After an extensive hiatus, the SWS blog returns. Today, we thank Danny Bradford for his service to our firm, and wish him much success upon his graduation from law school. Further, Danny kindly drafted today’s post.

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A 529 Plan is an education savings plan operated by a state or educational institution designed to help families save for college expenses. It is named after Section 529 of the Internal Revenue Code, which created these types of savings plans in 1996.

There are tax advantages for investments in 529 plans. While there is no federal tax deduction for contributions, money grows tax-free in the account. If you use the money for qualified educational expenses, such as tuition and textbooks, it comes out of the account tax-free, as well. Although you can take money out of the plan at any time, the IRS imposes additional taxes and penalties if the money is used for anything other than qualified expenses.

What schools are eligible institutions under 529 plans?

Many colleges and universities, both national and international, are eligible. One way to find out if a specific school is to search here.

What happens to the money in a 529 if the student receives a full or partial scholarship?

If a plan beneficiary receives a scholarship, the account owner may take a penalty-free withdrawal from the 529 account up to the amount of the scholarship. Although the withdrawal will not be subject to a penalty, state and federal income tax will still apply to the earnings portion of the withdrawal.

An alternative to taking a withdrawal is to name another family member, who may still need the funds for school, as the beneficiary. Also, even if a student receives a significant scholarship, there are numerous educational expenses covered by 529 funds.

Is it ever too late to start a 529 plan?

No. Even if a student has started his or her college career, a 529 plan may be opened for their benefit. However, your financial planner may be able to help you with a more effective short-term plan.

What 529 Plan is right for you?

The large number of 529 plans creates confusion. The U.S. Securities and Exchange Commission (“SEC”) recommends asking the following questions when evaluating 529 plans:

• Is the plan available directly from the state or plan sponsor?

• What fees are charged by the plan? How much of my investment goes to compensating my broker? Under what circumstances does the plan waive or reduce certain fees?

• What are the plan’s withdrawal restrictions? What types of college expenses are covered by the plan? Which colleges and universities participate in the plan?

• What types of investment options are offered by the plan? How long are contributions held before being invested?

• Does the plan offer special benefits for state residents? Would I be better off investing in my state’s plan or another plan? Does my state’s plan offer tax advantages or other benefits for investment in the plan it sponsors? If my state’s plan charges higher fees than another state’s plan, do the tax advantages or other benefits offered by my state outweigh the benefit of investing in another state’s less expensive plan?

• What limitations apply to the plan? When can an account holder change investment options, switch beneficiaries, or transfer ownership of the account to another account holder?

• Who is the program manager? When does the program manager’s current management contract expire? How has the plan performed in the past?

A 529 plan is all about maximizing your college savings. Questions like the above provide a great starting point for a conversation with your financial advisor.

Swendiman Wealth Strategies, Inc. has been blessed this summer to work with several interns, including Mike Duffy. Mike is a second year law student at the University of Dayton, and he worked with me to draft the following post comparing active and passive investment management.

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Vanguard. Fidelity. Two of the largest investment managers (and companies) in the United States. Vanguard, founded by John Bogle, was built on passive investment management. Fidelity is personified by Peter Lynch and his wildly successful (and actively managed) Magellan Fund. Both firms have achieved much – but which is best? More importantly, which style may be best for you and your money?

Passive Investing

Passive management is an investment strategy where mutual fund managers maintain a portfolio that matches a pre-determined investment index (e.g., the S&P 500, etc.) as closely as possible. This strategy aims to keep an investor’s long-term return substantially equal to the benchmark.

Because a passively managed fund tracks an index (sometimes referred to as an index fund) they typically require less resources than an actively managed fund and accordingly may charge lower fees to investors. The investor seeks to benefit from reduced costs combined with appropriate asset allocation rather than beating the index.

Active Investing

Active management, by comparison, is an investing strategy that seeks to outperform a particular index by adjusting the portfolio based on research (commonly called fundamental analysis) and picking stocks, market timing, and risk preferences. Fund managers applying this method constantly evaluate the holdings within the portfolio, and make changes in an attempt to provide investors with the highest possible return.

Active investing typically requires a larger staff and increased expense ratios. While an index fund will typically trail the index slightly net of fees (because of the fees, or sometimes, tracking error), over time most actively managed funds trail their chosen index net of fees.

