extended Warranties: Should You Take The Bait?

Extended warranties, by offering protection for expensive purchases and increasing the length of a product’s original warranty, have become the norm for many retailers. These warranties often appeal to thrifty consumers, for whom buying big-ticket items like appliances and electronics can be an exacting decision.

When you’re pulling out your wallet to pay for that new refrigerator, big-screen TV or treadmill for your home gym, it’s hard not to be tempted to buy into the extended warranty sales pitch – even if it will increase the cost of your purchase by hundreds of dollars. But are these warranties worth the price? We’ll show you why in most cases, the benefits of these warranties don’t extend beyond the profit margins of the companies that offer them.

An Extended Warranty Is Insurance
An extended warranty works like an insurance contract for the product you purchase and can be offered by either the product’s manufacturer, or by the retailer, which contracts this service out to an insurance company.

What most consumers fail to realize is that although the price of an extended warranty often seems like a bargain to a consumer who is aware of the steep price of repairs, it has actually been carefully considered through actuarial analysis by the company that offers it. In other words, the company uses probability and statistical methods to calculate the likelihood that your new refrigerator or big-screen television, for example, will require repairs. This figure is weighed against how much those repairs would cost to arrive at the price that a company will charge consumers for a warranty on a particular item. This formula is not designed to work in your favor.

Probabilities and Profit Margins
Extended warranties, like the products they claim to protect, are sold to consumers for a profit and can be big money-makers for retailers. According to “The Warranty Windfall” (BusinessWeek, 2004), profits from warranties accounted for all of CircuitCity’s 2003 operating income. In fact, the operating profit margins on extended warranties can be as high as 70%, compared to only 10% for the products they cover, according to a December 2003 article in Consumer Reports.

What this means is that for every dollar you spend on an extended warranty from a retailer, $0.70 goes to the retailer, with the remaining $0.30 going to the insurance company. Because the insurance company also expects to profit from the agreement, it is clear that it doesn’t expect to have to make very many payouts. In fact, when Consumer Reports conducted a survey of 38,000 consumers in 2000, it found that only 8% of camcorders, stove ranges, dishwashers and refrigerators were repaired within the first three years of when they were purchased. Because these warranties cost almost nothing to market and often go uncollected, they are a simple way for retailers to boost their bottom lines.

Suppose you are in the market for a new washer and dryer. You choose a high-end set that costs $2,250. The salesperson offers you an extended warranty that will cover the cost of services and repairs for three years and includes a replacement guarantee if the product can’t be fixed – it costs $660. If you’re tempted to shell out for this warranty, it’s because you know that the cost of in-home repairs for your new appliance would add up fast if you have to pay for them yourself and could easily exceed $660 if something goes wrong.

Figure 1: Consumer report repair rate

Risk-Reward Ratio
The concept of weighing risk and reward is a key principle in investing: taking on more risk increases an investment’s possible return. The same is true for warranties.

Let’s return to our example with the washer and dryer set. In a best-case scenario, you would purchase your appliances, turn down the warranty and your new purchase would not require repairs within the three-year period that the warranty would have covered. If this occurs, you save yourself $660. Of course, if you don’t buy the warranty, the worst-case scenario is that your new appliances require repairs within three years and that those repairs cost more than the $660 warranty you could have purchased.

However, according to the statistics from the Consumer Reports study shown in Figure 1, your washing machine has a 22% chance of needing repairs within the first three years, and your dryer is even more reliable, with only a 13% possibility that it will break down within that period.

If your appliance retailer (and its insurance company) is willing to bet on these odds, why shouldn’t you? Better yet, instead of handing your money over to the retailer, could put the $660 aside in case your new purchase requires repairs down the road. This way, not only will you get to collect interest on your own money, but you’ll also get to keep it if you beat out the odds and your appliances keep running as they should.

The Flip Side of Warranties
Manufacturers and retailers tend to push warranties because they’re profitable, but you need to decide for yourself whether the risk outweighs the reward; if a warranty gives you peace of mind, it may be worth the money. Also keep in mind that many products come with a standard manufacturer’s warranty – free of charge. This warranty usually applies to the first year of the product’s life. This should be enough to cover you if your product turns out to be defective. Furthermore, if you buy an extended warranty on top of this initial warranty, it will also start immediately, forcing you to pay a second time for coverage you already have.

Also consider the replacement cost of the product you are buying, particularly when it comes to electronics. As these goods continue to improve and the prices continue to drop, your warranty could easily end up costing more than it would to replace the product when it fails.

Although warranties may seem like an act of customer service that companies extend to consumers, they are actually carefully calculated to be profitable for the companies that offer them. Before you agree to insure your next big-ticket purchase against failure, carefully consider the likelihood that the product will fail as well as how much it would cost for you to repair or replace it yourself. In many cases, the odds will be in your favor and your best course of action will be to bet that your appliances and electronics will outlast the warranties you left behind.


to Rent Or Buy? There’s More To It Than Money

After you have thoroughly researched the financial issues of the rent-versus-buy decision, let’s look at the issue from a different perspective, one involving emotional factors and personal preferences that collectively determine the impact of your decision on your quality of life. These “non-financial” issues are based on your personality, abilities and values. They require careful consideration, beginning with this question: what attributes about the place you live in are most important to you?

Environment: City Vs. Suburbs
The environment you choose to reside in plays a major role in your quality of life. Consider your personality. Do you like the character of the city, with its nightlife, quaint caf├ęs and diverse cultures, or do you prefer the safety, conformity, green space and free parking in suburbia? Do you prefer to walk to work, take the subway or ride the train? How important is privacy, and how far do you like to live from your neighbors? If you can afford only those properties in environments that do not fit your preferences, you need to think about whether you are willing to forgo these preferences for the sake of owning a place.

Amenities versus Customization
Dollar for dollar, renting generally offers a substantially greater number and variety of amenities than buying. Consider, for example, the number of homes that come with an Olympic-sized swimming pool, clubhouse, tennis courts, basketball court and on-site gym. If you’re looking to have these amenities in your private residence, get ready to spend a lot of money. Upscale apartment buildings, found in nearly every city, offer such options at a comparatively lower monthly rent than a mortgage for a property with the same attributes. On the other side of coin, there are affordable homes with private outdoor spaces that you can customize to your liking. There aren’t many apartment buildings that come with acres of property in the country that will let you do your own landscaping, keep horses or grow a garden.

