Hugh F. Doherty, DDS, CFP
Married couples who leave everything to each other may be making a very expensive mistake. When the surviving spouse dies, his/her estate, including what was inherited, will be fully subject to estate tax. However, the Applicable Exclusion Amount (AEA) allows money to be left to beneficiaries free of federal estate tax. Married couples should divide property so that each person can take advantage of the AEA. For 1998, the AEA is $625,000. By 2006, it will rise to $1 million.
If either spouse`s estate exceeds the AEA, use a Credit Shelter Trust plus a Marital Trust in your estate plan.
- The Credit Shelter Trust should cover everything up to the maximum AEA. Trust assets will be taxed neither when the first spouse dies nor upon the surviving spouse`s death.
- Put the remainder of the estate into a Marital Trust, which also is not taxed upon the death of the first spouse. When the surviving spouse dies, only the amount in excess of the AEA is taxed before it goes to the beneficiaries.
You should choose mutual funds ...
- If you don`t have the time, the interest, or the ability to pick stocks.
- You only have a few thousand dollars to invest ... or want to invest additional small amounts regularly. Stock transition fees from even the cheapest brokers will eat up your profits if you invest less than $1,500 at a time.
- You want the benefits of diversification, but you don`t have enough money to acquire a large portfolio.
Go for individual stocks if ...
- You have the time, ability, and self-confidence to research and choose your own investments.
- You want to control exactly how your money is being invested.
- You don`t want management fees.
Beware the tax trap on unpaid debts
New regulations allow banks to contact the IRS if you have been delinquent on credit card or other payments for six months. Example: If you fail to repay a credit card debt of $600 or more, the bank notifies the IRS and sends you a 1099C tax form, requiring you to report the unpaid debt as income and pay taxes on it. If you do not report it as income, the IRS can come after you. Whether or not you report it, the bank can demand payment unless you are insolvent or file for personal bankruptcy. If you fall behind in payment, contact lenders to work out payment terms.
Real estate investment trust funds
These funds (REITs) are less attractive now than during the glory days of 1996-1997. They own everything from mental-health facilities to casinos, so only a small part may actually be in real estate, and tax benefits that led to their popularity may be abolished. Reduce exposure in your portfolios to 3- 4 percent.
These funds are ideal for assets not in retirement accounts. Our clients often ask where to place their personal savings. Tax-efficient funds would be an excellent choice. The tax code is more complicated for fund investors because of different capital-gains rates for different holding periods. If you have had success in the fund market over the past decade, distributions each year are getting bigger, as are the taxes. In the new breed of tax-efficient funds, the portfolio manager is shouldering some of the responsibility for minimizing the tax burden on shareholders. One way managers do this is by holding down portfolio turnover and investment growth, not dividends. Another strategy they use is tracking both winners and losers in the portfolio. When the fund sells off some winners, it sells off some losers as well. That way, the gains and losses are balanced inside the fund ... then there is no taxable distribution to shareholders.
Vanguard offers three of the lowest-cost, no-load tax-efficient funds:
- Vanguard Tax-Managed Fund Balanced Portfolio. Minimum initial investment: $10,000. Performance: 16.53 percent
- Vanguard Tax-Managed Fund Capital Appreciation Portfolio. Minimum initial investment: $10,000. Performance: 27.22 percent
- Vanguard Tax-Managed Fund Growth and Income Portfolio. Minimum initial investment: $10,000. Performance: 29.69 percent.
Hugh F. Doherty, DDS, CFP, is a national lecturer, financial advisor to the health-care profession and CEO of Doctor`s Financial Network. For personal financial consultations or to have Dr. Doherty speak to your study club or dental society, call (800) 544-9653.