So why use Active Management? Passive Management?

As one commentator recently offered, ”High quality active management is available in most asset classes; however, investing in passive management strategies in part or whole may improve portfolio construction when used in asset classes that have a more difficult time outperforming their benchmarks (e.g., large cap stocks).” We agree.

At SWS, we offer investors various portfolios comprised of active and passive offerings. We believe that certain segments of the market are structurally ill-suited to active management. For example, with so many financial professionals (and pundits, day traders, homemakers and little league coaches) breathlessly watching the S&P 500 and the Dow Jones Industrial Average (DJIA), there is little room for active managers to out-perform the market for large-cap stocks. Alternatively, in areas such as high yield bonds, emerging markets, and alternative investments – to name but a few – we think informational inefficiencies exist that active managers can exploit for their client’s gain.

By using active and passive investment management, we seek an asset allocation that minimizes expense and maximizes opportunity. Please contact us if you care to discuss how such a mix may benefit your portfolio.

Danny Bradford is back with the following article on charitable giving with life insurance:

Using a life insurance policy for a charitable donation is an attractive option because it allows the purchaser to give a sizeable contribution to a charity of their choosing at the cost of a calculated monthly premium. Additionally, choosing to donate a life insurance policy can leave the estate intact to be passed on to heirs.

Life insurance policies offer flexibility in financial planning and giving. For example, an individual who owns a very successful company may wish to make a sizeable and impactful donation to a charity that is important to them. They may also wish to keep the company in their family. This scenario could make it difficult to maintain the company and leave a significant donation to charity. However, with proper planning, a life insurance policy can offer the flexibility of affordable monthly premiums to the purchaser, and a significant policy payout to the charity. A charitable donation is accomplished while keeping the company assets in the family estate.

There are a variety of ways to donate a life insurance policy. While some methods are less involved, others offer greater benefits to all parties. Selecting the best strategy can be achieved with the help of your financial planner who understands your unique situation. A few of the most common methods are outlined below.

Giving a life insurance policy:

• May offer both income tax and estate tax advantages

• If policy is transferred early enough it is not counted as part of the donor’s estate

• Requires planning to maximize benefits

• Can provide large payout to charity

Naming charity as the beneficiary of life insurance policy (Revocable or Irrevocable):

• Relatively simple process for giving

• Typically does not offer income tax benefits

• Reduces the size of the donor’s estate by the benefit amount

• Flexibility in future planning

Giving cash dividends from life insurance policy to charity:

• May offer tax deductions for donor

• May offer fewer advantages for the receiving charity

A life insurance policy often allows the donor to give a much larger amount than he or she otherwise may have been able to give. When the donor purchases the life insurance policy, he or she is responsible for the premiums. As long as the premiums are maintained a charity can receive the policy payout. The donor realizes an advantage when the policy benefits exceed the amount of premiums paid.

Life insurance can be a great tool for charitable giving. Individuals are able to structure their life insurance gift in a number of ways to maximize both the amount they are able to give to a charity, and the tax benefits the donor receives. The variety of methods available for giving provides the donor with a great deal of flexibility. A financial planner, such as Swendiman Wealth Strategies, Inc., can help ensure the donor selects the most efficient and beneficial method of giving.

Swendiman Wealth Strategies, Inc. has been fortunate to have a number of interns join us during the summer months, including Danny Bradford. Danny is a third year law student, and he has penned the following post.

Reverse Mortgages

A number of retired clients have recently asked about reverse mortgages – what are they? How do they work? Are they right for me? This post tries to provide some answers.

A reverse mortgage is a loan that allows seniors to access the equity they have built up in their home as cash or a line of credit. These funds can then be used for anything from renovations to covering monthly bills.

A potential benefit of a reverse mortgage is flexibility – seniors are provided an additional source of cash for daily expenses. On the downside, however, reverse mortgages can be expensive and ultimately may not allow seniors the opportunity to pass their property to future generations.

While a traditional mortgage requires the borrower to make monthly payments and to have adequate income to qualify for the loan, a reverse mortgage is different. Because the reverse mortgage is based on the equity in the home there are typically no income requirements, and the borrower receives payments from the lender.

While there are three different types of reverse mortgages available, this article will focus on federally insured reverse mortgages as they are widely available and can be used for any purpose – however, they may come with greater expense.

