Thrifty (and Better) Fun
One of the biggest take-aways from the recent market meltdown, for many people, was the rediscovery of many kinds of fun that don't cost money--a lot of the things that people did years ago before the advent of 3D movies, gourmet restaurants, traveling soccer teams and endless consumerism.
In fact, one financial planning firm took a poll of its clients, asking them what kinds of fun things they had rediscovered while they were tightening their belts. What they found was that many people were having MORE fun with less money, simply by being creative.
Other advisors are asking similar questions, and reporting the answers so that everybody can see what their friends and neighbors have discovered/rediscovered. They received answers like: working jigsaw puzzles as a family, or playing board games (like Parcheesi or Scrabble) in the evening, inviting friends over to play cards, taking walks, creating a new flower garden (or, in one case, turning the entire front lawn into a flower garden of spectacular beauty), hiking in the local state park, attending a variety of free seminars, getting more involved in community meetings, having group cookouts where everybody shares the cooking or brings dishes, joining a book club--the original advisory firm now has several hundred suggestions, and counting.
Of course, the lesson is something that we somehow manage to forget from time to time: that the world is full of endless possibilities for fun and pleasure and satisfaction and beauty, and some of the most interesting cost us nothing. In fact, the shared togetherness of many of the "rediscovered" activities makes them superior to how many people were spending their time before the market dropped.
It would be shame if we learned these important lessons and then let our rediscoveries slip away now that people are feeling a bit wealthier again. They call these the "simple" pleasures, but there's nothing simple about being creative and really looking at the beauty and possibilities of the world around us. It's possible that we can be thriftier AND enjoy life more if we use our minds and hearts and each other to bring pleasure and fun into our lives.
Tuesday, May 11, 2010
Greek Tragedy
You probably read last week that the Greek debt crisis had something to do with the sudden loss of confidence investors were feeling last week--although they're apparently still investigating whatever caused the COMPUTERS to lose confidence and decide to sell anything they could get their electronic hands on.
The Economist has been giving nonstop coverage to what it has called the sovereign debt crisis in the PIIGS area of Euroland: Portugal, Ireland, Italy, Greece and Spain, all of which have taken on too much debt and are in the process of painful restructuring. (Iceland is doing the same thing, but the acronym probably would have looked funny with an extra "I" in the middle. The magazine notes that two-year Greek government bonds were selling at prices that would have yielded 20% returns--or about 100 times what Japanese bonds of comparable maturity are paying their investors. At the same time, Portugal's borrowing costs jumped, Spain's government debt was downgraded by the ratings agencies and Italy came close to a failed debt auction--meaning no buyers anywhere.
Just like the banking crisis in the U.S., any bailout of Greece is deeply unpopular to the citizens of the rest of Europe, particularly Germany, where the Greek politicians are about as popular as Goldman Sachs and AIG are to American voters. The problem, of course, is that most of the Greek debt is held by regional European banks, which means that without some kind of a bailout, there will be real economic pain everywhere across the Atlantic.
The whole Greek economic tragedy has made for lurid headlines, one of those rare global business stories that gets the attention of average investors. You know that a country is bordering on dysfunction when its AIR FORCE goes on strike.
What does all this have to do with U.S. stocks? An article in the Huffington Post suggests that a weaker European economy could reduce demand for U.S. exports, and as the euro declines against the dollar, U.S. goods become more expensive in the 16 countries that use the European currency. Under some economic scenarios, Europe could experience the second dip of a double-dip recession, where consumers stop spending and companies cut back on production and lay off millions of workers.
This past week, while the markets were on their wild ride, Europe and the International Monetary Fund finally crafted a $140 billion rescue package of Greek financing. Thirty percent of that will come from the International Monetary Fund, 40% of which is funded by U.S. taxpayers. Since then, the rescue package has been upped to a full $1 trillion and would be available to rescue other euro-zone economies. The rescue package includes loans from the U.S. Federal Reserve Board, the Bank of Canada and the Bank of Japan. Tony Boeckh, of the Boeckh Investment Letter, wonders why American citizens should have to share Greek's pain--sounding exactly like the angry taxpayers of Germany and France. The answer, in terms even the rogue computers can understand, is that in an interconnected global economy, everybody seems to have a vested business interest in avoiding the worst-case scenario. On Monday May 10th the markets seemed to agree when the Dow closed up 3.9% or 404.71 points.