Flexibility Vs. Stability
Renting a place to live gives you significantly more freedom to get up and go at a moment’s notice. The financial consequences of breaking a lease are minimal and can be addressed by simply writing a check. Homeowners wanting to leave their current residence face the much more complicated process of selling their property. The mortgage still needs to be paid and the grass still needs to get cut while you are waiting to find a buyer. Unless money is no object, the transition to a new place of residence is likely to take months, not days. On the other hand, with the flexibility of renting comes also some instability. The landlord can always raise the rent or ask you to move before you are ready to do so. If you own a house and make the payments, you can stay as long as you desire.

Personalized Aesthetics Vs. Less Work
Buying a house gives you the opportunity to choose a unique and distinct architectural style and to personalize it. But this freedom comes with the responsibility of keeping up with maintenance and repairs. Homeowners simply can’t avoid the need to cut the grass and fix leaky faucets. If you prefer to spend your weekends relaxing in the park instead of wandering the aisles at the local hardware store, you might want to think twice about buying a home – unless of course you can budget a substantial amount of money to hire some help.

Although renting gives you no control over exterior aesthetics, you don’t have to worry about dealing with wear and tear on your residence or problems resulting from bad construction. Renting still gives you plenty of opportunity to choose furnishings and decorate your interior environment in a manner that suits your style. And, as a renter, all you have to do when something goes wrong is notify your landlord.

Emotional Satisfaction Vs. Less Worry
Homeownership is often called “the American dream”. There’s just something emotionally appealing about putting down roots, getting involved in the community and having a place to call your own. Of course, homeowners also need to worry about the long-term character of the neighborhood and keep up with maintenance in order to sustain property values. If you’re simply looking for a place to rest between days at work and nights hitting the town, renting may be the perfect answer. Just keep paying the rent and let somebody else do all the worrying.

A Personal Decision
Unlike the financial aspects of homeownership, the aspects that have a bearing on your lifestyle and values cannot be calculated online with some mathematical formula. If you can make the rent payments or qualify for the mortgage, you can live anywhere that you want to live. But buying a home is a decision you should take some time to consider, determining how its location, amenities and need for repairs will affect your lifestyle and general emotional satisfaction.


to rent or buy? the financial issues

When making the decision either to rent or buy a place to live, there are two broad categories of factors that must be considered. The first and most obvious category represents the financial aspects of your decision. The second category is a set of personal and emotional factors, which are more intangible but play an important role in the decision to rent or buy. Here, we look at the financial factors, including the initial and ongoing costs as well as the long-term pros and cons of owning your home.

Examining Your Finances
The first step in the decision-making process is to determine whether or not you can afford to purchase a home. Issues to consider include your ability to make a down payment (generally between 5% and 20% of the home’s purchase price) and pay closing costs (which may be an additional 5%). These costs are likely to exceed substantially the initial payment and security deposit that would be required if you were renting instead of buying. Of course, having enough money to cover the initial purchase of a new home is only half of the battle.

Before moving into your new home, you’ll need to put some thought into how much it’s going to cost you to stay there after you take up residence. Many financial experts suggest that your monthly mortgage payment not exceed 28% of your gross monthly income and that your total monthly debt payments not exceed 36% of your gross monthly income. If you go beyond these limits, you may run into trouble because, in addition to paying the mortgage each month, you have to factor in home maintenance. From carpet to window coverings, new appliances to a new roof, everything costs money and nothing lasts forever. Renting may be a little easier on the pocketbook because it provides a fixed-dollar cost for monthly expenditures, which are paid simply with the rent. Besides perhaps increasing from year to year, the rent remains steady. And, if maintenance issues arise, the landlord pays for the repairs. Instead of spending your money on a new roof, you can invest it or spend it as you like.

If you’ve done the math and can afford to make the initial purchase and service the ongoing debt, the next factor you have to decide is whether this purchase benefits you financially. A rent-controlled apartment in New York City, or a place in a suburban location outside of a major city, quite possibly charges a month’s rent that is significantly less than a monthly mortgage payment for properties within the city. Of course, even if the monthly cost of renting is less than the cost of buying, there are long-term financial considerations that must be taken into account.

Long-Term Cost/Benefit Analysis Proponents of buying often cite the ability to build equity, the tax breaks and the investment value of a home as solid reasons to buy instead of rent. While these arguments have merit, there are downsides to all of them. This chart outlines the positive and negative long-term realities of the equity, tax breaks and investment value associated with buying a home.

Topic Pros Cons
Equity Some of the money that you give to pay a mortgage goes directly toward building equity in your home. You will never again see any of the rent money that you pay. Home equity can serve as collateral for a loan, enabling you to convert the equity into cash. Equity takes time to build, and payments made during the first few years of a mortgage go primarily toward interest on the loan. Should you move after living in a home for only a few years, you may have little or no equity in the property. And after the costs of selling the home, you could end up losing money.
Tax Breaks Unlike money spent on rent, the mortgage interest and property taxes you pay are both deductible on your federal income-tax return. If you sell your primary residence at a profit, much of your gain is likely to be exempt from federal taxes. If you take out a home-equity loan, some or all of the interest on the loan may be deductible on your federal income tax return. First, the tax breaks on interest and property taxes apply only when the amount of your itemized deductions is greater than the standard deduction amount. So you and your spouse have a standard deduction of $9,700 and itemized deductions of $8,000. You are better off taking the standard deduction because it\’s greater than the itemized amount. But you therefore receive no tax break on the mortgage interest you paid. Even when itemization provides a greater tax break than the standard deduction, you are allowed to deduct only a portion of your interest payments. For example, if you are in the 33% tax bracket, you get a $0.33 tax deduction for every $1.00 that you pay in interest on your mortgage. While some tax break is better than none, you need to ask yourself if it really makes sense to spend $1 in order to get a $0.33 tax break. The benefit of the tax break does not exceed the benefit of paying for the home in cash (if possible) and foregoing the tax break. Every dollar spent in interest adds to the amount above the purchase price of your home that you will need to make just to break even when you sell it. Owning a home means having to pay real-estate taxes every year. So even after your mortgage is paid off, you\’ll still have to keep making payments to someone to keep your home.
Investment Real estate in the form of your primary residence is likely the single largest asset in your portfolio. Over the long term, price appreciation can be significant. Many homeowners downsize their primary residence when they retire; they sell at profit, purchase a less expensive home and use the profits to supplement their income. While history shows it is likely that your home will appreciate over time, there are no guarantees. There are always areas of the country where homes have lost value, and owners are unable to sell them at a price equal to or greater than the purchase price.