Federally insured reverse mortgages are known as Home Equity Conversion Mortgages (HECMs) and are backed by the U. S. Department of Housing and Urban Development (HUD). This is the only type of reverse mortgage insured by the United States Government. The HECM is only available through Federal Housing Administration (FHA) approved lenders.

Eligibility requirements for an HECM through the FHA include:

1. Must be a homeowner 62 years of age or older;

2. Must own the home outright or have a balance that can be paid off at closing from the reverse mortgage;

3. Must live in the home; and

4. Must receive counseling prior to obtaining the loan.

The funds provided by a reverse mortgage can be received through different payment plans:

1. Tenure- equal monthly payments as long as at least one borrower lives and continues to occupy the property as a principal residence.

2. Term- equal monthly payments for a fixed period of months selected.

3. Line of Credit- unscheduled payments or in installments, at times and in an amount of your choosing until the line of credit is exhausted.

4. Modified Tenure- combination of line of credit and scheduled monthly payments for as long as you remain in the home.

5. Modified Term- combination of line of credit plus monthly payments for a fixed period of months selected by the borrower.

The amount a homeowner can borrow is determined by FHA guidelines and is based on the equity in the home.

There are a range of benefits that make reverse mortgages appealing to borrowers. One significant advantage of a reverse mortgage is that the homeowner is able to stay in the home without making monthly mortgage payments (because the balance of the mortgage is paid with funds from the reverse mortgage).

Additionally, a reverse mortgage cannot be outlived. As long as one of the homeowners lives in the home as their primary residence and maintains the home in accordance with FHA requirements (e.g., keeping taxes and insurance current), the loan does not become due. This is because the loan is eventually settled by the homeowner’s estate. Alternatively, if the homeowner leaves the residence, the loan is paid from the proceeds of the sale of the home.

There are some disadvantages to consider before choosing a reverse mortgage. The primary disadvantage with a reverse mortgage is that as the loan balance increases, the value of the borrower’s estate inheritance may decrease. Because the reverse mortgage is based on the equity in the home, that value is no longer available to pass on to heirs. However, heirs of the estate are not personally liable if the balance of the loan exceeds the value of the home.

Another disadvantage of a reverse mortgage is the cost. Depending on how much the homeowner needs to borrow, and for how long of a term, other loans including traditional mortgages may be less expensive. Additionally, as the FHA reverse mortgage is Federally insured the borrower bears some additional expense.

A third consideration with a reverse home mortgage is the effect the funds may have on the borrower’s eligibility for needs-based government programs such as Medicaid.

An important step before obtaining any reverse mortgage is receiving adequate counseling and advice. Specifically for an HECM through the Fair Housing Authority, a borrower must complete a counseling session with a HUD-approved reverse mortgage counselor. The advantages and disadvantages of a reverse mortgage will vary depending on the homeowner’s unique situation.

In short, while reverse mortgages may assist seniors who need cash for daily expenses, SWS advocates that all individuals (seniors or otherwise) work with a financial professional to determine whether a reverse mortgage is appropriate – and if the relationship begins early enough, perhaps a reverse mortgage will be unnecessary.

A strength of Swendiman Wealth Strategies is our ability to bring a single source wealth management practice to bear for our clients. In short, we believe that the various parts of a financial plan (investments, insurance, tax and estate planning, etc.) work best when created and implemented in concert.

For those members of our audience without ready access to SWS, the question arises: how can you create a financial “dream team?” The attached article from Kiplinger’s gives great guidance on this point.

And if you don’t believe you have access to SWS – give us a call at 859 468 7044. Please let us see if we may be of service to you.

Thanks, and here’s to you achieving your dreams.

I have been asked to serve as executor for family and clients.  Perhaps you have been asked to take on this role.  The executor has duties mundane and meaningful – for example, executors are asked to distribute baseball cards, sell homes, and assist widows and children wade through years of financial minutiae.

When advising on an estate plan, SWS typically suggests the following documents:

• Last Will and Testament;
• Health Care Power of Attorney;
• Financial Power of Attorney;
• Medical Directive / Living Will; and
• Living or Testamentary Trust.

These documents are key, however, what additional information can you provide to help your executor with this challenging role?

