July 14, 2011Vol 4, Issue 7
DFW Financial Planning

Jean Keener, CFPGood morning.


We have continued our roller coaster ride in the market over the last month.  Markets improved dramatically during the last week in June and first week in July as we received some encouraging news on the Greek debt crisis.  Then over the last week the S&P 500 retreated back to slightly lower than where it ended the quarter on renewed concerns about the economy, debt ceiling, and other issues.  You can see a full second quarter summary below.


While trying, it's especially important during these times to exercise discipline and stick with our long-term investment strategies. In case you're wondering about whether this is truly the best approach, check out the article below entitled Discipline: Your Secret Weapon.  Some of the findings may surprise you (or at least make you feel really smart if you were already aware of them).


I've received a lot of requests to hold the social security workshop again, so it's scheduled for this coming Tuesday July 21 and in October.  If you're over 55 and haven't filed for social security, this is a workshop you won't want to miss.  See all the details below. 


Also in this month's newsletter, we have an update on IRS mileage rates for the second half of the year, information on life insurance loans, and more.   As always, feel free to e-mail me at jean@keenerfinancial.com with requests for newsletter topics you'd like to see covered or to discuss concerns or questions on anything in the financial world.  Thanks, and Live Well.

In This Issue
Higher IRS mileage rates
Second Quarter Investment Recap
Investment Discipline: Your Secret Weapon
Estate Planning: ABCs of Trusts
Life Insurance Policy Loans
Maximizing Social Security Benefits Workshop
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Higher mileage rates for the second half of 2011
Keep financial records

Keep those mileage records!


The IRS has announced an increase in the optional standard mileage rates for the second half of 2011 for use in computing the deductible costs of operating a passenger automobile for business, charitable, medical, or moving expense purposes.  Effective July 1 through December 31 of 2011, the standard mileage rates are as follows:

  • Business use of auto: 55.5 cents per mile may be deducted (up from 51 cents per mile for the first six months of 2011) if an auto is used for business purposes
  • Charitable use of auto: 14 cents per mile may be deducted (remaining unchanged) if an auto is used to provide services to a charitable organization
  • Medical use of auto: 23.5 cents per mile may be deducted (up from 19 cents per mile for the first six months of 2011) if an auto is used to obtain medical care (or for other deductible medical reasons)
  • Moving expense deduction: 23.5 cents per mile may be deducted (up from 19 cents per mile for the first six months of 2011) if an auto is used to effect a work-related move to a new home
Second Quarter Investment Recap

Second Quarter Market ReportThe U.S. and many world market indices were looking at modest gains for the quarter until they ran headlong into the month of June, when a variety of concerns came together to drive prices lower pretty much everywhere in the world.  


In the U.S., the S&P 500 (large caps) fell 0.39% for the quarter, but is up 5.01% so far this year.  The Russell Midcap index was up 0.42% for the second quarter; up 8.08% for the first six months of 2011.  The Russell 2000 (small cap index) fell 1.61% in the second quarter; it was up 6.21% for the first half of the year.


Looking abroad, the MSCI EAFE index, which tracks a basket of developed-economy indices, was up 0.33% for the second quarter, up 3.00% for the year so far.  There are always lessons in the returns; the MSCI Europe index was up 0.78% for the quarter, and is up 6.71% in the first half of the year, when many analysts were betting on a decline due to the widely-publicized debt woes in Greece, and less dire sovereign debt issues in Ireland, Portugal and Spain.  The EAFE Emerging Markets Index, which measures the overall performance of less-developed nations, was down 2.11% for the second quarter, down 0.45% for the first half of the year.


In real estate, the Wilshire REIT index rose 3.64% for the second quarter of 2011, and is now up 10.62% for the year.


Commodities prices were almost unanimously down for the second quarter, led by energy (down 7.94%), agriculture (down 12.09%), livestock (down 9.80%), aluminum and nickel (down 5.32% and 10.32% respectively).  Gold was up a modest 4.29% to finish the first half of the year at a 5.42% gain.


Bond yields continue to scrape along the floor; you can get a 0.02% yield on 3-month Treasuries currently, 0.10% on 6-month government bonds, and the two-year (0.45%), three-year (0.79%) and 5-year (1.75%) are not dramatically higher.  The benchmark 30-year Treasury is currently yielding 4.36% a year.  


