Should you delay selling a stock to cut your tax? Comparing education IRAs and state-sponsored plans, Using pension contributions to buy life insurance, What the SEC requires an adviser to tell you, If a broker fails to abide by the golden rule, Steps to take in creating a custodial account, Using a bridge loan to make a down payment, When you purchase unregistered stock
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Q A stock I bought at 60 has gone up to 200 in less than a year. If I sell now, I'll have to pay tax at my regular rate (about 40 percent). I'm wondering whether to delay selling until my holding becomes long term and the profit will be taxed at the 20 percent capital gains rate. I'm not strong at algebra, so is there a simple way to figure how far a stock can drop and still leave me ahead?
A Yes, here's how to do it in five easy steps: 1. Subtract your cost basis from the stock's current price to get your profit if you sell now: $200 $60 = $140.
2. Figure your tax on this short-term profit: $140 x 40 percent = $56.
3. Subtract that from the total short-term profit to get your after-tax net: $140 $56 = $84.
4. Multiply by 1.25 (this factor stays the same, regardless of your other numbers): $84 x 1.25 = $105.
5. Add your cost to that amount: $60 + $105 = $165.
This is your breakeven point. If the stock's price is higher than $165 when you sell it as a long-term holding, you'll be better off than you would be by selling it at its present $200 price as a short-term holding. So you must judge the likelihood that the stock will fall more than 17.5 percentfrom $200 to below $165between now and then.
QAn insurance agent tells me that if a corporation uses part of its pension plan contributions to provide cash-value life insurance to participants, the corporation can deduct the premiums, but participants will have to pay tax on part of the cost. How is the taxable portion figured?
A Only the part of the premium that's attributable to "pure" (term) insurance protectionnot the cash-value portionis taxed as current income. The amount isn't based on the actual premium paid, but on a special table in the regulations that relates cost to agefor example, $4.42 per $1,000 at age 40, $9.22 per $1,000 at 50, etc. Suppose you're 50 and have a $100,000 policy with a cash value of $30,000 at year-end. The difference is $70,000, so your taxable income would be 70 times $9.22, or $645.40.
Despite the possible tax savings on premiums, many financial advisers would urge you not to use pension plan funds to buy life insurance. The increase in cash value is often glacially slow compared with other investments. And if you terminate your plan, you won't be able to roll over the policy tax-free into an IRA, so you may have to cash it in beforehand for substantially less than your cost.
Q I'm hunting for an investment adviser and plan to interview several with SEC registration. What information are they required to disclose?
A According to SEC rules, a registered adviser must give a prospective client a written statement or brochure describing his business practices as well as his educational and business background. It must disclose any financial conditions affecting the adviser that are "reasonably likely" to impair his ability to meet his contractual commitments to you, as well as all potential conflicts of interest. That includes any benefits he may receive from third parties as a result of his recommendations to you. The adviser must also reveal any legal or disciplinary events reflecting on his integrity. And if his annual fee is 3 percent of assets or higher, he must inform you if typical charges for similar services by other advisers are lower.
Generally, only advisers that have $25 million or more of assets under management register with the SEC. To do so, they must file Form ADV. The adviser can substitute Part II of the form for the statement or brochure mentioned above, since it covers the same ground. You should also request a copy of Part I, which describes the adviser's possible regulatory and financial problems. Ask for the accompanying schedules as well.
Q My broker gives me only three business days to deliver to his door securities or cash I owe. But when the shoe is on the other foot, I occasionally have to wait three or four times as long to get my money. Shouldn't I be entitled to the same treatment the broker expects from me?
A Brokerage firms must send funds "promptly" to customers following the settlement of a trade, but federal law and regulations impose no deadlines, according to the SEC. This enables a broker to make use of the sale proceedsyour moneybetween the time he gets it and the date you cash his check.
The broker may be tempted to stretch out the float period, but you can take steps to minimize or eliminate it. Some brokerage firms will immediately sweep your money into an account that earns interest, if you've set one up with them. You can then reinvest your funds at will or use them for other purposes simply by issuing a check, if the account (commonly called an asset management account) allows you check-writing privileges.
Alternatively, you can instruct your broker to transfer the sale proceeds to your bank by wire as soon as they become available. This should give you control of the money within four or five business days after the trade. Regular payments from retirement accounts, as well as dividends and interest on securities held by a broker, can also be handled electronically. If your broker won't cooperate, take your business elsewhere.
QA friend has suggested that I start a custodial account for each of my grandchildren. Can you fill me in on the key details?
