With the economy sluggish, a growing number of Americans are providing financial support to relatives, including so-called boomerang children and aging parents. Come tax day, those who pay a significant portion of the bills on behalf of a relative may be entitled to a tax break.

According to the Census Bureau, 59% of men and 50% of women ages 18 to 24 live with or are supported by their parents, up from 53% and 46%, respectively, in 2005. The same is true for 19% of men and 10% of women ages 25 to 34.

On the other side of the generational divide, 43.5 million Americans look after someone age 50 or older, up 28% from 2004. On average, each spends about $5,534 a year providing that care, according to the National Alliance for Caregiving.

To claim a relative as a dependent on your tax return, you must meet one of two tests. Those who qualify can reduce their taxable income by $3,700 for the 2011 tax year.

The first test applies to children, a category that includes stepchildren and eligible foster children. You must have provided more than half of your child’s financial support in 2011. In addition, he or she must have lived with you for at least six months, although there are exceptions for temporary absences, including attending college.

To qualify, the child must have been under age 19 on Dec. 31, 2011, or between 19 and 24 and a full-time student. (Parents can claim children of any age who are “permanently and totally” disabled, according to the Internal Revenue Service.)

To calculate how much you spent on support, include the costs of college, food, clothes, haircuts, recreation, weddings, and medical and dental care, in addition to the child’s prorated share of your mortgage, utilities and other household expenses, says Melanie Lauridsen, a tax manager at the American Institute of Certified Public Accountants.

If you provide significant financial support to older children or other relatives—including parents—you may be able to claim them as dependents. But you must meet a different set of requirements.

Again, you must provide more than half of the person’s financial support for the year. But under this test, the relative’s gross income for the year, excluding Social Security benefits and tax-exempt income, must be less than $3,700.

You can claim either a relative (living with you or elsewhere) or a nonfamily member who has lived with you for the past year. But he or she must be a U.S. citizen or a legal resident of the U.S., Canada or Mexico. In addition, the person can’t have filed a joint return or claimed himself or herself on a tax return.

If several people in your family together provide more than 50% of the financial support for a relative—but no single person meets the test—the family can file a “multiple support declaration” on Form 2120 from the IRS and designate one person to claim the dependent exemption each year. That individual must cover at least 10% of the care recipient’s annual expenses.

Email: next@wsj.com

Article source: Wall Street Journal

 

Our world is one where there is a considerable amount of risk and uncertainty.  Unfortunately, the current trend is that this uncertainty appears to be growing.  In nearly every facet of our personal, professional, and financial lives, the things that used to be taken for granted are no longer considered to be certain.

One of the most influential events of recent history is the financial crisis of 2008.  The credit bubble had escalated the stock market and real estate prices to unbelievable highs, just before they came crashing down.  A startlingly large percentage of people had been lulled into a belief that the government and Federal Reserve could “fine tune” the volatility out of the marketplace.

The reason for this belief was that for a long time, the fantasy of stable continuous growth was a reality.  In what appeared to be a triumph of financial science, the geniuses at the helm of our nation’s fiscal ship had guided us to what seemed like a magical place … a financial world where the market followed a nice smooth upward trajectory with no big disruptions.  All seemed to be bliss …

However, there is one critical observation that does not seem to receive much attention and that is asking why we allow a small group of people to have so much power over the US financial system?  It has always been true that the power to do good is also the power to destroy.  Our natural hubris dictates that we would rather have somebody be ‘in charge’ of the financial system who can ‘fine tune’ interest rates and the money supply to soften the impacts of recessions and accelerate recoveries.

The unfortunate problem with having ‘somebody in charge’ of the financial system means that any small mistake by the people in charge can create massive devastation for the entire national and world economy.  Realistically, it is inevitable that any system which relies on the discretion of a powerful committee for the health of the financial system is going to experience a dramatic collapse since it is not possible for any group of people to act correctly every time they need to make a decision.  When decisions are fragmented down to individual buying and selling decisions, prices are dynamic as people individually vote with their wallets.

Many years ago, Milton Friedman advanced a simple proposal for the Federal Reserve to grow the supply of money at the approximate annual rate of productivity growth (Somewhere around 2% and 3%) and allow the market to reach equilibrium on interest rates and asset prices.  Such a system would not attempt to mask the effect of economic downturns with accommodating monetary policy.  However, it would also lack the false sense of stability that was created by a prolonged period of smoothed cycles that was ruptured in a crash that nearly collapsed the entire financial system.

