Muni Bonds

Investors who bet that bond funds would be the best investment for 2010 were not disappointed with their investment choice. Since smart investors look down the road six months or more that begs the question: will bond funds be the best investment for 2011 and what are the risks?

Just a glance at average annual rates of return for the 3-year period ending in mid 2010 helps explain the popularity of bond funds. Money market funds paid between 1% and 2% a year on average paying virtually nothing for the last 12 months. Stock funds had a wild ride with many of them LOSING 10% a year or more. Many high-quality BOND funds returned over 6% a year. Under one possible scenario these INCOME funds could be the best investment for 2011, or at least the best mutual funds. But don’t overlook the risk factor.

Bonds offer a fixed yearly income based on a fixed interest rate that never changes for the life of the investment. When you own shares in a bond fund you own a small part of a large portfolio of these income producing securities, which trade in the open market like stocks do. Your total return from bond funds includes both interest income and gains or losses in the value of the securities in the portfolio. Hence, risk is a factor.

Bond funds are also referred to as income funds because that’s their major attraction… higher interest income than you can get from other popular investment options or other mutual funds. They have been good investments in recent times and the best investment for 2010 for investors in search of higher returns without high risk. There are two basic reasons for this. Interest rates have been falling and inflation has been tame. Falling interest rates make the fixed interest income from existing or older bonds more attractive than that of new issues coming to market. Investors bid the price (value) of bonds up in the market because they are willing to pay more for the higher income.

Lower inflation makes a bond’s fixed income payment more attractive, as the future buying power it represents will not be significantly diluted by a higher cost of living. Negative inflation is referred to as DEFLATION, where the cost of goods and services actually declines. If interest rates continue to fall and inflation follows suit and/or goes negative, bond funds are a candidate for the best investment for 2011. Some economists and professional money managers believe that this scenario could definitely happen.

On the other hand, interest rates are presently near historical lows due at least in part to the government’s efforts to keep rates low to stimulate a lackluster economy. The question is whether or not the powers that be and/or the markets will push interest rates up in 2011? When rates go up inflation generally does as well and this is a formula for losing money in fixed income investments like bond funds. Higher interest rates and inflation make the fixed income from their securities less attractive; and investors in the bond market send bond prices down by selling.

Income funds have been some of the best mutual funds over the past 10 years and three years when things have been dicey for stocks and stock funds. Don’t assume that this trend will continue. Watch the economic and business news. If interest rates continue to creep downward and inflation stays low or turns negative (deflation), bond funds could be your best investment for 2011 and beyond. If the opposite occurs it’s time to lighten up on, or avoid bond funds altogether.

Grim Reaper Costume

I was a little slow getting started this morning. See, last night I met up with some good friends at a local brewery.

What was supposed to be a quick drink lead to . . . well, we closed down the bar! All night we gorged on greasy and salty bar food and of course lots of liquid refreshments. But this was not a night of drunken debauchery. I was with a great group of guys who are all very accomplished.

Needless to say our varied topics of discussion quickly rose above the average bar chatter (at least on a Tuesday night). We discussed and argued about jobs, religion, women, politics, and of course the markets. It’s strange but somehow every conversation I have eventually moves into a discussion on the stock market. I guess it’s my favorite subject.

An interesting observation on the markets. . . .

Given the market gyrations over the last few weeks nobody was willing to go out on a limb and call this week the market bottom. Despite the recent Fed action, the collapse of a major Wall Street institution (Bear Stearns), and the amazing 400 point rally – everyone hedged. “Maybe we’ll know more in a few days”. “Let’s see how the dollar reacts.” “Maybe when we break the resistance of the downtrend channel.” Huh?

Who knows if we hit bottom yet . . .

This got me thinking. Is there an investment that has been relatively stable in the markets lately? Maybe something that would benefit from the declining US Dollar? Something that might give some protection from inflation? And maybe it could throw off some cash flow as well?

Impossible you say . . .

Well . . . not quite. I started thinking through all of the different types of investments out there. Common stock, Muni Bonds, Preferred Stock, Corporate Bonds, TIPS, Government Bonds, Options, Warrants, Convertible Securities, Derivatives. In my 10 years as an Investment Banker I had created many of these securities . . . then it hit me. REITs.

For those of you who don’t know, REIT stands for Real Estate Investment Trust. It’s a special type of designation given by the IRS. It allows for a company to distribute earnings pre-tax to its shareholders. The REIT designation eliminates the double taxation normally associated with corporate dividend payments. The REITs traditionally invest in real estate which throws off steady payments to the company. There are many different types of REITs – some are better than others. Before I tell you which ones I like, let me tell you why I like them.

