Estate Planning

1. Estate Planning

2. Estate planning may be defined as: “the creation, conservation and utilization of family resources to obtain the maximum support and security for the family during life and after the death of the planner.”

3. Estate planning is used to prepare for the 3 major exigencies of life: • retirement • death • disability

4. Sources of income for retirement can be chosen from: • Social Security • personal investments • self-employed retirement plans • business (employer) retirement plans Social Security faces an uncertain future. Thus investments and work-related retirement plans are usually relied upon.

5. For Americans who live to the customary retirement age—65 years—life expectancy increases by about 15 additional years. A retirement plan must provide income for this length of time (18 years on the average). If there is a younger spouse, it will have to provide income for the spouse's anticipated lifetime as well.

6. A 25-year-old optometry student has a 25% risk of not living until retirement at age 65. Life insurance is customarily purchased to cover this risk.A 25-year-old optometry student has a 33% risk of being disabled for at least 3 months before age 65. Disability insurance may be purchased to provide for this eventuality.

7. Estate planning has become necessary because of the economic impact of: • an elevated standard of living (own a home, 2 cars, provide a college education to children) • inflation ($1 in 2009 was equivalent to 59¢ in 1989) • A heavy tax burden (April 13th was 2009’s "Tax Freedom Day").

8. The first step is to establish personal and economic goals, both short term and long term. The second step is to adopt an approach to estate planning that will realize these goals.

9. Estate planning is necessary to prepare for retirement, death, and disability. A time-tested philosophy is one which is based on 4 fundamentals: • adequate income • a home • a cash reserve sufficient to meet emergencies • affordable and comprehensive insurance protection Investment may be added to the plan after these 4 fundamental requirements have been obtained.

10. Once an estate planning philosophy has been adopted, an inventory of the planner's financial position should be taken, enabling the planner to determine the income that can be expected in the event of retirement, death or disability.The estate plan is then used to provide the desired financial security for these 3 eventualities.

11. Income may be divided into 4 basic types: • ordinary (taxed at rates of 10%, 15%, 25%, 28%, 33%, 35%) • capital gain (taxed at rates from 0% to 15%) • deferred (not taxed at the time it is earned) • exempt (free of income taxation) For estate planning purposes, the type of income most highly sought is “deferred”; retirement plans such as IRAs, 401(k)s, Keogh plans, and profit-sharing and pension plans are the usual choices.

12. As of 2007, the mean net income for all US optometrists is $131,197.However, solo practice is $134,094; partnership is $176,944; and group practice is $179,205.AOA surveys have shown that the net income of optometrists in private practice requires 9 years to reach the mean; that income continues to rise until 21 years in practice; and that it thereafter declines slowly until retirement.

13. Buying a home requires a sizeable financial commitment: investment of capital, mortgage payments, taxes, insurance costs, repairs, furniture and decorations, remodeling expenses.Homes usually appreciate in value, but over the past 2 years property values have dropped considerably. Homes can require an extended period of time to sell.The title to a home should provide for an undivided interest between husband and spouse; Tenancy by the Entirety and Joint Tenancy with Right of Survivorship allow each spouse to own 100% of the property. In such a case, creditors of one spouse cannot satisfy their claims out of the realty.

14. A cash reserve is used to provide financial security for emergencies. The rule of thumb is to devote 10% of netincome to a reserve until 6 months' worth of gross income has been accumulated. Cash reserves may be built using savings accounts, interest bearing checking accounts, certificates of deposit, or credit cards.

15. Savings accounts are one of the most common and most conservative types of investment. They offer a fixed (and modest) return but provide no capital appreciation and no protection against inflation. Interest rates for commercial banks are generally less than those for mutual savings banks or savings and loan associations.Certificates of deposit are a type of savings account that offers a higher return but less liquidity (early withdrawal results in penalty). Most savings accounts are insured by the Federal Deposit Insurance Corporation or the Federal Savings and Loan Insurance Corporation (up to $100,000).