Economist article:
Click Here
Huffington Post article:
Click Here
Japanese government bonds with a 2-year maturity: 0.2%:
Click Here
You probably read last week that the Greek debt crisis had something to do with the sudden loss of confidence investors were feeling last week--although they're apparently still investigating whatever caused the COMPUTERS to lose confidence and decide to sell anything they could get their electronic hands on.
The Economist has been giving nonstop coverage to what it has called the sovereign debt crisis in the PIIGS area of Euroland: Portugal, Ireland, Italy, Greece and Spain, all of which have taken on too much debt and are in the process of painful restructuring. (Iceland is doing the same thing, but the acronym probably would have looked funny with an extra "I" in the middle. The magazine notes that two-year Greek government bonds were selling at prices that would have yielded 20% returns--or about 100 times what Japanese bonds of comparable maturity are paying their investors. At the same time, Portugal's borrowing costs jumped, Spain's government debt was downgraded by the ratings agencies and Italy came close to a failed debt auction--meaning no buyers anywhere.
Just like the banking crisis in the U.S., any bailout of Greece is deeply unpopular to the citizens of the rest of Europe, particularly Germany, where the Greek politicians are about as popular as Goldman Sachs and AIG are to American voters. The problem, of course, is that most of the Greek debt is held by regional European banks, which means that without some kind of a bailout, there will be real economic pain everywhere across the Atlantic.
The whole Greek economic tragedy has made for lurid headlines, one of those rare global business stories that gets the attention of average investors. You know that a country is bordering on dysfunction when its AIR FORCE goes on strike.
What does all this have to do with U.S. stocks? An article in the Huffington Post suggests that a weaker European economy could reduce demand for U.S. exports, and as the euro declines against the dollar, U.S. goods become more expensive in the 16 countries that use the European currency. Under some economic scenarios, Europe could experience the second dip of a double-dip recession, where consumers stop spending and companies cut back on production and lay off millions of workers.
This past week, while the markets were on their wild ride, Europe and the International Monetary Fund finally crafted a $140 billion rescue package of Greek financing. Thirty percent of that will come from the International Monetary Fund, 40% of which is funded by U.S. taxpayers. Since then, the rescue package has been upped to a full $1 trillion and would be available to rescue other euro-zone economies. The rescue package includes loans from the U.S. Federal Reserve Board, the Bank of Canada and the Bank of Japan. Tony Boeckh, of the Boeckh Investment Letter, wonders why American citizens should have to share Greek's pain--sounding exactly like the angry taxpayers of Germany and France. The answer, in terms even the rogue computers can understand, is that in an interconnected global economy, everybody seems to have a vested business interest in avoiding the worst-case scenario. On Monday May 10th the markets seemed to agree when the Dow closed up 3.9% or 404.71 points.
Economist article:
Click Here
Huffington Post article:
Click Here
Japanese government bonds with a 2-year maturity: 0.2%:
Click Here
Friday, May 7, 2010
A WILD THURSDAY ON WALL STREET
What's the difference between "billions" and "millions"? About 650 points.
Did a mistake make a selloff more severe? The Dow Jones Industrial Average settled at 10,520.32 Thursday after a 347.80 loss, with fears over European sovereign debt affecting Wall Street. Yet the 347.80 decline was just half the story.
The Dow also saw its greatest-ever intraday swoon Thursday, diving 998.50 below the open at one point and taking an intraday swing of 1,007 points.1,2
What happened? At this point, it looks like the same kind of thing that happened on Black Monday in 1987: technology and trading errors betrayed Wall Street.
