Money Management

Diversifying bond maturities with mutual fund shares

Q What are the advantages of a "laddered" bond portfolio, and can I achieve them by investing in bond funds instead of individual bonds?

A Laddering—putting substantially equal amounts of money into bonds that mature at different times—dampens the effect of interest rate fluctuations, just as dollar averaging in stocks helps neutralize price fluctuations. You can obtain some benefits of laddering by purchasing shares in different mutual funds that concentrate on short-, intermediate-, and long-term bond holdings.

The SEC requires that a fund calling itself short-term must have a portfolio with a dollar-weighted average maturity of not more than three years; for intermediate-term funds, three to 10 years; and for long-term funds, more than 10 years. However, a fund can own some bonds outside these parameters, as long as it maintains the specified average. This means you can't be certain that any mix of bond fund shares will meet your particular maturity target, though it can come reasonably close.

A laddered portfolio of individual bonds has an additional advantage: If you need to sell some of them to raise cash at a time when the bond market is slumping, you can select the more profitable ones for sale and hold the others to maturity. When redeeming bond fund shares, you may be forced to swallow a capital loss if the market is against you.

Avoid mortgage insurance despite a low down payment?

QI'd rather not pony up a 20 percent down payment to purchase a new home. But the mortgage lender says that unless I do, I'll have to pay for private mortgage insurance. Is there a way out?

A Yes, if you're creditworthy. You can take out a second mortgage for some of the 20 percent down payment and provide the balance from your own funds. Several major mortgage lenders offer such programs. Of course, this would increase the total monthly interest, but you won't have to choose between paying the private mortgage insurance premiums or depleting your savings and investments to avoid them.

In making your decision, keep in mind that you wouldn't pay for private mortgage insurance forever. The law requires the lender to terminate the insurance automatically when your equity in the home reaches 22 percent of the original property value, unless you've been delinquent in your payments, there are liens on the property besides the mortgage debt, or other high-risk factors exist.

How a charity can reimburse your car costs

QI drive my car an average of 100 miles a week to provide unpaid care at a charity clinic, which has offered to reimburse my expenses. How must I do this under the tax rules, and what documentation do I need?

A The regulations provide three options regarding reimbursements:

1. The clinic can reimburse you at the standard charitable rate of 14 cents per mile driven. You must keep a record of the date and purpose of each trip, and the number of miles involved. The clinic can also reimburse you for tolls and parking fees.

2. The clinic can reimburse you at the standard business rate, 36.5 cents per mile this year, plus tolls and parking. In that case, you must furnish the clinic with the previously specified information in writing, as if you were an employee. If you don't provide such an accounting, the clinic must report the reimbursements as income to you. You could claim an offsetting charitable deduction, but you'd need records to substantiate it if audited.

3. The clinic can reimburse your out-of-pocket costs for gas and oil. To figure that, you must divide your charitable mileage for the year by your total mileage and apply that fraction to your total outlays for gas and oil. Here, too, you must account to the charity. You can't claim any reimbursement for other car expenses—such as repairs or insurance—except tolls and parking.

If you decide to forgo the reimbursement altogether, you can claim a charitable deduction of 14 cents a mile, based on your trip log, or your costs for gas and oil figured as described, plus tolls and parking.

Rolling one Roth IRA into another

QI converted a traditional IRA at a bank into a Roth account in January. Now I'd like to roll that fund into another Roth IRA at a brokerage firm. Do I have to wait until next year to do that?

A No. Although you're allowed to make a rollover from one IRA to another only once every 12 months, a conversion doesn't count as a rollover for the purposes of this rule. You can also get around the 12-month rule by making a trustee-to-trustee transfer between Roth IRAs, just as you can for rollovers between traditional IRAs. You might want to take advantage of that, if your broker's performance proves unsatisfactory.

Can you exchange a home instead of selling it?

QAll our children are living on their own, so we'd like to move from our empty nest in the suburbs to an apartment in town. We've found a condominium whose owner is willing to trade it for our house. Would the tax-free exchange rules apply to the deal?

A No, because you're exchanging property used for personal, not business, purposes. Fortunately, the home-sale exclusion rules apply to an exchange as well as to a sale—and unlike a trade of business property, on which tax is merely deferred, the tax saving on a home exchange is permanent.

Assuming you and your spouse have owned and occupied your house for at least two of the five years preceding the date the exchange becomes final, you'll escape tax on up to $500,000 of capital gain. To figure the gain, add the amount you paid for your home and the cost of subsequent improvements, then subtract the total from the condominium's current market value.