16. Interest bearing checking accounts may also be used as part of a cash reserve but interest rates are typically low while account balance requirements are usually high.Credit cards can be used for emergencies, although they are not truly part of a cash reserve because the cash is borrowed and must be repaid at interest rates that are usually fairly high.Cash can also be stashed under a mattress or in a numbered Swiss account!

17. Affordable life insurance coverage is needed to: • pay for the costs of death, including estate taxes and costs of probate • create a "nest egg" for the surviving spouse or family • provide cash for the payment of a home mortgage balance • fund the buyout of a deceased partner's interest • secure credit for practice start-up or purchase

18. Life insurance coverage should provide payment equal to 5 to 7 years worth of gross income plus 5 to 7 years worth of debt.Disability insurance should provide coverage in the event of significant physical disability. Policies typically pay benefits as a percentage of the income earned prior to injury; this percentage can range from 50% to 66%, depending on the insurer.Group “income replacement” disability insurance can be used to protect against significant disability at reasonable cost.

19. Professional liability insurance should be obtained to protect against claims involving: • negligence • product liability • defamation • premises liability • vicarious liability (liability for employees) Coverage should be at least $1,000,000/3,000,000, although the cost of $2,000,000/5,000,000 coverage makes it easily affordable. Casualty and crime insurance should also be obtained to cover against the loss of office contents or theft. Replacement or extended replacement valuecoverage is preferred.

20. Personal insurance coverage is needed to protect: • health • home • vehicles Even for an associate, full insurance coverage costs can reach $10,000 per year. Thus choices must be made about the type and amount of insurance purchased, or which coverage to obtain as a benefit. Coverage amounts should be adequate and must be periodically updated.

21. Insurance coverage is not needed for the payment of educational loans in the event of premature death.That is because educational loans are forgiven if the debtor dies. The burden of payment is not passed on to the debtor’s heirs.

22. Once the basic requirements of estate planning have been fulfilled, investments may be considered. The usual choices are: • stocks • mutual funds • bonds • real estate • tax shelters Professional advice is needed to design a portfolio that meets the investor's objectives (i.e., growth or income).

23. The first requirement of investing is to have surplus capital, funds which are not needed for family obligations or the fundamentals of estate planning (home, cash reserve, insurance).A systematic savings plan is usually needed to produce surplus capital that can be used for investment.A long-term, well-balanced investment program will depend on the age of the investor, resources available for investment, investor's tax bracket, experience of the investor, and degree of risk the investor is willing to take.

24. There are a number of investments that may be considered by an investor: • savings accounts • payroll savings plans • municipal bonds • corporate bonds • stocks • mutual funds • variable annuities

25. Payroll savings plans automatically deduct money from an employee's salary for deposit in a savings program. Some companies offer 401(k) plans that provide options for saving or investing. Because these are deferred income plans, however, they have poor liquidity (there are penalties for early withdrawals).

26. US Savings Bond plans allow employees to make regular purchases of bonds; these bonds offer a fixed return and are non-marketable, but they are guaranteed by the US government and pay principal and interest at maturity; there are two types, series EE and series I. The series EE bonds cost 50% of face value and have a variable interest rate; the tax on the bonds may be reported and paid annually or in a lump sum when the bonds are redeemed (such as at retirement, when the taxpayer's income is usually less).Series I bonds are sold at face value, have a variable interest rate, and require that tax be paid each year.

27. For example, if a Series EE US Savings Bond worth $1,000 was purchased at the birth of a child in 1992, and held 18 years, it would now have the following value: • it would have initially cost $500 • it would have grown at an interest rate of 4% • it would have generated $764 in interest • as of 2010, it would be worth $1,264 (500 + 764) • it will reach final maturity in 2022 (30 years) • at final maturity it will be worth about $1,600

28. A bond is a contract between two parties where the owner of the bond is promised interest and principal payments in exchange for the money paid for the bond. The federal government, other government entities, and corporations sell bonds to raise money.

