Hard Work Pays – but Not Enough

Building wealth requires something more.

Your parents and the American education system instilled in you from an early age that hard work is a virtue. Schools are designed to impart knowledge that you can apply to a career to get a job, work hard and earn money.

That’s great — but it doesn’t go far enough. It’s doubtful that you’ll become wealthy if all you do in life is work hard. Building wealth requires you to do something else in equal measure. You must also work smart.

Here’s why: If you regularly save some of your hard-earned money in an account earning 1 percent, you won’t see much increase in value — even if you save for decades. But if you manage to earn a higher return, the compounding effect can help you produce the wealth you seek. Chapter 3 of The Truth About Money explains the principle this way:

If you save $150 a month at a 5 percent annual return, in 40 years you’d have $228,903 (ignoring taxes and fees). Such returns aren’t guaranteed, of course; this information is offered merely to illustrate the concept of compound growth.

If you double your savings to $300 per month, you will double your return — to $457,806. But to do that, you’d have to work harder — and most of us work hard enough as it is.

However, if you continued to save the same $150 per month but earned 10 percent instead of 5 percent, your account in 40 years would be worth $948,612 — four times what it would have been worth at 5 percent.

That’s a simple example of working smart (not that I’m suggesting that 10 percent returns are attainable, of course). As you can see, working smart is as important as working hard when it comes to building wealth. That’s why it’s important that you build and maintain a portfolio with the potential to help you earn the returns needed to benefit from compounding.

This is a hypothetical illustration meant to demonstrate the principle of compound interest and is not representative of past or future returns of any specific investment vehicle. They do not include consideration of the time value of money, inflation, fluctuations in principal or taxes.

Evaluating Your Advisor’s Performance

8 categories to consider when choosing an advisor.

Here are the eight categories you should consider when evaluating your advisor:

Category #1: Your relationship.
Do you feel comfortable talking with your advisor? Do you look forward to conversations, and when done, are you happy to have had the conversation?

Category #2: Services provided.
Is your advisor delivering services that are of value to you? Think of all the services you get, and ask if you’d be unhappy if any of them ceased. If you wouldn’t miss them, they aren’t of value. Also think of services you’d like to receive but aren’t currently receiving. Have you asked your advisor to provide them?

Category #3: Investment performance.
Are your returns competitive, based on your goals, risk tolerance, and personal situation? You should have a benchmark relevant to your situation for comparison purposes; your advisor can provide one for you.

Category #4: Investment risks.
Has your account fluctuated in value beyond your comfort level? If so, have you discussed this with your advisor, and are you satisfied with the results of that conversation (i.e. your investments were changed to better reflect your comfort level, or your advisor’s explanation made you more comfortable with the level of volatility you’re experiencing)?

Category #5: Outlook.
In times of economic volatility, is your advisor still equipped to effectively advise you? Has your advisor kept you up-to-date on his thoughts and perspective? Is your portfolio still properly positioned? If your advisor has been making or suggesting major changes in your investments, he may have lost confidence in his prior advice — rendering suspect the confidence you can place in his current advice. Even worse would be an advisor who does not seem able to articulate an effective, cohesive strategy going forward. And worst of all would be an advisor who has been and continues to be completely silent — no calls, no emails, no letters, no contact, and no responses to yours.

Category #6: Team-based or solo?
There is a lot of value in team practices vs. solo advisors. Don’t assume your advisor is part of a team just because he works at a national bank, insurance company, or brokerage firm. In most firms, each advisor works independently, with little to no regard for the advice, services, or strategies provided by others in the firm. Clients working with solo advisors are thus more dependent on the actions and decisions of that advisor than those who work as part of a team. Teams also provide greater depth and experience.

Category #7: Costs.
Are the total costs you’re paying competitive? It is foolish to try to seek the lowest costs possible, but it is equally foolish to be paying costs that are significantly higher than those available elsewhere. Your advisor can benchmark costs for you, and a quick Internet search or a few calls to other firms can give you an idea of what others charge.

Remember that there’s always a trade-off between costs and services/quality, and those you contact will try hard to convince you to switch firms. Therefore, it’s important when exploring costs that you examine all costs — not just the advisor’s fee, but also the costs of the investments that the advisor has recommended for you.

Category #8: Regulatory compliance.
Maybe you checked with FINRA, the SEC, and state regulators before hiring your advisor to make sure he had a clean record. But how do you know that there haven’t been complaints, violations, or fines issued in the years since you’ve been a client? Checking your advisor’s background every 3–5 years is a good idea.

