Newsletter

    The Financial Insider

An Economic and Investment Update

 

Disability-Proof Your Business

Business owners, who typically take great care to protect their businesses in the event of death, may, in fact, face a greater threat from disability. Along with addressing life insurance concerns through buy-sell agree­ments, business owners should also address the problems a lengthy disability can present.

Few business owners may be aware that the risk of suffering a prolonged disability is much greater than the risk of dying. In ad­dition, for those who become disabled, the average length of disability will be two and a half years. Not many businesses, however, may have a plan that addresses the continua­tion of the business in the event of a disability of one of the owners.

Realizing the potential for disability exists is just the beginning, because the next ques­tion business owners must address is twofold: First, how will personal income be maintained or replaced? Second, what about ownership interest? The form in which the business is run as a sole proprietorship, a partnership, or a corporation will dictate the way in which the answers to these questions are formulated.

The Sole Proprietorship. In the case of a sole proprietorship, the owner is “the busi­ness;” if he or she is disabled, business profits suffer as a consequence. The sole proprietor­ship differs from a partnership or a corpora­tion in that, although it may have employees, it typically lacks a management group that can direct operations in a coordinated manner in the absence of the owner. Thus, a permanent disability in a sole proprietorship is often tantamount to the cessation of the business. In order to provide the proprietor with needed income, in addition to relief from the responsibilities of running the business, there may be little choice but to close the doors and liquidate the assets.

The Partnership. A partnership may be more protected from the effects of one part­ner’s disability than a sole proprietorship. With one or more partners left to continue partnership business and make management decisions, one owner’s disability may have a less severe impact on the business. If the other partners cannot carry on the specific tasks of the disabled individual, a replacement gener­ally can be hired. In addition, and fortunately for the disabled partner, unless the partner­ship agreement stipulates otherwise, the laws of most states say that a partner is entitled to his or her share of partnership profits on an equal basis with the co-partners, whether disabled or not.

The Corporation. In contrast to a partner, a stockholder-employee of a closely- held corporation generally has no rights to a share of corporate profits unless he or she actually performs services for the corporation. While other stockholders may be willing to continue a disabled stockholder’s salary, even when needing to hire a possible replacement, their willingness may lessen over the course of a long disability. In addition, a disabled stock­holder of a closely held corporation may be in a bind due to the rare issuance of dividends typical of this form of business. Even if a dis­abled stockholder makes an appeal through the courts to force dividend payments, the courts are rarely willing to force corporations to pay dividends.

 

Protect Yourself As Well

While the solution to the loss of services in a partnership or corporation may be to hire a replacement for the disabled individual, this does nothing to replace the income of the disabled individual and fails entirely to ad­dress the issue of what to do with his or her ownership interest. Clearly a better solution is needed, and for most professionals, it is often a two-step process.

The first step involves replacing the disabled individual’s lost income at a level appropriate to meet his or her personal needs. This can be accomplished through the continuation of the individual’s salary out of business cash flow for an agreed-upon time period, through the purchase of disability income policies by the business as set out in a formal disability income plan, or through disability income insurance policies that are individually paid for and owned. Many busi­nesses may find the third alternative to be the least expensive.

The second step addresses how to handle the ownership interest of the disabled person. Insurance professionals generally recommend purchasing a fully protected, disability buy-out policy. Either the business can purchase the policy and use the proceeds (which are re­ceived income tax free) to buy out the owner’s interest if the disability becomes permanent. Or, the partners or co-owners can purchase disability income policies on each other. If one person becomes disabled, the remaining owners can use the policy proceeds to buy out his or her interest.

Disability income insurance can help solve the problems of replacing a permanently dis­abled business owner’s income and provide funds to buy out his or her ownership interest. In the process, it can smooth a difficult tran­sition for all. A consultation with a qualified insurance professional can help your business establish a disability income protection plan.

The Basics of Financing Your New Home

Buying a home is the single largest purchase most people will ever make, and for first-time homebuyers especially, the financing process can appear complicated. The fol­lowing information provides you with some preliminary information to understand how mortgages work.

The two basic mortgage types are fixed rate mortgages and adjustable rate mortgages (ARMs). Deciding which is right for you de­pends on a number of factors, including the spread between the prevailing fixed and vari­able mortgage rates, the length of time you expect to own your home, the current inflation rate, and the tax savings you expect to receive from the home mortgage interest deduction.

