-exempt and can also be state tax-exempt for residents of the issuing municipality.

Treasury Securities are issued by the U.S. Department of the Treasury and are backed by the full faith and credit of the U.S. government. For that reason, they are considered relatively safe. There are many different types of Treasury Securities, including, treasury bills, treasury bonds, and treasury notes. Investors do not owe state income taxes on Treasury securities; however, the interest is taxable as ordinary income at the federal level.

US Savings Bonds are issued by the U.S. Treasury. However, they are not traded on the open market, and are not considered Treasury securities. Savings bonds are registered bonds because the owner’s name is printed on them, and they must be redeemed by the registered owner or a beneficiary of the registered owner. Tax on savings bonds is generally deferred until maturity.

One way of comparing bonds is to look at their yields. When comparing various types of bonds, it is important to consider the taxable equivalent yield. The taxable equivalent yield will allow you to compare bonds that are taxed differently along a level playing field. Each person’s taxable equivalent yield will vary depending on their personal federal and state income tax rates. For example, the following chart illustrates the effective interest rate (the taxable equivalent yield) that you would earn when investing in different types of bonds, given a federal tax rate of 33% and a state income tax rate of 8%.

Taxable Equivalent Yields of Bonds
	Bond Coupons
	3.50%	4.00%	4.25%	4.50%	4.75%	5.00%	5.50%
Corporate Bonds/MBS (Taxable)	3.50%	4.00%	4.25%	4.50%	4.75%	5.00%	5.50%
US Treasuries (State Exempt)	3.80%	4.35%	4.62%	4.89%	5.16%	5.43%	5.98%
Out of State Municipals (Federally Exempt)	5.22%	5.97%	6.34%	6.72%	7.09%	7.46%	8.21%
In State Municipals (State & Federal Exempt)	5.93%	6.78%	7.20%	7.63%	8.05%	8.47%	9.32%

*Please note that this chart only considers the coupon or yield of an investment and not the yield to maturity of an investment. The yield to maturity incorporates both the coupon and the price appreciation (or depreciation) of a bond.

In the chart above, because of the tax-free nature of in state municipal bonds, a 3.5% yield is the equivalent of earning 5.93% on a taxable bond (given a 33% federal tax bracket and an 8% state tax bracket). As a person’s tax bracket declines, the taxable equivalent yield also declines, making tax-free bonds less enticing.

Making maximum benefit of the bond allocation in your portfolio can be a tricky component of managing an investment portfolio. For more information, or to discuss your personal investment strategy, please contact our office.

Do You Need a Living Trust?

Fri, 20 Nov 2009 17:47:00 GMT

Revocable Living Trusts have increasingly become a popular tool used in estate planning. A revocable living trust is a legal arrangement created for the purpose of holding ownership to an individual's assets during the person's lifetime, and for distributing those assets after death.

The individual who creates the trust (the grantor) names a person who will serve as trustee and will follow the trust's terms after the grantor dies. While alive, the grantor usually may serve as a trustee and control the assets even though they belong to the trust.

Although a revocable living trust is not a substitute for a properly drafted will, it may be appropriate for you in any of the following situations:

You own out of state property. If out of state property is held in a living trust, you will not be required to probate your estate in multiple states. Probate in one state can be a big headache. Imagine probating an estate in multiple states!
You want to avoid the probate process. Probate is a legal proceeding whereby the courts determine the allocation of your property based on your will or state laws. The probate process is a matter of public record and can be a hassle to your executor and somewhat costly. By allocating property to a revocable living trust, the probate process can be avoided.
You would like to appoint someone to manage your assets or property in the event of your incapacitation. Trusts allow a great deal of flexibility in carrying out your own wishes. Making a child or other individual a successor trustee of your trust means that they can make decisions on your behalf in the event you are physically (or mentally) incapable.

The assets in a living trust are considered the grantor’s and thus all income or capital gains (and losses) continue to be reported on the grantor's personal income tax return. Also, the assets held in the trust are considered part of the taxable estate for estate tax purposes

For more information, please contact Chip Hymiller, CFP® or Erin Campbell, CPA/PFS, CFP®, with Beacon Financial Strategies at (919) 321-8625.

Beacon Financial Strategies is an independent financial planning, tax and investment advisory firm. Beacon works with clients on a consultative and objective basis to help them achieve their personal financial goals. Beacon professionals specialize in the following areas of financial planning: retirement feasibility planning, estate planning and coordination, tax minimization strategies, and wealth management services. For more information, visit Beacon's Web site at www.BeaconFinancialStrategies.com.