When the housing market started collapsing the REITs were hit hard. Just take a look at the iShares Dow Jones US Real Estate Index (IYR). This index holds a basket of REITs, and the index fell more than 30% from a peak of $93 to its current price of $64. Needless to say some of the good REITs got thrown out with the bad. Many of these REITs have stabilized and are trading at good values.

What you need to know about specialty REITs

One particular group is classified as a specialty REIT. They own land . . . filled with trees. Yes, timberland. Now let me tell you why I like these Tree-REITs. First, the timberland they own is actively managed. They harvest trees for things like lumber and pulp for paper. The prices of these commodities are going up and up because of the weak dollar.

When the Tree-REITs sell their trees they generate a nice income – which is sent to shareholders in the form of dividends. All of these Tree-REITs are paying dividends around 5%. That’s better than government bonds.

In addition, the timber grows every year. The sun shines, the rain falls, and the trees get bigger – and that means more valuable. Also, timber is considered a hard asset. The US is already in an inflationary environment (whether the government wants to believe it or not). Owning hard assets is the best way to profit from inflation.

The Tree-REITs

I have found three different publicly traded REITs that hold timber. The first is Rayonier (RYN) which holds more than 2.6 million acres in the US and New Zealand. Rayonier also has two other core businesses, one in traditional real estate development and the other in fiber production (so it is not a pure play Tree-REIT). The second company is Plum Creek (PCL) which owns 8 million acres of timber. The third company is Potlatch (PCH) which owns 1.7 million acres of timber.

These Tree-REITs tend to be relatively stable, throw off a good dividend, benefit from a falling dollar, and are a great hedge to inflation. Consider one – or all of these – for your portfolio today.

Horse Insurance Wooden Daybed Trundle

California’s financial problems have been front and center in the media of late. This month, its credit rating was cut to the low end of investment grade. Facing insolvency, Governor Schwarzenegger and legislators have undertaken drastic action – selling off state assets, cutting the state’s university budget by 20 percent and releasing 27,000 inmates from prison. Already the state has given mandatory furloughs of three days a month to its 243,000 state employees. What is the impact on California’s crisis on the rest of the nation? What about the state’s municipal bondholders? Will Washington DC have to bail out the nation’s largest state? This edition of the newsletter will examine these questions and try to provide some helpful guidance.

Current State of Affairs

California now carries the lowest credit rating of the fifty states. In the current fiscal year of 2009-2010, its budget deficit was expected to be $24 to $28 billion. This is what prompted the recent marathon session of the state legislature. The state’s general fund budget is about $100 billion. The prospective deficit was large both in absolute and in relative terms.

As recently as Fiscal 1998-99, the state’s budget was in balance. A number of reasons have been put forth to explain the state’s ensuing misfortune. All have some merit.

The state’s tax structure is a contributory factor. Voters approved proposition 13 some 30 years ago placing severe limits on property tax increases. Consequently, the state has come to rely more and more on its rather large income tax. Unlike property taxes, income tax receipts tend to follow a boom and bust cycle along with the economy. During the good times, political pressure is applied by the state’s powerful special interests to ramp up benefits. During bad times, there is less wiggle room to reduce expenditures as revenues plummet.

Case in point: California’s state legislature passed SB 400 in 1999 that increased the pensions of state police officers by 50%! The same bill substantially upgraded the pensions and survivor benefits of other state employee Now, ten years later, the governor tried unsuccessfully to roll pension benefits to pre 1999 levels back for new hires.

The state’s constitution has been an impediment to fiscal responsibility. One problem is the requirement that a two-thirds vote of the California legislature is needed to pass the state’s budget and tax increases. There are only a handful of states that require a supermajority. Another problem with California law is the reliance on ballot initiatives to amend its constitution or statutes. These have become ubiquitous in recent years and are typically referred to as “propositions”. Not surprisingly, the popular vote has consistently supported an expansion of services without a commensurate increase in taxes. Direct democracy sounds good in theory but its practice invites deficit spending.

On July 20th, lawmakers approved a budget plan that should close the deficit this fiscal year. It includes spending cuts amounting to 60% of the deficit with the balance financed with short term debt. While some of the cuts were accomplished with accounting gimmicks, most of the state’s residents will be impacted by either a reduction in services or an increase in user fees.