A In most states, the law governing custodial accounts is known as the Uniform Transfers to Minors Act (or possibly the Uniform Gifts to Minors Act, an earlier version). As custodian under the law, you control gifts of money or securities made to a child until he or she comes of age at 18 or 21, depending on state law. Stocks or bonds should be registered in the custodian's name for the benefit of the child. Custodial accounts allow you to avoid the cost and administrative problems of a trust, while reducing your taxable estate. At present, yearly gifts of up to $10,000 per child (or $20,000 if the gifts are made jointly with your spouse) are tax-free. These figures are inflation-indexed.
To open an account, just ask your bank or brokerage firm for the proper form and turn over the cash or other assets. As a record for tax purposes, it's a good idea to establish a separate bank account to receive and disburse investment income and proceeds from the sale of assets. Remember, earnings are taxable to the parents of children younger than 14 or to the children themselves if they're older.
You may want to designate your spouse or some other adult as custodian instead of yourself. Otherwise, if you die before control of the account passes to the child, the account's value will be included in your estate. Bear in mind, though, that only the custodian can withdraw what you've contributed, so it's important to select a stand-in who's likely to carry out his or her responsibilities with integrity and good judgment and live until the child is of age.
Q I've found a house I'd like to buy, but I won't have the cash for a down payment until I sell my present home. Since sales in my area are slow, the real estate agent suggests I borrow against my existing home equity to get the down payment. Should I follow her advice?
A Maybe, but be sure you know what you're getting into. Lenders often put a six-month limit on such "bridge loans." Find out whether you can get an extension, in case your home sale doesn't close in time. You should also make sure the bridge loan will be large enough to see you through, in case you get less than you expect for the house you're selling.
If the amount you need plus your present mortgage debt total more than 80 percent of your home's value, some lenders will balk at making the loan. You'll also have to disclose this arrangement when you apply for the mortgage to buy the new home, so you may have to convince the prospective lender that you can fulfill all your obligations.
If you have sufficient cash on hand for at least a 10 percent down payment, you may be able to obtain the rest of the money via a first and second mortgage on the new property, instead of securing a bridge loan on your current home. Then you can pay off the second mortgage after you sell your home, without worrying about a deadline.
Q In order to buy stock in a privately held company that's not registered with the SEC, I've been asked to certify that my net worth is at least $1 million. Why should I have to do that, and will there be trouble if my net worth should drop below $1 million due to stock market reverses?
A Small companies can opt not to register with the SEC if they meet certain requirements. One is that some or, in special cases, all of their stock can be sold only to "accredited investors." You meet that standard if you (and your spouse) are worth more than $1 million at the time of the purchase, so what happens to your bank balance later doesn't matter.
Even if you're not that prosperous now, you're considered an accredited investor if your income exceeds $200,000 in each of the two most recent years (or $300,000, including your spouse's income) and you can reasonably expect to hit the same level in the current year. Keep in mind that these unregistered securities are "restricted," meaning they can't be resold for at least a year.
For more information about the SEC's registration policies and exemptions, go to www.sec.gov/consumer/search.htm and click on Accredited Investors, or send for the Commission's brochure, "Q&A: Small Business & the SEC." You can request it at the Web site, or by calling 202-942-4046 or writing to Publications Section, US Securities and Exchange Commission, 450 Fifth Street NW, Washington, DC 20549.
Q I contributed $500 to an education IRA for my daughter last year. Since I can afford more than that this year, I'm thinking of investing in a state-run college savings plan instead. What are the drawbacks to such plans, compared with education IRAs?
A With an IRA, you can generally invest your contributions where you please, whereas some college programs restrict your choices. Also, withdrawals from an education IRA escape tax when used to pay tuition and related expenses, but students pay tax on the portion of college-plan withdrawals considered earnings to the account.
However, if you want to claim a Hope or Lifetime Learning credit for the tuition expenses of a student who's the beneficiary of an education IRA, the student must waive tax-free treatment of withdrawals for that year. Similarly, you can't contribute to both a college plan and an education IRA for a particular student in the same year. So if you can afford to save more than $500 annually for your daughter's future education costs (and may The Force be with her if you can't), a college plan is probably the better alternative.
Do you have a money management question that may be stumping other doctors, too? Write: MMQA Editor, Medical Economics magazine, 5 Paragon Drive, Montvale, NJ 07645-1742, or send an e-mail to firstname.lastname@example.org (please include your regular postal address). Sorry, but we're not able to answer readers individually.
Lawrence Farber. Money Management. Medical Economics 2001;7:158.