February 16, 2012

The Truth About Debt Consolidation Programs


"Owe no one anything, except to love each other, for the one who loves another has fulfilled the law. " - Romans 13:8

"Do not be among those who give pledges, among those who become sureties for debts. If you have nothing with which to pay, why should he take your bed from under you?" - Proverbs 22:26-27



One of the biggest challenges individuals and families at every economic level have is living “within their means”. In the United States, more than 40% of families spend more than they earn. Credit card debt continues to be a major stumbling block for many individuals and families. Also, the number of personal bankruptcy filings has increased by more than 200% during the past ten years. [Keown, Arthur. (2004). Personal Finance. NJ: Prentice Hall]

It is amazing how families can go on in life, spending more than what they earn. Mathematically it does not add up. However, for a country that has shifted its focus from a producing/manufacturing country to a consumer country we needed to find a way to break the basic accounting formula of 1 + 1 = 2 and Assets - Liabilities = Equity. The solution, facilitate consumer credit and relax the requirements that were needed to qualify for such credit. Now even teens are provided with credit cards, the more the merrier! See by facilitating the access to credit cards, our impulses to purchases something are no longer controlled by the fact that there is no money in the bank account to cover such expenditure, now we just charge it and we worry about the payments later. You go back to jobs that many times people go just for the paychecks so they can go and pay their consumer debt. The process continues in a never ending circle. This way they keep us like hamsters running in the hamster wheel; The birth of a consumerist society.

During one of my readings on the subject of consumerism and debt slavery, I came across of a blog by Stiff Kitten written in May 2010 "Consumerism - enough is enough". I will share a short synopsis about it:

"There are true needs and false needs – but only false needs need to be manufactured and nurtured. Indeed, today’s consumerist society has more or less turned Maslow’s hierarchy on its head. According to Maslow, people should be satisfied when they reach the top of his pyramid-shaped hierarchy of needs, but in modern consumerist culture and society there can be no satisfaction of needs. Consumerist society never satisfies, indeed it is meant not to do so, as any form of satisfaction is an enemy of the consumerist, capitalist society – a society that requires the persistent buying of things we don’t need for its continued existence – what is usually referred to as “growth”."["Consumerism - enough is enough". Stiff Kitten's blog. May 9, 2010. Retrieved February 15, 2012.]

This buying trend is influenced by the saturation of advertising; new offerings from banks (loans and credit); the false perception of immediate gratification; and the false illusion of achieving a better life by buying more and bigger things that we do not need with money we do not have.

The U.S. has 5% of the world's population but uses 50% of the world's resources and creates 30% of the world's waste. The average American consumes 50% more than they did only 50 years ago and, according to author Annie Leonard, 99% of the items bought by consumers are no longer in use after only six months. This type of behaviour is financially and environmentally irresponsible and unsustainable, which is bound to cause havoc in our homes and society.

Now, what all of this has to do with debt consolidation programs. Everything as I will address shortly.

Debt consolidation programs do not address the root of the problem. It is just a band-aid on a blood gushing wound. Many families are lured into this programs as the "easy way out" of the problem and they will soon realise that it is not. True debt management and reduction requires work and discipline. Debt consolidation by itself does not reduce your debt nor addresses the problem, so even if you succeed and pay off your debt, unless you make a change in your behaviour regarding debt you will end up in the same problem shortly.

The solution for true debt reduction is taking responsibility and not by looking for the "easy way out". You need to be willing to work and sacrifice in order to fix the situations that you created with your own irresponsibility. If you are not willing, then you cannot be helped. You must address the behaviour that got you into the mess.

February 10, 2012

You May Miss a Great Opportunity if You Don't Act Now

Last week I wrote about wealth transfer strategies you should consider in 2012. I believe that many families, unless they take action soon they may miss a great opportunity. I do not think that families are understanding the tax legislation wave coming to us in 2013. Maybe the focus right now is the elections.