Before we go further, let’s answer: what does an executor do? These articles describe the executor’s role well, but typical duties include (but are not limited to):

• Find and distribute the deceased person’s assets;
• Manage probate proceedings;
• Determine who inherits property; and
• Manage daily details, such as establishing an estate bank account and pay continuing expenses, debts and taxes.

As this article shows, however, an executor may be faced with unexpected (and occasionally unpleasant) duties. When crafting your estate plan, what else can you do to ensure that your executor is prepared?

Burial Directions

Few people have – or want to – discuss their wishes regarding burial.  This commentator suggests that such directions be maintained separately from your will.  Regardless, making certain that your executor has clear instructions regarding the disposition of your remains is key.

Passwords

In today’s electronic age, we are asked to use and remember a vast number of passwords – for financial websites, social media, vehicle and home alarm systems, home safes, mailboxes or gates, locked boxes, and more. Executors should be provided with a list of passwords, as well as locations of keys, etc.

Safe Deposit Boxes

If you have a safe deposit box, make sure your executor knows where it is. Your executor may not have access to the box immediately after your death so it may not be the best place to store information needed immediately (burial arrangements, etc.).

Additional Assets

What other property do you have hidden away?  Make a list of (i) assets that are not stored at a financial institution, (ii) valuable items that your executor may not find without direction, and (iii) other information known only to you, like a map to buried treasure.  Describe each item, its location, and the location of any documents related to the item — such as appraisal records or a storage agreement.

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While a well crafted estate plan is foremost, these few additions may make life easier after death.  Be careful out there, and have a great week.

For those of you who carefully parse a corporation’s security filings for nuggets of information…well, this post is not for you.

Investors have long heard of the Super Bowl Effect – namely, in the years where the NFC has won the Super Bowl, the S&P 500 has risen an average of 15%. When the champion is from the AFC, the average return has been just 7%.

Recently, CNBC provided another list of surprising stock market indicators. While my brethren in the financial services community may dismiss these findings, some are supported by economic analysis, such as the number of Harvard MBA graduates entering Wall Street. Other market indicators are less grounded in economics, such as the nationality of the Sports Illustrated swimsuit cover model.

That said, with the market up sharply thus far in 2012, are you surprised to note that the N.Y. Giants knocked off the Patriots in February, or that Kate Upton was born in Michigan?

Have a great week, and happy investing.

Spring may be the greatest season.  Baseball begins, trees and flowers bloom, outside activities abound. Spring is also a time of lump-sum income – bonus payments, tax returns, and the like.  For those fortunate few who receive such a windfall – congratulations.  Reward yourself.  SWS also advocates, however, investing some of this money to meet future goals: retirement, a child’s education, etc.

So what type of account should receive this investment?

We consider three here: (i) a tax-deferred account (e.g., your employer’s 401(k) plan, etc.); (ii) a taxable investment account; and (iii) another type of tax-advantaged account – the Roth IRA.

Tax-Deferred Accounts

The traditional benefit to investors in tax-deferred accounts is that investments grow tax free, and are not subject to capital gains taxes upon withdrawal. Financial service providers often stress deferring taxes for as long as possible, suggesting that you may be in a lower tax bracket in retirement, so the taxes you pay then will be less than faced today.

At the time of this writing, however, the U.S. debt equals $15.67 trillion – or over $50,000 for every U.S. man, woman and child. Entitlement programs continue to be burdened, and will grow more so as additional Baby Boomers retire. A recent article details why tax revenues will need to rise to address the looming deficit. Faced with this evidence, we believe few investors can count on lower tax rates in retirement – therefore, a major benefit of tax-deferral is lost.

There is reason, however, to invest some part of your money in your employer’s 401(k) plan – the company match. A common formula is to match 50% of employee contributions up to the first 6% of salary. This is “free” money that you will not receive elsewhere.

We suggest investing enough of each paycheck in your employer’s 401(k) plan to maximize your company match. Then, you may wish to consider other account options.

Taxable Accounts

Why invest in a taxable investment account? We can think of several reasons:

1. No contribution or income limits. Taxable accounts allow unlimited contributions, while 401(k) and Roth IRA accounts limit the investment amount you may make each year depending upon your income.
2. Make withdrawals without penalty. Taxable accounts provide immediate liquidity, while 401(k) and Roth IRA accounts place limits on withdrawals before age 59 1/2.
3. Keep your money invested. Most tax-deferred accounts require minimum required distributions (“MRDs”) beginning at age 70 ½; however, Roth IRA accounts do not require MRDs.
4. Potential tax benefits. Tax-loss harvesting, which exceeds the scope of this post, is one way the federal tax code can help investors.