Donor-Advised Funds: An Effective Tool for Charitable Gifting

Fri, 20 Nov 2009 17:47:00 GMT

Improving financial markets have created a renewed interest in charitable gifting. One particular tool that we have found to be very effective in helping clients achieve their charitable objectives is donor-advised funds.

What are donor-advised funds?

Donor-advised funds are accounts that can be funded with appreciated stocks, real estate, cash or other assets. They can be established directly through charities or community foundations, as well as many mutual fund companies or brokerage firms. Contributions made to donor-advised funds are invested and remain in the fund until you determine which individual charity to send a contribution.

What are the benefits of using donor-advised funds?

Besides the non-financial benefit of helping a worthy charity, there are many benefits of utilizing donor-advised funds to help facilitate your charitable intentions including:

The grantor receives a tax deduction for the entire value of the contribution (with some limits) in the year the contribution is made, but the gifts to the individual charities can be spread out over several years.
You have control of the name of your donor-advised fund. In other words, you can name your fund The John Smith Memorial Fund (to honor a deceased family member). This aspect of donor-advised funds also helps facilitate anonymous gifting.
Most donor-advised funds allow the original donor to name a "successor” donor. This can enable other family members to become involved in the gifting process.
Gifts can be made to local charities (churches, animal shelters, etc.) or national charities (Red Cross, Salvation Army, etc.).
Donor advised funds are simple to establish and have relatively low minimum contribution levels ($5,000) compared to other charitable gifting techniques.

We are available to help you establish a charitable gifting strategy that fits into your specific financial plan. If you have an interest in donor advised funds or other charitable gifting strategies, please contact Chip Hymiller, CFP® or Erin Campbell, CFP®, CPA/PFS with Beacon Financial Strategies at (919) 321-8625.

Ease the Estate Settlement Burden

Fri, 20 Nov 2009 17:46:00 GMT

Whenever a loved one passes away, the grief can be more than a person can bear. However, the grief coupled with the burden of settling their loved one’s estate can be overwhelming. Here are a few things you can do to make the estate settlement process easier for your heirs:

Make sure your will is updated. The will should name your executor and if you have children under 18, it should name a guardian. Also, if you have minor children, you may want to have a trust in place for your children and named trustees.
Check beneficiary designations. Most people choose beneficiaries when they open an account, start a new job, or first buy insurance. Decades later, life may have changed (divorce, births, deaths, etc.) and the old choices could be problematic.
Create a notebook with all the information your heirs will need. You should include a net worth statement, contact information of relevant parties such as your financial advisor, valuables list, last wishes, and a key documents reference list.
Deposit your original stock and bond certificates in a brokerage account. If stock and bond certificates are in safe deposit boxes or somewhere in the home, there is a chance that they will be overlooked during the estate settlement process. Also, the process to change each certificate into the heirs’ names is much more rigorous than changing the registration of a brokerage account.
Make sure there are enough liquid assets to settle the estate. Monthly bills will still need to be paid so there needs to be enough money available in money market or a checking account to fund two to three months of ordinary expenses.
Write an ethical will or family letter. Ethical wills can share values, family history, explain estate planning decisions, or express feelings toward family members.
Communicate with your family now. In order to make sure there are no surprises later, you should meet with everyone significantly involved with your estate. This would include executors, trustees, and primary heirs. One rule of thumb would be to meet once every five years to discuss your estate.

Doing these things can make the estate settlement process much easier on your heirs. We are always available to help in the estate settlement process and to help you make decisions about your own estate. Call us today to set up an appointment to analyze your estate plans.

Economic Indicators and What They Tell Us

Fri, 20 Nov 2009 17:46:00 GMT

The Federal Reserve Board’s decision to stop raising the federal funds rate several months ago made many ask the question – Where is the economy headed now? Are we in for a sustained period of economic growth or are we headed down the road to an economic slowdown, or even a recession?

While there is always debate among economists about where the economy is headed, there are a number of economic indicators that are utilized to justify their predictions. Here is a list of the most commonly referenced economic indicators and a description of what these indicators may suggest about the direction of the economy:

