Cost of College

by Bruce Fenton

A college-bound student is likely to pay a huge price for that coveted sheepskin … $12,127 a year to cover tuition, fees, and board and room at a public institution … more than $29,000 per year at the average private college, according to the College Board.

The rest of the story is not much better. If college costs continue to inflate at the same rate as last year (6.6 percent), those same figures are $38,316 (public) and $91,627 (private) for a child born today. What’s more, congressional budget cuts mean variable-rate federal loans, with rates as low as 4.7 percent, will lock in July 1 at higher fixed rates. Stafford Loans, the most popular of all, will be fixed at 6.8 percent while Parent Loans for Undergraduate Students (PLUS) will be fixed at 8.5 percent.

In 1912 the late Supreme Court Justice, William O. Douglas, rode his horse from Yakima, Washington to Whitman College in Walla Walla where he lived in a tent (his story) while working his way through school and sending money home to his widowed mother. After graduation he hired on as a sheepherder to take a trainload of sheep to Chicago, riding the rails the rest of the way to New York and Columbia Law School. This makes a wonderful story, one that is sure to win points when you tell it at the dinner table to your children … but not the case today where the cost of college now exceeds the cost of a new home in parts of the country.

The College Board tells us that last year 13 million college students in the United States received $143 billion worth of financial aid. The American Council of Education estimates that more than 10 percent of those who didn’t apply would have been eligible for some aid.

There is plenty of financial aid available to those who learn how to use the system and resources available, according to student loan originator, Sallie Mae®. On January 1, the Department of Education began accepting the Free Application for Federal Student Aid, or FAFSA.

The FAFSA process is needs-based, taking into account parental and student income, age, and assets and determines how much the family is expected to contribute toward the student’s education. If this number is less than the amount charged by the selected college, the student is eligible for the difference, which can come in the form of grants, scholarships, or low interest loans.

To understand the FAFSA process, go to the web site, www.finaid.com where you can input your financial information and calculate an estimated family expected contribution figure.

Sallie Mae’s website connects to a database with more than 2 million scholarships worth roughly $15 billion. The database lists the scholarships for which students qualify, based on their financial needs, grade-point average and academic or extracurricular interests.

For families facing college expenses, those likely to qualify for financial aid should strive to get into the best colleges possible and those likely to not qualify should seek out the most economical college programs.

In the case of the former, if the family is expected to contribute $10,000 and the cost at an Ivy League school is $45,000, the family is going to pay $10,000 whether the student goes to a state college next door, or to the Ivy League institution.

In the case of the latter, parents and student should shop for the best school possible within their budget. The student might consider enrolling in Advance Placement classes while in high school to earn college credits. These credits may cut the college stay from 4 years to 3 … a significant saving!

Scholarship and aid money typically is handed out on a first-come basis. So learn the system, apply early and apply often.

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.

Financial Planning: It Should Be Simple

by Bruce Fenton

A famous general, who later became our President, once told us “Plans are worthless, but planning is everything.” Much the same can be said for financial plans.

Bookstores have stacks of self help financial planning books bearing titles such as the “Nine things you need to know now,” or “Eight secrets to a successful … ,” or “Seven Rules for ... ” etc. All miss the real point of financial planning and that it is the process and not the plan that counts. It’s how one lives their financial life that really matters.

Sometimes we get carried away with the idea that financial planning is a huge, complex task. In fact, it can be pretty simple. Or, as a speaker once concluded at an industry conference, “We all want the same thing … that is to pay our taxes, educate our children and retire comfortably.”

Over the years I have reviewed many, many financial plans. To one degree or another these plans touched the major areas of planning; cash flow, investments, net worth, taxation, risk management, specific goal achievement, estate plan and finally retirement. No doubt, every one of these areas is key to a good plan, but I’ve learned that the analysis that goes into the plan is not as important as the organization of the materials, the process of thinking through the relationship of each area to the plan as a whole, and the establishment of benchmarks by which we can mark progress.

One of the simplest, most straightforward, descriptions of this process came from the late John Savage. Savage was a well-known life insurance salesman from Ohio, highly regarded within the life insurance industry for his ability to simplify a complex problem and communicate it to his clients … and in later years to the thousands who heard him speak at industry gatherings.