Just to give you a short summary of tax changes scheduled to kick in with the coming of the new year in 2013 (here I am only covering federal tax legislations, to which you need to add the tax increases of states and cities in your particular area):

- Capital gains tax is scheduled to rise to 23.8% from 15%

- Dividend tax is set to rise to 43.4% from 15%

- Estate and gift tax will rise to 55% from 35%

- Estate and gift tax exemptions are going from $5 million back to $1 million

Regardless of your current tax levels, it is important that you review your current tax situation and meet with your tax advisor to determine how the new tax legislations will impact you. Today I will share with you a much simpler strategy you can implement this month. IRA conversions to Roth IRA. This continues to be an overlooked strategy and I will share with you two good reasons why you should take a closer look at Traditional IRA conversions.

1. In the past, Roth IRAs were capped at $100,000, but that ceiling was lifted in January 2010.
2. You can make contributions past age 70 ½ .

If you are in a situation where you don’t expect your tax rates to go down at retirement, 2012 may be the perfect time to leave your traditional IRA, pay the taxes, and convert the assets into a Roth IRA. Here is why:

1. Assets are currently depressed in value.
2. Lower current tax rates compared to the expected increases in tax rates as shown above, now is a good time to take the conversion tax hit now.

Once you complete the conversion your assets will not only grow tax free but then allow for tax free withdrawals at a period of time when you will probably be paying a much higher tax rate. By doing this you are in essence converting your traditional IRA into a dynastic vehicle by paying the taxes now in a low-tax environment, thus passing the Roth IRA on to your heirs, where the assets can grow indefinitely at a tax-free rate during the heirs’ expected lifetime and be drawn down, as needed, without the heirs paying any taxes.

However, before you go and make any rash decisions you need to take into consideration at least your liquidity and your needs during retirement. The best thing to do is to visit with your tax advisor to crunch the numbers to see if it makes sense in your particular circumstances.

February 4, 2012

Wealth Transfer Strategies for 2012

The preservation of a financial legacy in a efficient manner has always had its level of complexity due to the uncertainty of future transfer-tax laws which may tempt many people to put their wealth-transfer planning on hold. This can end up being costly to many families that our the fear of the uncertainty wait and decide for no action. However, strategies to pass wealth to future generations and to fund your desired missions can be put in place at little or no tax cost to the grantor.

The tax theme for 2012 is filled with uncertainty. There are concerns about whether the Bush-era tax cuts will expire at the end of this year. One of the main areas of discussion for this year are the estate tax, the lifetime gift tax and the generation-skipping tax. Currently they are set at $5 million. However, unless there is a change to the law before the end of the year they will be reduced to $1 million. There are also concerns about increases in taxes on capital gains and dividends.

This year will be critical in the implementation of wealth transfer strategies while the current law is still in effect. When the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 was signed into law, it  reunified the gift and estate tax exclusions, enabling individuals to transfer up to $5 million tax-free, which can be applied either to lifetime gifts or to amounts passing at death through an estate. The Act went even further by allowing for “portability” between spouses, so any unused exclusion amount may be transferred to a surviving spouse. Also, the Act increased the Generation Skipping Transfer (GST) tax exemption to $5 million. Finally, any transfers above the $5 million has a top tax rate of 35%, instead of the previous top rate of 55%. As you can see, this year offers a opportunity to transfer more wealth tax-free and pay a substantially lower rate for transfers above the transfer limits.

Keeping a current wealth management plan is critical to protecting wealth through changing tax environments. The following solutions offer particular advantages under the current law for individuals who are looking to tax-effectively transfer their wealth. Here are some tips for your consideration in 2012:

1. Make Lifetime Gifts - With the current higher transfer threshold available, more assets can be transferred tax-free. By transferring those assets now, any future appreciation of those assets will be removed from the estate as well. Here are a couple of ways to accomplish this:

* Utilize the annual gift tax exclusion - This is a simple way to transfer $13,000 to as many recipients ($26,000 for married couples) without reducing your $5 million threshold.
* Pay for others' medical and educational expenses - as long as the payments are made directly to the providers, this transfer of wealth does not count towards the $13,000 annual gift tax exclusion nor the $5 million lifetime transfer exclusion.