Originally published in The Truth About Money

Do You Have the Right Auto Insurance Coverage?

This checklist can also help you lower your auto insurance costs.

Auto policies offer a wide range of coverage. Have you really examined yours lately? Start with the “declaration page;” usually you receive it as part of your premium notice. If you can’t find yours, ask your agent or insurance company to send you a copy.

  1. The most important — and state-required — part of your policy is your liability coverage (Part A). This protects you against lawsuits arising from property damage or bodily injury for which you may be legally responsible due to an auto accident. Your liability coverage might be written as a single amount, which is the maximum your policy will pay,  such as $500,000. Sometimes, coverage is written in split amounts, such as $100,000/$300,000/$50,000. The first number refers to the maximum coverage for injuries to one person. The middle figure refers to the maximum coverage available for all those injured in the accident, and the third figure is the maximum that will be paid for property damage to vehicles, structures, etc. Although each state sets the minimum amount of liability coverage that you must maintain, make sure your coverage is significantly more.
  2. Medical payment coverage (Part B) is optional and usually ranges from $1,000 to $10,000 per insured who is injured in an accident. The insured usually includes a spouse and children of the insured. In some states it also includes the insured’s non-family-member passengers. If you already have excellent health insurance, you can drop this coverage, which will save you money. However, you may prefer to maintain only enough coverage here to offset your health insurance policy’s deductible, as well as its 20% co-payment requirement. Thus, you should review your auto policy in the context of your other insurance coverage.
  3. Uninsured and underinsured motorist coverage (Part C) pays for bodily injury and property damage when you or your vehicle is in an accident caused by an uninsured motorist or hit-and-run driver. This coverage may duplicate your health insurance and/or your collision coverage, but uninsured motorist coverage also can compensate you for “pain and suffering,” which the others do not.
  4. Collision and Comprehensive (Part D, also known as “other than collision”) compensates you for damage to your car regardless of who is at fault. Each portion has a separate deductible. The higher the deductible, the lower the cost, but the more you must pay out-of-pocket in the event your car is damaged.
  5. Some states require you to carry Personal Injury Protection. Unless it’s mandatory, avoid this feature – and its cost – by maintaining separate and more comprehensive health and disability insurance.

You can lower the cost of your auto insurance if you:

  • have had no accident or ticket during the last three years
  • are insuring more than one car with the same company
  • have a teenage driver who has taken an approved driver education course and/or is eligible for a good student discount
  • have a child who is in college and away from home most of the year
  • maintain your homeowner policy with the auto insurer
  • equip your car with anti-theft devices, air bags and/or automatic seat belts
  • are age 50 or older
  • don’t drive to work
  • commute less than 10 miles to work
  • buy a car with high safety ratings.

Check on your car’s rating at the Insurance Institute for Highway Safety’s web site, www.iihs.org.


Are You Susceptible to Investment Fraud?

Here are common traits of victims — and a quiz that might predict vulnerability.

Investment fraud schemes cost Americans tens of billions of dollars annually. But you probably think that you would never fall for any of them.
The AARP Fraud Watch Network recently released a study revealing traits common to victims, noting three key differences between investment fraud victims and the general investor population:

  • Psychological mindset. Victims prefer unregulated investments, such as gold and real estate schemes, rather than stocks, bonds and mutual funds. They measure success in life by the amount of wealth they accumulate — and their willingness to take risks leaves them susceptible to aggressive sales pitches.
  • Behavioral characteristics. Victims make five or more investment decisions per year and tend to respond to ads they see online, in emails and on TV commercials.
  • Demographics. Victims tend to be older than the overall population, male, married and military veterans. They also typically describe themselves as ideologically conservative.

AARP published the seven-question quiz to help you learn if you have the traits that predispose you to becoming a fraud victim.

Investment Fraud Vulnerability Quiz
1. How many times per year do you make an investment decision, such as selling one stock and buying another or investing in something new?
a. None
b. 1 – 2
c. 3 – 4
d. 5 or more

Score 3 for d, 2 for c, 1 for b and 0 for a.

2. In a typical month, how many solicitations do you receive from salespeople urging you to invest money in something — via phone calls, email and letters?
a. None
b. 1 – 7
c. 8 – 15
d. More than 15

Score 3 for d, 2 for c, 1 for b and 0 for a.