Do the Calculations
A variety of online calculators are available to help you evaluate the financial aspects of the rent versus buy decision, but keep in mind that you need to estimate a range of variables that includes the number of years you will stay in the home.

And to estimate the investment profit the home will provide for you, you must assume the yearly rate of appreciation on the home’s value. The results provided by a calculator and the investment evaluations you make are only as good as the assumptions used to calculate them, and don’t forget to consider the cost of ongoing maintenance. After you have carefully considered the financial issues, it’s time to explore the non-financial issues. In part two, To Rent or Buy? There’s More to It than Money, find out about a host of other factors that you will need to take into consideration.


take control of your credit cards

In 2008, credit card delinquency rates in the United States hit a four-year high, according to Equifax, a credit card analysis firm. A few factors may have been responsible for pushing consumers over the edge, including the mortgage crunch, rising energy costs and a decreasing savings rate. In times of economic softness, people are often tempted to use their credit cards to see them through. This gets the bills paid, but there can be consequences to relying on credit card funding. Here we go over some of the major advantages and drawbacks of credit cards and show you how to use yours wisely.

The Unwelcome Truth about Credit
There are plenty of great reasons to use credit cards. Credit cards eliminate the need to carry large amounts of cash, and many of them offer excellent rewards programs, enabling card users to earn airline miles, cruise ship rewards and other perks by purchasing everyday items like gasoline and groceries. Discover Card, for example, offers one of the most well known “cash back” programs, enabling card users to get a discount on almost everything they buy. Credit cards are also great in an emergency – they make it easy to lay your hands on some quick cash and provide a convenient way to make unexpected purchases, although it’s always a good idea to have emergency cash reserves.

However, the truth is that if you can’t pay cash to make a purchase, you can’t afford to make the purchase. Nobody likes to hear this, but it’s the bottom line when it comes to credit cards. Far too often, credit cards are used as a financial crutch by people who want to buy things that they can’t actually afford. Unfortunately, being able to make the payment isn’t the same as being able to afford the purchase. If a spike in gas prices suddenly leaves credit card holders unable to meet their minimum payment obligations, then gas isn’t the only thing these folks can’t afford: all those other things they bought on their credit cards were beyond their means as well.

Get Your House of Cards in Order
If you are carrying a balance on your credit cards – especially if you are only able to make the minimum monthly payments – it’s time to take control of the situation. Start by reading the fine print on your credit card agreements. Pay particular attention to the following:

  • Yearly Fees – Why would you ever pay a fee for the “privilege” of paying 14%+ interest on items you can’t actually afford? If the card in your wallet comes with a yearly fee, cancel the card.
  • High Interest Rates – Credit card companies charge sky-high interest rates because consumers are willing to pay them. Simply pick up the telephone and ask your creditors to lower your interest rate. You might be surprised to find that many companies will lower the rate simply because you called.
  • Late Fees This fee is assessed as a penalty when you don’t make your payments on time. When you are shopping for a credit card, be sure to compare late fees. If you can’t make the payment, this fee will set you even further behind.
  • Over-the-Limit Fees – Many companies will impose a penalty fee if you go over your card’s spending limit. Once again, you need to compare the fees before choosing a card.
  • Bounced Check Fees – Banks charge a fee for bounced checks; many credit card companies will also charge a fee if you send them a check that doesn’t clear. Avoid this added expense, if possible.
  • Minimum Payments – Minimum payments are the cardinal sin of credit card use. If you thought gasoline was expensive at $3.25 per gallon, why would you want to carry a balance and pay interest on top of the initial cost? According to Bankrate.com, if you only make the minimum payment, roughly 2% of your $10,000 credit card balance at 18% interest, it will take you roughly 610 months and nearly $29,000 to pay off the balance.

Credit cards themselves don’t put people in debt. After all, a credit card is just a tool, and tools are only as dangerous as the people who use them. To minimize the dangers to your financial health, choose your cards wisely, think twice before using them and, most importantly, don’t carry a balance. If your credit card doesn’t help you save money or provide a useful reward at no cost to you, don’t use it. There are plenty of places where your credit card will come in handy – just be sure that you don’t let the cost of this convenience get out of hand.


teaching your child to be financially savvy

When it comes to money, the advice parents usually give their children goes something like this: “Money doesn’t grow on trees”, or “Close the door when you leave the house – we’re not paying to heat the whole neighborhood”. Although that parental wisdom has stood the test of time, it takes a bit more effort to teach a child sound financial management principles.

Getting Started
The first step in the process is to engage the child’s interest. Start with an allowance and have your child dedicate a portion of it to spending and a portion to savings. Be sure to give your child discretion on his/her spending allocation. By giving a child money and the power to make decisions regarding its disposition, you will capture the child’s interest and give him/her a sense of responsibility.

Lesson No. 1: Saving
The portion of the child’s allowance that is dedicated to savings should be deposited into an interest-bearing savings account. Take your child to the bank when the account is opened and involve him/her in the process. Make sure your child understands the purpose of the account and has a working definition of the term interest.

The child’s involvement shouldn’t end with that first visit to the bank, however. It’s a good idea to set up the account so that statements come in your child’s name. When the mail arrives, let your child open the envelope. Review the account balance and help your child understand how and why the balance grows. Give your child a binder or folder and have him/her put each monthly statement in the binder. This teaches your child to be organized and to keep records, and it provides a historical document tracing the growth of the account balance.

Take your child to the bank on the day his/her allowance is paid. Let him/her participate in the process of depositing the money. Remember, the point here isn’t to try to turn a $5 deposit into a record-setting investment. The point is to teach your child about money, and lesson one is about saving instead of spending. Your objective is to lay the foundation for a lifetime habit of saving.

Lesson No. 2: Investing
Every child matures at a different rate, but when your child is older, start talking about making money grow more quickly. Most teenagers are able to grasp the basics of stock ownership. Spend some time explaining the concept of risk, highlighting the potential risks and rewards of investing in the stock market. If you can afford it, give your child a few hundred dollars and help him/her research companies that he/she finds interesting, such as toy or gaming companies, skateboard makers, and so on. Walk your child through the process of conducting research using the internet and the resources available at your local library. Most large public libraries in the U.S. subscribe to Value Line, a investment research provider, or offer net access to a variety of finance sites.