That was "millions", not "billions"! Citing multiple sources on May 6, CNBC and Reuters reported that a trader, possibly at Citigroup, mistakenly typed a "b" for billion instead of an "m" for million - apparently when authorizing a trade concerning Procter & Gamble. P&G shares fell 37% at one point (more than $22) before recovering to lose 3% on the market day.3,4,5
As the selloff gained momentum, some weird things happened Thursday. In a stretch of two minutes, 16 billion e-minis (futures contracts tied to the S&P 500) were sold. Accenture became a penny stock - no kidding, share values were showing up at $.01 on the New York Stock Exchange at one point. PG and 3M shares actually went below the "circuit breaker" level on the NYSE, freeing traders to purchase and sell shares of those companies on other exchanges. Clearly, technology was running wild.4,5,6
Will trades be erased? Apparently some will be: Thursday evening, the NASDAQ announced it would cancel all trades of stocks whose prices moved more than 60% between 2:40-3:00pm EST on May 6. Just minutes after that news item, the NYSE said it would do the exact same thing.7
What's the lesson here? Don't panic. Be patient. Don't succumb to impulse when it comes to stocks. In the last few years, we have seen amazing market volatility AND amazing rebounds - and the resilient bull market we've seen has taught every investor that stocks can impressively snap back. Curse the technology that caused this swoon if you like, but keep fundamentals and diversification ever in mind.
Citations
1 - money.cnn.com/ [5/6/10]
2 - cnbc.com/id/36988229 [5/6/10]
3 - cnbc.com/id/36999483 [5/6/10]
4 -money.cnn.com/2010/05/06/markets/markets_newyork/index.htm [4/29/10]
5- cnbc.com/id/36988229 [5/6/10]
6 - blogs.barrons.com/stockstowatchtoday/2010/05/06/no-ordinary-collapse-dow-snaps-back-from-1000-pt-drop/ [5/6/10]
7 - reuters.com/article/idUSN0614132620100506?type=marketsNews [5/6/10]
What's the difference between "billions" and "millions"? About 650 points.
Did a mistake make a selloff more severe? The Dow Jones Industrial Average settled at 10,520.32 Thursday after a 347.80 loss, with fears over European sovereign debt affecting Wall Street. Yet the 347.80 decline was just half the story.
The Dow also saw its greatest-ever intraday swoon Thursday, diving 998.50 below the open at one point and taking an intraday swing of 1,007 points.1,2
What happened? At this point, it looks like the same kind of thing that happened on Black Monday in 1987: technology and trading errors betrayed Wall Street.
That was "millions", not "billions"! Citing multiple sources on May 6, CNBC and Reuters reported that a trader, possibly at Citigroup, mistakenly typed a "b" for billion instead of an "m" for million - apparently when authorizing a trade concerning Procter & Gamble. P&G shares fell 37% at one point (more than $22) before recovering to lose 3% on the market day.3,4,5
As the selloff gained momentum, some weird things happened Thursday. In a stretch of two minutes, 16 billion e-minis (futures contracts tied to the S&P 500) were sold. Accenture became a penny stock - no kidding, share values were showing up at $.01 on the New York Stock Exchange at one point. PG and 3M shares actually went below the "circuit breaker" level on the NYSE, freeing traders to purchase and sell shares of those companies on other exchanges. Clearly, technology was running wild.4,5,6
Will trades be erased? Apparently some will be: Thursday evening, the NASDAQ announced it would cancel all trades of stocks whose prices moved more than 60% between 2:40-3:00pm EST on May 6. Just minutes after that news item, the NYSE said it would do the exact same thing.7
What's the lesson here? Don't panic. Be patient. Don't succumb to impulse when it comes to stocks. In the last few years, we have seen amazing market volatility AND amazing rebounds - and the resilient bull market we've seen has taught every investor that stocks can impressively snap back. Curse the technology that caused this swoon if you like, but keep fundamentals and diversification ever in mind.