Where do we go from here? 


We have both near-term issues with the debt ceiling debate, and longer term economic recovery issues.


In the near-term, the August 2 debt ceiling deadline looms.  We don't know when or how any failure to reach an agreement may affect the markets in the short-term.  It seems likely that if investors begin to panic about U.S. debt, the effect would be substantial and swift across both stock and bond markets, international and domestic.  Of course we don't know if or when that panic might occur or the timing of a rally based on any encouraging news.  


For the longer term recovery issues, the U.S. Bureau of Economic Analysis reports that America's economy--the gross domestic product (GDP)--rose 1.9% in the first quarter of 2011, which is significantly less robust than the 3.1% growth rate reported for the fourth quarter of 2010.  If you've take a trip to the gas pump, you are probably not surprised that the inflation rate reached 3.9% in the first quarter. 


As you've no doubt read elsewhere, we are experiencing an unusual recovery from an unusual recession; in past economic downturns, the economy has come roaring back during the recovery, but today we are dealing with a more deliberate climb out of the hole.  A quarterly survey by the Associated Press suggests that the U.S. economic recovery will be slow and deep, held back by shoppers reluctant to spend and employers hesitant to hire.  A poll of 42 economists has concluded that economic growth will probably stay below 3% for the rest of this year and early next year, and their crystal balls say that the U.S. unemployment rate will end the year about where it is now: between 9.0% and 9.5%.  GDP growth would have to reach 5% for a full year to drive the unemployment rate down by one percentage point; 125,000 jobs must be added each month just to keep up with population growth.  


The other longer term headline-grabbing issue is housing.  A series of charts created by the web site NumberNomics.com makes clear that existing home sales, new home sales median new home prices have all been essentially flat since January of 2009.  But with interest rates at record lows, a new house is far more affordable today than it was in 2007; the site notes that the cost of purchasing a home is now actually lower in many sections of the country than what it costs to rent.  Distressed sales represented 31% of total sales in May, down from 37% in April--which is progress of sorts.


The rocky month of June, which started with six straight days of losses in the U.S. markets, is further evidence that even positive growth and positive returns don't guarantee a smooth ride.  The returns of the first half of the year have come with a certain share of anxiety, but it may be helpful to remember that the great returns of 2009 came at a time when many investors were living in a state of fear bordering on terror.  Let's count our blessings; the mild reversal of the past three months wasn't enough to offset the gains in the first quarter of the year for most of the elements in a diversified investment portfolio.


Quarterly market summary adapted with permission of Financial Writer Bob Veres.

Discipline: Your Secret Weapon

As all of us are bombarded by constant news of the the debt ceiling negotiations in Washington, debt turmoil in European countries, and the ploddingly slow economic recovery, the sense that we need to "do something" in response to the news can be powerful.  The more news we're exposed to, the more likely we are to feel compelled to act based on this information.  The following article by Jim Parker with Dimensional Funds provides compelling support for why we should resist the urge to act based on short-term financial news.  So while it may feel lonely or crazy to not be making investment moves right now, it's actually the smart move to exercise discipline and stick with our long-term strategy.


Discipline: Your Secret Weapon

by Jim Parker (used by permission)


Jim ParkerWorking with markets, understanding risk and return, diversifying and portfolio structure-we've heard the lessons of sound investing over and over. But so often the most important factor between success and failure is ourselves.


The recent rocky period in financial markets has brought to the surface some familiar emotions for many, including a strong urge to try to time the market. The temptation, as always, is to sell into falling markets and buy into rising ones.


What's more, the most seemingly "well-informed" people-the kind who religiously read the financial press and watch business television-are the ones who feel most compelled to try and finesse their exit and entry points.


This suspicion that "sophisticated" investors are the most prone to try and outwit the market was given validity recently by a study, carried out by London-based Ledbury Research, of more than 2,000 affluent people around the world.1


The survey found 40 per cent of those questioned admitted to practising market timing rather than pursuing a buy-and-hold strategy. Yet the market timers were more than three times more likely to believe they traded too much.