29. A straight bond is one where the purchaser pays a fixed amount of money to buy the bond. At regular periods, the buyer receives an interest payment, called the coupon payment. The final interest payment and the principal are paid at a specific date of maturity. For example, a $10,000 bond that pays $650 in annual coupons has a yield of 6.5%. At maturity $10,000 is paid to the bond holder. The total interest paid is $13,000.Income taxes are paid annually on the payment received.

30. Zero coupon bonds are unique. They are sold at a discount, pay no interest until they mature (usually after a long term, such as 10 or 20 years), and at maturity are worth the face amount. They are usually offered by the federal government, corporations, or municipalities.For example, a zero coupon bond worth $20,000 in 20 years will cost about $6,700 if it pays 5.5% interest.Income taxation depends on the type of bond—whereas government and corporate bonds are taxable, municipal bonds are not.

31. Municipal bonds are issued by states, counties, or cities to provide revenue for government; they provide a tax-free return, both for federal income tax and for state tax in the state of issue. They tend to be long-term investments. Because they are tax-free, the interest return on municipal bonds is generally less than for corporate bonds; for higher-income investors, this can produce a relatively high yield nonetheless.Example: for a taxpayer in the 28% tax bracket a tax-free bond paying 7% interest produces a return equal to a taxable investment with an interest of 9.5%.

32. Corporate bonds are issued by companies to raise revenue; they provide a stated interest and date by which they are to be redeemed for principal and interest.$626 billionof corporatebonds wereissued in2000. The better bonds are known as secured bonds, because they are backed by collateral from the company. Debenture bonds are less desirable because they are unsecured by assets.

33. Corporate bonds offer a fixed return that is higher than government bonds; these bonds can be traded at any time (there is usually excellent liquidity). The chief disadvantage is that the market value of these bonds will decrease if interest rates rise (because the interest rate of the corporate bond is fixed at issue). This effect can be offset, however, if convertible bonds are purchased. These bonds may be converted at the option of the owner to shares of stock in the corporation. These shares of stock can then be sold at increased value if the company prospers and the value of the stock grows.

34. Corporate bond interest is taxable. In addition, if a bond is purchased at discount (for less than its issue price), and held to maturity, tax must be paid on the difference between the purchase price and the price for which it is redeemed.Corporate bonds that are not convertible have growth potential only if interest rates decline (and thus are lower than the interest paid by the bond). As an investment, bonds are only as sound as the company that issues them. There is a system (A, B, or C) for rating bonds to guide investors.

35. Bond ratingsare based on the bond issuer’sability to make all payments ofinterest andprincipal in fulland on schedule.Ratings shouldbe reviewedbefore purchasing.

36. Unlike the preceding investments, stocks do not have a fixed return. They are added to investment portfolios because they offer growth potential. Corporate stocks provide ownership and hence the opportunity to participate in the company's profit or loss. Traditionally, stocks offer a higher return than bondsissued by the same company. There are two types of stock: preferred and common.

37. Preferred stock provides a fixed return (dividend), but there is no maturity date; if the company cannot pay a dividend (which must be paid out of profit), the stockholder in effect has a loss.Preferred stock is like a bond because its market value increases and decreases as interest rates change, but it is like a stock in that it requires earnings to pay a return (dividend).Convertible preferred stock may be converted to common stock. This option usually cannot be exercised, however, until a certain period of time has been reached or has elapsed.

38. Common stock has the greatest risk of loss and the greatest potential for growth. Stocks range in quality from "blue chip" to "highly speculative"; the mix of stocks in a portfolio depends on the degree of risk an investor is willing to take.Stocks offer two sources of income: dividends (return of profit) and increased market value due to success of the company (long-term growth). Established companies may offer excellent growth potential, but new businesses and industries are the usual source of high growth in stock value.

39. For example, 100 Microsoft shares bought for $2,100 at the company's initial public stock offering in 1986 became 3,600 shares worth half a million dollars a decade later in 1997. By 2006 the shares were worth more than $693,000.