3. Have you ever made an investment in response to any of the following? (yes or no)
a. An ad you saw on television
b. A solicitation via email
c. A call from someone you didn’t know
d. A presentation you attended as part of a free lunch or dinner seminar

Score 2 for each “yes.”

4. Do you strongly agree, somewhat agree, somewhat disagree or strongly disagree with the following statements?
a. Some of the most important achievements in life include acquiring money.
b. The most profitable financial returns often are found in investments that are not regulated by the government.
c. I don’t mind taking some risks with my money, as long as I think there’s a chance it might pay off.
d. I like to keep my eyes and ears open for emerging investment opportunities that others haven’t yet heard about.

For each, score 2 for strongly agree, 1 for somewhat agree, and 0 for somewhat disagree or strongly disagree.

5. Which of the following best describes your worldview?
a. Liberal
b. Moderate
c. Conservative

Score 2 for c and 0 for a or b.

6. What is your gender?
a. Male
b. Female

Score 2 for a and 0 for b.

7. What is your age group?
a. Under 18
b. 19 – 39
c. 40 – 54
d. 55+

Score 2 for d, 1 for c and 0 for a or b.
High risk: 14 – 28
Moderate risk: 8 – 13
Low risk: 0 – 7

Did you score a high number on the quiz? If so, you should apply greater caution when receiving unsolicited investment pitches and adhere to these protection tips:

  • Do: Invest only with advisors who act in a fiduciary capacity.
  • Don’t: Make an investment decision based solely on a TV ad, a telemarketing call or an email.
  • Do: Put yourself on the Do Not Call registry.
  • Do: Get a telephone call blocking system to screen out potential scammers.
  • Do: Limit the amount of personal information you give to salespeople until you verify their background.
  • Don’t: Make an investment decision when you are under stress — such as soon after a job loss or the death of a loved one.

Of course, the best way to avoid investment scams is to talk with your Financial Planner

Originally published in Inside Personal Finance.

10 Taboos Between You and Your Advisor

advisor answering client investment questions

Follow these tips to help prevent being taken advantage of.

Here are 10 things you should never do with a financial advisor:

Taboo #1: Never write a check made payable to your advisor, other than for his fee.
When investing money, your checks should be made payable only to mutual funds, ETFs, brokerage firms, or insurance companies. No legitimate advisor would ever allow a client to write a check for investments or insurance payable to him personally or to his firm.

Taboo #2: Never allow your advisor to list himself as a joint owner, beneficiary, or trustee on your accounts.
Your money is yours, not your advisor’s. Keep it that way. The only place your advisor’s name should appear on documents is a citation as “advisor of record.”

Taboo #3: Never lend money to your advisor.

Taboo #4: Never let your advisor sign your name to any document.
Many transactions require your signature — particularly those involving the disbursement of funds from your account. If you are in urgent need of cash, you might be tempted to urge your advisor to bend the rules. Don’t. Forgery is a felony.

Taboo #5: Never let your advisor allow you to sign a blank form or contract.
It’s a violation of FINRA rules and a pretty dumb thing to do. Cross out sections that do not apply.

Note: For privacy considerations, it is common for your advisor to send you documents that omit account numbers and other identifying information. It’s okay to sign such forms; your advisor will fill in the missing data after you return the forms. This step is designed to reduce the risk of identity theft.

Taboo #6: Never let your advisor list his firm’s address instead of yours on account statements.
You should receive monthly or quarterly statements directly from the mutual fund, brokerage firm, or insurance company. Never let your advisor arrange for the statements to go to his office instead of to you.

Taboo #7: Never let your broker or advisor sell you an investment that isn’t available from others.
Some advisors sell in-house or proprietary investment products. There’s only one reason they do that: because they earn compensation for doing so. If an investment product is not available elsewhere, it is probably high in risk and low in liquidity — meaning you could find it very difficult to sell for as much as you invested. Like a box of cereal, all the investments and insurance products your advisor recommends should be available from any number of sources, not just him.

Taboo #8: Never let your advisor receive a share of your profits.
I’d never let an advisor share in my profits unless he was also willing to reimburse me for my losses — and while you might find an advisor offering the former, no one would ever agree to the latter.

It’s your money, so you get to keep all of the profits.

Taboo #9: Never let your advisor assign any agreement with you to another advisor.
One day, your advisor may retire or sell his practice. If so, you are immediately relieved of any and all contractual obligations you may have had with him or her. Never let an advisor — or his successor — make you think you are obligated to work with the successor. Assignment is an SEC violation.