Fixed Rate Mortgages

A fixed rate mortgage is characterized by an interest rate that remains the same for the life of the loan, consistent monthly payments, and a principal that will be fully repaid at the end of the loan. The total amount of interest you will pay on a fixed rate mortgage increases with the term, which generally ranges from 15 to 30 years.

 

One major advantage of a fixed rate mort­gage is the certainty of knowing your monthly payments will not increase over the life of the loan, even if interest rates rise. On the other hand, the major disadvantage is that if interest rates drop, your monthly payment will not decrease. The only way you will be able to take advantage of a drop-in interest rates is to refinance the loan, which may or may not be costly, depending on rates at the time.

Adjustable Rate Mortgages (ARMs)

An adjustable rate mortgage carries an interest rate that a lender can vary during the loan term. ARMs are designed to shift the risk of rising interest rates from the lender to the borrower. To offset the increased interest rate risk, ARMs usually offer borrowers a lower rate—compared to a fixed rate mortgage—during the first year. If you are considering an ARM, you will probably encounter the following terms:

• Index. An index is a benchmark used by a lender to adjust an ARM’s interest rate. Commonly used indexes include the rate on U.S. Treasury securities and the aver­age cost of Federally-insured savings and loan funds.

• Margin. Also called the “spread,” this is the amount a lender can add to the value of the index specified in the loan agreement.

• Initial Rate and Adjusted Effective Rate. The initial rate is the interest rate at the start of the mortgage. It is typically lower than the amount you would owe on a fixed rate mortgage. Very low initial rates, called “teasers,” are designed to persuade you to enter into the loan.

The adjusted effective rate is the rate you pay when the adjustments kick in. It is cal­culated as the value of the index specified in the loan agreement plus the margin. For example, if the index value rises to 8% and the margin is 2%, the adjusted effective rate is 10%. (The adjusted effective rate is not the same as the annual percentage rate (APR), which includes the points levied on the mortgage.)

• Adjustment Period. Mortgage payments or interest rates may change¾every six months, annually, or every three years—according to the length of the adjustment period.

• Caps. ARMs may include several kinds of caps. A payment cap limits the increase in monthly payments at each adjustment period. An interest adjustment cap limits the amount by which the interest rate can rise or fall at each adjustment period. A lifetime interest cap limits the maximum interest the lender can charge during the loan term. A lifetime payment cap limits the percentage by which principal and interest payments can increase during the loan term.

• Negative Amortization. Negative amor­tization occurs when your mortgage payment is less than the amount necessary to cover the interest on the loan. As a result, the unpaid interest is added to the loan principal. The loan agreement may cap the amount of negative amortization allowable.

Understand Your Options

There is no “right” way to finance a home. All fi­nancing arrangements in­volve trade-offs. The more informed you are about your options, the better equipped you will be to ar­range a mortgage that suits your needs.

Offset the Effects of Inherited Wealth with Incentives

For many affluent individuals, estate planning extends well beyond tax plan­ning and involves very personal decisions about the distribution of future wealth. In more traditional estate plans, the spendthrift trust is used as a vehicle for distributing trust income, while limiting immediate access to trust principal.

A spendthrift trust can help provide a finan­cial head start for minor children and protect adult heirs from certain creditors and limita­tions in financial judgment. However, such trusts may provide heirs with little incentive to expand their own professional, academic, or philanthropic horizons. Thus, affluent individuals who are particularly sensitive to the potential ramifications of “handing over” considerable wealth to heirs may choose to establish an incentive-based estate plan.

One of the cornerstones of an incentive-based estate plan is the family incentive trust (FIT). Like typical trusts associated with estate planning, a FIT helps trustees implement an affluent grantor’s expectations about the uses of his or her estate. Similarly, a FIT can help ensure proper care and financial support if an heir falls on hard times or has special needs. However, a FIT is somewhat unique in that the general distribution of trust income is based on a series of predetermined “incentives.”

 

Promoting Success and Reinforcing Values

The incentives outlined in a FIT are at the discretion of the grantor. Each incentive provides the grantor with the opportunity to encourage specific future behavior. For instance, the trust could have provisions that pay each heir $10,000 on acquiring a bach­elor’s degree, $25,000 for a master’s degree, and $50,000 for a doctorate.