40. The Dow Jones index was created in 1896 to monitor how selected publicly-owned industrial companies traded during daily sessions of the stock market. The first Dow average was $40.94.There are currently 30 companies that are monitored, but today only 10 are industries (e.g., General Electric), and the other 20 vary (including Bank of America, Wal-Mart, ExxonMobile, Pfizer, Hewlitt-Packard, McDonald’s, Microsoft, Walt Disney).

41. The New York Stock Exchange is the largest stock exchange in the world. Its trading floor is located on Wall Street, and it is where buyers and sellers trade stocks in publicly-owned companies. It began in 1792, and today it includes about 3,200 publicly traded companies.NASDAQ (National Association of Securities Dealers Automated Quotations) is the second largest stock exchange, only performs trades electronically, and features technology companies (Apple, Amazon, Google). NASDAQ began in 1971.

42. Historically the stock market has provided about a 10% increase in annual value—at least until the past 2 years! Note: the Dow Jones average did not break 1000 until 1966. It broke 10,000 in 1999.

43. Dow Jones Industrial Average 2007 to 2010 In July 2007 the Dow broke 14,000 for the first time, and in October 2007 it hit its all-time high, 14,164. In October 2008 it dropped below 10,000. In March 2009 it dropped below 7,000. In 2010, it has rebounded and for a time topped 11,000.

44. One Year Returns for the Dow Jones industrial Average (1928-2008) Stocks have delivered a positive return in 59 out of 81 one year periods (73% of the time). Five Year Returns for the Dow Jones Industrial Average(Five Year Periods Ending 1932-2008) If the holding period is five years, stocks delivered a positive return 92% of the time (71 out of 77 periods).

45. Mutual funds are open end investment companies. The investor who buys shares in a mutual fund often must also pay a “loading” or “sales” charge. Shares in a mutual fund are not traded on the market, but rather are purchased or redeemed by the fund company or through a broker.

46. The value of the shares is based on the success of the company, which invests the funds contributed by investors and—hopefully—generates a profit. As the market value of the securities held by the fund fluctuates, so does the value of the fund's shares. Thus, the purchase or sale of shares in the fund is often driven by economic changes in the marketplace.

47. Selection of a mutual fund is usually based on a review of the past performance of the company. Earnings over a period of years, long-term growth of the fund, and performance of the fund during "down" markets are the usual indices used by investors (data are available over the internet). For beginning investors, mutual funds with conservative, diversified stock or bond portfolios are usually preferred (there is less risk). The 25 Best Mutual Funds top picks for building a ByAndrew Tanzer, Senior Associate Editor, Kiplinger's Personal FinanceFebruary 2008EDITOR'S NOTE: This article is from Kiplinger's Mutual Funds 2008 special issue. Order your copy today. If you feel confused, even dazed, by the thousands of mutual funds available, you’re forgiven. But with the Kiplinger 25, we've screened this vast universe for you and picked the best stock and bond funds to help you meet your wealth-building goals

48. Example: The Baron Growth Fund (BDRGX) was launched in December 1994 and now has $4.9 billion assets under management. It is a no-load fund with an initial investment limit of $2,000. Its performance took a big dip in 2008 but it has recovered and the 2010 return of 18.77% compares favorably with the market average of 16.7%. Growth of $10,000 invested in 2000 in BDRGX—now $19,705

49. Variable annuities are a relatively new form of investment, often offered by employers as a benefit to employees, with both employer and employee contributing to the annuity. The money paid into the plan is used to purchase both fixed-return and growth-potential securities; at retirement, the plan pays a benefit for the remainder of the investor's life. The amount paid is based upon the success of the investment, and the cost of living (if it goes up, the annuity payment amount should go up, but if it goes down, so will the payment amount).

50. Investment information and advice may be obtained from a variety of sources. For individuals who seek to keep abreast of investing trends, there are various market letters (e.g., Kiplinger) that can be subscribed to, and comprehensive reports may be obtained from well-established companies like Moody and Standard & Poor.Brokerage houses offer investment services, including portfolio management. They are required to follow the rules and regulations of the stock exchange. However, brokers are paid to buy and sell securities, which may affect judgment.