Taboo #10: Never let your advisor invest your money in something you don’t understand.
If you don’t understand an investment or strategy, don’t invest in it. Bernie Madoff’s clients used to joke that he put their money into a “black box.” They aren’t laughing anymore.


10 Important Lessons About Personal Finance

Financial wisdom from America’s favorite TV judge.

Have you ever seen Judge Judy’s TV show? The program is hard to miss, airing worldwide. She’s also the highest-paid television personality, which is appropriate because most of her cases involve money. What we find interesting is that her decisions often contain an important lesson about personal finance. Here are 10 pieces of financial wisdom, courtesy of Judge Judy:

  1. Money makes people irrational. Even the nicest folks can get vicious and vindictive when their finances are threatened. Consider this before engaging in economic dealings.
  2. Don’t co-sign a loan. But if you must, always draft a legal document between you and the co-signer stipulating who’s to repay the loan and what happens if they don’t. Remember: When you co-sign a loan, the lender can come after you for the full amount if the person for whom you co-signed fails to pay.
  3. Don’t take out a loan for someone else. Someone who can’t get a loan himself might ask you to do this. Don’t. If your relationship sours or that person defaults, the loan is yours to repay.
  4. A gift is not a loan. Plaintiffs on Judge Judy’s show often sue to recover money they say they lent to the defendant, but the defendant claims the money he or she received was a gift. If the recipient didn’t sign a loan agreement, the loan is not a loan.
  5. Oral contracts aren’t binding. Plaintiffs in Judge Judy’s court prove this time and again when they try to sue someone for money they claim that person orally agreed to pay back — but there’s no written proof. A verbal promise to repay doesn’t hold up in court.
  6. Lending money can ruin relationships. That’s true of all types of relationships — romantic, familial and friendships. Judge Judy’s cases frequently involve people whose ties are irreparably torn apart when someone fails to repay money. Hurt feelings, tension and rifts can last for years, making family gatherings tense and uncomfortable. The best way to prevent this is not to lend money in the first place; instead, try to help the person find alternative solutions to his or her money needs.
  7. Be smart about managing your money. Most defendants in Judge Judy’s court are there because they made poor financial decisions, spending their money unwisely or irresponsibly or trying to help someone else who couldn’t manage theirs.
  8. Have paper trails for big purchases. If you and someone else make a large purchase together, such as a house or car, or if you give cash to someone to pay off a large loan, make sure you keep written records of how much you personally spent and when. If you claim in court that you paid for something and don’t have the paperwork to verify it, you’ll likely lose your case.
  9. Don’t lend money you don’t have. It’s unwise to lend money in the first place, but it’s far worse when you lend money you personally need for yourself. Never put yourself into debt for others. Unfortunately, we often see this occur, such as when parents jeopardize their retirement by using what little money they have on college costs for children.
  10. Don’t expect anyone else to pay your bills. Many of Judge Judy’s cases deal with children or significant others who expect to be provided for while they contribute nothing toward the household finances. Remember: You are the one responsible for your own bills, and no one is obligated to bail you out of a financial mess you created.
This material was prepared for informational and/or educational purposes only. Neither Financial Engines Advisors L.L.C (also referred to as Edelman Financial Engines) nor its affiliates offer tax or legal advice. Be sure to consult with a qualified tax or legal professional regarding the best options for your particular circumstances.

Market Summary: July 2019

US stocks rise despite a month-end decline.

What happened.

US stocks closed July higher, with large-caps up 1.44 percent and small-caps up 1.14 percent (S&P 500 and 600 indices). They would have closed considerably higher if the month had ended on the 30th. But the 31st saw large-caps decline by 1.09 percent, the only burst of market volatility in July.  International stocks didn’t fare so well.  Developed-market stocks were down by 1.27 percent and emerging-market stocks by 1.22 percent (MSCI EAFE and Emerging Markets indices).  The stronger dollar accounted for these falls from a US investor’s perspective: when the dollar is stronger, the value of foreign assets measured in dollars falls. Bonds rose modestly with the Bloomberg Barclays Global Index up 0.22 percent.

Why it happened.

July was the beginning of “earnings season,” the period in which companies report their financial results for the second quarter of the year.  About three-quarters of companies who reported earnings in July beat expectations—and as a result investors revised their expectations of companies’ future prospects, immediately sending prices higher.