The underlying theme of a John Savage financial plan was simply “There are two kinds of people … those who spend first and save what is left, and those who save first and spend the remainder. The former always end up employed by the latter!”

Someone one once mentioned that the secret for successful retirement is to… “Watch what you put in your mouth, get plenty of exercise, and always put a little aside.”

This advice is a home run. A successful retirement is not just about money … it’s about your health and well-being as well. It doesn’t matter how much money one has when they enter retirement if their poor health precludes enjoyment of their riches. Proper dietary practices and a good exercise regimen are the least expensive of all “set-asides” in life, but for some, the most difficult. There is nothing complicated about a financial plan that calls for eating right, exercise and saving a little at a time.

Setting up a dietary plan or a gym routine is beyond the scope of my expertise, but I do think we can tune up our financial lives by considering what author Thomas Stanley, PhD, “The Millionaire Next Door” describes as common denominators of the wealthy. They live well below their means. They allocate time, energy and money efficiently in ways conducive to building wealth. They believe financial independence is more important than social status. Their parents did not support them. Their adult children are economically self-sufficient.

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.

Cash Flow Is Basic

by Bruce Fenton

A basic part of family planning begins with cash flow management. In many cases it is this first step that determines the ultimate financial successes of the household. By understanding cash flow, the family can make good decisions that will enable it to avoid unnecessary debt, borrow responsibly, accumulate wealth for the future, and plan for major needs such as education expenses or retirement.

My experiences have shown me that many families and individuals do not have a sound understanding of how they spend their money. Due to the ease of purchasing with credit cards, its accompanying deferral of debt, and the proliferation of ATMs, it is not uncommon to encounter situations where the family unit has no idea how much it costs them to live.

The cash flow statement to the family unit is similar to the profit and loss statement for the business. It tracks income in and expenses out. An easy way to develop the cash flow statement is to begin by setting up a simple spreadsheet that lists sources of cash coming in and expenses going out.

Cash may come from a variety of sources including, but not necessarily limited to, employment income of the working household members, gifts, realized investment gains and losses (a subtraction), net rental income earned, interest earned and reinvestment of dividends and capital gains in non-retirement investment accounts.

I like to categorize my expenses into three main categories: fixed costs that must be paid each month, variable living expenses, and discretionary expenses.

In the book, How to Run A Business In Trouble, the author advocates breaking expenses between those you had to pay to keep the bank from shutting down the business, such as bank loans and insurance, and all others. The former you pay first and the latter you negotiate or make choices with. The smaller the former amount is in relation to income, the better. The lesson of this is simply to lower fixed costs such as mortgages, loans, and credit card payments for financial health!

Variable living expenses make up the bulk of our remaining expenses. These include the many basic expenses over which we have some choice as to how we spend. These include utilities, household upkeep and maintenance, food, transportation costs, insurance, personal care and clothing, subscriptions, and club dues.

If we take the total of these two expense categories and subtract that from our income, the remainder is money we have available for discretionary spending.

Discretionary expenses include expenses we choose to incur, although they are not essential to our basic lifestyle, including gifts to charity and gifts to others, recreation, travel, unaccounted-for-spending, hobbies, and savings in retirement and other investment accounts.

Knowing where we can make choices is the most important part of this exercise. It has been said that there are two kinds of people: Those who spend first and save what’s left and those who save first and spend what is left. Invariably, the former ended up working for the latter. Taking that to heart and knowing where you are spending money for wants vs. needs is the first step in developing a sound financial plan.

Bruce Fenton is a financial consultant, a writer, and the Managing Direcetor of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.

Funding for College

by Wendell Cayton

The folks in Kalamazoo, Michigan have it right … the key to an economically viable community and society can be found in education. Struggling with rust belt blight they came up with a plan that is innovative in the annals of redevelopment … a free college education for graduates of their public school system.

These smart, and generous, civic leaders of Kalamazoo put their heads together, realizing that there was a link between jobs and education, and began working with the Superintendent of Schools, Janice Brown. Together, they came up with the Kalamazoo Promise.