Any time that volatility can be artificially suppressed is conditioning people to panic when the inevitable market disruptions transpire.  The fundamental question that we must ask ourselves is whether it is more advantageous to make our own decisions instead of relying on the government authorities to create stability.  Change is a reality of life, and attempting to create artificial stability will not accomplish anything more than further conditioning people for panic when the fictional expectations of stability are eventually broken.

In this way, it is much better for us to pattern our lives in a manner that allows us to adapt to changes rather than be destroyed by them.  This is most certainly easier said than done, but it is nonetheless quite important to do.  One of the first things that we should make sure to do is ensure that our financial future is dependent on our own efforts.  Many people have been promised pensions or entitlement payments from both private companies and government entities.  Unfortunately, the same entities that have promised pension benefits are proving that they may be unable to make good on their obligations.  This has the potential to leave many people in a very difficult financial position if the pensions they had depended on for their financial future disappear.

In the end, each of us must condition ourselves to accommodate uncertainty, since change is becoming an unavoidable fact of life.  Since we are unable to stop the risks and uncertainty of life, we must take action to ensure that we are able to withstand the changes that are an inevitable part of life.  Ultimately, the future of our personal, professional, and financial lives come down to the decisions that we make.

 

WASHINGTON—The Treasury Department and the governments of five European nations reached broad agreement Wednesday on a proposal to prevent U.S. taxpayers from dodging taxes through foreign accounts.

WSJ’s John McKinnon stops by Mean Street with an interesting detail in the Senate’s proposed highway bill: it would be funded in part through taxes on IRAs and retirement accounts. Photo: AP.

At the same time, the Treasury and the IRS also released proposed regulations to implement a 2010 U.S. law known as the Foreign Account Tax Compliance Act, which requires foreign financial institutions to report detailed information about U.S. account holders to the IRS and possibly withhold taxes on individual accounts.

If firms don’t comply, they could face U.S. tax penalties. An agreement among the U.S. and the other countries could help streamline implementation of the law.

The Treasury aims to make the regulations final by this summer.

France, Germany, Italy, Spain and the U.K. expressed support for the Treasury Department’s proposal, while other nations will be given a chance to evaluate the proposal and join in.

Washington for the past three years has been aggressively pursuing foreign accounts to make sure people aren’t using them to dodge U.S. taxes.

In a landmark 2009 settlement, Swiss bank UBS AG agreed to turn over to the U.S. the names of more than 4,000 U.S. taxpayers with secret accounts.

The IRS has since rolled out two programs allowing U.S. taxpayers who step forward to, in many cases, pay large penalties but avoid prosecution. At least 33,000 have taken the deal.

The 2010 law, known as Fatca, targets foreign banks to make sure U.S. taxpayers are paying the IRS what they owe.

The Treasury said various provisions of the regulations would be phased in from 2013 to 2017, to allow banks to develop appropriate systems and ensure they don’t violate local rules.

A Treasury official said several specifics of the new regulations would ease potential administrative burdens while still achieving the law’s purposes. For example, the proposed regulations allow foreign banks to rely on data they already collect to comply with anti-money-laundering rules, the Treasury said.

The announcement also appeared to embrace a recommendation by U.K. financial institutions for reduced information-gathering requirements on investment accounts that aren’t marketed to U.S. investors.

David Miller, a partner with Cadwalader Wickersham Taft LLP, said the proposed regulations are less burdensome than they could have been and satisfy the objective of ensuring “that U.S. taxpayers with foreign accounts pay what they owe.”

European banks for months had raised concerns that the U.S. law, as originally passed, might conflict with European privacy laws by requiring banks to enter into information-sharing agreements directly with the IRS. They initially reacted with favor to the new proposals.

Wednesday’s announcement included a joint statement from the U.S., Germany, France, U.K., Italy and Spain expressing intent to adopt a “common approach” to implementing the new law. That could allow banks to report U.S. account-holder information to their own governments rather than the IRS, solving many of the potential legal problems, European financial institutions said.

“I think this is a very positive approach,” said Peter De Proft, director general of the European Fund and Asset Management Association in Brussels. “We were very worried with the original approach and the burden it would bring.”