When the research is complete, help your child buy shares. Remember, the purpose of this exercise isn’t to create a portfolio that will sustain your child through the ages, and it isn’t to demonstrate your fine stock-picking skills. The objective is to give your child the opportunity to learn about money and risk and reward by making his/her own choices. If you don’t have a lot of disposable money to give your child, or if you are concerned about his/her research and stock selection abilities, limit the investment to one or two companies at $100 each. Online brokerages make this an affordable exercise for almost everyone.

Don’t forget that the possibility of losing money is part of the process. Any investor who claims never to have lost money during a lifetime of investing isn’t telling the truth. Keep in mind that this should be a learning experience. You are not expected to hand a 13-year-old child the sum of his/her life’s savings and suggest that he/she have a go at the markets. The intention is to teach him/her about investing and the consequences of making decisions.

Once again, statements for the brokerage account should be addressed to the child. The statements should go into your child’s folder or binder. You can use them to compare the fluctuations in the account balance against the balances from the savings account. Review the returns on the child’s portfolio, discuss the results and stick with this process over a period of years.

Look to the Future
As your child matures, he or she can grasp more sophisticated investing concepts, such as the importance of asset allocation and portfolio diversification and the advantages of different types of investment vehicles. You can explain that, as people age or accumulate assets, fixed-income investments may become an appropriate addition to an investor’s portfolio. When possible, you can use your personal portfolio as a tool to demonstrate how portfolio construction evolves over time based on an investor’s needs.

Knowledge is power. While some adults may blanch at the prospect of giving their child the freedom to pick stocks, it is important to remember that you won’t always be around to do the job on the child’s behalf. Bear in mind the old saying about teaching a man to fish and feeding him for a lifetime versus giving him a fish to feed him for a day. Ideally, these early exercises in money management will teach your child valuable financial lessons to last him or her well into adulthood.

While affluent adults will invest substantial sums on behalf of their children, including setting up college savings and personal trusts, giving a child the knowledge required to handle his/her own financial affairs is an equally important parental responsibility. In the long run, teaching children about money may be more valuable than giving them cash and no direction on how to handle it. So, start early and make the experience fun. Good saving and investing habits become second nature over time, and your child will be able to draw on these skills for a lifetime.



investing in your childs education

Let’s face it: with steadily rising expenses in our daily lives, raising children is becoming more and more expensive. Forget about the $300 PlayStations, the $5 G.I. Joes or even the $30 Barbies. The growing concern for many parents is their financial readiness for sending their little and not-so-little ones to a post-secondary institution. Tuition costs alone are ranging between $5,000 and $30,000 per year, and the average degree requires four years to complete – provided, of course, that the kids don’t decide to change majors or take their sweet time graduating. By the time we factor in the costs for books, spending allowances, housing and food, the total bill may be in excess of $50,000.

This is a significant amount of money for most people, and many of us are simply not ready for such a financially draining situation. Some parents aren’t even aware of its severity until it’s too late – when their children have only a few years left until high school graduation! Others may hope that their kids inherited the “smart” gene from old Uncle Bill and will earn plenty of scholarships to pay the costs.

For those of us who don’t have that much faith in genetics, don’t even have an “Uncle Bill”, or aren’t financially independent enough to cover the associated costs of sending kids to post-secondary institutions, there’s another way. The U.S. government, realizing that these costs have been increasing steadily over the past few decades, has provided ways to make saving for educational fees easier. Presently, there are three popular methods whereby you can increase savings benefits and earn enough money to pay for your children’s costs.

Coverdell Educational Savings Account
Formerly known as an Education IRA, the Coverdell account benefits parents and children as it provides a tax shelter for capital gains. In 2001, Congress passed a bill that allowed parents to increase annual contributions, depending on their income, to up to $2,000 per child. Thus, families with only one individual filing an income tax return less than $95,000/year are allowed to contribute $2,000/year per child. If the amount you file is between $95,500 and $110,000, the contribution limit is $1,800/year per child, and, if the amount you file is above $110,000/year, you’re out of luck: the contribution amount is $0. If the family income has joint filers, the income limits are doubled with the contribution limits remaining identical.

Withdrawals from this account are penalty-free if they are made for qualified educational expenses, and are taxed as income at the beneficiaries’ tax rate. Additionally, this account provides flexibility in investment content, and, should the beneficiary not require all the funds within the account, the remaining portions can be changed to the name of any other family member below 30 years of age. The one drawback of this type of account is that, if the beneficiary applies for financial aid, the assets within the account are designated as those of the beneficiary.

Using a child’s social insurance number, an adult can open an account on behalf of a minor and act as the custodian of the account. Contributions by any single individual to a minor can be up to $11,000/year. If the minor is below the age of 14, the first $700/year is tax-free, the second $700/year is taxed at the child’s rate, and anything above $1,400 is taxed at the parent’s rate. If the minor is above 14 years of age, any investment income over $700/year remains taxed at the child’s rate.

These UGMA/UTMA types of accounts provide flexibility as the funds do not have to be used solely for educational purposes; however, these accounts do have substantial drawbacks. First, the custodian has limited power in controlling what the assets are used for once the power of the assets is transferred to the beneficiary. What this means is that after the beneficiary legally becomes an adult, the funds are transferred into the beneficiary’s name and he or she can use the funds for whatever he or she wishes, regardless of the contributor’s approval. Second, there is no tax shelter as capital gains are taxed regularly, albeit at the beneficiary’s rate, which is typically lower than that of the contributor. Third, as with the Coverdell account, these assets also count against the beneficiary who, possessing ownership, decides to apply for financial assistance for higher education.

Education 529 Plan
This is a service provided by all 50 states within the United States. These accounts create an educational tax haven for beneficiaries. Any gains within the account accumulate tax-exempt, and distributions for education-related expenses are also untaxed. Anybody can open one of these plans, contribute to it, and be listed as a beneficiary. Unlike the donors of the UGMA/UTMA accounts, the donor of the 529 plan is always in control of the money and can generally change beneficiaries without much difficulty; furthermore, the assets within the plan are not considered to be those of the beneficiary, so the funds will not significantly harm any applications for financial aid.