The Promise, as Ms. Brown announced to Kalamazoo parents and students in November, states: “All students who graduate from Kalamazoo Public Schools, and are residing in the district, and have been students there for four years or more will be given funding for college tuition and mandatory fees. The amount of available dollars depends on years of residency and the number of grades attended in KPS, up to 100% of tuition and mandatory fees. The funds will be available to use at any public university or community college in the State of Michigan
A recent article in the Wall Street Journal by Neal Boudette noted that the impact on Kalamazoo was quick in coming. Developers who struggled to sell homes suddenly found a demand for their new homes. Land that went begging is being snapped up by builders. People are moving into the community from other parts of the country and finding more house for less money … and an unusual opportunity for their children.

The jury is still out on how this will spur growth and economic development. But John Austin, a nonresident fellow at the Brookings Institution is quoted by Boudette: “The places that produce and attract talented people are going to be the places that participate in today’s economy. Your economic future is linked to how many people get to post-secondary higher education and how many you can keep in the community.”

The problems facing Kalamazoo are typical of a community or region with a manufacturing base to their economy. Those matriculating through the school system found it easy to take a high school diploma to the nearest factory, get a well paying job, raise a family in comfortable style and ultimately retire with a livable pension. Those days are gone.

Technology is replacing humans on the assembly line. Jobs are going to those educated and skilled in a knowledge-based economy. A high school diploma no longer guarantees a decent living.

The anonymous donors see The Promise as a way to revitalize their city. “They understand that equal access to higher education for all creates a powerful incentive that will bring people and employers back to Kalamazoo,” states Superintendent Brown.

On a personal note, a service club in our community began challenging selected 10th grade students to graduate from high school. These students were identified as being in considerable risk of not finishing school. If they accepted the challenge and successfully completed high school, the club pays for the first two years of college tuition.

The results have been remarkable. In one case, the club challenged the oldest of a family of 10 whose parents were migrant workers. He accepted the challenge, went on to four years of college and inspired others in his family to do the same. The family boasts one PhD, two master’s degrees, one BS degree and several currently enrolled.

Education does make a difference. The best investment we can make in the futures of our community and nation is to support our schools and encourage our students to strive for a higher education.

Asset Allocation

by Bruce Fenton

Asset Allocation, long thought of as a basic tenet of a good investment strategy, is not always every investor’s friend. Controlling risk is important to most when markets are going down, not when they are going up. A good asset allocation model relies on the premise that a portfolio balanced between various asset classes will help control or mitigate investment risk.

In theory, this might be true. But in practice, many investors lack the discipline to make this a truism. The basic problem stems from the emotional disorder afflicting many investors…they buy and hold when the markets are good and sell when markets are bad. In other words they buy high and sell low.

To make asset allocation work, they would have to be willing to buy assets that no one wants, that are down in price, that look as if they will never recover. They would have to sell assets going up in price that everyone wants and that look like they are going to the moon. Not an easy bridge to cross!

The broadest and easiest form of asset allocation to understand is a model based upon equal parts stocks, bonds, and cash. Periodically the holder of this portfolio would sell a portion of the assets gaining value and buy that class going down in value. This requires faith that the asset classes will periodically cycle from low to high.

In strong up markets, this implies selling favorite stocks, for example, and buying low performing bonds. In 1999 or 2000 this concept would have resulted in most financial advisors losing their jobs, since getting a client to sell a prized asset that had just doubled or tripled in value in order to buy a bond earning 5% would have generated a rancorous argument.

An investor building a portfolio around sector analysis would buy sectors that have bottomed and sell those that have topped out. Obviously the trick is to know which is which, and then have the discipline to buy low and sell high.

A second asset allocation model focuses on investment style. Style refers to value versus growth, large cap vs. small cap, and domestic vs. international equities. Style analysis works well when reviewing performance of mutual fund managers where funds have a wide variety of holdings.

Stanford Professor and Nobel Prize winning economist William F. Sharpe pioneered returns-based style analysis. This allows investors the opportunity to evaluate portfolio managers by estimating a portfolio manager’s style by determining the mix of passive benchmarks that best matched the actual returns of the fund. This technique enables an analyst to develop a perspective about how the fund might behave in the future based upon historical performances.

Always keep in mind that historical performance does not guarantee future performance. We are still subject to event risks that can disrupt the ordinary course of events in an economy and the investment markets.

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.

