Giving’s on the Rise—and a Deadline Approaches for Foundations

Now’s the season for helping others who are less fortunate than you by giving your time, talents and resources to a worthy charitable cause. According to “The Nonprofit Fundraising Survey: November 2010,” compiled by the Association of Fundraising Professionals, Blackbaud, the Center on Philanthropy at Indiana University, the Foundation Center, GuideStar USA Inc., and the Urban Institute's National Center for Charitable Statistics, charitable donations in the U.S. are on the upswing, but still have not climbed back to pre-recessionary levels.

Specifically, 36% of the charities surveyed recorded an increase in donations during the first nine months of 2010, compared to just 23% that saw an increase in 2009. Additionally, just 37% of the charities reported lower donation levels this year, versus the 51% that experienced declines last year. Other findings: Organizations focused on international causes such as the Haitian earthquake and Pakistani flood relief efforts reported the greatest increase in donations. Domestic health organizations and religious charities reported the greatest declines in contributions.

Overall, charitable organizations remain “guardedly optimistic” about 2011. In fact, 47% plan to spend more, while only 20% expect to make budget cuts.

If you have a family foundation, you know that to avoid taxes for under-distribution, you must generally distribute at least 5% of the value of investment assets (minus fees and investment taxes) each year. Ideally, of course, this annual amount has been calculated and distributed throughout the year. However, as the year draws to a close, it’s often wise to take a look at the year’s distributions to avoid shortfalls.

Missing the 5 percent distribution can result in penalties from the IRS, but often the agency allows the offending foundations to make up for their miscalculations by contributing more than 5 percent in the following year. However, missing your mark could also result in higher taxes on investment income.

A Question of Ethics

In her recent article “Why do investors trust advisors, but not Wall Street?” Susan Antilla explores the disconnect between investors who proclaim their distrust of the financial securities industry, but exempt their financial advisors from that profound mistrust. In fact, it seems many investors are so trusting of their advisor that they fail to vet them properly. For example, the article includes details of an arbitration won by actor Larry Hagman where Citigroup Inc. was ordered to pay $1.1 million in damages, plus $439,000 in legal fees for the mishandling of his account by a broker who had seven customer disputes registered with the Financial Industry Regulatory Authority.

Investors looking to work with an advisor can avoid such a situation by working with a fiduciary, someone who is sworn to act in their best interests. In addition to being a fiduciary, I am governed by the professional codes of conduct that accompany my CPA, CFP^® and AIF^® designations.

While Citibank was justly punished, our society has become too willing to excuse serious ethics violations. For example, although Congressman Rangel was convicted of 11 ethics charges, amazingly, he is not going to lose his seat. What does this teach our children? Our kids are certainly getting mixed messages – like the one highlighted in a recent Washington Post story about a Fairfax County high school that allows cheaters to retake tests.

Sadly, we have witnessed too many examples of unethical behavior from political leaders over the last two decades. And the same is true in business world with Enron, Worldcom, Madoff, the list goes on. As is the case in my business, there must be consequences to ethical violations. All politics aside, we must strive to set a positive example for our young people and underscore that there are consequences for ethical violations.

Passage Likely for Estate-Tax

Although agreement seemed highly unlikely just weeks ago, Democratic support for a plan put forward by Republicans and accepted by President Obama seems to be gaining steam. The compromise in waiting would reinstate the estate tax at 35% for two years starting next year, with the first $5 million of an individual’s estate exempted. According to data from the nonpartisan Tax Policy Center, this plan would result in about 43,540 taxable estates in 2011, and raise about $34.4 billion.

Arizona Republican Jon Kyl authored the current estate tax provision accepted by the President. Although House Democrats offer tough opposition, it’s likely there are enough moderate Democrats to side with Republicans and President Obama to pass the bill. If Congress doesn’t act before the end of the year, the estate tax, which lapsed in 2010, is set to return at a 55% rate, with a $1 million exemption on January 1, 2011.

The battle over the state tax has long provoked heated philosophical debate. As Lee Farris, senior organizer on estate-tax policy for United for a Fair Economy, has noted, there’s more than simple politics at work as Congress works towards forging an agreement. According to Farris, “an agreement has proven more complicated than splitting the difference on the numbers because this has been cast as a moral issue” being debated between those who believe the estate tax destroys family businesses and those who argue it is necessary to preserve meritocracy in the U.S.