One of the serious drawbacks to this type of plan is the limitation placed on its investments. Many of the funds limit investments to only a few choices, which can be restrictive as a hands-on approach to investment management. Another concern is the longevity of these plans. The name of these plans refers to the tax loophole within the IRS code’s section 529, whose existence is only guaranteed until 2010 by Congress. This can create some uncertainty for parents with children who won’t be attending university until well after 2010.

The Bottom Line
The multitude of different savings plans for a child’s education provides a situation that is important to take advantage of. Time is always an asset when trying to save, and tax-sheltered accounts help make sure that any earnings won’t be slowly eaten away by the government. If time is no longer on your side, a 529 account is generally better as it will provide for the maximum tax savings in the shortest duration of time, without affecting your children’s application for financial aid. However, if you don’t want to be limited in your investment decisions and portfolio mix, the 529 plan may not be the best choice. If you have plenty of time before your child graduates from high school, the ESA may be a good choice. If you don’t want to give full control to your children, the UGMA/UTMA accounts may not be the best route. Whatever you decide, make sure you understand the rules of the game before you play.


don’t forget the kids : save for their education and retirement

The vast majority of taxpayers will agree that, regardless of the order of priority, retirement planning and education financing are their two most important financial-planning items. Funding our retirement plans is encouraged by the convenience of contributions through automatic salary deductions, the income-tax deductions allowed for some contributions and the tax-free growth for some others.

Consequently, we often fund our retirement plans on a consistent basis while financing the education accounts of our children is usually placed on the list of items “we will get to later”. However, with the ongoing rise in the cost of higher education you will want to make sure that at least a portion of your children’s education expense is covered. Fortunately, there are several means of funding education accounts for your children, and ways to help them save for their retirement.

Roth and Traditional IRA for Minors
If your child is a minor and earns income from babysitting, paper routes, assisting mom and dad in the store, and the like, he or she may use the income from those jobs to fund a Roth or Traditional IRA. This will not only give your child a head start on saving for his or her retirement years, but also start cultivating healthy saving habits at an early age. The following are some considerations that apply to your child’s IRA.

Contribution Limits and Eligibility Requirements
The contribution limits and eligibility requirements are the same for adults and children who are minors. For example, a minor is allowed to contribute up to 100% of compensation or the dollar limit in effect for the year – whichever of the two is less – to his or her Roth or Traditional IRA . A minor whose income is subjected to income tax may reduce the taxable amount by making a deductible contribution to a Traditional IRA. Refer to IRS Publication 929 for information on the tax rules for children.
Legal Issues
State laws generally prohibit minors from entering into contracts, which means that a minor cannot establish the IRA him- or herself. The parent or legal guardian will sign adoption agreements and other legal documents on behalf of the minor. The IRA should be titled to include the name of the adult and the minor in a way that clearly shows who is the minor and who is the guardian. The account is usually transferred to the name of the child when he or she reaches the age of majority as defined by the state of residence.

Except amounts for which no deduction was allowed or taken, distributions from IRAs are treated as ordinary income. For Traditional IRAs, earnings and amounts representing deductible contributions are treated as ordinary income when distributed, and they may be subjected to early-distribution penalties unless certain exceptions apply. Qualified distributions from Roth IRAs are tax and penalty free.
Investment Options
The investment options for Roth and Traditional IRAs vary depending on the financial institution with which the account is maintained. These investment options include, stocks, bonds, mutual funds, certificate of deposits and money market funds. Make sure you conduct a thorough research and consult with your financial planner to ensure that the investments you choose are compatible with your risk tolerance and financial profile.

Education Savings Account (Formerly Known as Education IRAs)
The Education Savings Account (ESA) is usually established to finance the education of the designated beneficiary. Qualified education expenses include certain elementary and secondary education expenses, as well as certain expenses for special-needs students. Eligible expenses include student-activity fees, fees for course-related books, supplies, equipment and some boarding fees.

While contributions to the ESA are not deductible, the earnings do accumulate on a tax-free basis, provided distributions are used to cover qualified expenses. For amounts withdrawn that are not used to cover qualified expenses, the earnings will be treated as ordinary income and may be subject to a 10% early-distribution penalty for beneficiaries under age 59.5.

Similar to the deadlines for making contributions to Roth and Traditional IRAs, the deadline for making a contribution to an ESA for one year is April 15 the following year.

Contribution Limits
The annual contribution limit for the ESA is $2,000 per beneficiary. Should you decide to fund ESAs for multiple beneficiaries, you may contribute up to $2,000 for each beneficiary. If multiple individuals contribute on behalf of one beneficiary, the total contributions cannot exceed $2,000, even if multiple ESAs are established for the beneficiary. It is therefore important that the different individuals who are funding ESAs for one beneficiary communicate their decisions with each other.Who Can Contribute to an ESA?
One of the most attractive features of the ESA is that anyone who meets certain income requirements can contribute to the account on behalf of the designated beneficiary. This includes aunts, grandparents, parents, friends and even the beneficiary him or herself.
In order to contribute to an ESA, the contributor is not required to have income. However, should an individual\’s income exceed certain limits, he or she is not eligible to contribute to an ESA. If the contributor is married and files a joint income tax return, he or she cannot contribute to an ESA if his or her modified adjusted gross income (MAGI) is $220,000 or more. The limit of $2,000 is gradually reduced once the MAGI falls into the range of $190,000 to $220,000. For other taxpayers who are not married or file a joint income-tax return, the range is between $95,000 and $110,000, so individuals whose MAGI is $110,000 or more are ineligible to contribute to an ESA.
Contributions that exceed the $2,000 limit or contributions made by individuals who exceed the income limits stated above are considered excess contributions and could be subjected to IRS penalties.

Portability Among Family Members
If the original designated beneficiary does not use the funds in the ESA, all is not lost; the assets can be rolled over to one of the designated beneficiary\’s family members who is under age 30. To allow flexibility, the IRS defines the following as the family members to whom the beneficiary\’s assets can be redesignated:

  • Son or daughter or their descendants
  • Stepson or stepdaughter
  • Brother, sister, stepbrother or stepsisters
  • Father or mother or ancestor of either
  • Stepfather or stepmother
  • Son or daughter of a brother or sister
  • Brother or sister of father or mother
  • Son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law or sister-in-law
  • The spouse of any individual listed above
  • First cousin

Age Limitations
Unless the beneficiary is a special-needs beneficiary, contributions can no longer be made on his or her behalf after age 18, and the assets must be distributed within 30 days after his or her 30th birthday. If the distribution is not used for qualified expenses or rolled over to the ESA of a family member who is under the age of 30, the earnings will be treated as ordinary income and may be subjected to a 10% early-distribution penalty.
The Investment options for an ESA are similar to those of Traditional and Roth IRAs.