Citations
1 - money.cnn.com/ [5/6/10]
2 - cnbc.com/id/36988229 [5/6/10]
3 - cnbc.com/id/36999483 [5/6/10]
4 -money.cnn.com/2010/05/06/markets/markets_newyork/index.htm [4/29/10]
5- cnbc.com/id/36988229 [5/6/10]
6 - blogs.barrons.com/stockstowatchtoday/2010/05/06/no-ordinary-collapse-dow-snaps-back-from-1000-pt-drop/ [5/6/10]
7 - reuters.com/article/idUSN0614132620100506?type=marketsNews [5/6/10]
THE FINANCIAL REFORM BILL
Main Street's anger over Wall Street reaches the Senate floor.
Another reform bill is now making its way through the Senate - a bill that would reregulate the financial services industry with a few goals in mind:
1) Preventing failures of large banks and financial services firms, or at least insulating taxpayers and the economy in such an emergency
2) Creating a new financial watchdog agency to protect consumers
3) Tightening regulations on derivatives
4) Banning banks from proprietary trading (with the "Volcker Rule")
5) Increasing transparency1,2,3
Anger on Main Street, while palpable, won't pass these reforms. In the Senate, Democrats are largely driving them; Republicans want to see them altered. Let's look at them briefly.
The bailout issue. The bill introduced by Senate Banking Committee Chairman Chris Dodd (D-CT) would set up an "orderly liquidation fund" - $50 billion deep - to help the federal government wind down any big banks that threaten to go belly up.3 Senate Republicans argue that this would amount to a permanent "bailout fund" that would implicitly encourage federal bank rescues. Some Republicans think it perpetuates the "too big to fail" mentality.
A group of Congressional Democrats have introduced the S.A.F.E. Banking Act, which would cap bank size: no U.S. bank or bank holding company could hold more than 10% of the country's insured deposits. The S.A.F.E. Act would also hold the amount of non-deposit liabilities at financial institutions at 2% of GDP for banks, and set a 6% leverage limit for bank holding companies.4
The proposed new Bureau. The reform bill proposes creating a Bureau of Consumer Financial Protection, possibly as an offshoot of the Federal Reserve. It would watch over banks and credit unions with $10 billion or more in assets, as well as major investment firms and mortgage lenders apart from the banking industry. In addition to trying to protect people from predatory or discriminatory practices, the BCFP would also seek to better inform consumers via an Office of Financial Literacy.2 Skeptics see this as another multibillion-dollar layer of bureaucracy, a "fifth wheel" whose mission could just as well be handled by an augmented Fed.
Crackdowns on derivatives & proprietary trading. Ah yes, derivatives - those investments no one really understood. Or watched closely. The reform bill would require banks to build a wall between their derivatives trading and their commercial banking operations - in other words, the "Volcker Rule" would be the law. Well, banks do make a lot of money through proprietary trading in their own accounts. In late April, JP Morgan analysts concluded that if the Volcker Rule went into effect, the six biggest global investment banks would need $85 billion more to capitalize the new investment banking divisions they would need to create. According to the JPMorgan scenario, Deutsche Bank would have to grab $26 billion alone and BNP Paribas would have to come up with $21.1 billion. 5
A better understanding for all? If the reforms become law, regulators would work to make the "fine print" that comes with a credit card, a mutual fund or a mortgage product clearer, so that fees and other quietly assessed charges would become easier to understand. Hedge funds would have to register with the federal government. Certain Democrat-driven amendments would even demand more transparency at the Federal Reserve. As Sen. Bernard Sanders [I-VT] remarked in late April, "During the bailout, the Fed lent trillions of dollars at zero or near-zero interest rates to large financial institutions. During the Budget Committee hearing, I asked Chairman Bernanke who received that money, [and] he refused to tell us."
A new chapter, or a whole new book? You could argue - convincingly - that a loosely regulated Wall Street caused or least exacerbated the "Great Recession". In the aftermath of that downturn, we may see the biggest rewrite of financial rules and regulations since the Great Depression coming before 2010 ends.