A FIT can also be an ideal tool to reward family members who pursue and/or distinguish themselves in a career path of the grantor’s choosing, such as the family business, music, the arts, research, or teaching. A FIT can reward younger heirs for academic success or community involve­ment. In addition, the trust can match certain levels of income for heirs who are younger than a specified age.

A FIT may also be an appropriate vehicle for education funding. Unlike a custodial ac­count, which generally becomes the property of the child once he or she attains the age of majority (determined by state law), a FIT can dictate that some trust assets be used to help cover education costs. Thus, the trust—rather than a young, inexperienced adult—can maintain control of monies earmarked for education.

Another interesting use of a FIT is treat­ing the trust principal as a “family bank.” The FIT can offer low-interest-rate loans for start-up business ventures or the purchase of a primary residence. To minimize risk to the trust, a lending process similar to that of a traditional lending institution can be established.

Philanthropy creates another possibility for an incentive-based estate plan. Certainly, many affluent individuals consider philan­thropic pursuits to be important endeavors. A FIT can be used to match the charitable contributions of a beneficiary. Also, the FIT’s matching contribution can be arranged as a distribution to the beneficiary, who then contributes it to the charity. Thus, the ben­eficiary can reap the benefits of a charitable deduction for his or her contribution, as well as the FIT’s matching contribution. As an alternative, any remaining trust income that has not been distributed through incentives may be used to make a charitable contribu­tion. Such contributions can also be arranged to be made on behalf of trust beneficiaries.

Sometimes, inherited wealth can have a negative impact on the motivation of heirs. For instance, when some heirs receive a substantial inheritance, they may be content with a life of leisure. Thus, the reasoning behind incentive-based estate planning is fairly straightforward. Assets and income are distributed to assist heirs who are realizing career or academic goals and/or whose ac­tions are consistent with the expectations of an affluent grantor. By adopting some of the principles of incentive-based estate planning, the affluent grantor can promote a family legacy of excellence and productivity for generations to come.

Domestic Partner Agreements: A Legal Leg to Stand On

As we journey further into the millennium, there are many forms of personal rela­tionships. Today, unmarried partnerships are a fact of life. If you are in an unmarried part­nership, one important consideration is how you share financial assets and obligations. Married couples have the benefit of the law to protect their rights, dictate their responsibili­ties, and guide the disposition of property in the event of separation or death. On the other hand, few, if any, laws govern the rights and responsibilities of unmarried partners. If you are planning on “sharing” your lives, here are some questions you might want to answer:

• What right do you expect to have to each other’s income now, and if your relation­ship ends?

• How much responsibility will you each assume for household expenses? Will you split costs according to income, use, or some other measure?

• Will you share joint bank accounts and credit cards? If so, how may they be used?

• Who owns the property you each bring into the relationship? Who owns the property you acquire together, and how will you divide it if you separate?

• What are your intentions for the distribu­tion of your property if you die?

 

Covering Income, Expenses, and Property

A domestic partner agreement provides a legal way to address these concerns. It is a written contract between unmarried partners that primarily covers the sharing of income, expenses, and property. It clarifies owner­ship rights and directs the distribution of the property if the relationship ends. It also provides a valuable supporting document for other legal instruments, such as deeds of title, living trusts, wills, and durable powers of attorney. For instance, in case of death, it can support your partner’s claim to jointly held property by verifying your intent to pass the property to your partner, rather than to your legal next of kin.

Some couples even use domestic partner agreements to address non-financial concerns, such as who will wash the dishes and who will trim the lawn, although courts generally provide only limited remedies for so-called personal service agreements.

Pros and Cons

A domestic partner agreement offers some important advantages. By setting clear ground rules, it can help prevent disagree­ments before they occur. It can also help ease the handling of disputes in the event of sepa­ration or death, possibly averting costly and emotionally draining legal battles.

Despite its potential benefits, a domestic partner agreement can be a delicate subject to broach, especially if you and your partner have never held frank discussions of financial matters. Only you can decide whether a legal approach will help or hurt your relation­ship, and whether, on balance, the long-term advantages are worth it. If you do choose to proceed with a domestic partner agreement, bear in mind, it will require periodic updating as you continue to acquire property together.

Some relationships endure until death with no major financial differences. Other relation­ships end, yet the partners separate amicably. However, if your relationship ends—and you and your partner differ about who gets what—without a domestic partner agreement you risk leaving it to a judge to divide your commingled assets and ultimately determine your financial fate. It is best to consult a qualified legal professional to prepare your domestic partner agreement or, at the least, to review it.