When collecting coins, look out for two-faced dealers

QI may take up coin collecting, for both pleasure and profit. What are some pitfalls a novice collector/investor should be wary of?

A According to the Professional Numismatists Guild (www.pngdealers.com), a dealers group, one of the "biggest and costliest" traps for new investors is overgrading by dealers. Rare-coin grades range from 1 (worn nearly smooth) to 70 (perfect). Very small distinctions between grades can often mean large differences in market value. Make it a practice to buy only coins that have recently been certified by an independent grading service. (PNG lists several that it has confidence in.) Even then, says the Federal Trade Commission, you should protect yourself by comparing prices quoted for identical items by other dealers and coin publications.

The FTC also warns against being taken in by misleading claims of high appreciation potential. For instance, the dealer may show you data compiled by an investment banking firm, indicating annual appreciation rates of 12 to 25 percent. Such rates are accurate, but they apply to very rare coins that aren't representative of the ones you're likely to be offered.

For more information on the subject, contact PNG and the American Numismatic Association (www.money.org ), a nonprofit organization of collectors and dealers. You may also want to read William Atkinson's The Consumer's Guide to Coin Collecting, recommended by the ANA as especially useful to beginners.

Guarding against mechanic's liens

QThe owner of the house I'm buying has contracted for extensive repairs that will be completed shortly before the sale closes. Will my title insurance cover me if mechanic's liens are filed in connection with this work?

A Not necessarily. Normally, title insurance doesn't protect against unrecorded claims. However, state laws usually allow only a limited time for filing such liens and notifying the property owner of them. Your best course would be to find out what the time frame is and choose an appropriate closing date. If you must take title before the deadline expires, you may be able to obtain "extended coverage" from the insurer, for an extra premium.

Keep in mind that a mechanic's lien isn't a judgment; the claimant must sue within a fixed period—six months, say—and prove his case in court. Otherwise, the lien is lifted.

How a family partnership can save gift taxes

QI want to give my two children an interest in some rental property I own. I've heard that doing this through a family limited partnership reduces gift tax. How do I go about it?

A You name yourself general partner and retain majority ownership. The shares you give your children will then be minority interests. This allows you to discount their value because of "lack of marketability" (prospective buyers for such interests are scarce).

For example, if you give a child a 10 percent share of a $500,000 property, the gift will be worth less than $50,000—perhaps as little as $35,000, depending on what restrictions you include. Another plus: If the property produces income, a proportionate share of that cash will be taxable at the child's rate if he or she is 14 or older.

Transfer title to your home, but keep the tax deductions

QI want to transfer ownership of my home to my children but reserve the right to occupy it while I live. Can I claim deductions for mortgage interest and property taxes if I continue to pay those expenses?

A You can deduct the interest only if the mortgage is secured by your home. To qualify, you must actually use the property as your home, not merely retain the right to do so. (Such a right is technically called a life estate or life interest.)

However, you can claim the taxes you pay on the property to protect your life interest, even though the children will be liable for them. Of course, your children can't claim the expenses you deduct.

Renting a cell phone for use abroad

QI'm told my cell phone won't work overseas, so I plan to rent one for a forthcoming trip to Europe. Should I rent the phone at my destination or get it before I leave?

A Major airports abroad have phone rental facilities, or you can rent one through an agency in the city where you'll be staying. That's probably cheaper than renting from an American company. But the convenience of having the phone in your possession before you depart may be worth the extra cost. For one thing, you'll be able to give your cell phone number to prospective American callers in advance. For another, you'll have time to familiarize yourself with the phone's features before you use it. To check comparative costs, search for "cell phone rental" or "mobile phone rental" on the Internet, using your favorite search engine.

Profit-sharing contributions when you're self-employed

Q I expect to net about $140,000 from my unincorporated practice in 2002. What's the maximum deductible contribution I can make to my profit-sharing plan under the new tax law?

A The law raises the deductible contribution for employees from 15 percent of compensation in 2001 to 25 percent in 2002. Because you're self-employed, however, you're limited to only 20 percent of your net practice income, after first subtracting half your Social Security and Medicare taxes. The former law would have limited your deductible contribution to about 13 percent of your adjusted practice income.

On net income of $140,000, half your self-employment taxes would come to around $7,100, so you could claim a deduction for contributing 20 percent of $132,900, or $26,580.

Edited by Lawrence Farber,
Contributing Writer

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 memoney@medec.com (please include your regular postal address). Sorry, but we're not able to answer readers individually.

Lawrence Farber. Money Management. Medical Economics 2002;5:122.