California’s Municipal Bonds

For municipal bondholders, the events of the past several months have raised troubling questions. Could the state of California default on its debt and what would the spillover effects on local California bonds be?

The good news is that California’s bondholders are actually senior creditors. Proposition 98, passed in 1988, mandated that the state allocate 40 percent of its general fund to public elementary and high schools as well as community colleges. Roughly another 5% of education spending is also guaranteed by the state’s constitution. This commitment is senior to the claims of bondholders. However, the state’s bondholders are next in line. Today payments to those bondholders account for another 5% of the general fund as there are about $59 billion outstanding. Below the bondholders contributions. Some very key stakeholders must suffer before the state fails to pay its debt service. Unlike corporations or municipalities, the states cannot file for bankruptcy in an attempt to reorganize their debt obligations. Moreover, California needs continuous unfettered access to the credit markets to fund ongoing infrastructure projects and to cover short term seasonal cash flows.

What about the spillover effect on local issuers of tax-exempt bonds within California? Different local jurisdictions have varying levels of reliance on state funding. School districts and counties are among the most dependent. Most general obligation bonds are secured by local property taxes – a source of revenue that is comparatively stable. While municipalities can declare bankruptcy, they have been loathe to do. The relevant precedents indicate that bondholders are made whole regardless of the financial woe of the local issuer. Orange County CA filed for bankruptcy in 1994 but did not miss any bond payments. The City of Vallejo CA filed for bankruptcy more recently but has thus far continued to service its debt.

In fact, the default rates nationwide for municipal bonds are extremely low. According to Moody’s, the default rate has averaged 0.01% per year since 1970. The average recovery rate for defaulted muni bonds was 60% compared to 40% for corporate bonds. And even during the Great Depression, the average annual default rate was 1.8%, with 97% of the defaulted principal eventually recovered.

There are additional risk factors today. Unfunded pension liabilities and infrastructure projects place a greater strain on state and local governments. However, most tax-exempt bonds are fairly senior in the credit structure of the issuer. And access to credit is essential for any public enterprise.

Bond markets have long memories. Any government defaulting on its debt would lose access to the capital markets for years. And, even then, the credit rating of its next issue would be so low that heightened borrowing costs would swamp any short term relief offered by reneging on payments in a time of crisis.

A Federal Bailout?

Governor Schwarzenegger has spent a good deal of time in Washington DC in 2009. There has been speculation that the Federal Government will bail out its largest state. In fact, Washington DC has already gone a long way to shore up the state and local bond markets. Of the nearly $800 billion federal stimulus money authorized in February 2009, about $135 billion was earmarked for the municipal bond issuers. The state of California has received at least $6 billion in direct transfers from Washington under the stimulus.

That same stimulus package authorized municipal issuers to issue “Build America Bonds” (BABs) to repair infrastructure. The federally taxable bonds offer a subsidy to issuers of 35 percent on their interest costs. Effectively, this program opens up municipal finance to potential investors that are already tax-exempt – thereby adding a new set of lenders to troubled local borrowers.

Federal tax dollars are hard at work today in supporting the finances of municipal issuers. But that is different rom an explicit bailout of a sovereign state. No state has defaulted in modern times. It’s hard to imagine the consequences of default in today’s credit markets.

One major consideration of any effort directed towards California is the potential domino effect on other state governments. California is hardly alone. A report from the National Conference on State Legislatures says that, collectively, states faced $142.6 billion in deficits for the 2009-10 fiscal year and many already are seeing signs that the total could grow.

There is a moral hazard to any federal bailout of California. Where does it stop? Wouldn’t every state and municipality cut corners to deliver services to its constituents if it knew that the Federal Reserve would print the money to rescue it? California may facing similar travails a year from now. It will be interesting to see what measures, if any, Washington DC offers.

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Do you know what a bond is?

A bond can be defined as an organization’s IOU; which basically means a promissory note issued that offers to pay you later at a certain fixed rate of interest over a definite period of time. Issuing of bonds is thus a debt collecting measure. Other similar debt collecting instruments are notes and debentures. The maximum numbers of bonds issued today have a fixed rate of interest though variable rate bonds are also coming in vogue.

Corporations issue bonds in order to raise a large sum of money quickly. The money raised may be used for diverse activities like building new offices, purchasing latest equipment etc. Government bonds may be issued when the government needs money for constructing roads, schools, hospitals, etc. for building the infrastructure of the country.

What exactly is a municipal bond?

