MARCH/APRIL 2015 MAKING THE MOST OF DIVIDEND INCOME WHICH TYPE OF MORTGAGE LOAN MEETS YOUR NEEDS?

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1 PLANNING FOR PROSPERITY MARCH/APRIL 2015 MAKING THE MOST OF DIVIDEND INCOME REVIEW IN CASE OF DIVORCE When it s critical to revise your estate plan WHICH TYPE OF MORTGAGE LOAN MEETS YOUR NEEDS? FOREIGN ACCOUNTS CALL FOR SPECIFIC REPORTING REQUIREMENTS

2 Making the most of dividend income Dividends, the portion of earnings that a company or fund distributes to shareholders, may seem like a relatively small component of your overall portfolio. But they can play an important role in your financial success over time. You ve probably heard that it s a good idea to reinvest your dividends, and it s true that reinvestment can help your portfolio grow more quickly. But for some investors, such as those who are retired, regular dividend distributions can provide a potentially useful source of income. The course of action that makes the most sense for you will depend on your individual needs. TWO Types of dividend-oriented investments Dividends are commonly associated with stocks. But professionally managed assets such as mutual funds, exchange-traded funds, real estate investment trusts and separately managed accounts can collect earnings from their underlying investments and distribute them to shareholders. You likely receive stock dividends quarterly (though some stocks follow different schedules), while your funds may distribute them to you annually, semiannually, quarterly or monthly. You can check the frequency in your fund s prospectus. Reinvesting vs. withdrawing cash With dividends you have two basic options: Reinvest for long-term growth. If you re primarily concerned with growing your portfolio over many years, reinvesting dividends might be an appropriate strategy. Because of the power of compounding, reinvested dividends have the potential to boost your return over time, assuming your investments gain in value. Automatically reinvesting has an added benefit of forcing you to stay disciplined about saving. Another benefit is that dividends are often reinvested free of transaction costs. Check with your account s administrator to see if any charges apply.

3 Withdraw as cash. If you re primarily concerned with paying monthly expenses or reducing highinterest debt, taking dividends in cash may be the right decision. Retirement is a particularly good time to weigh the benefits of taking your dividends in cash. Drawing your income directly from investments can provide you with a supplemental source of cash flow if your other income sources are insufficient to meet expenses. Also, using dividends for income keeps your principal invested, potentially preserving your retirement savings for longer. Understand the risks Reinvesting dividends can have some drawbacks. By adding to your holdings in the same stock or fund, you may be increasing your exposure to that investment and therefore your risk if it later experiences a loss. A growing position in a particular investment can also throw your portfolio s asset allocation off balance, which may mean incurring costs when selling shares to rebalance. To avoid some of these disadvantages, consider setting up your accounts to deploy dividend distributions directly into a separate investment or, if you want to keep your funds available for future investment opportunities, a money market fund. Talk with your advisor about the transaction costs of any option you re considering. Don t forget about taxes Reinvesting dividends can also present challenges during tax time. For taxable accounts, each purchase you make with dividends must be added to your cost basis, meaning the original value of the investment when you bought it. (Inherited and gifted assets have different tax basis criteria.) When you sell the investment, the higher cost basis is used to calculate your capital gain or loss. A careful accounting of your changes in cost basis including increases from all of your reinvested dividends prevents you from over- or underpaying your income taxes. None of this is relevant to your assets held in retirement accounts, because dividend reinvestments are taxed the same as your regular contributions when you begin taking distributions. Re-evaluate your strategy Bear in mind that dividends aren t guaranteed, and you should be comfortable with the risks of investing in the types of assets that offer dividends. Whether you originally decided to reinvest dividends, it s worth a conversation with your financial advisor to assess whether it s still the appropriate choice for your current situation. n Seeking tax efficiency Whether you should hold dividend-oriented investments in taxable or tax-advantaged accounts depends on your situation. A taxable account may offer advantages in some circumstances. Under current tax law, your tax rate on qualified stock and stock-fund dividends is lower than your ordinary-income rate. Bond funds, real estate investment trusts and other nonqualified stock dividends continue to be taxed at your ordinary rate. THREE In contrast, in tax-deferred accounts such as a 401(k) plan or traditional IRA, earnings grow tax-free, an attractive option for putting more of your dividends to work. However, you ll be taxed at your ordinary-income rate when you begin taking withdrawals, whether the money originally came from dividends, price appreciation or your regular contributions. (Roth IRA distributions are tax-free if you take them as qualified distributions.) When considering the tax implications of dividends in retirement accounts, remember that your ordinary rate might be lower in retirement than it was while you were employed.