While GDP growth for the second quarter was lower at 2.1 percent than it was for the first quarter, it remained solid.  Employment remains strong, and consumer sentiment rose.

Central banks played an important role in markets this month.  In the Eurozone, the UK, and the US, central banks indicated that they are standing ready to use monetary policy to help their economies overcome challenges.  In this month’s sidebar, we examine what happened on July 31st, the day on which the Federal Reserve reduced interest rates by 0.25 percent, as expected.  Markets fell, not in response to the anticipated cut, but to signals that future cuts are not certain.

What this means for you.

At Financial Engines, we build you a portfolio tailored to your situation.  Your portfolio will probably have only moved slightly in July, as international and domestic stocks headed in different directions.  Remember, it’s best to keep your focus on your long-term goals.  Make sure you are comfortable with the amount of risk you’re taking and keep us informed of any changes to your situation, so we can make adjustments as needed.

©2019 Edelman Financial Engines, LLC. This publication is for informational purposes only and does not constitute investment advice or an offer to buy or sell any security. Future market movements may differ significantly from the expectations expressed herein, and past performance is no guarantee of future results. Edelman Financial Engines assumes no liability in connection with the use of the information and makes no warranties as to accuracy or completeness. Future results are not guaranteed by any party. Financial Engines® is a trademark of Edelman Financial Engines, LLC. Advisory services are provided by Financial Engines Advisors L.L.C. Call (800) 601-5957 for a copy of our Privacy Notice. Bloomberg Index Services Limited. BLOOMBERG® is a trademark and service mark of Bloomberg Finance L.P. and its affiliates (collectively “Bloomberg”). BARCLAYS® is a trademark and service mark of Barclays Bank Plc (collectively with its affiliates, “Barclays”), used under license. Bloomberg or Bloomberg’s licensors, including Barclays, own all proprietary rights in the Bloomberg Barclays Indices. Neither Bloomberg nor Barclays approves or endorses this material, or guarantees the accuracy or completeness of any information herein, or makes any warranty, express or implied, as to the results to be obtained therefrom and, to the maximum extent allowed by law, neither shall have any liability or responsibility for injury or damages arising in connection therewith. All other intellectual property belongs to their respective owners. Index data other than Bloomberg is derived from information provided by Standard and Poor’s and MSCI. The S&P 500 index and the S&P SmallCap 600 Index are proprietary to and are calculated, distributed and marketed by S&P Opco, LLC (a subsidiary of S&P Dow Jones Indices LLC), its affiliates and/or its licensors and has been licensed for use. S&P®, S&P 500® and S&P SmallCap 600®, among other famous marks, are registered trademarks of Standard & Poor’s Financial Services LLC, and Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC. ©2019 S&P Dow Jones Indices LLC, its affiliates and/or its licensors. The MSCI information may only be used for your internal use, may not be reproduced or redisseminated in any form and may not be used to create any financial instruments or products or any indices. The MSCI information is provided on an “as is” basis and the user of this information assumes the entire risk of any use made of this information. MSCI, each of its affiliates and each other person involved in or related to compiling, computing or creating any MSCI information (collectively, the “MSCI Parties”) expressly disclaims all warranties (including, without limitation, any warranties of originality, accuracy, completeness, timeliness, non-infringement, merchantability and fitness for a particular purpose) with respect to this information. Without limiting any of the foregoing, in no event shall any MSCI Party have any liability for any direct, indirect, special, incidental, punitive, consequential (including, without limitation, lost profits) or any other damages.

Test Your Retirement Income Knowledge

3 out of 4 failed this quiz!

How would you feel if your child correctly scored only 47 out of 100 on an important exam? Perhaps you’d take away the child’s smartphone and video games, and restrict TV viewing, until he or she demonstrates scholastic improvement. Well, lots of adults need to do a better job, too — when it comes to financial literacy.

Nearly three out of four people aged 60 to 74 failed a 38-question quiz on retirement income topics administered by the American College of Financial Services New York Life Center for Retirement Income.Those surveyed had at least $100,000 in household assets, excluding their primary residence, so one would assume they would be fairly knowledgeable about savings and investments. But that wasn’t the case. Their average score? 47 percent!

Men answered slightly more questions correctly than women did. Only 5 percent of the 1,224 participants scored a B — 80 percent — or higher. Those who reported being the primary financial decision-maker in their family had a higher pass rate, the college said. While 55 percent were extremely confident they would have enough money to live comfortably in retirement, only 42 percent of the extremely confident men and 24 percent of the extremely confident women passed the test.