In the United States, a city or local government issues bonds from time to time and this is known as A Municipal Bond (or muni). In the U.S Municipal Bonds can be issued by cities, counties, school districts, redevelopment agencies, and publicly owned airports, as well as seaports and all other government bodies below the state level.

These bonds are guaranteed by either the local government or a subdivision of the local government or a group of local government. These Municipal Bonds are appraised for risks and are rated accordingly.

Most of the times the income generated by the Municipal Bond by a bondholder is non-taxable. The income generated from Municipal Bond is exempt from Federal Income Tax and State Income tax in the state that issues them. But there are other bonds that may be taxable.

However one has to keep in mind the fact that bonds issued by cities, states, and other local agencies of the government are not as reliable as corporate bonds. Whereas some Municipal bonds that are issued are supported by the taxing authority of the town or the state as the case may be others are supported the earning income to pay the interest as well as the principal. However since Municipal Bonds are not taxable by the federal government they have to pay very little interest compared to corporate bonds.

People find investing in Municipal bonds (also known as “munis”) remunerative because the income is exempt from federal income tax and sometimes also from state and local taxes. Apart from this, you also have the satisfaction of knowing that you are contributing to building the infrastructure of your state and city, which includes funds for welfare of the general mass in building hospitals, schools, highways and other public undertakings.

Two kinds of Municipal Bonds

Generally, Municipal Bonds are of two kinds: general obligation bonds and revenue bonds. The first kind, i.e., General obligation bonds, is issued to cover immediate expenses and are backed by the taxing power of the person issuing it. The second kind of bond that is, Revenue bonds are issued to generate income for future projects for building infrastructure. Both kinds of Municipal Bonds are exempt from state and federal taxes. This makes them attractive to investors who are prone to avoiding high-risk ventures.

Computerrental Accordion Data Tape

OBAMA’S HEALTHCARE REFORM JUST PASSED: INVESTMENT AND TAX IMPLICATIONS

President Obama’s newly passed healthcare reform package will result in higher taxes for individuals making more than $200,000 and couples earning more than $250,000. Fortunately, these new tax laws don’t kick in until 2013.

MEDICARE PAYROLL TAX HIKE

The current Medicare payroll tax is 2.9% of all wages, with the worker and the employer each paying half. Starting in 2013, high income workers will pay an extra.9% of income above $200,000 for individuals and over $250,000 for couples. These extra tax and income limits apply to wage income only. Thus, a couple making $500,000 in wage income would pay an extra $2,250 in Medicare taxes in 2013. A couple making $1 million would pay an extra $6,750 in taxes.

NEW MEDICARE TAX ON INVESTMENT INCOME

High income families will also be subject to a new 3.8% tax on investment income starting in 2013. This applies to capital gains, dividends, interest, annuities, etc. This tax will apply to people with total income (wages plus investment income) in excess of $200,000 for individuals and $250,000 for couples. This new 3.8% tax applies to whichever is less-your total investment income or the excess of your modifi ed adjusted gross income (AGI) over the high-income limit of $200,000 or $250,000. Thus, if a couple has total income of $300,000 and investment income of $100,000, they would only owe the 3.8% tax on $50,000 (their total income of $300,000 less the high income threshold of $250,000). Tax exempt investment income (such as municipal bonds) is not subject to this new tax!

COMBINED IMPACT OF BOTH NEW TAXES

Adding both of these new taxes together, a couple with wage income of $500,000 and investment income of $100,000 would owe an extra $6,050 in Medicare taxes in 2013. A couple with wage income of $1 million and investment income of $200,000 would owe an extra $14,350 in Medicare taxes.

ANOTHER CAPITAL GAINS AND DIVIDEND TAX RATE HIKE COMING IN 2011

Independent of these new Medicare tax hikes, the tax rates on dividends and capital gains are likely to go up from the current low 15% level to 20% (or higher) next year. If Congress does nothing, the Bush tax cuts will expire and these tax rates will automatically go up. Thus, combined with the new extra 3.8% Medicare tax on investment income (including capital gains) in 2013 means taxes on investment income are defi nitely going up over the next several years. Based on the quote above and the experience in Massachusetts, this may be just the start of new higher taxes on “the rich.”

INVESTMENT IMPLICATIONS AND STRATEGIES FOR INVESTORS

• Since the new Medicare tax on investment income does not apply to tax-exempt income, this is a positive for investing in tax-free municipal bonds relative to regular taxable bonds. Muni bonds are more attractive going forward.

