Smart Money: Debt can be useful, profitable tool

Dear M.S.: If you have a high interest rate, I would continue to do what you are doing or, considering your substantial income, look for a new mortgage. On the other hand, if you have a competitive rate – less than 6.5 percent – I would not even consider paying off the mortgage by midyear. For one thing, it will take away your tax deduction. And you could have invested the money and had a substantially higher return. I think it’s terrific that you’re investing her entire income, but it should be saved in a more traditional way – say, one or more of the markets in a balanced portfolio. Somewhere along the line, we picked up the idea that debt is a bad thing, and it is not. Debt is a useful tool and, if used properly, can be a profitable one. Abused, of course, it can be devastating.

Monetary gifts and taxes

Dear Bruce: I am confused about the gift tax and lifetime exclusion. My mother left annuity and life-insurance policies totaling $180,000 to my 91-year-old aunt. She doesn’t want or need the money and wants to gift it to me. I understand there is a $12,000-per-year, per-person gift amount that is tax-free. But a larger sum has to be reported to the IRS, and then is it applied toward the $1 million lifetime gift-tax exclusion? Does that mean there would be no taxes owed, regardless of how long she lives? I have not received any gifted money from her before. I have heard conflicting stories about whether she will owe taxes on the money she has gifted beyond the $12,000-a-year limit. – S.V., via e-mail

Dear S.V.: We need to straighten out a couple of things here. First, the lifetime exemption is $2 million, not $1 million. This means that you can claim against that number and be able to give away assets to be credited against the exemption. Not a hard thing to work out. Your aunt can give you the annual amount of $12,000 a year without any taxable event, and if you are married, $12,000 to your spouse if she chooses. At 91, the lady will probably not live enough to convey all the money to you. She could, of course, just leave the money in her will or claim against her lifetime exemption and give it to you now. I would have an accountant handle the paperwork.

Aggressive education planning

Dear Bruce: I have a nephew who will turn a year old this month. I’m thinking about getting him a savings bond an interest-bearing savings account, making biweekly or monthly deposits until he is 18. Which is the better choice? – A.W., via e-mail

Dear A.W.: I certainly salute your affection for your nephew, but I can’t say much positive about either of your choices. Right now, savings bonds and savings accounts produce almost no income. I think a far better choice would be one of the 529 education plans, in which you have full control over the money until such time it can be used for college. In these plans, you can choose more aggressive forms of investment than just interest, which today is almost nonexistent. You may have to come up with a minimum of $1,000 to enter these plans. Do the homework and find out what’s available.

Never too young to learn

Dear Bruce: My son is 16 years old. He has a part-time job and goes to school. I want to know where he can invest a small amount of money so that he will have a good nest egg, maybe even a million dollars, by the time he retires. How much does he have to save each month for that investment? – C.T., via e-mail

Dear C.T.: I wouldn’t worry about making your son a millionaire. If he works hard and saves hard, that will be up to him. The big thing now is to get him in the habit of investing a small amount of every dollar he earns. If someone had taken the time and the energy to teach more people this lesson early on, most would be very comfortable at retirement. A number of securities can be purchased directly from companies in small amounts. A quick trip to the library or the Internet can alert you to hundreds of companies. Not only would your son be saving, you’d also be encouraging him to invest in the stock market, which will be invaluable later in life.

Conservative approach not a given

Dear Bruce: My wife and I are both 60 years young. We own our home and have little debt, only a car payment of $400 per month. Our major monthly expense is $650 for health insurance. I will be getting Social Security in the fall. My wife worked part time as a nurse for 30 years, and she will be collecting Social Security this summer. Retirement income is $2,700 a month. We are heavily invested in the stock market, with mutual funds worth $280,000 and individual stocks valued at $250,000. We have additional investments in certificates of deposit, savings, life-insurance annuities, etc., totaling $60,000. I think it is time to move toward a more conservative portfolio. What do you think? – B.S., via e-mail

Dear B.S.: There are many people in the investment business who believe that a more conservative approach is called for as one matures. If you subscribe to that theory, the portfolio you have articulated seems OK to me. If you’re more comfortable with less risk, make the switch.