Indicator	What it tells us	Where to find it
Gross Domestic Product	Overall growth in the U.S. economy	www.bea.gov/bea/dn/home/gdp.htm
Durable Goods Orders	Future manufacturing activity	www.census.gov/indicator/www/m3/adv
Factory Orders	Manufacturing orders and sales	www.census.gov/indicator/www/m3/prel/index.htm
Business Inventories	Domestic business sales and inventories	www.census.gov/mtis/www/mtis.html
Industrial Production	Domestic industry output and available capacity	www.federalreserve.gov/releases/g17/current
ISM Manufacturing Survey	Leading indicator of manufacturing strength	www.ism.ws/ismreport/index.cfm
Index of Leading Economic Indicators	Indicator of future economic strength	www.globalindicators.org/us/latestreleases
New Housing Starts	New housing construction permits	www.census.gov/const/www/newresconstindex.html
Existing Home Sales	Sales of previously owned homes	www.realtor.org/research.nsf/pages/ehsdata
New Home Sales	Sales of new homes	www.census.gov/newhomesales
Federal Reserve Beige Book	Domestic economic strength	www.federalreserve.gov/frbindex.htm
Consumer Price Index	Price inflation in retail goods and services	www.bls.gov/cpi/
Producer Price Index	Inflation in prices paid by businesses	www.bls.gov/ppi
Employment Cost Index	Domestic labor costs	www.stats.bls.gov
Productivity and Costs	Changes in worker efficiency	www.bls.gov/lpc

Exchange Traded Funds - A Possible Solution for the Prudent (and Tax Sensitive) Investor

Thu, 19 Nov 2009 13:02:00 GMT

Exchange Traded Funds (ETFs) are investments that offer many of the benefits of a mutual fund, but trade like an individual stock. ETFs generally represent a basket of securities, which vary based on the stated objective of the ETF. Some of the most popular exchange traded funds are based on certain indices including the S&P 500, Dow Jones, Nasdaq and the Russell 2000. Additionally, there are those that invest in a specific economic sector or even a specific country or region.

Advantages of ETFs

As with all investments there are pros and cons. Some of the advantages of utilizing ETFs in a portfolio are as follows:

ETFs generally have very low operating expenses which rival even the cheapest mutual funds.
Since most ETFs are a passive (non-managed) investment, they tend to be very tax efficient.
Investors have the ability to make intraday trades.
ETFs are transparent, allowing investors to see portfolio holdings on a daily basis.

Disadvantages of ETFs

Unfortunately, exchange traded funds do have several negatives including the following:

Like stocks, there are commission charges with every transaction. This can make utilizing ETFs cumbersome and costly for people making systematic investments.
Some of the more popular ETFs are very highly correlated with one another giving some investors a false sense of diversification.
Since ETFs are unmanaged portfolios, stocks (or bonds) that are obviously poor investments are not eliminated from the ETF.
Many exchange traded funds investing in stocks are market capitalization weighted. This means that the larger the company, the greater the weighting that company will occupy in the ETF.
Certain types of exchange traded funds are not very tax efficient, so make sure you read the prospectus of any ETF in which you are considering.

While exchange traded funds can be fantastic tools for some investors, there may be alternatives that are more appropriate given your specific situation. For more information, please contact Chip Hymiller, CFP® or Erin Campbell, CFP®, CPA/PFS with Beacon Financial Strategies at (919) 321-8625.

About Beacon Financial Strategies

Life Insurance Alternatives

Thu, 19 Nov 2009 13:01:00 GMT

Term Life Insurance:

Term life insurance provides coverage over a certain term, usually between five and 30 years. Today, most term policies will guarantee a level premium for only a specific number of years. For example, a 30-year Term life plan may guarantee a level premium for the first 15 years; then, the Insurance Company reserves the right to raise the premium within specified limits for the remaining 15 years. This is in direct contrast to Whole life insurance where premiums are locked in at one rate throughout the life of the policy. With Universal life insurance, the policyholder generally has an adjustable premium, within a specified range, that can directly affect the term of the policy and the cash value.

Some Term life insurance policies can be renewed to age 95. Usually, the premium goes up a varying amount every time the policy is renewed, with the reasoning that the policyholder gets older, and is therefore at more risk.

Some Term life policies offer the option to convert the policy to a permanent or whole life policy at the time of renewal.

Initial premiums are usually lower for Term life than for similar amounts of insurance purchased through Universal or Whole life insurance plans. However, Term life insurance builds no cash value. As with Universal and Whole life plans, premiums for Term life insurance are considerably higher for those purchasing coverage in later years.

Universal Life Insurance

Universal life insurance has become popular among people who want a policy offering some of features of Term life insurance, as well as certain other features found in Whole life insurance policies.

Universal life policies usually have flexible or adjustable premiums as defined within the actual policies. This means the policyholder can change the amount of premium payment, within an acceptable range set by the insurance companies. By paying the lowest premium allowed for the policy, the death benefit may last only a few years, similar to Term life insurance. On the other hand, by paying higher premiums, the death benefit generally extends the coverage over more years. In addition, higher premium rates can help build cash value in the policies.