Qualified Tuition Programs & 529 Plans
Qualified tuition programs (QTP) and 529 plans are established to allow you either to prepay or contribute to an account established for paying the beneficiary’s higher education expenses at certain institutions. Check with your financial institution or with the educational institution to determine expenses that qualify. Your child’s QTPs/529 Plan may be established and maintained by a state, an agency of the state, or by an educational institution.

No Age/Income Restrictions
Unlike the ESA, QTPs and 529 plans do not have age or income restrictions. Although the plans are offered by individual states, there is no residency restriction, which means that if you live in one state, you are allowed to participate in a QTP offered by another state.
For QTPs, the maximum contributions is the amounts required to cover the eligible educational expenses of the beneficiary. For 529 plans the limits vary among state plans, with some being as high as $235,000. Some states even allow their residents tax deductions for contributions made to the plan.
A growing number of employers are forming relationships with QTPs and 529 providers so that contributions can be made through payroll deduction. For many, monthly contributions are as little as $15. If you are interested in participating in a salary deduction program for funding these plans, check with your employer regarding its participation status.
For most QTPs plans, earnings accrue on a tax-deferred basis, and distributions used for qualified dispenses are tax-free. The qualified expenses are similar to those of the ESA. To be sure, check with the plan provider for a list of eligible expenses.
The investment choices for QTPs are usually limited to mutual fund or annuities. For some plans, the investment choices are based on the age of the beneficiary. The more aggressive investments are targeted at younger beneficiaries.Portability Among Family Members
Similar to the ESA, the QTP and 529 plans may be transferred to a family member.

Be sure to compare the features and benefits of the different plans, and choose the one that best suits your financial goals for your child’s education. Of course, there are always the good-old student loans and tax credits that you may claim for educational expenses. When you look into these options, remember that you too may meet the eligibility requirements – just something to consider for those of you who plan to continue your education.


life insurance clauses determine your coverage

Do you have a life insurance policy? How many times have you gone through your policy document? Once or maybe twice, right? And do these important clauses like incontestable clause, spendthrift clause or reinstatement clause mean anything to you? If you are totally clueless about terms like these, don’t worry, this is the right article for you.

Life insurance is a wealth-generating tool – it eases your surviving family’s financial burdens in your absence and also provides periodic income, which takes care of temporary needs like mortgage repayments, education etc. However, in order to make sure that your life insurance policy will provide for you family when you can’t, you need to understand the product you are buying. Here we’ll cover some sections of life insurance policies that you need to be aware of.

Beneficiary Clause
The main aim of life insurance is to transfer wealth to your heirs or to provide liquidity to your family. For that reason, you need to name a beneficiary who will receive the life insurance proceeds after your death. This beneficiary can be your spouse, children or relatives. You also can change the recipient anytime during the term of the policy.

However, if you still have not nominated a beneficiary, then your family is going to be in some trouble. The insurance money will go to your estate and the probate fees needed to settle your estate can dig a big hole in your surviving family’s liquid assets.

Therefore, it is always practical to have a primary and a contingent (secondary) beneficiary in your policy. For example, you can choose your wife as a primary beneficiary and your children as contingent beneficiaries. That way, in case your spouse also dies, your children will qualify for the insurance money.

You pass through various phases in your life: marriage, divorce, a new business, the birth of your child and more. Consequently, you need to stay with the changing times by updating your beneficiaries to adjust for those events.

Preference Beneficiary Clause
If you have not nominated a beneficiary in your policy, your insurance company will disburse the life insurance money to the individuals listed in your policy. Presume that the order of priority in your policy is: 1) your spouse, 2) your children, 3) your parentts. If the proceeds are distributed, they will go the first living individual which, in most cases, will be your spouse.

Survivorship Clause
According to this clause, after your death, the policy proceeds will go to the beneficiary – for example your wife – but only if the beneficiary survives you by a stated number of days.

Misstatement of Age Clause
Your age plays an important role in determining adequate life insurance coverage. The older you are, the higher the premium that is charged. Therefore, if you lie about your real age to reduce your premiums you may to pay a huge price for it. In this situation, your insurer may choose to cancel your policy entirely, increase your premiums or adjust your policy amount.

Incontestable Clause
Your insurance company is entitled, usually during the first two years of the policy, to challenge the validity of your policy on the basis that you held back material information. If you are found guilty of concealment, your insurer will void the policy and return the premiums.

For instance, if you concealed the important fact that you are a heavy drinker in order to get a lower premium and your insurer finds out about this lie, it will not pay the claim on your death if it occurs during the first two years of the policy.

However, after the two-year period, your insurer cannot revoke the policy and has to pay the insurance money to your family without any opposition.

Despite this clause, there are exceptions in which the insurance company will not have to pay the claim, such as in cases of deliberate fraud, where your insurer may opt to contest your policy even after the two-year period.

This is the most important clause of your life insurance policy and, therefore, you should make sure that this clause is included in your policy and that you are familiar with the specified time limit.

Spendthrift Clause
If you have named your gambler son as a beneficiary, there is a chance that upon your death, your son’s creditor may pounce on your life insurance proceeds. The spendthrift clause gives the insurer the right to hold back the proceeds and protect them from creditors. In this case, your insurer may prefer to pay the insurance money in installments to your son.

Suicide Clause
The suicide clause in your policy specifies that the insurance company will not pay the money if the insured attempts or commits suicide within a specified period from the beginning of the coverage. If the insured’s death is a result of suicide, an insurer will only return previously paid premiums to the family.

War Clause
Normally, insurance companies do not compensate for death due to war or war-related developments. As per this clause, if you are a victim of war, your insurer will not pay out the benefits to you. In its place, your insurer will reimburse the previously paid premiums to your family.

Aviation Clause
According to this clause, your insurer will not pay compensation to your surviving family due to death on an airplane.

However, if you are an airline employee, you can buy aviation insurance by paying higher premiums.

Free Look Period/Free Examination Period
If you are not satisfied with the terms and conditions of the policy, you can return the policy within a specified period after receiving it and your premiums will be fully refunded. Here, the time frame will vary depending your insurer.