Long-Term Care: Better to be Safe than Sorry

As you enter your “golden years,” perhaps you imagine yourself traveling, visiting grandchildren, or pursuing a favorite hobby. Unfortunately, none of us can predict what the future may bring. But, according to the U.S. Department of Health and Human Services (HHS), more than 70% of individuals over the age of 65 will ultimately require some form of long-term care (LTC).

LTC refers to a wide range of medical, re­habilitation, personal care, and social services, whether in a nursing home, assisted living facility (ALF), or at home, for those who need assistance due to an illness or disability. If you should need LTC at some point, your world could change significantly, affecting not only your quality of life, but your finances, as well. For example, the national average cost of a semi-private room in a nursing home is more than $220 per day, which may be higher or lower in certain parts of the country (HHS), and will continue to rise.

Who Pays?

Many people believe that Medicare covers the cost of LTC. However, Medicare does not cover custodial or personal care, and coverage for skilled nursing home care is limited. By default, Medicaid funds LTC, but generally requires recipients to substantially reduce their assets by “spending down” before becoming eligible for assistance.

Unless you plan ahead, the high cost of LTC could deplete a lifetime of hard-earned sav­ings. For couples, this is especially challenging because one spouse may live for many years after his or her partner requires LTC. Whether you are single or married, LTC planning now may give you the opportunity to make appro­priate choices for you and your family. Here are some important considerations with regard to your future payment of LTC:

• Medicare does not cover LTC. Medicare covers some nursing home costs, but only for skilled care, which is medically neces­sary for a limited period of time after a patient is released from a three-day stay in the hospital. Depending on the medical necessity, Medicare may also pay for skilled care at home for a limited period of time.

• Medicaid covers LTC with strict eligibil­ity requirements. Medicaid is the primary payer of LTC services in the U.S. (Life Care Funding). Medicaid also covers a limited amount of services offered at home, and in the community, for those who might oth­erwise require nursing home care. Without advance planning, you may be required to substantially reduce or nearly exhaust your financial resources before meeting Medicaid’s strict financial qualifications.

• Those ineligible for Medicaid generally use personal assets. Unless you are cov­ered by LTC insurance, you may have to rely on your personal funds before becom­ing eligible for Medicaid. With the rising costs of extended care, you could deplete your savings quickly with an LTC event, leaving few or no assets for your spouse and future generations.

• LTC insurance can help pay for extended care. Private LTC insurance can be used to help cover the cost of care. You may want to consider having a policy benefit period that is at least as long as Medicaid’s “look back” period (a five-year time period dur­ing which the transfer of assets can result in the disqualification for Medicaid), so that you may be able to protect your assets from being used to cover the cost of LTC.

Covering All the Bases

By planning today, you may help ensure that you have the financial resources for quality LTC in the event you need it, while easing the caregiving burden on your fam­ily and loved ones. Be sure to consult with a qualified insurance professional who has experience in LTC planning.

The Changing Face: Dual Income Families

The concept of the “traditional” American family is continually changing. The dual income family—with both spouses maintain­ing separate careers and contributing to the financial success of the household—has now become commonplace.

The economic challenges and opportuni­ties of this century may often require two incomes to meet overall family expenses. Many families ask themselves, “How will we be able to plan for our retirement, save for our children’s education, and perhaps help our aging parents deal with some of their financial burdens?” These concerns may be especially pressing given today’s high cost of living and the current economic climate.

The Cost of Working

Although it may seem that dual income families will have more dispos­able income to afford life’s necessities, this may not always be the case. Fami­lies with both spouses working often lose some portion of the second pay­check to extra expenses, such as unreimbursed childcare, domestic help, job-related transporta­tion, business attire and dry cleaning, lunches and dinners at restaurants, and take-out meals. These additional, daily expenses all eat away at that second income.

When both parents work outside the home, childcare concerns are especially critical. Qual­ity childcare is a major expense for many families with working parents—after housing, food, and taxes. It is this cost that often reduces the income that could be used to help fund education or retirement.

As American businesses continue to re­structure and downsize, some dual income families may face the possibility of living on a single or reduced income for an unspecified period of time. For those who need the addi­tional income to help pay for basic expenses, a loss or reduction of one income could have a serious impact on the family finances.