Citations
1 - msnbc.msn.com/id/36770907/ns/business-us_business/ [4/27/10]
2 - csmonitor.com/USA/Politics/2010/0429/Financial-reform-bill-101-what-it-means-for-consumers [4/29/10]
3 - csmonitor.com/USA/Politics/2010/0428/Financial-reform-four-sticking-points [4/28/10]
4 - memphisdailynews.com/editorial/Article.aspx?id=49660 [4/29/10]
5- reuters.com/article/idUSN2924718120100429 [4/29/10]
6 - csmonitor.com/USA/Politics/2010/0428/Republicans-relent-clear-financial-reform-bill-for-debate/%28page%29/2 [4/28/10]
Main Street's anger over Wall Street reaches the Senate floor.
Another reform bill is now making its way through the Senate - a bill that would reregulate the financial services industry with a few goals in mind:
1) Preventing failures of large banks and financial services firms, or at least insulating taxpayers and the economy in such an emergency
2) Creating a new financial watchdog agency to protect consumers
3) Tightening regulations on derivatives
4) Banning banks from proprietary trading (with the "Volcker Rule")
5) Increasing transparency1,2,3
Anger on Main Street, while palpable, won't pass these reforms. In the Senate, Democrats are largely driving them; Republicans want to see them altered. Let's look at them briefly.
The bailout issue. The bill introduced by Senate Banking Committee Chairman Chris Dodd (D-CT) would set up an "orderly liquidation fund" - $50 billion deep - to help the federal government wind down any big banks that threaten to go belly up.3 Senate Republicans argue that this would amount to a permanent "bailout fund" that would implicitly encourage federal bank rescues. Some Republicans think it perpetuates the "too big to fail" mentality.
A group of Congressional Democrats have introduced the S.A.F.E. Banking Act, which would cap bank size: no U.S. bank or bank holding company could hold more than 10% of the country's insured deposits. The S.A.F.E. Act would also hold the amount of non-deposit liabilities at financial institutions at 2% of GDP for banks, and set a 6% leverage limit for bank holding companies.4
The proposed new Bureau. The reform bill proposes creating a Bureau of Consumer Financial Protection, possibly as an offshoot of the Federal Reserve. It would watch over banks and credit unions with $10 billion or more in assets, as well as major investment firms and mortgage lenders apart from the banking industry. In addition to trying to protect people from predatory or discriminatory practices, the BCFP would also seek to better inform consumers via an Office of Financial Literacy.2 Skeptics see this as another multibillion-dollar layer of bureaucracy, a "fifth wheel" whose mission could just as well be handled by an augmented Fed.
Crackdowns on derivatives & proprietary trading. Ah yes, derivatives - those investments no one really understood. Or watched closely. The reform bill would require banks to build a wall between their derivatives trading and their commercial banking operations - in other words, the "Volcker Rule" would be the law. Well, banks do make a lot of money through proprietary trading in their own accounts. In late April, JP Morgan analysts concluded that if the Volcker Rule went into effect, the six biggest global investment banks would need $85 billion more to capitalize the new investment banking divisions they would need to create. According to the JPMorgan scenario, Deutsche Bank would have to grab $26 billion alone and BNP Paribas would have to come up with $21.1 billion. 5
A better understanding for all? If the reforms become law, regulators would work to make the "fine print" that comes with a credit card, a mutual fund or a mortgage product clearer, so that fees and other quietly assessed charges would become easier to understand. Hedge funds would have to register with the federal government. Certain Democrat-driven amendments would even demand more transparency at the Federal Reserve. As Sen. Bernard Sanders [I-VT] remarked in late April, "During the bailout, the Fed lent trillions of dollars at zero or near-zero interest rates to large financial institutions. During the Budget Committee hearing, I asked Chairman Bernanke who received that money, [and] he refused to tell us."
A new chapter, or a whole new book? You could argue - convincingly - that a loosely regulated Wall Street caused or least exacerbated the "Great Recession". In the aftermath of that downturn, we may see the biggest rewrite of financial rules and regulations since the Great Depression coming before 2010 ends.