Grace Period Clause
There are times when you cannot pay the premiums as a result of financial troubles. In these circumstances, the “grace period” provision works in your favor. Your insurance company will provide a grace period within which you can make the necessary monetary arrangements and pay your premiums. During this time, you will continue to be covered by your insurance policy. If you still do not pay your premiums, your policy may be cancelled.

If you die within the grace period, your insurer will pay the insurance money after subtracting the unpaid premium from that money.

Reinstatement Clause
If your policy has lapsed due to non-payment of premium, you can revive it by paying all the past outstanding premiums along with interest. However, you need to prove to your insurer that you continue to enjoy good health to qualify for this provision.

If you haven’t yet taken the time to understand your insurance policy, you should do so as soon as possible. Life insurance is an asset if you know how to make the most of it, but many choose not to bother with insurance jargon and instead blindly follow their insurance advisors and this choice can have serious consequences for you and your family. Your knowledge of the insurance clauses described above can give you an upper hand when purchasing life insurance and can help you ensure that your insurance coverage works in the best interests of your family.


life insurance: how to get the most out of your policy

life insurance can be a very important investment for you, especially if you have a growing family. You can get hassle-free wealth distribution among your children, emergency loans at low interest, assured benefits and in the end, a death benefit. All you need to do is to work out a sensible plan with your insurance advisor, through which you can avail yourself of these aspects of your life insurance policy.

In this article, we’ll show you how these life insurance concepts can make a huge difference in your life now.

The most prominent feature of a life insurance policy is the beneficiary clause, which facilitates the easy transfer of your money to your successors.

However, you need to be aware of the different kinds of beneficiaries in life insurance:

Multiple Beneficiaries
You can have your children as multiple beneficiaries. All you have to do is to indicate the names of these recipients and the amount of proceeds that they are going to get.

Contingent Beneficiary
Naming a contingent beneficiary is always practical. Suppose that your first (primary) beneficiary dies near the time of your own death. In this case, your children will qualify for your insurance money if you nominate them as contingent (secondary) beneficiaries. A contingent beneficiary can get life insurance proceeds if the primary beneficiary dies before he or she can receive the assets.

Minor as a Beneficiary
If you have named your minor child as a beneficiary, you will have to appoint a guardian/trustee who will administer the insurance proceeds upon your death.

Revocable Beneficiary
Here, the recipient can be changed any time during the policy.

Irrevocable beneficiary
In this type of beneficiary class, you cannot change your beneficiary’s name unless they consent to it. With an irrevocable beneficiary, creditors cannot touch the policy proceeds as these monies are not considered to be a part of your assets.

It can happen that due to certain circumstances you forget to pay your premiums, even in the specified grace period. Unfortunately, because you have missed the deadline your policy will lapse.

Consequently, your insurance company can stop covering you or may provide you reduced insurance coverage equivalent to the total premiums paid formerly (also called paid-up policies). Nonetheless, a lapsed policy may be renewed in some plans, although the exact renewal procedure varies among different insurers.

Cash Surrender Value
Permanent life insurance policies like universal life insurance, whole life insurance and variable life insurance are more attractive thanks to the presence of built-in cash value. (Term life insurance policies do not offer cash values). The interesting aspect of these policies is that you can surrender your policy and get the accrued cash value in your hands provided you have a substantial amount of cash value.

Cash Value
Here, a part of your premium is put in savings or another investment account according to the type of policy you purchase. As a result, the ongoing interest you receive from your investment account gradually increases your cash value.

Non-Forfeiture Options
In permanent life insurance policies, if you fail to pay the premiums in the grace period, you won’t lose your life insurance – your accumulated cash value will come to your rescue with the following options:

  1. Terminate your policy and get the cash surrender value in hard cash.
  2. Go for reduced coverage for the remaining term of the policy with no future premiums. (i.e. paid-up policy)
  3. Use your accumulated cash value to pay the future premiums (also referred as automatic premium loan).
  4. Buy an extended term insurance with the remaining cash surrender value. (no further premiums required)

The above non-forfeiture options may differ from one insurance company to another.

It is always easy to terminate (surrender) your policy and get the entire cash surrender value, which will solve your liquidity problems. However, you need to consider many factors before surrendering your policy, such as the increase in the cash surrender value if your policy is maintained for the full term. Consult your insurance advisor to about the full consequences of these issues before deciding whether the policy should be cashed or kept.

Policy Loans
Another positive characteristic of a life insurance policy is that you can take out a policy loan against your policy to cater to your emergency needs. The interest is relatively low and the policy loan can be repaid in a lump sum or installments.

If you are incapable of repaying your policy loan, your insurance company will use your cash value to settle the loan.

Participating Vs. Non-Participating Policies
You can opt for participating policies in which you participate in the profits of your insurance company and get dividends annually. Here, the premiums are somewhat higher.

Conversely, non-participating policies do not participate in the profits of the insurance company and therefore do not have the dividend option. Here, the premiums are relatively lower.

Unlike permanent life insurance policies, term life insurance policies are non-participating policies.

Policy Dividends
Dividends are the earnings paid out by the insurer to its shareholders and/or policyholders. You are entitled to enjoy the fruits of your insurance company’s labor, for example, dividends if you own a participating policy.

If you do receive a dividend, it is up to you to decide how to make use of it. Here are some common options:

  1. Get your dividends in cash.
  2. Use your dividends to reduce existing premiums.
  3. Keep the dividends on deposit with your insurance company where they will steadily earn and accumulate interest.
  4. Use your dividends to purchase extra coverage, such as a one-year term insurance or whole life insurance, that matures along with your original policy.

There are many benefits to owning a suitable life insurance policy, including fast loans at comparatively low interest rates (with no restrictions on how to spend the loan amount), annual policy dividends and the presence of the cash surrender value. Life insurance also comes with the assurance that the financial worries of your loved ones will be taken care of in your presence as well as your absence!


how much life insurance should you carry?

Very few people enjoy thinking about the inevitability of death. Fewer yet take pleasure in the possibility of an accidental death. If there are people who depend on you and your income, however, it is one of those unpleasant things that you have to consider. In this article, we’ll approach the topic of life insurance in two ways: first, we will point out some of the misconceptions about life insurance and then we’ll look at how to evaluate how much and what type of life insurance you need.

Does Everyone Need Life Insurance?
Buying life insurance doesn’t make sense for everyone. If you have no dependents and enough assets to cover your debts and the cost of dying (funeral, estate lawyer’s fees, etc.), then insurance is an unnecessary cost for you. If you do have dependents and you have enough assets to provide for them after your death (investments, trusts, etc.), then you do not need life insurance.