In short, one word describes why you may wish to maintain some of your investment assets in a taxable account – flexibility.

Roth IRA

Contributions to a Roth IRA are made with after-tax dollars, and these accounts provide numerous benefits, including:

1. At age 59 ½, contributions to and earnings in a Roth IRA are available for withdrawal with no income tax liability. Compare withdrawals from tax-deferred accounts, which are taxable as ordinary income.

2. Before age 59 ½, you may access contributions without tax consequences, as tax has already been paid. Note: withdrawal of account earnings are subject to penalty if withdrawn before age 59 ½. This allows account owners to tap contributions to fund a child’s education, pay a down payment on a house, or more.

3. Roth IRAs do not require minimum required distributions (“MRDs”).

Why do we like Roth IRAs? Like taxable accounts they provide flexibility, while the tax benefits (in our opinion) exceed that of traditional tax-deferred accounts.

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We hope this summary will help you consider your options amongst these different types of accounts.  While each account has its merits, one investment truth is certain – none of these accounts will help you without you first deciding to invest, rather than spend. Enjoy the Spring!

Thank you for spending time perusing our website – it is a pleasure to provide our readers with content that may improve their financial circumstances.

In addition to the posts provided here, I suggest that you turn to AdviceIQ.com.  The editors of AdviceIQ, led by former Wall Street Journal senior editor Larry Light, have decades of experience providing informational articles similar to those that you will find on these pages. Their site offers articles penned by investment professionals throughout the United States.

In addition, Larry and his team have kindly published our recent post on cash equivalents, with more on the way.

I recommend adding a bookmark for AdviceIQ – you’ll learn a lot.  Have a wonderful weekend.

Few people wait with bated breath so they may read an annual shareholder letter.  Very few people, however, craft so fine a shareholder letter as Warren Buffett.

Mr. Buffett has served as the Chairman of Berkshire Hathaway since the 1960′s, and during that time has become America’s most well known – and most successful – investor. In this year’s shareholder letter, Mr. Buffett highlights his firm’s financial success in the first paragraph:

“The per-share book value of both our Class A and Class B stock increased by 4.6% in 2011. Over the last 47 years (that is, since present management took over), book value has grown from $19 to $99,860, a rate of 19.8% compounded annually.” (emphasis supplied)

Investment professionals are drawn to Mr. Buffett because of his knowledge of value investing.  Investors envy his near 20% annualized return track record.  I suggest, however, that everyone would benefit from reading Mr. Buffett’s letters, including those from past years. The home-spun wisdom offered by Mr. Buffett applies to investing particularly, business broadly, but also to life in general.

Just this year, for example, I was taken by the following nuggets from Mr. Buffett:

1. “Buy commodities, sell brands.”

Mr. Buffett explains that this “has long been a formula for business success. It has produced enormous and sustained profits for Coca-Cola since 1886 and Wrigley since 1891.”

Simply: buy goods cheaply, develop a brand about them, sell them for more.

2. Great companies create cash flow.

Mr. Buffett trumpets the “float” created by Berkshire Hathaway’s various insurance operations – namely, premiums paid by insurance customers creates cash that Berkshire Hathaway gets to invest and profit from while waiting to pay claims.  A CFA charter is not needed to see that you would rather receive interest (own bonds, have savings, etc.) then pay interest (have debt, etc.).

Businesses – and families – that have net positive levels of cash flow succeed.

3. Lower stock prices can be more beneficial.

Mr. Buffett, when talking about volatile stock prices says: ”If you are going to be a net buyer of stocks in the future, either directly with your own money or indirectly (through your ownership of a company that is repurchasing shares), you are hurt when stocks rise. You benefit when stocks swoon. Emotions, however, too often complicate the matter: Most people, including those who will be net buyers in the future, take comfort in seeing stock prices advance. These shareholders resemble a commuter who rejoices after the price of gas increases, simply because his tank contains a day’s supply.”

If you are still working and are consistently saving, lower stock prices mean you can buy more shares – period.