Here are nine of the easiest questions. Test yourself and see how well you do:

1, A single person who’s likely to live to age 90 or longer will generally be better off claiming Social Security benefits at what age? (a) 62 (b) 66 (c) 70 (d) 75

2. Who pays the majority of long-term care expenses? (a) Medicare (b) Medicaid (c) long-term care insurance (d) individuals

3. True or false: Medicare typically pays for a nursing home for one year.

4. In order to avoid a penalty, you must begin taking distributions from your IRA in the year you attain what age? (a) 55 (b) 59 and a half (c) 65 (d) 70 and a half

5. Which of the following long-term bonds typically has the highest yield? (a) triple-A-rated corporate bonds (b) B-rated corporate bonds (c) treasury bonds

6. Suppose your savings account pays you 2 percent a year and inflation is running at 4 percent a year. After one year, you will be able to buy: (a) more (b) less (c) exactly the same amount.

7. Most experts agree that the best way to protect against inflation is to have a diversified portfolio of what? (a) stocks (b) bonds (c) bank CDs

8. True or false: Buying a single stock is usually safer than a stock mutual fund.

9. If 100 percent of a mutual fund’s assets are invested in long-term bonds, and interest rates go up substantially, what will happen to the value of the fund? (a) It will go up substantially. (b) It will drop substantially. (c) It won’t change at all.

Not knowing the correct answers can cause you to make costly mistakes. Show this quiz to your family members and friends; perhaps they’ll discover they could benefit from working with financial professionals.

Quiz Answers:
1. (c) 70, not 75, because once you reach age 70, benefits do not increase further.
2. (b) Medicaid, the federal health plan for the poor. You must be in poverty to have the federal government cover your long-term care needs. Medicare doesn’t pay much in long-term care benefits.
3. False. Medicare pays for 100 days — after you’ve first spent three or more days in a hospital getting skilled nursing care. A lot of folks don’t need that. They go straight to a nursing home, in which case Medicare doesn’t pay anything.
4. (d) 70 and a half. You have until April 1 of the year after you reach that age to take the first distribution, but at that point you’d need to take one for the current year as well.
5. (b) B-rated corporate bonds. The others may be rated higher and have higher quality and safety, but not the highest yield. (Those who don’t know this answer could end up buying bonds that are riskier than they thought or lower in yield than they thought.)
6. (b) less. If inflation is more than your earnings, your buying power goes down. Many people don’t know the basic elements of how inflation works and its impact on paychecks.
7. (a) stocks. Yet today more than half of households don’t own stocks, preferring to have their savings in bonds and CDs, wrongly believing those will protect them against inflation.
8. False. A basket of stocks is safer than a single stock, because if one goes down you still have many others. It’s like having 12 eggs in 12 baskets instead of all 12 in one basket.
9. (b) It will drop substantially. Bond values and interest rates are inversely proportional: When one goes up, the other goes down.


Should You Create a Trust?

Different types of trusts can fill different types of needs.

People often create trusts to help them manage their assets. Here’s a quickie on the basics of a trust, along with a description of common uses.

A trust is created by the grantor (that’s you). The grantor writes the rules governing how the trust is to operate, what it is to do, and how and when to do it. If the trust is revocable, you can change the rules at any time. If the trust is irrevocable, you can’t. (Each form has advantages and disadvantages, including tax implications.)

When creating the trust, you appoint a trustee, who will have the job of managing the trust and its assets. (People often appoint themselves to serve as trustee.) The trustee must follow the trust’s rules, although, some trusts let the trustee use discretion in certain matters.

After you create the trust, it receives gifts from a donor (that’s also usually you, although you might permit your trust to receive gifts from others in addition to you or instead of you). The trustee collects the gifts and invests the money in accordance with the rules of the trust. As a result, the trust will find itself with three things: principal (the money it was given, also called the corpus), interest and dividends earned on the principal (called income), and profits (if any) from increases in value enjoyed by the principal (called capital gains).

The rules you’ve written for the trust will determine who gets the income, capital gains and, ultimately, the principal. The recipient is called the beneficiary. Some trusts have lots of beneficiaries. They can be family members, friends, or charities — anyone you want, in any combination. Some trusts give the income to certain beneficiaries, while others get the capital gains and still others get the corpus — with the trust itself stating who is to get what and when (or under what conditions). It’s the trustee’s job to make sure all this happens in accordance with the provisions of the trust.