"On the face of it, you might think that those who were trading more actively would be more experienced, sophisticated and able to control themselves," the authors said. "But that seems not to be the case-trading becomes addictive."


This perspective has been reinforced recently by one of the world's most respected policymakers and astute observers of markets-Ian Macfarlane, the former governor of the Reserve Bank of Australia and now a director of ANZ Banking Group.  In a speech in Sydney2, Macfarlane made the point that the worst investors tend to be those who follow markets and the financial media fanatically, extrapolating from short-term movements big picture narratives that fit their predispositions. 


"Most people experience loss aversion," he said. "They experience more unhappiness from losing $100 than they gain in happiness from acquiring $100. So the more often they are made aware of a loss, the unhappier they become."  Because of this combination of hyper-activity, lack of self-control and loss-aversion, investors end up making bad investment decisions, Macfarlane noted.


These behavioural issues and how they impact on investors are well documented by financial theorists. Commonly cited traits include lack of diversification, excessive trading, an obstinate reluctance to sell losers and buying on past performance.3 


Mostly, these traits stem from over-confidence. Just as we all tend to think we are above-average in terms of driving ability, we also tend to over-rate our capacity for beating the market. What's more, this ego-driven behaviour has been shown to be more prevalent in men than in women.  A study quoted in The Wall Street Journal4 showed women are less afflicted than men by over-confidence and are more likely to attribute success in investment to factors outside themselves - like luck or fate. As a result, they are more inclined to exercise self-discipline and to avoid trying to time the market.


The virtues of investment discipline and the folly of 'alpha'-chasing are highlighted year after year in the survey of investor behaviour by research group Dalbar. The latest edition showed in the 20 years to the end of December 2010, the average US stock investor received annualised returns of just 3.8 per cent, well below the 9.1 per cent delivered by the market index, the S&P 500.5


What often stops investors getting returns that are there for the taking are their very own actions-lack of diversification, compulsive trading, buying high, selling low, going by hunches and responding to media and market noise.


So how do we get our egos and emotions out of the investment process? One answer is to distance ourselves from the daily noise by appointing a financial advisor to help stop us doing things against our own long-term interests.  An advisor begins with the understanding that there are things we can't control (like the ups and downs in the markets) and things we can. Some of the things we can control including ensuring our investments are properly diversified-both within and across asset classes-ensuring our portfolios are regularly rebalanced to meet our long-term requirements, keeping costs to a minimum and being mindful of taxes.  Most of all, an advisor helps us all by encouraging the exercise of discipline-the secret weapon in building long-term wealth.

1. 'Risk and Rules: The Role of Control in Financial Decision Making', Barclays Wealth, June 2011

2. 'Far Too Much Economic News for Our Own Good', Ross Gittins, Sydney Morning Herald, June 13, 2011

3. Barberis, Nicholas and Thaler, Richard, 'A Survey of Behavioral Finance', University of Chicago

4. 'For Mother's Day, Give Her the Reins to the Portfolio', Wall Street Journal, May 9, 2009

5. '2011 QAIB', Dalbar Inc, March 2011

ABCs of Trusts

ABCs of TrustsIf you're married, a combination of trusts, often referred to as A/B, A/B/C, or A/B/Q trusts, may be useful for estate planning purposes. The combination of trusts can sometimes be used to minimize total estate tax for two spouses, and can provide nontax benefits as well.

A federal estate tax overview

  • An unlimited marital deduction is generally available for transfers of wealth between you and your spouse.
  • Currently, an estate of $5 million can be sheltered by a $5 million basic exclusion amount and a tax rate of 35% applies to any excess. Any unused portion of the basic exclusion of a deceased spouse is portable and can be transferred to a surviving spouse. The $5 million amount will be indexed for inflation in 2012.
  • Absent further legislation, in 2013, the amount that can be sheltered is reduced to $1 million, the top estate tax rate increases to 55%, and the basic exclusion amount is no longer portable.

The A, or power of appointment marital, trust

The A trust is structured to qualify for the marital deduction. You give your surviving spouse a right to all of the trust's income for life and the power to appoint who receives the trust property at your spouse's death. You would typically fund the A trust (together with a Q trust, if desired) with the amount of your estate in excess of the applicable exclusion amount.