• This is another reminder to try to manage your reported income to under $200,000 for individuals and $250,000 for couples, if you can. There are many ways to manage your reported income down: saving more in tax-deferred vehicles such as 401K plans, profi t sharing plans, SEP’s, deferred compensation plans, investing in muni bonds, offsetting capital gains with capital losses, and investing in stocks that pay little or no dividends. Investing for capital appreciation will be taxed less than investing for current income.

• The rising tax rates on investment income make strategies around tax location even more important. Smart tax location means putting your tax ineffi cient investments (like bonds) in your tax deferred accounts and your tax effi cient assets (like growth equities) in taxable accounts.

• If you have investments with large capital gains (your business, real estate, securities, etc.) that you are thinking about selling soon anyway, you may want to consider selling them now (or part of them) at the current low 15% capital gains rate. Tax rates are going up.

Alamo Car

A couple of years ago in this column I warned readers not to buy municipal bonds. A few were smart enough to follow that advice.

One of those who did not was Warren Buffett.

Warren has plunged in with hundreds of millions of bond guarantees in his insurance company similar to both MBIA and Ambac Financial that went belly up.

It has been blatantly obvious for a long time that the majority of state and local municipalities had over spent and over committed their budgets. Many had issued their tax free bonds for favorite projects such as stadiums and new office buildings. They were not paying any attention to what was happening to the housing market.

The majority of income (usually about 80%) comes from real estate taxes based upon home and commercial valuation.

The subprime home defaults are now dragging down the value of the first class homes creating something called “upside down”. Very simply it means the home is worth less that the amount of the mortgage that was issued by the bank or other lender.

A $350,000 home with a $250,000 mortgage is now appraised at $200,000. Home values are continuing to fall. In this writers opinion they will continue to fall for at least the next 2 years, maybe 5 years before we hit final real bottom prices. There will be brief periods of “up”. Please don’t shoot the messenger. I am not causing this, just reporting it.

It is my opinion (and I know you hope I am wrong as I do) that those who are buying the current foreclosures will end up being foreclosed upon. It is not a pleasant anticipation.

Because of the tightening of credit restrictions the banks are loaning less and less. They have been badly burned and now every piece of paper must be filled out and double checked. No more “no doc” loans. You remember those. Anyone could put any exaggeration on a mortgage application and nothing was verified.

When folks bought those “safe” munis some even bought a guarantee that in the event of default a special insurance would pay the full amount. Now those insurance companies (like MBIA and the one Mr. Buffett owns) are in trouble. They seem to have under estimated the rate of default.

A muni bond holder should check the balance sheet of his guarantor to see the liability to cash ratio. Also it wouldn’t be a bad idea to see the cash flow of the municipality.

Investors should become aware of not only the decreased Mall traffic but also the number and amount of packages people are carrying. There are now more and more empty store fronts. Mall municipal bonds are questionable also.

To find out how businesses are being affected talk to the UPS and FedX drivers. They know.

Unless the economy picks up dramatically municipal bonds remain a questionable investment.

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The best bond funds and best stock funds have something in common. Looking forward, you are probably not familiar with some of the best bond funds; and the best stock funds are getting more difficult to find. This article might help you out.

The best bond funds for most of the people, most of the time are intermediate-term funds that hold debt securities (bonds) maturing in 5 to 10 years on average. Every bond fund will state in its literature the average maturity for the debt securities held. Intermediate-term funds have been good investments for years with a nice blend of return vs. risk. They are popular and you might own one.

Things could change in the foreseeable future as the government deals with new threats of higher inflation and higher interest rates (the dynamic duo). Debt securities will be affected significantly if the duo ignite and drive higher. Most bond funds and their investors will go along for the ride, down a slippery slope. The hardest hit and biggest losses will be in long-term bond funds with average maturities of 20 to 30 years. Intermediate-term bond funds will take smaller losses.

Suggestions for the best bond funds: Avoid long-term funds, and keep some money in the intermediate-term varieties. Then, consider some you might not be presently familiar with. SHORT-TERM bond funds have average maturities of less than 5 years. If inflation and interest rates head north, you have much less risk here. INFLATION-PROTECTED bond funds that hold debt securities issued by the government that are adjusted (principal and interest) for changes in inflation could be good investments as well.

Our dynamic duo is no friend of the domestic equities market or stock funds, either. Rising inflation and interest rates hurt corporate sales and profits, and investors could find themselves on another downhill sled ride. Last year’s best stock funds can fall as fast as they went up in value. When it’s hard to pinpoint your target, a shotgun approach might be more appropriate. Own a core or primary equity holding, like an S&P 500 Index fund. Then consider branching out by adding the following.