Countries such as Canada, Japan, Australia and China will be able to evaluate the proposed regulations and join in the negotiations with the U.S., said Phil West, a former international-tax counsel for the Treasury who is now at Steptoe Johnson LLP in Washington.

As the network of participating countries grows, “it may be that ‘bank-secrecy’ jurisdictions feel increasing pressure to move toward a growing international consensus on information exchange,” Mr. West added.

U.S. financial institutions, which also had worried about the potential burden of the new rules, had mixed reactions to Wednesday’s announcement. Some expressed relief U.S. officials appeared to accept a number of their suggestions for reducing the potential negative effects on them. But others warned the new system still could lead some foreign banks to reduce their investments in the U.S., to minimize their exposure to U.S. tax penalties.

“Implementation of [the new rules] will impose significant challenges and costs for many United States financial services firms and their customers,” the Securities Industry and Financial Markets Association, a Wall Street trade group, said in a statement.

While the Treasury is still implementing the law for financial institutions, individuals already are feeling the impact. U.S. taxpayers holding foreign financial accounts above a threshold as low as $50,000 will have to file Form 8938 disclosing the accounts with their 2011 tax returns or risk financial penalties. These thresholds are different from those for the annual Foreign Bank Account Report form, which is due separately to the U.S. Treasury by June 30.

Write to John D. McKinnon at john.mckinnon@wsj.com and Laura Saunders at laura.saunders@wsj.com

Article source: Wall Street Journal

 

The terms ‘profit’ and ‘loss’ are common parts of the business vernacular, but not many people fully understand their role in a market economy.  This has become even more pronounced after the recent financial crisis, as the government has attempted to perpetuate a system of profits without losses.  The problem implicit within trying to build a market economy without both profits and losses is that it will inevitably lead to one of two extremely undesirable results.

One sentiment that was popular in the middle of the 20th century was the notion that private profits are fundamentally immoral and that all production should be socialized.  This is the fundamental tenant of socialism and communism, and ultimately results in a stifling of risk taking since the rewards for entrepreneurship become non-existent.  In this environment, the resources available for redistribution don’t grow, and the costs of government control place a tremendous burden on national output as access to wealth becomes a function of political connections instead of skill or productivity.

Another sentiment that has been unfolding over the second half of the 20th and early 21st century is the notion of socializing losses from private activities through creditor bailouts.  The textbook term for business sector that enjoys government sponsored monopoly power and implicit (or explicit) guarantees of solvency is the “corporate state.”  In this model, profits are privatized to politically connected businesses and losses are socialized on the backs of taxpayers.  Some people refer to this as “crony capitalism” … however, the term is an oxymoron since capitalism is a system where market conditions are allowed to prevail and political officials are unable to provide special benefits to their “cronies” through the power of government.

The fundamental characteristic that both of these flawed models share is that they distribute wealth based on political influence instead of ideas and productivity.  In both cases, the government wields tremendous power and entrepreneurship is suppressed by either an absence of profits from success or from entrenched competitors with government backing that crush competition.  The danger that is posed by this model is that the “profits” it generates look the same as earnings from legitimate business activities.  However, the former provides nothing of net value to the marketplace, and the latter is the fundamental foundation of every market-based economy.

In a ‘real’ capitalist economy, profits are generated by success in the marketplace and failure results in losses for both equity and debt investors.  The current brand of “crony capitalism” has architected bailout after bailout of creditors who financed excessively risky business operations.  The importance of this comes from the fact that creditors have historically been the primary guardian of prudence in business activities.

Consider that a creditor receives no premium if a business is successful like a stockholder . . . all that they get is their regular interest payment.  Because of this, creditors in a ‘normal’ environment will demand a higher interest rate from risky businesses.  These higher interest rates will temper risk taking by entrepreneurs since the increased financial obligations will reduce their probability of success.

However, if the government guarantees the debtors of a particular company, then they have no reason at all to encourage prudence . . . they are going to get their money back from the government if things go upside down.  This creates perverse incentives where risk taking becomes more and more intense while the cost of borrowing stays low because of a government guarantee.  When big profits roll in, management gets big bonuses.  If a collapse occurs, the government bails out the creditors and the taxpayers get stuck with the bill.