Flipping the Switch to Retirement

by Bruce Fenton

Flipping the switch from work to retirement mode is not quite like flipping a switch to light a room. It is not a black and white transition. And neither is handling your investment accounts during the change.

Ask anyone recently retired about the adjustment process … according to a poll done by American Demographics®, 41% of retired workers said they were having a difficult time adjusting to retirement … compared to 12% of the recently married having a difficult time adjusting to marriage!

I suspect that many of those disenchanted follow a similar pattern … hit the local coffee shop in the morning, hang out with the other retirees, drink too much coffee, listen to the same stories over and over … and, finally, one morning saying to themselves, “Is this all there is to life?”

Our way of thinking about retirement needs an overhaul. We are geared to think of retirement in terms of the way it was defined 100 years ago: Work to age 65 (never mind that life expectancies were 46). If lucky enough to live to retire, we wouldn’t have to worry about a long line at the coffee shop. We persist in asking our retirees to make what author Mitch Anthony (The New Retirementality) calls “age-justments” or simply turn off who they are and the activities that drive their pulse … simply because they reached age 62.

Retirement is really a three-phase process.

The first phase occurs between 50 and 61 when the kids leave and our focus becomes wealth accumulation. At this time we concentrate on building the nest egg, paying off education bills, and thinking about where and how we wish to live the last third of our life. Our investment focus is growth-oriented and the larger portion of our portfolio will be in equities.

The next phase extends from age 62 to 75. Real change begins, as we leave the work life behind, but not necessarily abandoned. At this point we begin to trade leisure time for human capital … the latter defined as the present value of future earnings.

This is probably the most misunderstood phase of retirement … because to retire does not simply mean quitting work. It is more about the choices we make for the use of our time.

A study done by the Gallup® organization found that 60% of retirees want to become entrepreneurs or to seek a new job to fulfill their dreams, 10% are seeking a new work-life balance, 15% hope to enjoy a traditional retirement and the remaining 15% do not want to retire. Clearly this phase is not about quitting work … more like having the freedom to do what we want, without having the economics of the endeavor as the chief motivating factor.

From an investment perspective, those who continue to work and earn, at whatever they choose to do, are continuing to build human capital and can afford to take more risk with their investments. Their portfolios should reflect a bias toward equity or growth investments, consistent with their willingness to accept investment risk. As their production of human capital tapers off, and the need to depend upon investments for support or other retirement goals increases, this more risky strategy should begin to give way to less risky investments.

The third and final phase of retirement begins about age 75. Now health concerns manifest themselves and we cut down on expensive travel and recreation that we pursued with such abandon 10 years before. The option of generating human capital has all but disappeared, and with it so should the risk in our portfolio. This does not mean that we throw out all stocks in favor of bonds … rather, that we begin to take a more cautious approach to investing with preservation of capital key.

Man’s life, as with all things in nature, has seasons. His investment strategy should reflect seasons as well.

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.

Cohabitation Raises Legal Issues

by Bruce Fenton

It’s a fact…according to the 2000 U.S. Census, the number of unmarried partner households rose 72% nationwide during the ’90s. Changing values and economic conditions have combined to make cohabitation a part of our national culture and raised important legal issues for those who choose to so live.

Unlike married partners, those who cohabit do not share legal rights to property, inheritance, income and debts. And, if children are involved, additional issues of custody and support arise.
As unromantic as it may seem, a clearly written partnership agreement at the beginning of a relationship becomes the proverbial ounce of protection worth more than a pound of cure. The time to make these decisions regarding property ownership, inheritance, and support is before any triggering events occur. To attempt to prove the existence of an agreement after the fact, and without a written contract, can be costly and time consuming.

Even without formal documents, traditionally married couples have certain rights to property, protected by law. Those rights, such as the right to inherit property upon the death of a partner, are not available to the unmarried couple, same-sex or otherwise. Executing an appropriate contract can protect these rights.

For a contract to be valid it must pass four basic tests. First, the parties to the contract must be capable of contracting. This rules out a contract involving a minor or someone deemed incompetent.

Second, there must be valid consent. To be valid, the parties must agree without coercion, duress, undue influence, or fraud.

Third, the contract must have a lawful object…not an illegal activity.