Find a quality VALUE FUND that pays higher than average dividends. If the market declines, at least you’ll earn higher dividends. Add a diversified INTERNATIONAL EQUITY fund in case foreign equities perform better than domestic ones. Then consider specialty (non-diversified) sectors like NATURAL RESOURCES, ENERGY, BASIC MATERIALS, PRECIOUS METALS (gold & silver) and REAL ESTATE funds. As a group, these can be good investments when inflation and/or interest rates rear their ugly heads.

Limit your risks in bond funds and increase your expose to a variety of stock funds as the future unfolds. Regardless of the specific investment decisions you make, the best bond funds and best stock funds do have one thing in common: lower than average costs and expenses. High overhead directly eats away at your investment returns. The two largest mutual fund companies in America offer funds with NO sales charges, and lower than average yearly expenses: Vanguard and Fidelity.

You can pay more than 5% to invest with yearly expenses of more than 2% a year. Or, you can pay nothing to invest (no-load), and less than ½% a year for expenses. It’s your choice; and the good news is that you will not need to sacrifice quality. The two mutual fund companies above did not become the biggest by offering poor product or service. They got to the top by offering value to customers like you and me.

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When searching to buying municipal bonds, an individual should comprehend how tax exempt benefits operate. If tax bracket grows, the benefits consequently grow either. If investors are supposing to purchase a six percent municipal bond at a rating and they are in the twenty eight percent tax bracket, the tax free benefit is higher than six percent.

There are two common kinds or approaches a municipal government can assure or back its bond. One approach is through the taxing power of the municipal government. This can be called a General Obligation Bond. The second bond is a Revenue Bond. Revenue Bond utilizes particular profit sources to make the issue safe. General Obligation Bonds are the most general and actually the higher rated issues. A state increasing finances and backing the bond issue with bigger profit or sales tax would be supposed to be a General Obligation Bond. An educational institution field increasing finances through a broker company on a municipal bond and guarding the bond investors with school or property tax revenue is supposed to be a General Obligation bond either. Since taxes are the safest option for finances at the present time and in the future, some investors use them over most profit issues.

Revenue Bonds Issues that count on the profit generating capability of an opportunity or from the issuer through other alternative are considered as Revenue Bonds. There are some kinds of issuers. These kinds of bonds are offered frequently by municipal government for a range of industrial businesses, containing the construction, renovation, advancements, remodeling, of the dissimilar industrial projects. The bonds can be issued in bulk and should work within forty years from their dates. Nevertheless, there is no responsibility on the interest or principal of the establishment offering the bonds. Municipal government would also be liable for setting, collecting, and changing profits for the specific objectives.

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Everyone has insecurities. Whether you feel your nose is a little crooked; you’re not as intelligent as others around you; or you feel you need to shed a few pounds to be at your best; we all feel there are changes we can make to make us feel better about ourselves.

One of my insecurities has always been that I’m more of an introvert. Even though I was a cheerleader in high school, love to perform, participated in lots of group activities throughout my life, and actively seek opportunities to lead, I still consider myself a more reserved person (maybe an introvert with extrovert tendencies). While I am funny to those who really know me (kind of a nerdy goof ball), I still find myself pretty quiet (definitely not shy) around those who don’t know me well. I can honestly say that in party settings, I am not the “go to” person for fun.

I love to have fun, but I love to be in control, too. That’s probably the root of the insecurity, I guess. I never enjoy feeling “out of my element”. And, I sometimes avoid situations in which I feel out of control. However, I also balance this insecurity by placing myself in some of these same situations.

For me, being more introverted allows me to manage my life better. So, to an extent, it serves me well. But, if it ever gets to a point where I cannot be comfortable without being in control, then I’ll know I have a problem. My goal continues to be to challenge myself to experience bouts of free reign in my life, so that I can loosen more and more of my self-restraint.

When you look at yourself, what do you see and how do you feel about yourself? Small levels of insecurity are common in all people. But when insecurity debilitates your life, you have to consider why you succumb to anxieties about yourself. What is the root cause of your insecurity? If you don’t identify the root cause, your potential for a better life can be strangled by the uncertainties you feel about yourself.

Ask yourself these questions to determine your level of insecurity:

1. Am I shy or uneasy with strangers?

2. Do I wish I was smarter?

3. Do I wish I was better looking?

4. Am I overly cautious?

5. Do I think I’m an emotionally weak person?

If you have more yes than no answers, then you may have an issue with insecurity. If so, you’ll need to restructure your thoughts and perceptions about yourself. You can do this by replacing the negative mental energy of your insecurity with positive action.