Even in cases where government guarantees have been “successful” for companies that did not require an explicit bailout, they have contributed to insane risk taking that eventually culminated in the financial crisis of 2008.  Furthermore, these ‘successful’ bailouts are fomenting an even larger collapse, since the fundamental incentives have not changed.  Thus, the system of government guarantees results in an ever increasing avalanche of risks that are concealed from the public through clever accounting tricks until they eventually explode into a massive market collapse.

In the end, both profits and losses are necessary for true capitalism.  Unfortunately, true capitalism has not been present in the developed world for nearly 100 years.  In an environment of increasing manipulation and government control, the strategy for success is to gain control of income producing assets that can be financed with fixed-rate debt.  This will allow you to realize financial gains when the day of financial reckoning arrives and the US government falls back on creating inflation by printing money to finance its bailouts and entitlement promises.

 

So … you’ve put the finishing touches on your retirement plan, and you’re set to withdraw 4% from savings each year, because that’s what financial planners (and columnists) have long advised.

Can you guess what’s coming?

Last year, a research paper in the Journal of Financial Planning predicted that a safe nest-egg withdrawal rate for retirements begun in 2010 is 1.8%. In other words, a new retiree with $500,000 should pull no more than $9,000 from savings annually to help ensure that his money lasts as long as he does. Stunned? Wait. There’s more.

Within weeks of that report’s appearance, a study in Retirement Management Journal made the case that a safe withdrawal rate for some individuals could be as much as 7%. Which means the same person with $500,000 could start retirement by pulling about $35,000 from savings annually.

See? Isn’t retirement-planning fun? In fact, both papers make some intriguing points. (We’ll get to them in a moment.) But here’s the real lesson: Retirement planning — or rather, good retirement planning — is never really finished. Ideally, your particular plan is open to new ideas and research and, as such, is able to evolve.

Take the so-called 4 percent rule. Based on pioneering work in the early 1990s by William Bengen, a certified financial planner in El Cajon, Calif., the rule states that retirees can pull about 4% annually from their nest egg, with a high probability that their savings will last 30 years. (Bengen himself eventually set the figure at 4.5%.) The findings helped establish budgets and spending patterns for countless individuals. Recently, though, researchers have been investigating how additional variables — investment fees, the timing of retirement, retiree spending patterns — could affect Bengen’s benchmark. Here’s what some of that work might mean for your retirement.

On your mark

“Market valuations” — the relative health of markets at the moment you enter retirement — are now an important part of calculating withdrawal rates. The thinking: Markets move in cycles (bull markets follow bear markets, and so on), and we can measure (to some extent) whether we’re on the cusp of the former or the latter. Why is that important? If you happen to retire at the start of a bear market and withdraw too much too soon, your nest egg might expire before you do.

In his study in the Journal of Financial Planning, economist Wade Pfau notes that when price/earnings ratios (to cite one marker) are at or above historical averages, as they are today, investors in coming years are more likely to see anemic returns. As such, a new retiree would want to keep his initial withdrawal rate on the low side — perhaps as low as (gulp) 1.8% — to weather coming storms.

Care to gamble?

Most research into withdrawal rates assumes retirees, in effect, want a guarantee that their savings will last 30 years or more. But what if you’re willing to gamble? Would you risk having (virtually) no savings for a brief period late in life in order to draw more early in retirement? Having a pension, for instance, might make that a risk worth taking.

Article source: Wall Street Journal

 

One of the things that we have been conditioned to believe in both business and in life is that mistakes and errors need to be avoided.  This idea pervades our education system, our mindset as employees, and our behavior as business owners.  It is important to understand that mistakes cannot be completely avoided.  Thus, an attempt to “eliminate” mistakes generally results in hiding them until they are so large that they become devastating.

This is what precipitated the financial crisis of 2008.  A long history of regulations that consolidated power in major banks, and policy decisions that attempted to “fine tune” the economy and seemingly avoid a crisis resulted in a financial disaster that is beyond the ability of most people to comprehend.  The thing that is important to understand is how the financial crisis emerged from an attempt to disguise risk and hide errors instead of any particular lack of regulation.

The financial system was built for “stability” since each bank purchased a “diversified” portfolio of debt from other banks.  This meant that all of the major banks had access to a regular stream of capital … until investors became justifiably concerned that they might not be paid back.  This happened because the banks financial decisions became progressively more risky, until the plank finally broke and Bear Sterns announced they would not be able to pay their financial obligations since nobody would lend them new capital, and their investment portfolio contained a large amount of toxic debt.  What precipitated was a freeze of credit markets as all the players became concerned that they would lose their investment if they loaned to the troubled entities.