Citations
1 - msnbc.msn.com/id/36770907/ns/business-us_business/ [4/27/10]
2 - csmonitor.com/USA/Politics/2010/0429/Financial-reform-bill-101-what-it-means-for-consumers [4/29/10]
3 - csmonitor.com/USA/Politics/2010/0428/Financial-reform-four-sticking-points [4/28/10]
4 - memphisdailynews.com/editorial/Article.aspx?id=49660 [4/29/10]
5- reuters.com/article/idUSN2924718120100429 [4/29/10]
6 - csmonitor.com/USA/Politics/2010/0428/Republicans-relent-clear-financial-reform-bill-for-debate/%28page%29/2 [4/28/10]
Tuesday, May 4, 2010
Portfolio Magic
Here's a great idea: let's add something risky to your investment portfolio.
One of the mathematical mysteries of investing--which earned Harry Markowitz a Nobel prize in economics--is how it's possible to add volatile investments to an investment portfolio and get higher returns with less risk. Roger Gibson, author of "Asset Allocation and the Rewards of Multiple-Asset-Class Investing," recently showed an audience of financial advisors some updated statistics on how this works.
Let's suppose that in 1972, you were to visit a gypsy and ask her to look into her crystal ball. You ask her to tell you what the returns will be on U.S. stocks (measured by the S&P 500 index), international stocks (the MSCI EAFE index), real estate securities (the FTSE NAREIT Equity REIT index) and commodities (the S&P GSCI Index) ending in the year 2009--December 31 of last year.
The gypsy tells you with perfect accuracy that U.S. stocks will rise 9.91% a year, international stocks will go up 10.28% a year, real estate securities will go up 11.62% annually, and the yearly return on commodities will be 9.56% a year. What would you do with this information?The intuitive answer is to put it all in the asset that will go up the most--the real estate market. But the modern portfolio theory answer is that you would do better if you invested equal amounts of money in all four assets. Your overall return would be a hair below the REIT return--11.58% a year--but with dramatically lower volatility. In many time periods, combining all four asset classes will actually result in a higher annual return than the highest individual asset class return. In other words, even if you could find a gypsy who had perfect foresight, you would still be better off combining different assets together.
Mr. Gibson shows the return since 1972 of each individual asset class, and how adding another risky asset will actually reduce the overall up/down movements of the blended portfolio. Add another risky asset, and the overall return tends to go up and the volatility goes down. Add another, and you get more of the same effect.The magic is in what Markowitz called the correlations; that is, the amount that one asset moves in relation to the others. If the correlations are equal to 1, all the assets go up and down in tandem. If they're less than one, then you tend to get this multiplier effect on return and dampening effect on risk--and the lower the correlations, the better this works.
This, of course, is only one component of portfolio design; you also want to have diversification within each asset class, and control costs, and a variety of other elements. But getting the overall asset mix right is the most complicated part of the formula--and, seemingly, the most magical and mysterious. If you can achieve results that are better than a person with perfect foresight, isn't that pretty remarkable?
Here's a great idea: let's add something risky to your investment portfolio.
One of the mathematical mysteries of investing--which earned Harry Markowitz a Nobel prize in economics--is how it's possible to add volatile investments to an investment portfolio and get higher returns with less risk. Roger Gibson, author of "Asset Allocation and the Rewards of Multiple-Asset-Class Investing," recently showed an audience of financial advisors some updated statistics on how this works.
Let's suppose that in 1972, you were to visit a gypsy and ask her to look into her crystal ball. You ask her to tell you what the returns will be on U.S. stocks (measured by the S&P 500 index), international stocks (the MSCI EAFE index), real estate securities (the FTSE NAREIT Equity REIT index) and commodities (the S&P GSCI Index) ending in the year 2009--December 31 of last year.