And fourth, after the precedent setting Marvin v. Marvin case of 1976, the contract between partners cannot be based primarily on the rendition of sexual favors. The Supreme Court of California in the Marvin case held that contracts between unmarried couples are not against public policy and are enforceable, as long as the contracts are not founded explicitly on the consideration of sexual services.

The major elements of a living-together agreement should include property ownership and property rights, inheritance rights and support.

Like a business agreement, property ownership should address the issues of title and division of ownership interests, credit toward future property interests created by contributions to property, the rights of the parties in the event they choose to dissolve the partnership, and, equally important, inheritance rights.

Inheritance rights are a particularly sticky issue, since state intestacy laws have been written to favor a blood family member, never an unmarried partner. Therefore, a valid will and/or living trust are a must if the partners intend to pass on property to each other at death.

Partners can agree to pool their earnings for mutual support. Or, they may choose to treat income earned by each as that person’s separate property. Or, as the Marvin case pointed out, one may be the breadwinner while the other provides non-income producing support.

Unmarried couples do have one advantage over traditional married couples, especially in community property states. They may transfer property between partners for the purpose of avoiding future creditor claims, something difficult to accomplish in community property jurisdictions.

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.

Teaching Children About Money

by Bruce Fenton

Among life’s important little lessons to pass along to our children is how to handle money. Shrinking stock market returns are echoing through family structures, and where there was once abundance, now there is less; and older children who have come to depend upon their parents for financial support have, in some cases, tapped out the till.

Parents who were once able to make cash gifts to adult children are finding themselves thinking twice about handing out this largess, as they wonder about their own financial futures.

Many are finding themselves sandwiched between taking care of older parents who did not plan on living this long, and continuing to support a younger generation who grew up thinking a TV in every room, a credit card in every pocket, and a nifty new sports mobile was a right, and not a privilege.

Thomas Stanly, PhD, author of a seminal study of family wealth, The Millionaire Next Door, referred to parental support for adult children as Economic Outpatient Care.

Stanley noted that many of the older generation who provide Economic Outpatient Care showed uncommon skill at accumulating wealth earlier in their lives. Yet these same parents feel compelled, even obligated, to continue to provide support for adult children.

The net result is that the children, or those who receive such outpatient care, accumulate less on their own. They use the gifts to present a facade of a lifestyle. Worse, they become adept at manipulating their parents for more, rather than taking on responsibility for their financial situation.

Parents of younger children still have a chance to guide offspring along the road to financial responsibility.

There is a nifty piece of software on the Web for teaching younger children about money. Family Bank at www.ParentWare.org is a computer-based allowance manager that helps children learn money skills and management. According to the author it comes with a set of rules that, when agreed to by the parent and child, and adhered to by the parent, will help the child develop the habit of sound financial management.

According to Nellie Mae (college loan administrator) over 78% of college students are carrying loads of high-interest, unsecured, credit card debt. Not surprising, since credit cards solicitations are everywhere on today’s college campuses…“no income, no employment, no problem!”

Parents can do their kids a favor by teaching them a few simple rules about credit cards. First, explain to them the facts of life regarding their credit history. Without good credit, buying cars and renting apartments become more expensive at best…impossible at worst. Second, put training wheels on a credit card; start them with a prepaid or debit card that is simple to monitor. You can see if they are using it wisely while controlling the amount they spend.
Third, explain the cost of credit. Show them the math. They are smart enough to figure out what 18% interest means if added to the cost of a purchase. Explain late fees…even when only $10 might be owed. It still has to be paid on time!

Finally, monitor their purchases and teach them what is appropriate and necessary versus what is “nice to have” or an impulse.

Teaching children about money, in many respects, can be as valuable as any other aspect of their education!

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.

Liquidity and your Retirement Plan

by Bruce Fenton

Liquidity, liquidity, liquidity is as important to retirement planning as location, location, location is to buying real estate. A retirement plan without adequate consideration for liquidity can become a scenario of frustrations and dashed dreams.

Liquidity in a retirement plan is the ability to write a large check to cover an unforeseen expense, without paying early withdrawal or surrender penalties, without having to sell an asset (real estate or stocks) in a down market and/or without having to liquidate an investment that is currently providing income.