What all of this demonstrates is how a cluster of (minor) errors is necessary for a robust business, life, and economy.  Making mistakes is how we learn.  It is much better to learn from small mistakes than from large ones, and a system that is built around steady course-correction from many small errors is much more robust than one that attempts to conceal errors and mistakes with bailouts and guarantees.  Sooner or later these concealed risks will become too large to conceal, and will result in a collapse.

An example of this phenomenon in the physical world is to consider driving an automobile.  If you run into a wall at 5 mph, it will cause a small degree of damage to your car, but will not result in any permanent harm.  Furthermore, it will serve as a legitimate warning to avoid driving habits that could cause collisions.  In fact, you could reasonably sustain 100 of these 5 mph collisions without significant adverse effect, outside of the nuisance associated with re-painting your bumper.  However, let’s assume that a new technology designed to avoid collisions warns you when you are about to hit something.  Furthermore, let’s assume that the quality of your automobile rises such that you can run at very high speeds and receive preliminary warning before a crash occurs.

Carrying this analogy further, let’s assume that you are able to drive your car at 500mph, achieving incredible mobility and with no perceived risk because of your warning system.  You have increased the efficiency of your transportation by a factor of one hundred.  You are a genius of efficiency and mobility … until something in the system doesn’t work.  What happens when your warning system does not signal correctly while you are moving at 500 mph?  The answer is that you become involved in a crash that is fatal to you, everybody riding with you, and everybody around the area of the accident.

Now take this same principal, and apply it to the entire financial system.  What results is the situation that precipitated the financial crisis of 2008.  The way that future disasters of this variety can be mitigated is by ensuring that mistakes are localized instead of centralized.  In the realm of our personal lives, this means taking more small risks.  This allows us to learn from our failures and evolve them into future successes.  It also avoids a situation where years and years of playing it safe back us into a corner where we must take large risks all at once, and place our entire future on a single roll of the dice.

In the end, mistakes and errors are impossible to avoid.  They can be hidden or concealed for a certain amount of time, but they will eventually come to bear.  The key principal for people to understand is not how to avoid mistakes, but how to ensure that the impact of our mistakes stay small and localized so that we can learn from them to achieve more in the future.  Ultimately, each of us are responsible for our own personal, professional, and financial future.  In order to get there, it turns out that a perpetual cluster of (minor) errors is a necessary part of the growth and development that we all need to reach our goals.

 

In the midst of the current sluggish economy that has engulfed the government and business sectors in an avalanche of difficulty and uncertainty, there is a great temptation to ‘curse the darkness’ by casting blame.  It is certainly true that the current financial situation has plenty of blame to go around.  Typically, entities such as “Wall Street Greed” and “Irresponsible Government” are dogs that frequently get kicked.  However, there is a very large elephant that frequently seems to be overlooked.  That elephant is personal responsibility.

The reason why personal responsibility plays such an important role in the current economic situation is because it is impossible for a financial crisis to develop unless there are a LOT of people using credit to live beyond their means.  The crisis develops when the people who have been living on borrowed money can no longer make the payments.  Once the borrowers stop paying the creditors, there is suddenly a crisis.  (Note that the crisis is the proverbial ‘hangover after the party’ since it is necessarily preceded by people living high on borrowed money.)

This phenomenon highlights a curious and unflattering corner of the human condition.  Namely that people are more eager to “curse the darkness” and blame somebody else for their problems than seek a path of action that they can personally take to influence their personal situation.  This is not to say that all things are all our fault.  Quite to the contrary, there are many parties who have earned a considerable measure of blame.  However, the collective malfeasance of various players on the economic stage is not within our direct control.  Taking personal responsibility for our personal decisions is of paramount importance because our actions are the primary points of influence that we have control over in regard to our personal, professional, and financial well being.  The only way that our life will improve is if we take action. Past precedent has most clearly shown that the so-called guardians of our financial well being will look after their own interests before ours.

An unfortunate and disappointing part of the current economic situation is that the ‘solution’ being sought isn’t one of returning to responsible spending and lending practices . . . no, it is the exact antithesis of responsibility referred to affectionately as a ‘bailout.’  The extreme danger posed with the ‘bailout’ solution is that it simply subsidizes the irresponsibility that caused the problem in the first place.  My greatest fear with this ‘bailout’ mindset is that constantly rewarding irresponsibility can only lead to an increase in irresponsibility by more and more people until the problems eventually get so big that it is beyond of the ability of the government to bail out.