The policyholder must be careful to not pay premium amounts above the maximum amount specified for the policy over a period of time, or it may become disqualified as life insurance for federal income tax purposes. The result would be some unexpected income taxes due upon the death of the insured.

Universal life insurance plans are also useful in estate planning. This is especially true for married couples who have a lot of non-liquid assets like real estate, and want to provide enough liquidity to pay estate taxes that will become due after the death of the surviving spouse. In this case the couple might consider purchasing a joint and last survivor universal life insurance policy with flexible premiums. The death benefit is paid at the death of the second joint insured.

Whole Life Insurance

Whole life insurance provides coverage of the policyholder's entire life. Therefore, the policy does not need renewing, and the premiums generally remain the same.

Whole life policies are called other names as well, including Permanent insurance and Ordinary life insurance.

Whole life insurance offers both a death benefit and a cash value. The cash value builds throughout the duration of the policy. Some people borrow from the cash value. It is not necessary to pay the loan back, but there is an interest charge. In addition, if death of the policyholder occurs before the loan is paid back, the amount outstanding will be deducted from the face value before payment is made to the beneficiary.

If a policy owner or policy holder is still living at age 100 and the premium requirements are current, plus, no outstanding loan exist against the policy, most companies will pay the full death benefit.

Whole life insurance is popular for those who like the forced savings feature (cash value building, partly from premium payments) as well as the tax-deferment option. In addition, Whole life insurance is especially attractive to those who do not want to worry about the renewability of the policy due to possible declining health in advanced years, as well as higher premiums.

Protecting the Most Important Asset…Your Earning Power

Thu, 19 Nov 2009 13:01:00 GMT

What would your family do if you had a temporary or permanent loss of income? While most could handle a short-term loss of income such as a job loss or temporary illness, few families can financially endure a more sustained loss of income.

Consider the following statistics from the Journal of the American Society of Chartered Life Underwriters:

People age 35 or younger have a 50% chance of becoming disabled for at least 90 days prior to reaching age 65
People between the ages of 40 to 50 have a 40% chance of being disabled prior to turning 65
60% of those who become disabled between the ages of 35 to 55 remained disabled after 5 years
70% of all disability applicants are rejected for Social Security disability benefits (Source: Social Security Handbook)

We generally recommend clients take a two-tiered approach to protecting against an unexpected loss of income.

Establish an emergency fund that is adequate to cover approximately 6 months of your household expenses in the event of a temporary loss of your income (through a job loss or short-term disability).
Obtain a disability income insurance policy to cover a sustained loss of income exceeding 6 months.

Disability Income Insurance

As with most insurance products, there are many types of disability insurance policies. However, from the most basic standpoint, disability insurance can best be categorized into two types of policies based on their definition of disability.

Own Occupation policies will generally cover a disability if you cannot perform the job duties of your specific occupation. "Own Occ” policies, as they are commonly referred, are the most comprehensive and expensive form disability income insurance. If an insured cannot perform the exact job held before becoming disabled, they would receive a benefit under the terms of an own occupation policy.

Any Occupation policies will only pay a benefit if your disability prevents you from performing any job. This type of disability policy is so limiting in its definition of disability that benefits are rarely paid (the Social Security Administration uses this definition of disability when granting disability benefits).

Selecting a Disability Income Policy

Check with your employer or professional organization that you are a member to see if you are eligible for group disability coverage. Group policies are usually cheaper than individual policies. Unfortunately, with most group policies your coverage may cease if you change jobs or drop out of the professional organization offering the coverage.

It may be most appropriate to seek coverage through a highly rated insurance company. Since disability income insurance can be somewhat costly, here are a few of the key features of disability insurance that can be adjusted to meet your specific needs:

Benefit Amount – this is the monthly benefit your policy would pay if you were to become disabled. Most policies will replace no more than 70% of your earned income prior to the disability.

Benefit Period – this is the amount of time your policy would pay a benefit in the event of a disability. Common benefit periods are 2 years, 5 years or to age 65.

Elimination Period – this is the amount of time that you would need to be disabled prior to receiving any benefit from your policy. Longer elimination periods result in less expensive policies. We generally recommend an elimination period of at least 90 days.

Cost of Living Adjustment (COLA) – this is a rider that allows your benefit amount to be adjusted periodically for inflation.

If you have any questions, or would like to discuss disability income planning in the context of your specific financial plan, please contact Chip Hymiller, CFP® or Erin Campbell, CFP, CPA/PFS with Beacon Financial Strategies at (919) 321-8625.