Financial planning for retirement is a fairly simple process. Start with the fixed income sources such as pensions and social security. Subtract expected expenses, being careful to add inflation each year, from this income. If the number is negative, the retiree will either have to cut expenses or increase withdrawals from investments. Here is where it gets tricky.

Retirees with fewer resources needing investment income will generally elect to cut expenses in anticipation of trying to live off available income and/or a small investment portfolio. There is no margin for error in this planning. These retirees should be extremely careful that they do not “lock up” their available investment capital in non-liquid investments.

Here are several situations frequently seen in retirement planning:

• Investors chasing higher yields in order to squeeze out a little more income can find themselves paying a stiff price measured in lack of liquidity. This is especially true in the case of some limited partnerships and higher bonds with severe credit risk (costly to sell if forced to sell in a down bond market). Long term CDs that can carry substantial early withdrawal penalties are also costly to liquidate early.
  
• Annuities can present a difficult problem. Maximum income can be derived from a deferred annuity by annuitizing the contract. To do so, the owner enters into an irrevocable decision with an insurance company calling for the company to pay a stream of income for a period of years or for the lifetime of the annuitant. However, the owner gives up the right to withdraw additional cash to meet unexpected expenses.
  
• If the annuity is left in a deferred state, the owner can withdraw from the contract but may pay surrender charges or unexpected taxes.
  
• Retirees deriving income from rental real estate should be particularly careful in their planning. If the property has a mortgage their plan should provide for unforeseen expenses or vacancies that may reduce income flow required to cover the mortgage. If they are managing the property themselves, they need to consider how feasible it is to continue managing the property as they age or develop substantial travel interests.
  
• Even if the property does not have a mortgage, their plan should provide for a source of funds to take care of costly repairs, such as replacing the roof. This is not usually the case when one is working, since lenders are much more willing to lend to a working individual than to an individual with only portfolio or rental income.
  
• Finally, retirees should factor in the need to replace automobiles, household appliances and major household maintenance. As life expectancies increase the probability of wearing out durable household devices and automobiles increases.

Even if it means reducing some income, keep an eye on the need to maintain liquidity in your plan.

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.

Financial Planning for the Small Business Owner

by Bruce Fenton

The tech bubble burst and subsequent restructuring place in corporate America has cast talented workers out of jobs. Many of these talented workers, armed with a “can do” attitude and entrepreneurial talents honed in the past five years, can be expected to go off and start their own small businesses.

The success or failure of these new enterprises will hinge not only on their creative skills, the markets and economy, but also on how well they develop a financial plan for their business. The scope of a good plan should incorporate the traditional business plan, as well as the personal financial plan of the business founder/owners.

There are a few key elements of the business plan that are likely to impact the personal financial plan of the owners. For example, the form of business ownership should be coordinated with an owner’s estate plan.

If the business is incorporated, the stock held by the owner should be titled in the name of the owner’s living trust, if a trust exists. If not, upon the owner’s death, the stock interest could be held up in a probate court for months, or even years, as the court rules on a change of ownership.

If the owner held her stock in joint tenancy with her husband, for example, and then died, her surviving spouse would not have the advantage of inheriting the business interest with a 100% stepped-up basis. In other words, were he to sell the interest to the other owner/shareholders, he would be taxed on one-half of the gain. In this case, the parties would be better off holding the stock as community property which would allow the survivor to inherit the ownership interest with a full, stepped-up basis.

Cash is king in a small business startup…and as the business grows, cash needs will grow at a rate seemingly faster than the business. Notwithstanding winning the lottery, the founders may find themselves borrowing heavily to keep the business afloat.

If the business is mature enough to have developed a banking relationship, as an entity it may be able to borrow or set up a line of credit with a bank. Even though the business may be the borrower, and the form of business ownership is a corporation or a limited liability corporation, our founders will probably have to personally guarantee the business debt…even a Small Business Administration guaranteed loan. Banks always look for a secondary source of repayment!

Therefore founders should have a good feel for their personal cash needs and how they can be met if all the business cash resources are required to keep the enterprise afloat and the bankers happy. Founders who sign as personal guarantors should also be aware of what they stand to lose under the worse case scenario…their house for example.