For example, if you wish you were smarter, rather than ruminating on your feeling of inadequacy, you can choose to learn more about a subject of interest to you. In this instance, taking the time to learn while worrying less about your personal anxieties will give you the confidence you need to gradually banish this thought from your mind.

This same method can be used for any type of insecurity, but you also have to remember to stay in balance. Overcompensating in your life because of insecurity proves futile, as well. Just remember, worry without action is just as destructive as too much action due to little self-worth.

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While there is a present lapse in the estate and generation-skipping transfer taxes, it’s likely that Congress will reinstate both taxes (perhaps even retroactively) some time during 2010. If not, on January 1, 2011, the estate tax exemption (which was $3.5 million in 2009) becomes $1 million, and the top estate tax rate (which was 45% in 2009) becomes 55%. However, it is the author’s opinion that the estate tax exemption will be at least $3.5 million once Congress acts.

Estate planners commonly use life insurance as a method of paying estate taxes. But, according to the Tax Policy Center, only 5 out of every 100,000 people have estates over $3.5 million. Thus, for most decedents the federal estate tax has been repealed. Nevertheless, for the reasons described below, life insurance can still play a significant role in a non-taxable estate.

1. Capital Needs.

Life insurance has long been used to protect young families from the disastrous Effects of a householder with early death. And 'the only way to ensure that the potential deficit will be covered in a family need for capital in the event of premature death.

2 Wealth replacement.

Charitable remainder trusts are often used by people who have highly appreciated assets, without wishing to sell a capital gains tax liability. The main disadvantage of using a CRT is that after the death of the donor and the donor's spouse, the remaining tasks inthe CRT pass to charity. A life insurance policy can be purchased for the benefit of the donor’s heirs to “replace” the wealth passing to charity.

3. Estate Equalization.

Most parents want to treat their children equally when dividing up their estate. But, this may prove impossible with family businesses in which only the children active in the businesses are to receive the businesses. If the business’ value exceeds the active children’s share of the estate, it is impossible to treat the children equally. A simple solution is to use a life insurance policy as an estate equalizer. The non-active children (or a trust for their benefit) would be the beneficiaries of the policy.

4. Creditor Protection.

The cash value of a life insurance policy and/or the death proceeds from a policy may be protected from creditors based upon state law. The amount protected varies from state to state, and may be dependent upon who are the Beneficiary of the policy. For example, some states protect only the policy cash value and death, if the spouse of the insured person and / or children are the beneficiaries of the policy.

5 Second marriage.

When children are involved from a previous marriage, succession planning is more complicated. Take the example of a second marriage where the husband has children from a previous marriage. The man makes a living trust, that after his death, provideshis wife with income and principal as needed to maintain her accustomed standard of living, with the remainder passing to his children at his wife’s subsequent death. This approach has two problems. First, the children have to wait until their stepmother’s death to inherit their father’s wealth. Second, as the remainder beneficiaries of the trust, the children have legal rights to challenge the distributions from the trust to their stepmother if those distributions exceed (in the children’s opinion) the amount called for by the trust. A solution to these problems is life insurance on the husband’s life. The policy beneficiaries can be either the wife or the children. If the wife is the beneficiary, the husband can leave his estate to his children (either outright or in trust). Alternatively, if the children are the beneficiaries, the husband can leave his estate to his wife outright. In either case, the second wife and the children from the first marriage will have no financial involvement with one another after the husband’s death.

6. Special Needs Children.

A developmentally disabled individual is usually eligible for Supplemental Security Income (SSI), a federally funded program administered by the states, upon reaching age 18. Prior to age 18, SSI eligibility is dependent upon the parents’ income and assets. SSI eligibility generally is accompanied by eligibility for Medicaid, a state-administered federal program which primarily provides medical assistance. Many parents are skeptical about the future and/or level of the SSI and Medicaid programs. As a result, they establish (at the death of the surviving parent) a “special needs” trust for the benefit of the disabled child. A special needs trust is designed to “supplement” SSI and Medicaid without disqualifying the child from any government assistance. Unfortunately, the special needs trust strategy provides little consolation to those parents who do not have funds to provide for their disabled child or for parents who eventually would have to disinherit their other children to provide adequately for the disabled child. A solution to both of these problems is for the parents to purchase a survivorship life insurance policy. The policy would be owned by the parents and payable to a special needs trust tor the benefit of the disabled child at the surviving parent’s death. Upon the death of the disabled child before the complete distribution of the trust property, the assets remaining in the trust can pass to the other children.