Simple arithmetic clearly demonstrates that the extent of government financial obligations will soon exceed its financial resources by an impossibly large margin.  This will lead to a situation where many people receive far less than they have been promised for their benefits, pensions, salaries, and many other varieties of services.  This will compel many of them to “curse the darkness” as well, saying that the problem comes from taxes not being high enough on the “rich” or from unfair foreign competition, and from a variety of other sources.  In order to endure this ensuing storm of financial darkness, it is completely necessary that we take action now so that the financial well being of our families are safeguarded.

Ultimately, there is only one way to permanently restore stability.  That is to retreat from blaming other people for the financial problems that we the people have created.  Put another way . . . instead of cursing the darkness, try lighting a candle.

 

One of the curious aspects of the human condition is that we grow to achieve comfort, but when we achieve that comfort it prevents us from growing.  It has long been said that luxury is the lull to apathy.  In practice, this means that it is difficult to reach new heights if we do not leave our present place.  For most people, this means that personal, professional, or financial growth will require that we “Dial up the Discomfort” of the conversations and decisions that we must make.

The reason why this principal takes on such importance is because we all have a natural tendency to perpetuate the standard quo.  Keeping things going the way that they have been going in the past is the path of least resistance.  The problem is that following the path of least resistance cannot be expected to produce results that are different than what has been achieved in the past.  Fundamentally, this means that each time we wish to expand and grow our personal abilities, we must push beyond the realm of our comfort zone.

Why is Discomfort Necessary?

Whether we are talking about the context of personal, professional, or financial life, dialing up our level of discomfort is necessary to grow and progress.  If our relationships never experience any friction, they will not progress … they will simply stay where they are, and may possibly slip into decline.  If a business never challenges itself to accomplish new goals, it will pass through the stage of maturity and into decline.  If our financial decisions are rooted only in the desire for comfort, it will result in many lost opportunities throughout our career.

Fundamentally speaking, the way that we grow is to break out of our current ‘normal’ and seek out a new equilibrium that generates higher and greater levels of achievement.  Once this has been achieved, a new ‘normal’ is established, and the process begins over again.  The world’s high achievers must learn that constantly challenging the limits of their comfort zone is part and parcel to the growth and development that a high achiever should expect from themselves.

How Far Should We Dial It Up?

Once a person has accepted the necessity of discomfort as a piece of personal, professional, and financial growth, it becomes necessary to determine how far we must push the envelope.  If we push too hard, it can create destructive results from failed ventures, nervous breakdowns, and the like.  Conversely, if we do not push hard enough, we cannot expect to grow and progress.  In order to achieve this “Sweet Spot” of personal and professional development, it becomes necessary that we learn to recognize how much discomfort is necessary without pushing the boundaries so hard that they collapse.

The True Hallmark of Success

The true characteristic that differentiates those who achieve success and everybody else is the number of uncomfortable conversations that they are willing to have.  This does not mean that successful people need to become a “Bull in a China Shop” who constantly disrupt the environment around them.  Rather, it is a testament to the fact that constantly growing means that we will constantly be pushing the boundaries of our comfort zone.

In this way, we should go into each day asking ourselves what we are going to do that pushes our zone of comfort?  What conversations are we willing to have that we would rather put off?  What difficult work are we stalling on by keeping ourselves busy with something else?  What do we avoid by telling ourselves that we will get to it later?  The sooner we develop the ability to take these tasks head-on, the faster our trajectory of personal, professional, and financial growth will accelerate.

In the end, each of us who seek to follow a trajectory of continued growth must find a way to consistently push our personal boundaries of comfort.  The exact way that each person dials up their own level of discomfort will be unique.  However, there is one common characteristic that is shared between the journey of all aspiring achievers.  This common thread is that we must all find a way to push our comfort zone, and find the right way to undertake this task in such a way that it propels us onward and upward, but does not wreak a destructive force upon our lives. Ultimately, this serves as one of the many challenges that all achievers must undertake.  And like all other challenges, ignoring it will not make it disappear.  It will only be accomplished if it is addressed.