Because different trusts do different things, it’s routine for people to have more than one. In fact, having four or five trusts is not uncommon. In some cases, trusts are even created by other trusts or in a will!

Is a trust right for you? Your answers to these questions can help you decide.

  1. Are you worth more than $10 million? If yes, read about the Bypass Trust.
  2. Are you concerned about a family member who has a disability that limits his or her ability in any way? If yes, read about the Special Needs Trust.
  3. Do you fret that your heirs might squander the money you leave to them? If yes, read about the Spendthrift Trust.
  4. Do you own a lot of life insurance? If yes, then read about the Life Insurance Trust.
  5. Would you like a charity to receive a substantial amount of money upon your death? If yes, read about the Charitable Remainder Trust.
  6. Do you have children and expect your spouse to remarry after you die? Then read about the Qualified Terminal Interest Property (QTIP) Trust.
  7. Do you want to make certain that your assets are used for your benefit even if you are unable to manage them yourself? Do you want your assets to go directly to your heirs, avoiding the costs, delay, and publicity of probate? If so, read about the Living Trust.
  8. Do you want the bulk of your assets to go directly to your grandchildren? If yes, then read about the Generation-Skipping Trust.

Bypass Trusts
Also called the credit shelter trust, marital trust, and family trust, this trust is designed to help a married couple avoid estate taxes. Each person may pass to heirs a certain amount of money at death with no estate tax. The bypass trust can increase this. Because tax laws vary year to year, speak with an experienced financial advisor or estate planning lawyer to make sure you have current information.

Special Needs Trusts
This trust provides financial support to a person who is unable to manage his or her own financial affairs. To avoid the risk of interfering with the support that’s otherwise available from social services, the trustee may not want to use these assets for housing, clothing or food.

Spendthrift Trusts
Instead of leaving an heir a bucket of money that he or she may quickly squander, you place that inheritance into this trust. The trust would then distribute the inheritance to the heir later, perhaps when the heir reaches a certain age, or in the form of an allowance, or for specific expenses, such as college or medical expenses.

Life Insurance Trusts
For high net-worth individuals, owning their own life insurance is a big mistake — because the death benefit is subject to estate taxes. To solve this problem, have a life insurance trust own your policy. Instead of paying for the insurance yourself, you’d give that money to the trust, which would pay the premium for you. The trust would be the beneficiary, and your heirs would be the beneficiaries of the trust.

An additional benefit of a life insurance trust: Instead of beneficiaries automatically getting the insurance proceeds immediately upon your death, you can instruct the trust to distribute the money to the heirs more slowly (see Spendthrift Trust above).

Charitable Remainder Trusts
If you plan to donate assets to a charity after your death, you may find it beneficial, instead, to donate to a CRT now. By doing so, you get a tax deduction right now for your gift. You also can name yourself as the income beneficiary (giving yourself an annual income) and the charity gets what’s left after your death, tax free — just as you’ve intended.

If you’re concerned that making the gift to the CRT denies your children their inheritance, you can buy a life insurance policy equal to the size of your gift, naming your children as beneficiaries of the insurance, using some of the trust’s income to pay the policy’s premiums (see Insurance Trust above).

QTIP Trusts
Say you die leaving a spouse, minor children and assets. Further, say your spouse remarries, then dies. Result: Your spouse’s new spouse gets all your money, and your children are left with nothing. (We’ve seen this happen too many times.) To avoid this scenario, consider the Qualified Terminal Interest Property Trust. Instead of leaving your assets to your spouse when you die, you leave your assets to the QTIP trust.

The trust gives income to your surviving spouse for his or her lifetime. But when your spouse dies, the assets remain in the trust for the benefit of your children. Because your spouse doesn’t directly own the assets, he or she can’t convey them to a new spouse and his or her own heirs.

Living Trusts
This tool is designed to pass your assets to heirs without going through probate. Also, it can help insure that your assets will be used for your benefit and welfare if you become unable to manage your own affairs.

Generation-Skipping Trusts
Such trusts, intended for truly wealthy estates, can preserve your assets for several generations while avoiding estate taxes. You can fund a GST with the same amount as the bypass trust for the benefit of your grandchildren and great grandchildren, and the assets will appreciate free of income and estate taxes. Such assets can also be protected from creditors.