7. Annuity Arbitrage.

Many people, who are adverse to the stock market’s daily fluctuations, prefer to park their investments in municipal bonds or certificates of deposit (CDs). In exchange for this security, the yield on these investments is quite low. A better alternative to municipal bonds and CDs in many cases is a single-premium immediate annuity contract. Not only is the annuity a safe investment (based on the strength of the carrier), it invariably will produce a significantly higher yield than muni-bonds or CDs. The problem with an annuity is that the payments cease when the annuitant dies. Accordingly, unlike the case with muni-bonds or CDs, the annuity owner’s children will not inherit the annuity. The solution is to purchase a life insurance policy to “replace” the wealth lost when the annuitant dies. The cash to pay the premiums is generated from the increased cash flow from “converting” the muni-bonds and CDs into an immediate annuity.

8. Medicaid Planning.

For a person to become eligible for long-term care Medicaid benefits (i.e., nursing home care), the recipient must have income and assets below frightfully low levels (i.e., as low as $2,000 in some states). But, what about those persons with substantial assets who are not financially eligible for Medicaid? What options are available to them to protect their assets from the high cost of long-term care? First, at least 60 months before applying for Medicaid (or 36 months for those states that have not enacted the Deficit Reduction Act of 2005), the recipient can “divest” himself or herself by gifting away all of his or her assets to children and grandchildren. Many people reject the idea because of the loss of control and financial independence, among other disadvantages. Second, long-term care (LTC) insurance can be purchased to pay for such care. LTC insurance premiums, however, increase dramatically for persons over age 65. A better answer may be to purchase life insurance. If the insured needs long-term care and, therefore, must use private funds to pay for such care, the insurance proceeds will some day “replace” the assets spent on long-term care. Life insurance assures that the insured’s heirs are not “disinherited” by the high cost of long-term nursing care. In the event that the insured never requires long-term care, then, upon the death of the insured, the heirs will receive a larger inheritance.

9. Charitable Planning.

Even without transfer taxes, many charitably inclined persons will want to make lifetime gifts to their favorite charities. The advantages of naming a charity as the owner, beneficiary, and premium payer of a life insurance policy are numerous. First, the insurance proceeds eventually will provide the desired capital gift for a comparatively small outlay in the form of premium payments. Second, each year the donor-insured will receive an income tax deduction equal to the premium payments gifted to the charity (subject to the 50% of adjusted gross income deduction limitation). Third, because only the purchase of life insurance is involved, there are no complex details to be handled. Fourth, if the donor is unwilling or unable to gift future premium payments to the charity, the charity either can continue to make the premium payments or surrender the policy for its cash value. Finally, during the donor-insured’s lifetime, either in the form of a loan or a partial surrender, the charity can access the policy’s accumulated cash values to meet an emergency need.

10. Avoiding Income Taxes on Retirement Plans.

Contributing to a retirement plan or IRA is perhaps the best way to accumulate wealth because of the combination of tax-deductible contributions and tax-deferred savings. Such plans, however, are the worst way to distribute wealth because of the double tax (estate and income taxes) imposed on the distributions. Even without an estate tax, upon the death of the surviving spouse, the children must begin taking distributions and incurring income taxes. A better strategy for a charitably inclined IRA owner might be to withdraw cash from the IRA or pension plan, pay the income tax, and use the after-tax proceeds to purchase a life insurance policy for the benefit of the participant’s heirs. The policy would have a face value equal to the IRA’s projected value at the death of the participant. After the participant has died, the heirs would receive the insurance proceeds income tax free, and the balance in the retirement plan could pass to charity or to a private foundation – income tax free! For a married participant, a survivorship policy can be used. The only “loser” in this scenario is the IRS.

Conclusion.

While it is impossible to predict what lies in store for transfer taxes, for the many reasons described above, life insurance is uniquely suited to handle many non-estate tax issues commonly confronted in estate and financial planning.

TO THE EXTENT THIS ARTICLE CONTAINS TAX MATTERS, IT IS NOT INTENDED OR WRITTEN TO BE USED AND CANNOT BE USED BY A TAXPAYER FOR THE PURPOSE OF AVOIDING PENALTIES THAT MAY BE IMPOSED ON THE TAXPAYER, ACCORDING TO CIRCULAR 230.

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