 

One of the oldest and most frequently cited geometric axioms is that the shortest distance between two points is a straight line.  While this is most certainly true in the sphere of mathematics and geometry, the path we take through business and life rarely (if ever) moves in a straight line.  Because of this, much of our ability to realize success is dependent on our ability to adapt to the twists and turns that we are presented with on a perpetual basis.

This is especially important for our financial calculations and decisions.  It is not a secret that most financial planning models are built on the assumption of indefinite steady compounding that is expected to make you rich after a certain calculated period of time.  Of course, real life does not work in that manner.  The stock market does not compound at 9% per year, every year, with no deviation.  In some years … or in the past decade, in many years, gains do not meet expectations or values decline.

Thus, it is not just the paper performance of our decisions, but their ability to absorb uncertainty that is highly important.  The problem is that most people do not fully understand the impact of uncertainty, and even fewer people are not aware of how to make their financial plans sufficiently robust so that they can withstand abrupt, significant changes to the marketplace.

Adaptability is Key

Regardless of whether you are talking about a manufacturing line, a small (or large) business, or a financial portfolio, it is absolutely critical to ensure that your strategy is adaptable to new market realities.  The more you allow yourself to depend on static models, the more you will be susceptible to destructive changes in the marketplace.  This concept must be internalized when planning, executing, and revising our personal and professional strategies.  As reality changes, we must be able to adapt and change with it.

A simple way to understand this concept is by internalizing the following three truisms about business/life:

1. Business/Life is a game
2. The game has rules
3. The rules are always changing

If this feels highly chaotic, that’s because in many cases it is.  We cannot suffice ourselves with learning the rules (both written and unwritten) of business/life.  We must also learn how and when the rules change so that we can adjust our personal, professional, and financial decisions.  An unfortunate fact of life is that none of us possess the power to change the larger reality … we only have the ability to change the decisions we make and influence the decisions that people close to us make so that we can adapt to the larger reality more successfully.

Learning When the Rules Change

Many people make a regular habit of following the news both in print and on the internet.  The typical result of most people’s news consumption is agreement with stories support their political views, and anger at stories that stand in contrast to their personal views.  This typically manifests itself in political arguments over current events with friends, co-workers, and family members.  The only problem is that none of us have the ability to change the political reality of the world at large.  Our vote counts as one of many, many millions, and political decisions do not vary as much many are led to believe.  Politicians are wildly different in their rhetoric (what they say), but their decisions (what they do) are much more closely tied to their incentives.

At first blush, this can easily lead to a belief that the news is useless, and it is optimal to tune out.  While temping, this view is not completely accurate.  The news is not useful from the context of my ability to change the global political reality, but it is useful from the context of understanding what changes are coming in the national and global marketplace.  From this perspective, news and information take on an entirely new light.

Signal and Noise

The key to making use of what we learn through the news is the concept of signal and noise.  Within most transmissions, there is an element of useful information (signal) and an element of useless information (noise).  In everything that we see, sense, or experience, there is something we can learn (signal) and there is everything else (noise).  The challenge that we have as people and as businesses is to act on the signal, and not on the noise.  In practice, this is much easier said than done.  In following the news, we should not be simply looking for stories that either confirm or conflict with our beliefs, but looking for useful information signals that can help us make better personal, professional, and financial decisions.

In the end, each of us will be able to achieve the best results if we realize the importance of adapting our strategy and decisions to a changing marketplace, while using the signals that we gain from our everyday experience to inform better decisions in the future.  By learning to do this on a consistent basis, it will allow us to perpetually move closer to our goals, dreams, and aspirations.

 

A larger share of people’s savings is winding up in IRAs—even as estate-tax rules are getting trickier and the markets are growing more volatile.

All of this is making life more complicated for widows and widowers, and could cause them to make significant mistakes with their money.

“There’s so much fear and anxiety, even if you have everything in place,” says Karen Altfest, a certified financial planner in New York who often works with surviving spouses.

One big problem: Standard advice that doesn’t fit your situation—such as rolling your spouse’s individual retirement account into your own. Don’t follow any rules of thumb before weighing them against your own circumstances.