However, if you have dependents (especially if you are the primary provider) or significant debts that outweigh your assets, then you likely will need insurance to ensure that your dependents are looked after if something happens to you.

Insurance and Age
One of the biggest myths that aggressive life insurance agents perpetuate is that, “insurance is harder to qualify for as you age, so you better get it while you are young.” To put it bluntly, insurance companies make money by betting on how long you will live. When you are young, your premiums will be relatively cheap. If you die suddenly and the company has to pay out, you were a bad bet. Fortunately, many young people survive to old age, paying higher and higher premiums as they age (the increased risk of them dying makes the odds less attractive).

Insurance is cheaper when you are young, but it is no easier to qualify for. The simple fact is that insurance companies will want higher premiums to cover the odds on older people – it is a very rare that an insurance company will refuse coverage to someone who is willing to pay the premiums for their risk category. That said, get insurance if you need it and when you need it. Do not get insurance because you are scared of not qualifying later in life.

Is Life Insurance an Investment?
Many people see life insurance as an investment, but when compared to other investment vehicles, referring to insurance as an investment simply doesn’t make sense. Certain types of life insurance are touted as vehicles for saving or investing money for retirement, commonly called cash-value policies. These are insurance policies in which you build up a pool of capital that gains interest. This interest accrues because the insurance company is investing that money for their benefit, much like banks, and are paying you a percentage for the use of your money.

However, if you were to take the money from the forced savings program and invest it in an index fund, you would likely see much better returns. For people who lack the discipline to invest regularly, a cash-value insurance policy may be beneficial. A disciplined investor, on the other hand, has no need for scraps from an insurance company’s table.

Cash Value vs. Term
Insurance companies love cash-value policies and promote them heavily by giving commissions to agents who sell these policies. If you try to surrender the policy (demand your savings portion back and cancel the insurance), an insurance company will often suggest that you take a loan from your own savings to continue paying the premiums. Although this may seem like a simple solution, this loan will cost you, as you will have to pay interest to the insurance company for borrowing your own money.

Term insurance is insurance pure and simple. You buy a policy that pays out a set amount if you die during the period to which the policy applies. If you don’t die, you get nothing (don’t be disappointed, you are alive after all). The purpose of this insurance is to hold you over until you can become self-insured by your assets. Unfortunately, not all term insurance is equally desirable. Regardless of the specifics of a person’s situation (lifestyle, income, debts), most people are best served by renewable and convertible term insurance policies. They offer just as much coverage and are cheaper than cash-value, and, with the advent of internet comparisons driving down premiums for comparable policies, you can purchase them at competitive rates.

The renewable clause in a term life insurance policy means that the insuring company will allow you to renew your policy at a set rate without undergoing a medical. This means that if an insured person is diagnosed with a fatal disease just as the term runs out, he or she will be able to renew the policy at a competitive rate despite the fact that the insurance company is certain to have to pay out.

The convertible insurance policy provides the option to change the face value of the policy into a cash-value policy offered by the insurer in case you reach 65 years of age and are not financially secure enough to go without insurance. Even though you will be planning in the hope of not having to use this option, it is better to be safe and the premium is usually quite inexpensive.

Evaluating Your Insurance Needs
A large part of choosing a life insurance policy is determining how much money your dependents will need. Choosing the face value (the amount your policy pays if you die) depends on:

  • How much debt you have: All of your debts must be paid off in full, including car loans, mortgages, credit cards, loans, etc. If you have a $200,000 mortgage and a $4,000 car loan, you need at least $204,000 in your policy to cover you debts (and possibly a little more to take care of the interest as well).
  • Income Replacement: One of the biggest factors for life insurance is for income replacement, which will be a major determinant of the size of your policy. If you are the only provider for your dependents and you bring in $40,000 a year, you will need a policy payout that is large enough to replace your income plus a little extra to guard against inflation. To err on the safe side, assume that the lump sum payout of your policy is invested at 8% (if you do not trust your dependents to invest, you can appoint trustees or chose a financial planner and calculate his or her cost as part of the payout). Just to replace your income, you will need a $500,000 policy. This is not a set rule, but adding your yearly income back into the policy (500,000 + 40,000 = 540,000 in this case) is a fairly good guard against inflation. Remember, you have to add this $540,000 to whatever your total debts add up to.
  • Future Obligations: If you want to pay for your child’s college tuition or have your spouse move to Hawaii when you are gone, you will have to estimate the costs of those obligations and add them to the amount of coverage you want. So, if a person has a yearly income of $40,000, a mortgage of $200,000, and wants to send his or her child to university (let’s say this will cost $80,000), this person would probably want an $820,000 policy ($540,000 to replace yearly income + $200,000 for the mortgage expense + $80,000 university expense). Once you determine the required face value of your insurance company, you can start shopping around for the right policy (and a good deal). There are many online insurance estimators that can help you determine how much insurance you will need.
  • Insuring Others: Obviously there are other people in your life who are important to you and you may wonder if you should insure them. As a rule, you should only insure people whose death would mean a financial loss to you. The death of a child, while emotionally devastating, does not constitute a financial loss because children cost money to raise. The death of an income-earning spouse, however, does create a situation with both emotional and financial losses. In that case, follow the income replacement trick we went through earlier (your spouse’s income/8% + inflation = how much you’ll need to insure your spouse for). This also goes for any business partners with which you have a financial relationship (for example, shared responsibility for mortgage payments on a co-owned property).

Alternatives to Life Insurance
If you are getting life insurance purely to cover debts and have no dependents, there is another way to go about it. Lending institutions have seen the profits of insurance companies and are getting in to the act. Credit card companies and banks offer insurance deductibles on your outstanding balances. Often this amounts to a few dollars a month and in the case of your death, the policy will pay that particular debt in full. If you opt for this coverage from a lending institution, make sure to subtract that debt from any calculations you are making for life insurance – being doubly insured is a needless cost.

If you need life insurance, it is important to know how much and what kind you need. Although generally renewable term insurance is sufficient for most people, you have to look at your own situation. If you choose to buy insurance through an agent, decide on what you’ll need beforehand to avoid getting stuck with inadequate coverage or expensive coverage that you don’t need. As with investing, educating yourself is essential to making the right choice.