The gypsy tells you with perfect accuracy that U.S. stocks will rise 9.91% a year, international stocks will go up 10.28% a year, real estate securities will go up 11.62% annually, and the yearly return on commodities will be 9.56% a year. What would you do with this information?The intuitive answer is to put it all in the asset that will go up the most--the real estate market. But the modern portfolio theory answer is that you would do better if you invested equal amounts of money in all four assets. Your overall return would be a hair below the REIT return--11.58% a year--but with dramatically lower volatility. In many time periods, combining all four asset classes will actually result in a higher annual return than the highest individual asset class return. In other words, even if you could find a gypsy who had perfect foresight, you would still be better off combining different assets together.
Mr. Gibson shows the return since 1972 of each individual asset class, and how adding another risky asset will actually reduce the overall up/down movements of the blended portfolio. Add another risky asset, and the overall return tends to go up and the volatility goes down. Add another, and you get more of the same effect.The magic is in what Markowitz called the correlations; that is, the amount that one asset moves in relation to the others. If the correlations are equal to 1, all the assets go up and down in tandem. If they're less than one, then you tend to get this multiplier effect on return and dampening effect on risk--and the lower the correlations, the better this works.
This, of course, is only one component of portfolio design; you also want to have diversification within each asset class, and control costs, and a variety of other elements. But getting the overall asset mix right is the most complicated part of the formula--and, seemingly, the most magical and mysterious. If you can achieve results that are better than a person with perfect foresight, isn't that pretty remarkable?
Monday, May 3, 2010
WHAT'S GOING ON WITH THE ESTATE TAX?
Good question. Congress has elected to keep us in suspense.
0% estate taxes in 2010 ... for now, anyway. On January 1, the federal estate tax went away - at least for the time being and perhaps for all of 2010 as envisioned back in 2001. President Obama and Congressional leaders wanted the estate tax to stick around in 2010 at 2009 levels (estate taxes up to 45% with a $3.5 million exemption), but lawmakers were preoccupied with other matters.1,2
Will Washington really give families million-dollar tax breaks? If no estate tax is imposed in 2010, it could mean a savings of millions for wealthy families. There is talk of bringing the tax back retroactively - after all, the federal government could really use the money. Yet the further we get from January 1, the more difficult reinstating the estate tax for 2010 may become.
As American Institute of Certified Public Accountants vice-president for taxation Tom Ochsenschlager told MarketWatch, "They're still talking (in Congress) about making something retroactive, but at some point they can't do that ... is it even constitutional? There's a real question about that."
The unconstitutional argument goes like this: if Congress moves to retroactively apply the estate tax for 2010, an estate could take the mater to court and point out that Congress had all year to reinstate it but failed to do so.
That argument aside, some estate planners think Congress will get around to a retroactive measure - one that would put the 2009 estate tax levels back into place for 2010.
What taxes are in place now? Some taxes still apply to estates in 2010 even if the estate tax doesn't. People who give away more than $1 million during their life still face federal gift taxes - though in 2010, they max out at 35% instead of 45%.3
Also, all assets with capital gains are to be taxed at 15% above a $1.3 million federal exemption when sold by heirs in 2010. The big news here is that heirs don't get to use a step-up this year. When they compute the value of an inherited asset, they have to use the basis (the original price paid for the asset) instead of how much that asset was worth when the original owner died. (In addition to the $1.3 million exemption per estate just mentioned, there is another $3 million exemption available for assets inherited from a spouse.)3
What precautions may be wise this year? As a potential heir, you'll want to document the cost basis of any assets you might receive in 2010. Good recordkeeping is in order.
Additionally, you may want to search a trust or a will for so-called formula clauses anchored by words such as "that portion", "that amount" or "that fraction", especially if the will or trust was created some years ago with the presumption of a constantly increasing federal estate tax exemption.
These formula clauses are fundamental to bypass trusts created to defend estate tax exemptions for a couple. However, these clauses assume that there is an estate tax. With no estate tax in place, there is the possibility (depending on how the formula clause is worded) that a deceased spouse's assets would not be inherited by the surviving spouse, but instead go directly into the family trust - not the most useful result for the surviving spouse.3
What will 2011 bring? Well - if there are no changes - the estate tax and the generation-skipping tax would come back in 2011. Only the first $1 million of an estate would be exempt from estate taxes. Assets above the exemption would be hit with a 55% federal penalty.3 However, the Obama administration had talked of keeping the 2009 estate tax levels in place for 2010 and beyond, which would be better than returning to the pre-EGGTRA levels in 2011.