This material was prepared for informational and/or educational purposes only. Neither Financial Engines Advisors L.L.C (also referred to as Edelman Financial Engines) nor its affiliates offer tax or legal advice. Be sure to consult with a qualified tax or legal professional regarding the best options for your particular circumstances. The use of trusts involves a complex web of tax rules and regulations. Consider enlisting the counsel of an estate planning professional and your legal and tax advisors prior to implementing such sophisticated strategies. The cost and availability of life insurance depend on factors such as age, health, and the type and amount of insurance purchased. Before implementing a strategy involving life insurance, it would be prudent to make sure that you are insurable by having the policy approved.

Q&A: Sharing Net Worth with Adult Children

What should I tell my family about my assets?

Ric Edelman is a co-founder of Edelman Financial Engines. The following is taken from his weekly radio call-in show.

Question: My wife and I are in our early 70s, and we have three children in their early 40s — all married — and seven grandchildren ranging in age from 3 to 14. We’re retired and have a substantial estate — a net worth of about $5 million. My question is what to tell our children about our assets. We’re generous to them and the grandkids, but I don’t want to say something that would cause our children to change their behavior. It’s not that we want to keep secrets, but what if anything should we tell them? Should we be specific or just give them general information? I don’t think we should discuss this with the grandchildren — at least not anytime soon. Do you agree?

Ric: First, we believe keeping secrets is unwise when it comes to estate planning. You should have an estate plan in place that does two major things: protects your assets while you’re alive and provides for their distribution to your designated heirs after you’re gone.

Estate planning tools are available to help protect you and the management of your assets should you and your wife become incapacitated or unable to handle your affairs. These include everything from medical directives to revocable living trusts. You should arrange for these now if you haven’t already. This is important because you and your wife are (actuarially speaking) going to live for many years. Statistically, at least one of you can be expected to live well into your 90s. That means your children who are currently in their early 40s will be in their mid-to-late 60s by the time you and your wife pass away.

Assuming your three children will be your primary heirs, this question arises: Will they need the money in their 60s as much as they need the money right now in their 40s? I’d argue that it is this stage of their lives when they need the money most. They’re raising kids, buying houses and cars, saving to send your seven grandchildren to college, and more. This likely puts them under a great deal of financial and emotional stress.

You should ask whether that stress could be eased somewhat if they were to know there is an inheritance coming one day. Perhaps they wouldn’t need to save as much for retirement knowing part of it will be covered by you. This could let them shift their savings to the kids’ college costs. Conversely, if your plan is to help pay for college for the grandchildren, your kids could shift their saving emphasis to retirement.

Thus, knowing your intentions — when you plan to give them money, how much and for what purpose — can help your children make mature, rational and important decisions. On the other hand, you must also evaluate whether they might change their behavior for the worse. Might the news prompt them to take off for Tahiti and party? Might they quit a job? Might they become slovenly or abusive, saying in effect, “Hey, my daddy’s rich, so I don’t have to work real hard anymore — let’s have fun”? Or perhaps one of your in-laws might say, “I think I’ll simply divorce now because I’ve got this windfall coming and I’ll just negotiate that in the divorce settlement. Or perhaps I’ll quit my job.”

You know these people better than anyone else. You know your relationships with them and your attitudes about them. You need to evaluate whether your disclosure would do more harm than good and whether you should limit its nature and timing.

You might conclude that what you and your wife disclose about your assets could have a positive impact, easing the stress and pressure of your children’s own financial planning to the benefit of them and your seven grandchildren. You might conclude otherwise. At the very least you need to let them know that you have your estate planning in place and what your desires are regarding your funeral and charitable intent. You need to tell them who the executor of the will is and who the trustee of the trust is — and the executor/ trustee needs a copy of your documents because after you’ve passed it’s too late for them to ask questions. You might also decide to start giving your heirs some money right now, or annually.

So, yes, have the conversation, but you and your wife need to evaluate to what extent you should go, how much detail to give and when you will do it. (I agree with you that you needn’t include young grandchildren.)

If this seems daunting — and it does for many — a financial advisor can facilitate this conversation. It’s not uncommon for clients to bring their kids with them to an appointment when they’re ready to talk. This can remove some of the emotion and embarrassment — yes, occasionally there is an embarrassment of riches.

This material was prepared for informational and/or educational purposes only. Neither Financial Engines Advisors L.L.C (also referred to as Edelman Financial Engines) nor its affiliates offer tax or legal advice. Be sure to consult with a qualified tax or legal professional regarding the best options for your particular circumstances.