Note: Please remember that gifts are irrevocable. Gift decisions must be done after careful analysis and consideration: Are the beneficiaries ready to manage the gifted assets responsibly? Will there be other beneficiaries to consider in the future? Are the grantors comfortable living with their remaining assets? 

Because future tax law changes are always unpredictable, making gifting decisions solely for tax reasons without considering family issues can result in an undesired outcome, especially if future tax law is more favorable than expected.

2. Use a GRAT -  A Grantor Retained Annuity Trust (GRAT) is an irrevocable trust that can allow individuals to transfer the appreciation of assets to heirs free of gift tax. GRATs are particularly attractive for individuals who have assets they believe will significantly appreciate and who would like to remove this appreciation from their estate.

The grantor transfers assets to the GRAT and, in turn, receives an annuity paid from the trust over a specified term. Generally GRATs are set up so that the annuity payments to the donor equal the amount of assets originally transferred into the GRAT, plus an assumed rate of return that is established by the IRS, known as the “hurdle rate” (this technique is called “zeroing out”). At the end of the GRAT’s term, any appreciation of trust assets that exceeds the IRS hurdle rate passes free of gift tax to the beneficiaries.

Note: The environment for GRATs is especially advantageous because the IRS hurdle rate is just 1.4% (IRC 7520 rate as of February 2012). Since any appreciation above the hurdle rate amount transfers tax-free to beneficiaries, the lower the hurdle rate, the higher the potential amount transferred to beneficiaries. 

3. Get to know more about Charitable Lead Annuity Trust (CLAT) - CLATs can be used to leverage your charitable contributions to shift wealth to family members in a tax-efficient manner. A CLAT can be funded either during the your life or upon death as a testamentary transfer. As a split-interest trust, a CLAT names two beneficiaries. The charitable lead beneficiary, receives a fixed annual annuity payment throughout the term of the trust. At the end of the trust term, the assets remaining in the CLAT are then distributed to one or more noncharitable remainder beneficiaries―typically the grantor’s children or family members.  


Note: CLATs generally are more efficient as long-term vehicles; they tend to work far better in low-interest-rate environments, and should be well diversified.
When considering a CLAT three fundamental questions should be addressed;
What is the optimal trust term? ; How should the assets be allocated?; Are they advantageous only in low-interest-rate environments?

4. Consider a Dynasty Trust - Some states will allow you to establish a trust that exist in perpetuity, called Dynasty Trusts. The main attraction of these trusts is that assets placed in the Dynasty Trusts pass from one generation to the next free of estate tax. Also, if individuals elect to apply their gift and generation-skipping transfer (GST) tax exclusion, they will not be subject to gift tax when funding the Dynasty Trust.

The GST tax is a federal tax that was designed by Congress in 1986, to prevent people from being able to avoid paying estate taxes. Generally, as property is passed down from generation to generation, an estate tax is imposed on the value of the transfer. For many years, people were able to get around paying this estate tax by instead of transferring their property to the next generation, usually their children—they would “skip” this generation—and pass it to the following generation, usually their grandchildren.

As part of the Obama administrations Tax-Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, the GST tax was taken away completely.  However, in 2011,  the GST tax returned at 35% to the Bush tax-cut levels; the GST exemption is inflation-indexed for 2012. However, as scheduled, the GST tax will rise again to pre-2001 levels in 2013: A 55% tax for any part of a transfer made that is valued at over $1,000,000.

Note: A Dynasty Trust is most effective if grantors have not already depleted their GST tax exemption. By allocating the GST exemption to the trust, the grantor can avoid the imposition of significant GST taxes on distributions to beneficiaries. Also, individuals who made gifts directly to grandchildren in 2010 to take advantage of the 0% GST tax rate must opt out of the automatic allocation of the GST tax exemption on their gift tax return. 

Like with all tax planning strategies, consult with your tax advisor about how to utilize the available vehicles to most efficiently transfer wealth to your desired destinations. With current tax laws set to expire on December 31, 2012, now is a good time to review your estate plan.