Here are some of the most common mistakes that widows and widowers make while sorting out their inheritance:

Paying unnecessary IRA penalties. If you inherit an IRA from your spouse, you can roll it over into your own IRA. In fact, some IRA custodians and 401(k) plans automatically do that unless the surviving spouse’s financial planner intervenes. Such a “spousal rollover” generally makes sense if you are at least 59½ years old, the age at which you are allowed to start tapping an IRA without paying a 10% penalty on early withdrawals—though you will still owe income tax.

But the median age for women widowed the first time is 59.4, according to the U.S. Census Bureau. That means many widows are younger than 59½, and if they need to tap IRA assets to supplement their income or cover other expenses, they would have to pay that 10% penalty.

People under 59½ often are better off transferring the money into an “inherited IRA,” which remains in the deceased spouse’s name, and then transferring it into their own IRA when they hit the age when withdrawals are penalty-free, says Michael Lynch, a certified financial planner with MetLife’s Barnum Financial Group in Shelton, Conn.

With an inherited IRA, most beneficiaries have to take a required withdrawal every year based on their life expectancies. But if the deceased spouse was not yet 70½, the surviving spouse doesn’t have to take any required distributions until the year the deceased spouse would have turned 70½. (With an inherited Roth IRA, you still would have to follow the same withdrawal schedule, but you generally wouldn’t owe any income tax.)

One 50-year-old widow who Mr. Lynch worked with recently already had planned to quit her job to go back to school when her husband died, so he encouraged her to use IRA withdrawals for tuition and living expenses. That way, her income, and her corresponding tax bracket, would be relatively low while she wasn’t working.

“So often all the focus is on deferring taxes, but you’re going to pay taxes [on IRA withdrawals] eventually,” Mr. Lynch says. “It’s better to do it when you’re in a lower bracket.”

Portfolio paralysis. What about the investments inside the inherited IRA, or inside any inherited brokerage accounts? The portfolio should reflect the survivor’s circumstances, Ms. Altfest says, not the couple’s.

She says she has had clients come to her because their deceased spouse frequently traded stocks or owned lots of high-risk commodities they knew little about.

Ms. Altfest suggests widows assess their own risk tolerance, seeking help from a financial planner to do so if they need it, and then redeploy the assets in investments with which they are comfortable.

“Find somebody who’s sympathetic and interested in teaching you as you go along what to ask about,” she says.

Forgoing future estate-tax breaks. Under federal law, spouses can use what as called “portability” to double the $5 million estate-tax exemption to $10 million.

But there is a catch: Even if the first spouse’s estate is valued at less than $5 million, that estate still has to file a federal estate-tax return and elect portability to use the leftover exemption in the future, says Paul McCawley, an estate-tax lawyer at Greenberg Traurig in Fort Lauderdale, Fla. (The law, enacted late last year, expires after 2012, though many tax-policy experts think Congress may make the portability perk permanent.)

Say the wife dies first with a $1 million estate, which doesn’t necessarily have to file an estate-tax return. But the husband runs a growing business and someday could wind up with a multimillion-dollar estate. His wife’s estate should file a tax return electing portability, Mr. McCawley says, so that down the road the widower’s heirs could add the remaining $4 million exemption to his $5 million one.

Still, filing an estate-tax return when isn’t required is a bit of a hassle, especially with portability’s future uncertain. An estate-tax return “can easily cost a few thousand dollars,” Mr. McCawley says, and there are often extra appraisal costs.

An estate also can get hit by state-level estate taxes in about a dozen states with estate-tax thresholds that are less than $5 million, says James Cundiff, a partner at McDermott Will Emery in Chicago. Such taxes can apply when the first spouse dies and again when the second spouse dies. Trusts can help defer such taxes.

In Illinois, for example, the amount exempt from estate tax is $2 million. So if your spouse leaves you $5 million in a trust, you would owe Illinois estate tax on $3 million. To defer that tax until you die, you could divide the trust into two—one a $2 million trust and the other a $3 million trust—and make what is called a “qualified terminable interest property” election, Mr. Cundiff says.

If Illinois eliminated that tax before the second spouse’s death, the estate might never have to pay it, he says.

Collecting Social Security too soon. Surviving spouses are allowed to start collecting Social Security survivor benefits at 60—but, as with Social Security retirement benefits, they would get a smaller amount each month than they would if they waited until their full retirement age. For more information, go to ssa.gov/retire2/agereduction.htm and ssa.gov/survivorchartred.htm.

Write to Kelly Greene at familyvalue@wsj.com

Article source: Wall Street Journal