4. To achieve real positive returns, you must outdistance taxes and inflation.

Mr. Buffett offers the following about Treasury returns: “For tax-paying investors like you and me, the [purchasing power] picture has been far worse. During the [past] 47-year period, continuous rolling of U.S. Treasury bills produced 5.7% annually. That sounds satisfactory. But if an individual investor paid personal income taxes at a rate averaging 25%, this 5.7% return would have yielded nothing in the way of real income. This investor’s visible income tax would have stripped him of 1.4 points of the stated yield, and [inflation] would have devoured the remaining 4.3 points.”

Investments limited to fixed income likely create a loss of real purchasing power – for this reason, even our most elderly investors need to consider an equity exposure in their portfolio.

5.  Gold creates nothing, and pays no dividend.

Mr. Buffett explains the perils of investing in gold in a few paragraphs better than I can summarize – here is his take in its entirety: “[A] major category of investments involves assets that will never produce anything, but that are purchased in the buyer’s hope that someone else – who also knows that the assets will be forever unproductive – will pay more for them in the future. Tulips, of all things, briefly became a favorite of such buyers in the 17th century.

This type of investment requires an expanding pool of buyers, who, in turn, are enticed because they believe the buying pool will expand still further. Owners are not inspired by what the asset itself can produce – it will remain lifeless forever – but rather by the belief that others will desire it even more avidly in the future.

The major asset in this category is gold, currently a huge favorite of investors who fear almost all other assets, especially paper money (of whose value, as noted, they are right to be fearful). Gold, however, has two significant shortcomings, being neither of much use nor procreative. True, gold has some industrial and decorative utility, but the demand for these purposes is both limited and incapable of soaking up new production. Meanwhile, if you own one ounce of gold for an eternity, you will still own one ounce at its end.

What motivates most gold purchasers is their belief that the ranks of the fearful will grow. During the past decade that belief has proved correct. Beyond that, the rising price has on its own generated additional buying enthusiasm, attracting purchasers who see the rise as validating an investment thesis. As “bandwagon” investors join any party, they create their own truth – for a while.

Over the past 15 years, both Internet stocks and houses have demonstrated the extraordinary excesses that can be created by combining an initially sensible thesis with well-publicized rising prices. In these bubbles, an army of originally skeptical investors succumbed to the “proof” delivered by the market, and the pool of buyers – for a time – expanded sufficiently to keep the bandwagon rolling. But bubbles blown large enough inevitably pop. And then the old proverb is confirmed once again: “What the wise man does in the beginning, the fool does in the end.”

Today the world’s gold stock is about 170,000 metric tons. If all of this gold were melded together, it would form a cube of about 68 feet per side. (Picture it fitting comfortably within a baseball infield.) At $1,750 per ounce – gold’s price as I write this – its value would be $9.6 trillion. Call this cube pile A.

Let’s now create a pile B costing an equal amount. For that, we could buy all U.S. cropland (400 million acres with output of about $200 billion annually), plus 16 Exxon Mobils (the world’s most profitable company, one earning more than $40 billion annually). After these purchases, we would have about $1 trillion left over for walking-around money (no sense feeling strapped after this buying binge). Can you imagine an investor with $9.6 trillion selecting pile A over pile B?

Beyond the staggering valuation given the existing stock of gold, current prices make today’s annual production of gold command about $160 billion. Buyers – whether jewelry and industrial users, frightened individuals, or speculators – must continually absorb this additional supply to merely maintain an equilibrium at present prices.

A century from now the 400 million acres of farmland will have produced staggering amounts of corn, wheat, cotton, and other crops – and will continue to produce that valuable bounty, whatever the currency may be. Exxon Mobil will probably have delivered trillions of dollars in dividends to its owners and will also hold assets worth many more trillions (and, remember, you get 16 Exxons). The 170,000 tons of gold will be unchanged in size and still incapable of producing anything. You can fondle the cube, but it will not respond.

Admittedly, when people a century from now are fearful, it’s likely many will still rush to gold. I’m confident, however, that the $9.6 trillion current valuation of pile A will compound over the century at a rate far inferior to that achieved by pile B.”

In short – commodities are a vital part of a diversified portfolio; however, neither Mr. Buffett nor Swendiman Wealth Strategies, Inc. will be driving to Fort Knox soon.