Interestingly, if a plan is passed this year, Congress may allow this year’s heirs to choose whether they factor taxes based on this year’s rules, whereby some inherited assets are subject to higher capital-gains taxes, or next year's rules – whatever they may be. Stay tuned.

Still Dreaming of Early Retirement?

In spite of all your best laid plans, there may be a glitch in your retirement dreams. If you retire early, before you would qualify for Medicare, you may be looking at a costly gap in your health insurance. If you figure you will simply keep the coverage you have from your employer, think again. The nonpartisan Employee Benefit Research Institute (EBRI) recently examined data for private-sector establishments to answer the question: How many employers offer retiree health benefits to early retirees? Here’s what EBRI found:

• Overall, 444,150 private-sector establishments offer health benefits to early retirees, or about 11.2 percent of the total.
• Large employers are much more likely to offer retiree health benefits than small employers; 34.5 percent of employers with 1,000 or more workers offered them, compared with 1.2 percent of employers with fewer than 10 workers.
• Of the 984,697 employers with 1,000 or more workers, the 34.5 percent account for 339,720 employers that offered early retiree health benefits.

While these statistics don’t boost your confidence in your plans to rely on your employer, keep in mind that there is plenty more uncertainty in the mix. As companies cut costs to survive in an increasingly challenging economy, keep in mind that health benefits to retirees could be on the chopping block. Also, it is anyone’s guess what will happen to healthcare reform when the new Congress takes over.

A Trusting Relationship is a Two Way Street

Trust is a curious thing. Having faith in someone – trusting a person or an institution can be a bond that is stronger than steel. Witness a mother bonded to her young child, or a soldier’s unflinching obedience to a commanding officer, or how you feel when you board an airplane for a flight. The weight of the world can hang on the bond of trust. We will literally step into the void holding only a thread of trust.

Naturally, you want to work with a financial advisor who tells the truth and looks out for your best interests. As I’ve said before, you owe it to yourself to work with an advisor who is sworn to act as a fiduciary and therefore bears the legal obligation that requires them to act in your best interest at all times.

However, trust is a two way street. To gain the most from your financial advisory relationship, don’t keep secrets from your financial advisor. That is, you also must trust your advisor enough to fully disclose all your financial assets and liabilities, your dreams and desires, your hopes and your needs, your fears and worries, even if the truth isn’t comfortable to discuss.

Interestingly, many investors apply the concept of diversification as a risk reducer to purveyors of financial advice and work with multiple financial advisors. There’s no question that in today’s complex, challenging market you require the expertise of financial advisors, CPAs, estate planning attorneys, even insurance professionals and bankers to manage your wealth accumulation, preservation, and transfer. However, new research from State Street Global Advisors and the Wharton School at the University of Pennsylvania illustrates how using multiple advisors -- who often do not communicate with each other -- can increase rather than dilute risk and put you in danger of not achieving your short- and long-term goals.

Specifically, because multiple advisors work out portfolio strategies independently you might be left with overlapping exposures or an unintended over concentration in an asset class. Especially in this challenging market, you need a firm like ours that functions as a personal chief financial officer to take a complete, aggregated view of your finances and prioritize sometimes conflicting needs and goals.

What Is It Going to Take for Housing to Rebound?

Changing demographics are the main cause of today's housing surplus, according to new research by University of Virginia urban and environmental planning professor William Lucy. He says the path to a housing market rebound doesn't lie in new construction, but in rethinking housing needs based on changing demographics.

Lucy’s study of U.S. Census Bureau data, U.S. Housing Market Conditions: Historical Data, U.S. Department of Housing and Urban Development reports, Joint Center for Housing Studies and research by the Urban Land Institute and other scholars, resulted in this conclusion publicized in a University of Virginia press release: "Today’s surplus housing is not caused by either excessive new construction or by foreclosure.” In fact, Lucy found only 20 percent of housing units for sale or sold from 2009 to 2010 were new houses and foreclosures.