The B, or bypass credit shelter, trust

You would typically fund the B trust with an amount equal to the applicable exclusion amount, or credit shelter amount. You can give your spouse interests in the B trust, but generally none that would cause the trust to be includable in your spouse's estate for estate tax purposes (thus, the B trust bypasses your spouse's estate). You can name the persons who will receive trust income or other distributions from the trust. You can also provide that, at your spouse's death, the trust will continue for the benefit of, or be distributed to, your children or other beneficiaries. Or, you could give your spouse a limited power to appoint property among a limited class of beneficiaries, such as your children from your current marriage.

The C, Q, or QTIP marital, trust

The C or Q trust, typically a QTIP trust, is also structured to qualify for the marital deduction. You give your surviving spouse a right to all of the trust's income for your spouse's life. However, you retain for yourself the right to designate who receives the property at your spouse's death. This can be useful when you have children from a prior marriage who you would like to benefit after your spouse's death. You would typically fund the C trust (together with an A trust, if desired) with the amount of your estate in excess of the applicable exclusion amount.

Everything to spouse versus A/B trusts

Because the exclusion amount is higher and portable in 2011 and 2012, some couples may think they do not need A/B or A/B/C trusts. Everything could be left to the surviving spouse who uses both spouses' exclusions. However, there are still tax advantages to using this basic planning strategy as shown in the following example.


Example: John is married to Mary and has an estate of $10 million. Assume a $5 million basic exclusion amount that is indexed and portable and a top estate tax rate of 35%. John leaves $10 million to Mary at his death. The transfer qualifies for the marital deduction, no estate tax is due, and John's unused $5 million exclusion is transferred to Mary. Everything (except the unused exclusion) doubles in value. Mary's estate of $20 million is partially sheltered by Mary's applicable exclusion amount of $15 million ($10 million basic exclusion plus John's unused $5 million exclusion). After estate taxes of $1,750,000 are paid, $18,250,000 remains for John and Mary's children.


Assume instead that John leaves $5 million to Mary in an A trust and $5 million in a B trust for Mary and their children. No estate tax is due. Everything doubles in value. Mary's estate of $10 million is sheltered by Mary's basic exclusion amount of $10 million. No estate tax is due. The entire $20 million (the $10 million B trust plus Mary's $10 million estate) remains for John and Mary's children. By using the A/B trusts, estate tax has been reduced by $1,750,000, and the tax savings go to John and Mary's children.

Other trust benefits

The use of trusts can also provide other benefits, such as control over who receives your property and when, investment management of trust property for trust beneficiaries, avoidance of probate, and asset protection.

Life Insurance Policy Loans

Life insurance policy loansThe loan options available with a cash-value life insurance policy are often cited as a benefit of purchasing the policy.  However, it's important to understand the effects a loan can have on your taxes and the policy itself. 


Effect of policy loan on policy


 You can generally borrow an amount up to the policy's cash surrender value (less an adjustment for interest) from the insurer. The insurer will charge you interest on the loan. Generally, interest is not actually paid, but is added to the amount of the loan. Interest charged on a policy loan is not generally deductible for income tax purposes. There could be other adjustments as well under the contract; for example, a participating policy may restrict the payment of dividends to you while a loan is outstanding.


You are not required to repay a life insurance policy loan. But you can generally repay a life insurance policy loan at any time while the insured is alive. If you do not repay the loan, the cash surrender value paid to you or the policy proceeds at death will be reduced by the amount of the loan (plus interest). Thus, a loan generally reduces life insurance protection.


If the amount borrowed plus interest ever equals or exceeds the cash surrender value, the policy can terminate if additional amounts are not paid into the life insurance policy. Life insurance protection could be lost.


If you have any incidents of ownership in a life insurance policy on your life, proceeds paid at death are includable in your gross estate for federal estate tax purposes. The right to obtain a policy loan is an incident of ownership. Generally, life insurance proceeds received at death by your beneficiary are received income tax free.

Taxation of policy loan

You can borrow against your life insurance policy, and the loan proceeds are generally not taxable to you unless the policy is considered a Modified Endowment Contract (MEC). 