Looking on the brighter side, a successful business can provide its founders/owners with many personal financial benefits that directly affect their personal financial plan.

Health insurance, certain forms of life insurance, disability income replacement, as well as nursing home insurance can be paid with company funds. Retirement plans, funded by the company for the benefit of the owners, offer a terrific tax-advantaged wealth creation benefit.

Finally, the business plan should provide for an exit strategy for the owners in the most tax efficient way in the event of disability, death, or retirement. What the owner or her heirs will receive should be part of the owner’s plan. How the company will fund these eventualities…insurance, deferred compensation, sinking fund, etc… is an integral part of any good business plan. The personal and the business plan should complement each other!

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.

Private Annuity in Retirement Planning

by Bruce Fenton

Retirement income planning has traditionally been built around the three-legged stool of Social Security, company pension, and private savings. Congress kicked out one of the legs, the company pension, with changes in the tax laws in the mid 1980s. By using a private annuity, retirees can replicate the company pension in their plan.

As life expectancies increase and returns from stock market investment come back to reality, running out of money in retirement is a real fear for retirees. The quandary for many people about to retire (or those recently retired) is whether to work a little longer now and delay drawing on retirement assets, or run the risk of not having enough in later years when working is no longer an option.

Part of the solution may lie in creating an annuity to take the place of the defunct company pension. An annuity is simply a steady stream of income provided on a regular basis for the lifetime of the beneficiary or for a set number of periods. An annuity can be guaranteed, as in a commercial fixed annuity purchased from an insurance company or non-guaranteed as in an insurance company variable annuity or an annuity derivative created from equity investments, bonds, rental real estate or similar income producing assets.

The income or cash flow statements of a household and business are very similar. Both identify income sources, as well as fixed and variable costs. In the case of the household, the fixed costs are those required to cover an acceptable minimum standard of living, such as shelter costs, utilities, food, clothing, insurance, and medical expenses. Variable expenses are the discretionary expenses that are nice to have, but not necessary for basic subsistence, such as travel, recreation, and hobbies.

When planning for retirement living, if fixed costs can be met by Social Security and other annuitized income sources, other private savings and investments can be earmarked for the discretionary portions of the budget. And, if the risk of the annuitized income sources can be lowered, the remaining portion of investments can be invested more aggressively to take advantage of the long-term, potentially greater, returns offered by the stock market (e.g., using an insurance company immediate annuity).

A few years ago when stock market investments were clipping along at 20% or more per year, the returns offered by an immediate annuity seemed paltry by comparison. A total return approach was feasible by selling off investment assets to provide income. In a down market, selling assets becomes an expensive proposition as more have to be sold for lower prices in order to meet income requirements. In this case, if high cash balances have been maintained, the annuity income stream can be generated by liquidating cash and holding the more risky portion of the portfolio in equities, allowing it to recover over time as the economy and the markets turn to the positive.

Although the insurance company guaranteed approach is appealing, there are both good and bad points to consider. In the latter case, the decision to enter into a contract with an insurance company is irrevocable. Second, since these annuity payments are fixed, it’s important to consider inflation. Fortunately, many companies are now offering riders with cost-of-living increases.

On the plus side, income can be guaranteed for life. When non-qualified funds are used to purchase the annuity, only a portion of the payments are taxed, providing significant tax advantages. Finally, the older the annuitant, the greater is the return/payout.

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.

Children and Money

by Wendell Cayton

Our children hold our economic future in their hands. As frightening as that may seem, the fact is how they learn to handle money and how they learn to save (rather than spend) will shape the ultimate financial success of our retirement years.

If they learn to save rather than spend, interest rates will stay low and the stock market will remain strong. If they learn self-reliance they will be a productive economic force rather than an inflationary drag on society, all of which makes our retirement savings more valuable.

As a society steeped in the virtues of higher education and entrepreneurial spirit we are poised to put vast stores of wealth into their hands. For example, a child born today, whose family is fortunate enough to save $5,000 per year for the next 18 years in preparation for college, at age 18 will have more than a quarter of a million dollars to manage!

But that is just a small piece of the pie. The younger generations are expected to inherit more than10 trillion dollars from their parents’ estates within the next forty years. That wealth can either be productive or destructive . . .depending upon their management skills!