Lucy says our excess housing supply is not linked with the economic downturn, but caused by the increase in homeowners over age 55 who want to sell and downsize, coupled with the decrease in number of 30- to 45-year-olds who want to buy. He found from 2000 to 2009, the number of homeowners 55 and over who may want to sell increased by 8 million, while the number of potential 30- to 45-year-old homebuyers decreased by 3.6 million. Moreover, the ratio of aging baby boomers to young adults was 5 to 1 in 2010, a dramatic increase from 3.5 to 1 in 2000 and 3 to 1 in 1990.

Because the demographic shift of too many sellers and too few buyers is not likely to change anytime soon, Lucy says economic drivers of the future housing market will be “more decentralized, multidimensional and shared solutions by developers, builders and government and opportunities for fix-up, remodeling, expansion and condominium projects in cities and inner suburbs, fueled by preferences for convenient locations.”

Read the full Report, where Lucy stresses that “location, location, location” is still a real estate mantra, but that homebuyers will continue to favor more urban settings over distant suburbs.

Take Maximum Advantage of Your 401(k)

I always tell my clients not to leave money on the table, but according to a recent 401(k) study, many American employees are doing just that. In fact, of the 2.8 million 401(k) participants Financial Engines surveyed, 39 percent were not saving enough to receive their employer’s full matching contribution (or they weren’t saving at least 5 percent of salary in companies with no match). That figure is up from 33 percent in 2008. Younger workers (presumably with lower salaries) are most likely not to secure the free cash: 53 percent of participants under age 30 did not save enough to receive the full match. That percentage dropped to 47 percent for participants under age 40.

And while my standard advice for retirement saving is to max out your 401(k), only 6% are saving within $500 of their annual pre-tax IRS limits, down one percent from 2008.

According to Financial Engines, the key to participant savings comes from automatic escalation, where a participant’s savings rate is increased automatically on an annual basis to a pre-determined maximum. Sixty-seven percent of participants in plans with automatic escalation save enough to receive the full employer match, compared to just 52% of participants in plans without automatic escalation.

Remember, increasing your 401(k) contribution as your salary increases is especially important given the fact that many companies eliminated 401(k) matches during the recession. So you may have some catching up to do.

Family Businesses: Make Lemonade out of Lemons

According to the Small Business Administration, 90% of the 21 million US businesses are family owned. Amazingly, less than one third of these companies will transfer successfully to the second generation, and only 15 percent will survive by the third. Why the low survival rate? Most of these businesses lack a succession plan, or an exit plan.

Exit planning is the process of ensuring the future success and continuity of your business after you retire. Your exit plan should address business, personal, financial, legal, and tax questions and includes contingencies for illness, burnout, divorce, and even your death. Ideally, your exit plan should maximize the value of your business at the time of exit, minimize the taxes paid, and position you and your family to achieve your future goals.

In one of the most compelling opportunities found in the down market, low valuations makes this an ideal time for family business owners interested in moving assets out of their estate to transfer ownership of their business to their heirs. For example, if your business was worth $8 million five years ago, but revenues are down 50 percent, consider selling 25 percent to a child. You could even provide financing for the transaction via an interfamily loan. Ten years from now when you are that much closer to retirement and the 25 percent you sold could well be back to being worth $2 million, you will be pleased with your foresight. Of course, you could also gift stock that has plummeted in value to your heirs. Advantageously, the tax consequences of your gift will be figured based on the fair market value of your company stock at the time you gift it.

Especially in today’s uncertain market and increasingly crowded marketplace, there is no substitute for getting a head start on your exit plan.

CAUTION: Long-Term Care Insurance through Your Employer!

Long-term care insurance (LTC) pays for the things Medicare does not--assisted living, in-home care, adult daycare and nursing homes. One of the biggest trends in LTC insurance is group coverage sold through your employer, an association you’re a member of, or even through your bank or credit union. We’ve heard from clients who have asked us if they should buy group long-term care insurance.

First things first

The first step in LTC Planning is just that--planning! Bernhardt Wealth Management has retained the services of a nationally recognized expert in LTC, Allen Hamm and his company Superior LTC, to help our clients with planning for long-term care. There’s no additional charge to our clients for this service. Allen is the author of the book “Long-term Care Planning: Assuring Choice, Independence & Financial Security” which is available at Amazon online.

Allen uses a seven step LTC planning process and insurance may or may not be the best option for you. He starts by assisting you with understanding the implications of relying on each available option to pay for long-term care, not just insurance.