A life insurance policy purchased after June 20, 1988, is a modified endowment contract if the accumulated premiums paid at any time during the first seven years exceed the sum of the net level premiums for a policy that would be paid up after seven years. A single premium policy is one example of a modified endowment contract. A loan from a MEC is treated as a distribution from the MEC. A distribution from a MEC is subject to the income-out-first rule. As amounts are distributed, they are treated as consisting of taxable income to the extent that they do not exceed the excess of the cash surrender value of the policy over the investment in the contract (generally, premiums paid less tax-free distributions). The taxable income will also be subject to a 10% penalty tax unless the distribution is made after age 59, on account of disability, or as part of a series of substantially equal periodic payments.


Example:  You have a MEC with a cash surrender value of $100,000. You have paid premiums of $50,000. You take a policy loan for $60,000. The first $50,000 ($100,000 cash surrender value - $50,000 investment in the contract) of the loan is taxable income to you.

Lapse or surrender of policy

An outstanding loan is generally treated as an amount received if a policy lapses or is surrendered and may result in taxable income. A policy can lapse if premiums are not paid and the policy terminates when any policy benefits are exhausted as a result. Also, as noted above, if the amount borrowed plus interest ever equals or exceeds the cash surrender value, the policy can terminate if additional amounts are not paid into the life insurance policy. You can cash in a policy by surrendering the policy to the insurer in return for the policy's cash surrender value (as reduced by the amount of the loan plus interest).


If you surrender your policy to the life insurance company or the policy lapses, any gain realized is taxable at ordinary income tax rates. The gain is the excess of the amount you receive over the net premium cost. The net premium cost is the total premiums you paid less any tax-free distributions received. An outstanding loan is generally treated as an amount received if a policy is surrendered or lapsed and may result in taxable income.


Example:  You have a life insurance policy with a cash surrender value of $200,000. You have paid premiums of $75,000. You also have an outstanding policy loan of $175,000. There have been no distributions from the policy. You surrender the policy to the insurer for $25,000 cash. You have taxable ordinary income of $125,000 ($25,000 cash + $175,000 loan - $75,000 premiums). If you have not prepared for it, it may come as quite a shock.


Example:  You have a life insurance policy with a cash surrender value of $200,000. You have paid premiums of $75,000. You also have an outstanding policy loan of $200,000. There have been no distributions from the policy. The policy lapses. You have taxable ordinary income of $125,000 ($200,000 loan - $75,000 premiums). Once again, if you have not prepared for it, it may come as quite a shock.

Maximizing Social Security Benefits
Keller Public Library Free Financial Education SeminarsI am conducting my social security workshop on Tuesday, July 19 at 6:30 pm at the library.  If you are 55 or older, have not yet filed for social security, and have not yet attended this class, I highly encourage you to attend.
Attendees will learn:
  • 5 factors to consider when deciding when to apply for benefits
  • Why you should always check your earnings record for accuracy
  • How to coordinate benefits with your spouse
  • How to minimize taxes on Social Security benefits
  • How to coordinate Social Security with your other sources of retirement income

Most participants (even those already knowledgeable about social security) are surprised by some of the options they learn about in this class.


Registration is encouraged for planning purposes to library@cityofkeller.com.


Topics for the rest of the year:

  • August: Saving for college in Texas
  • September: Couples and Money
  • October: Maximizing social security benefits for baby boomers (repeat of July)
  • November: The Long Term Care Insurance Decision: should you buy it, and if so when, what kind, how much?
  • December: Structuring your retirement income (designed for those in or very near retirement)

Workshops are usually on the 3rd Tuesday of the month at 6:30 pm.  Please mark your calendars and tell your friends about ones that interest you.  The Keller Public Library is located at 640 Johnson Road.

I hope you found this newsletter informative.  KFP offers a free, no-obligation initial consultation to start the financial planning process for new clients.  To learn more or schedule a time, call 817-993-0401 or e-mail jean@keenerfinancial.com.
Jean Keener, CFP, CRPC, CFDS
Keener Financial Planning

Keener Financial Planning is an hourly, as-needed financial planning and investment advisory firm working with individuals at all financial levels.

All newsletter content except where otherwsie credited Copyright 2011, Keener Financial Planning, LLC.