Protecting Your Family’s Future

How would your family protect its in­come if either working parent should die or become disabled? One solution may be to purchase a permanent life insurance policy that will pay a death benefit upon the death of the insured spouse. There are several advantages to life insurance plans: For example, policies bought at a younger age may have lower premiums, and some policies maintain level premiums and build cash value.

Generally, the cost for life insurance policies is lower when purchased relatively early in life. However, it is important to re-evaluate insurance coverage as time goes on and circumstances change. The protec­tion that life insurance policies provide for dual income families can best be calculated by periodically analyzing all life insurance needs in order to determine the best plan for your family.

Now, what about loss of family income due to disability? This possibility is not as unlikely as you might think. According to the Social Security Administration*, studies show that just over 1 in 4 of today’s 20 year-olds will become disabled before reaching age 67.

A debilitating illness or injury that eliminates or reduces your family’s primary source of income can be financially dev­astating. An individual disability income insurance policy to help replace a portion of those lost dollars would be a worthwhile consideration.

Dual income families have become a fix­ture in today’s society. Although individuals may have different motives for working, most families come to depend upon that second income, whether it is used to meet current or future needs. Thus, it is important to ensure that both spousal incomes are protected from loss with life and disability income insurance. *Source: Social Security Administration, 2018. http://www.ssa.gov/dibplan/

Workers’ Financial Well-Being Is Linked To Their Job Performance

There is a significant relationship between the level of financial stress workers expe­rience and their on-the-job performance, ac­cording to the findings of a study of employee data published by human resources consul­tancy Willis Towers Watson on December 27, 2018.

Researchers cited the results of the “2017/2018 Willis Towers Watson Global Benefits Attitude Survey,” which showed a clear relationship between employees’ fi­nancial worries and their work performance, engagement levels, and record of absences. Specifically, the survey revealed that em­ployees who were struggling financially lost 41% more work time to absence than peers without financial worries, had lower engagement levels than their peers without financial worries (51% vs. 29%), and were less productive than their peers without financial worries (32% vs. 5%).

To examine the performance gap between employees who are and are not financially stressed in greater detail, the study used a large employer’s records of work quantity and quality for a relatively homogeneous group of 17,587 employees serving in consum­er-facing roles. The financial stress level of each employee was categorized as high, medium, or low based on a range of indicators drawn from the administra­tive records. These indicators include whether the employ­ee was contributing to a 401(k) retirement plan, had taken a loan or a hardship withdrawal from 401(k) plan savings, was subject to active wage garnishment, and had a recent qualified domestic relations order.

The results of this analysis showed that 24% of the employees had high stress levels, 33% were experiencing medium stress levels, and 43% had low stress levels. Additional analysis indicated that middle-aged employ­ees (aged 35-54) were far more likely to be in the high and medium financial stress groups than their younger (aged 18-34) and older (aged 55+) counterparts.

The findings also showed that having more family responsibilities was associated with higher stress levels. For example, researchers noted, 69% of the high-stress group, but just 42% of the low-stress group, had children; and more than a quarter of the high-stress group, but only 10% of the low-stress group, were single household heads.

The relationship between financial stress and time lost to absence was measured by employees’ use of sick days, unpaid leave, and non-pregnancy-related disability leave. The results indicated that for every one ab­sence day taken by the employees with low stress levels, the employees with high stress levels took 1.75 absence days, and the em­ployees with medium stress levels took 1.37 absence days.

The full study sample was then split into two subpopulations according to their job characteristics: field technicians or phone agents. The analysis found a strong associa­tion between financial stress and job perfor­mance among the field technicians, as the field technicians with high stress levels had significantly worse work performance than their peers with low financial stress. For the phone agents, the pattern of differences was found to be similar, but less pronounced. Researchers pointed out that this variation in the patterns of the phone agents and the field technicians suggests that the impact of financial stress on productivity may differ across occupations.

The study concluded, however, that “the impaired job performance observed in the employees with high financial stress are concerning because of the potential impact on customer satisfaction and customer retention, both key determinants in profitability.”

 

The information contained in this newsletter is for general use, and while we believe all information to be reliable and accurate, it is important to remember individual situations may be entirely different. The information provided is not written or intended as tax, legal, or financial advice and may not be relied on for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax coun­sel. Neither the information presented nor any opinion expressed constitutes a representation by us or a solicitation of the purchase or sale of any securities. This newsletter is written and published by LIBERTY PUBLISHING, INC., BEVERLY, MA COPYRIGHT 2019.