But let’s say that you’ve gone through this process and it’s been determined that LTC insurance is the best option for your particular situation. Is Group LTC insurance a good value for you? The answer is: Usually not, but there may be an exception.

Adverse Selection

Unlike most types of group insurance, LTC is usually more expensive than individually issued coverage. This is because group LTC insurance is normally issued on a guaranteed or modified guaranteed issue basis. This means that unhealthy individuals, who would not otherwise pass the underwriting requirements of the insurance company, can obtain coverage through the group. This causes “adverse selection”: a disproportionate number of people buying coverage through the group who are in poor health and likely to have early claims, resulting in higher premiums for everyone.

In future years, adverse selection can also cause premium rates to be raised more frequently and more dramatically than premiums for individually issued coverage. Rates on some older group policies have been raised to the point where people have been forced to cancel the coverage.

The consequences of adverse selection are particularly negative if you’re healthy. By purchasing group coverage, you’ll heavily subsidize higher premiums for those in poor health, and will continue to subsidize increasingly higher premium rates in the future.

“But the Premium Seems so Low!”

Group LTC coverage has the appearance of a lower premium than individually issued coverage, which is why it’s common for people to automatically jump to the conclusion that they should buy it. But when comparing the details and benefits apples to apples, group LTC coverage premiums are higher than individually issued coverage.

The initial appearance of lower premiums for group coverage has to do with the fact that group coverage does NOT include the automatic inflation protection benefit as a component of the base policy. Yes, you may be able to purchase additional coverage later through the policy’s Guaranteed Purchase Option, but the new benefits will charge a premium at your new attained age rate. Based on Mr. Hamm’s experience in auditing older group policies for clients, people normally don’t exercise the option to increase their coverage, due to the increasing higher premium. In fact, people rarely revisit the group LTC insurance decision until several years later, after premiums have gone up dramatically.

Is Group LTC Coverage Ever a Good Value?

If you’re not in good health and you’re unable to qualify for individually issued LTC insurance, group coverage may be a viable alternative for you. But when people are educated about the higher premiums, the likelihood of increasingly higher premiums in future years, and the limited coverage options available through group coverage, they usually choose an option other than insurance as their plan for long-term care. The rare exception is if you have a strong desire to obtain coverage due to health conditions that make the odds of you needing long-term care very high.

Summary

Planning for long-term care can be confusing. If you haven’t yet developed a plan for long-term care or if you’re being offered group LTC insurance, please contact your independent advisor to begin the planning process . LTC insurance may not be the best option for you and your family - so paying for it, even at low cost, is a bad investment.

What the new Congress means for you?

What does the new Congress--with a Republican controlled House and Democratic controlled Senate--mean for your investments?

In my mind it’s too early to answer that question. While we will almost certainly be dealing with some measure of the gridlock we are so accustomed to in D.C., I worry that gridlock will be paramount in the two month lame duck session before our newly elected representatives and Senators take their oaths. If so, we will wait for answers to our most pressing questions: Will the Bush tax cuts be extended? If so, for whom and for how long? Will the estate tax be allowed to be reinstated at pre-2009 levels? Trouble is, if our representatives fail to address these questions by the end of the year, taxes will increase for nearly everyone unless a retroactive provision is passed.

As for the election’s impact on the investment environment, market commentator Todd Schoenberger has noted that we are closer to the optimal formula for investment success of a Republican-controlled House; Republican-controlled Senate; and a Democrat in the White House. Going back to back to 1940, he says the RRD combination has provided investors with an average stock market return of 15.3% per year, whereas the DDD combination we’ve had for most of this year has lifted stocks only 5.0% on average.

Wall Street Journal writer Brett Arands reminds us, however, that the historical basis for this analysis--data since 1949 via the Stock Trader's Almanac--is meager. I agree with Arands’ observation: “You can't extrapolate universal rules from such a small amount of data. The results are too heavily skewed by the Reagan (1981-86) and Clinton (1995-2001) booms under divided governments."

Could it be we are falling into the behavioral trap of identifying pattern where none exists in order to help ourselves feel more in control? I certainly don’t blame anyone for desiring a measure of predictability in the wake of such recent volatile markets, but markets are just that–unpredictable.