Exaggerated expectations

Dear Bruce: My wife and I have several accounts in different banks. We are in our 80s. One of our insurance agents wants us to take this money and invest in insurance accounts that will double the guaranteed interest payments we are receiving from the banks. We are not sure which way to go. We want to protect our principal. – T.P., via e-mail

Dear T.P.: The likelihood is that the salesman is trying to persuade you to invest in some kind of annuity. Annuities return a little higher percentage rate, but oftentimes, the salesman (not financial adviser) tends to exaggerate the amount of the return. The annuity is nothing more than a contract between you and a company, and there is a possibility that the company could go broke. I’ve never been a big fan of annuities, as many readers know. If you were younger, it might be what you are looking for; but in your senior years, there may come a time when you’ll need to get at that money – and most annuities come with heavy early-withdrawal penalties.

Talking tax-free bonds

Dear Bruce: I am considering putting a large portion of my portfolio into short-term, triple-tax-free bonds, but I understand there is a portion that is taxable. Can you explain what that means? – L.S., via e-mail

Dear L.S.: Triple tax-free means that if the bond is properly purchased in your state, there is no state, local or city tax on the interest. The portion that may be taxable depends on your income and other investments and may be subject to the alternate minimum tax. Before you buy the tax-frees, there are two things you should consider.

First is the alternate minimum tax, and that would require a tax professional to figure out whether there would be some penalty because of your current situation.

Second, one reason people buy tax-frees is that they are “guaranteed and insured.” While I believe the insurance companies are going to survive the subprime crisis, many of them are on the hook for billions of dollars for other investments that have gone south, which they have to pay off. A lot of folks have rejected tax-free bonds on the basis of this insecurity from the insurance companies, which, in turn, has not had a good effect on the tax-free resales at the current time. Personally, I would not avoid them because of the insurance companies, but I most surely would have a competent tax professional determine whether you will have an alternate-minimum-tax liability.

Cash in on whole life

Dear Bruce: I am a recently divorced mother with two small children. I currently carry $100,000 in term life and $50,000 in whole life, but I am having trouble making the premium payments. Should I cut back on either of these? If so, which one? – Reader, via e-mail

Dear Reader: If you’re struggling to make the premiums, you should retain the term insurance and cash in the whole life. While it may have better long-term benefits, whole life is far more expensive from the out-of-pocket perspective in the short term.

Interest-only debate

Dear Bruce: My fiance bought a house nine years ago for $185,000 and has an interest-only mortgage. The house is now valued at $245,000. We want to purchase another home in a few months and have been disagreeing about what type of mortgage to take out. I think an interest-only mortgage is a waste of money, since you get nothing back from it at the end. His argument is that it allows us to have more cash flow, and we are still gaining equity. What is your take on interest-only mortgages? – K.P., via e-mail

Dear K.P.: I suspect you and your fiance´ are relatively young. His argument that an interest-only mortgage allows you to have more cash flow is accurate to some degree, but as to gaining equity, that can be totally in error. He is assuming that the price of real estate always goes up and – as most of the country has learned – real estate goes down, too. In general, unless you are an astute businessperson and a professional in the real-estate industry, I believe there should be principal as well as interest on a mortgage.

Technically, I think your fiance is correct, but the reality is that it is not a good practice. The house has only gone up $60,000 in nine years, which is not a particularly high appreciating property. If you are as young as your letter indicates, now is not the best time to be selling this home. Unless it is going to bring a reasonable return, you should sit and wait.

Juggling an income reduction

Dear Bruce: My wife and I have a combined annual income of $100,000. She wants to return to graduate school for two years. This will reduce our income about $20,000. In addition, we have about $15,000 to our names. Our monthly mortgage is $800, and we have car payments of $350. We have no credit-card debt and are careful about our spending. With this loss of income, I’m concerned about our savings. Is there a formula for figuring this out? – Reader in Pennsylvania

Dear Reader: I can’t say definitively, but it seems as if you are living well within your means. Unless there are other expenses not articulated, I don’t see any reason your family can’t get along quite nicely on your income alone. Your retirement savings may suffer for a time, but it should be noted that a great many families, living on substantially less money and carrying debt similar to yours, are also preparing for their retirements. I can see no financial reason you folks shouldn’t proceed as you have planned, with no appreciable affect on your style of living.

Bruce Williams is a national radio talk-show host and syndicated columnist. He can be reached at bruce@brucewilliams.com.[[In-content Ad]]