Citations.
1 marketwatch.com/story/money-for-nothing-congress-awol-on-the-estate-tax-2010-02-15 [2/15/10]
2 online.wsj.com/article/SB123846422014872229.html [3/31/09]
3 investmentnews.com/apps/pbcs.dll/article?AID=/20100214/REG/302149985/1031/RETIREMENT [2/14/10]
Good question. Congress has elected to keep us in suspense.
0% estate taxes in 2010 ... for now, anyway. On January 1, the federal estate tax went away - at least for the time being and perhaps for all of 2010 as envisioned back in 2001. President Obama and Congressional leaders wanted the estate tax to stick around in 2010 at 2009 levels (estate taxes up to 45% with a $3.5 million exemption), but lawmakers were preoccupied with other matters.1,2
Will Washington really give families million-dollar tax breaks? If no estate tax is imposed in 2010, it could mean a savings of millions for wealthy families. There is talk of bringing the tax back retroactively - after all, the federal government could really use the money. Yet the further we get from January 1, the more difficult reinstating the estate tax for 2010 may become.
As American Institute of Certified Public Accountants vice-president for taxation Tom Ochsenschlager told MarketWatch, "They're still talking (in Congress) about making something retroactive, but at some point they can't do that ... is it even constitutional? There's a real question about that."
The unconstitutional argument goes like this: if Congress moves to retroactively apply the estate tax for 2010, an estate could take the mater to court and point out that Congress had all year to reinstate it but failed to do so.
That argument aside, some estate planners think Congress will get around to a retroactive measure - one that would put the 2009 estate tax levels back into place for 2010.
What taxes are in place now? Some taxes still apply to estates in 2010 even if the estate tax doesn't. People who give away more than $1 million during their life still face federal gift taxes - though in 2010, they max out at 35% instead of 45%.3
Also, all assets with capital gains are to be taxed at 15% above a $1.3 million federal exemption when sold by heirs in 2010. The big news here is that heirs don't get to use a step-up this year. When they compute the value of an inherited asset, they have to use the basis (the original price paid for the asset) instead of how much that asset was worth when the original owner died. (In addition to the $1.3 million exemption per estate just mentioned, there is another $3 million exemption available for assets inherited from a spouse.)3
What precautions may be wise this year? As a potential heir, you'll want to document the cost basis of any assets you might receive in 2010. Good recordkeeping is in order.
Additionally, you may want to search a trust or a will for so-called formula clauses anchored by words such as "that portion", "that amount" or "that fraction", especially if the will or trust was created some years ago with the presumption of a constantly increasing federal estate tax exemption.
These formula clauses are fundamental to bypass trusts created to defend estate tax exemptions for a couple. However, these clauses assume that there is an estate tax. With no estate tax in place, there is the possibility (depending on how the formula clause is worded) that a deceased spouse's assets would not be inherited by the surviving spouse, but instead go directly into the family trust - not the most useful result for the surviving spouse.3
What will 2011 bring? Well - if there are no changes - the estate tax and the generation-skipping tax would come back in 2011. Only the first $1 million of an estate would be exempt from estate taxes. Assets above the exemption would be hit with a 55% federal penalty.3 However, the Obama administration had talked of keeping the 2009 estate tax levels in place for 2010 and beyond, which would be better than returning to the pre-EGGTRA levels in 2011.
Citations.
1 marketwatch.com/story/money-for-nothing-congress-awol-on-the-estate-tax-2010-02-15 [2/15/10]
2 online.wsj.com/article/SB123846422014872229.html [3/31/09]
3 investmentnews.com/apps/pbcs.dll/article?AID=/20100214/REG/302149985/1031/RETIREMENT [2/14/10]
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