Fortunately there are some excellent resources available for both parents and children to learn money skills.

Willard Stawski, a stockbroker in Grand Rapids, Michigan, developed a system to teach children money management skills, The Cash University Money Management for Kids. It’s a kit that includes an audiotape explaining the program and various tools such as an Allowance Calculator, an erasable board with a section to list chores for making money and a section for negative behaviors that lead to deductions. The child receives his own checkbook, which can be used to write a check to a parent for an immediate cash need and to track funds. In addition, there is a College Savings Board to list special chores for the child to earn college education funds. The kit is targeted at kids ages 4 to 9 and sells for $24.95. Contact: phone (800) 209-4800 or www.cashuniversity.com.

If you want to put that home computer to use for something besides games and email, here are a few Web sites that teach children and young adults about money and investing.

• Investing for Kids is a site designed by kids that covers a wide variety of topics. It is divided into three levels: beginner, intermediate and advanced. It features a nifty stock market game as well as a bulletin board for questions and comments.
  
• Kids Bank.com was developed by a bank and teaches about money and banking through the use of cartoon-like characters. This is a great spot to start the younger set learning about money, where it comes from, and how it works.
  
• Young Investor, (this site is no longer available) teaches the basic concepts of investing through various character guides, from which the child can choose. It contains a handy library with financial articles and a dictionary of financial terms, as well as tips for parents on how to teach their children about investing.
  
• Independent Means is a site targeted at girls under 20. The content focuses on entrepreneurial as well as investment skills. The emphasis is to teach financial self-reliance to young women. A feature on the site that I found especially meaningful is a book titled No More Frogs to Kiss by Joline Godfrey (Harper Business) which discusses 99 action plans to financially empower girls. This is a must–visit site for parents and their daughters!

Harry Dent, the often-quoted author of “The Great Boom Ahead” and “The Roaring 2000s”, has forecasted a sharp drop in the stock market sometime after the year 2010 as baby boomers stop saving and investing and begin spending. The X factor in his predictive models is our children. Will they be productive? Will they be savers and investors? Will they handle their money, and that which they inherit from us, wisely? If they do, the severity of Dent’s predicted down market will be greatly reduced to all of our benefit. Therefore it makes sense to invest in educating our children now . . .they are our future!

Divorce is a Taxable Event

Divorce, better known as the instant wealth reduction plan, hits about half of all first marriages and more than 60% of second marriages. Few things will stir emotions more in the settling of a dissolution case than the issues surrounding child custody and support.

Over the years, courts and families alike have become more civilized and sensitized to these issues, as dissolution agreements have attempted to craft solutions that seem fair and equitable to all. Unfortunately, fair and equitable sometimes doesn’t always work when money is involved.
A dissolution agreement that awards joint, physical custody and support responsibilities to both parents can work against the children when it comes to obtaining financial aid for college. If both parents share these responsibilities, typically, the joint incomes and assets of two separate households will be counted when the colleges compute the Family Expected Contribution amount. This effectively reduces the amount of aid available.

For example, assume a situation where the non-custodial parent has a much higher income than the custodial parent. Assume the divorce agreement specifically excludes the higher income parent from any responsibility for college support. As a result the two children would qualify for financial aid based upon the much lower income of the custodial parent. This would result in more financial aid than would otherwise be available if both incomes were used to calculate aid eligibility.


In a recent tax court case, a divorced couple shared support and custody of their one child. The IRS challenged their respective tax returns on the basis that both parents claimed an exemption for the child, claiming that each supplied one half of the support.

The IRS denied the dependency exemption for both parents because neither could prove that the child had spent the greater portion of the calendar year with either.
The divorce agreement provided for joint custody of their child, with physical custody split equally between the parents on a weekly basis.

In the case of split custody where neither parent could prove to the court’s satisfaction that that parent had provided more than one half of the physical custody, their documentation and testimony would not be convincing enough. In an understatement of confusion, it would be sheer unguided guesswork for the court to find otherwise. As a result the exemption would be denied.

This loss of taxable benefit could have been avoided if the parents had agreed to a specific number of days, even to the extent of alternating years taking the dependency exemptions. Another viable alternative would be for the parties to bargain for a more generous settlement that allows the other to claim the exemption every year.