4 Review in case of divorce When it s critical to revise your estate plan There are few events that can completely upend a person s life more than divorce. Of course, there s the emotional toll on you and your family to contend with, but you also have to consider the divorce s impact on your estate plan. When you originally crafted your plan, you likely centered many of its strategies around your spouse. Thus, when divorce proceedings begin, it s crucial to update your estate plan as soon as possible to avoid unintended outcomes. FOUR Who s next in line for your wealth? Unless you wish to provide your former spouse with an inheritance, amend your will and any trusts to eliminate him or her as a beneficiary. In addition, unless you re comfortable with your former spouse administering your estate or controlling your wealth, you should designate someone else as executor or trustee. This is true even if you live in one of the many states where divorce automatically nullifies any gifts or bequests to an ex-spouse and automatically revokes an appointment of a former spouse as executor or trustee. There are several reasons for this. First, if you die before the divorce is final even if you re legally separated your spouse will still inherit in accordance with your will or revocable trust and his or her appointment as executor or trustee likely will stand. Second, typically, the laws in these states treat your estate plan as if your former spouse had predeceased you. If you ve named contingent or residual beneficiaries, any property your spouse would have received will go to them. If not, the property will pass according to the laws of intestate succession. But relying on these laws can be dangerous. Suppose, for example, that your will leaves all of your assets to your spouse or, if your spouse predeceases you, to your children. If you and your spouse divorce, your children stand to inherit your estate. But what if your children are minors? In that case, the court would appoint a guardian to manage their inheritance and that guardian would most likely be your former spouse. To avoid this result, update your estate plan. In this case, for example, you might want to leave your assets in a trust for the benefit of your children, managed by a trustee of your current choosing. Finally, keep in mind that, in many states, as long as you re legally married, your spouse will retain elective share or community property rights to a portion of your estate. So while updating your plan soon after you decide to divorce can reduce the amount your spouse will receive if you die while you re still married, it s difficult to disinherit him or her completely before the divorce is final.

5 Who are your designated beneficiaries? Amending your will or trust isn t enough if, like most people, you own assets that are distributed on death via a written beneficiary designation. These assets include life insurance policies, IRAs, other retirement plans, payable-on-death (POD) bank accounts and transfer-on-death (TOD) brokerage accounts, as well as property held in joint tenancy with right of survivorship. In some states, a divorce automatically revokes spousal beneficiary designations under certain circumstances. But, again, relying on state law is risky. Third parties, who may not be aware of your divorce, aren t liable for distributing assets to the person named on a valid beneficiary designation form. So, to ensure that your wishes are carried out, contact your employers, financial institutions, insurance providers and brokerage firms and submit change of beneficiary forms. Be aware that, if you d like to change the beneficiary of a qualified retirement plan to someone other than your spouse, you ll need to obtain your spouse s consent. This requirement no longer applies once your divorce is final. Who has power of attorney? Many married people execute powers of attorney or directives that authorize their spouses to make financial and/or health care decisions on their behalf should they become incapacitated. If you ve signed such documents and you don t want your former spouse to exercise this kind of authority, be sure to revoke them. And if you ve provided copies to third parties, such as financial institutions or health care providers, notify them in writing of the revocation to ensure that they don t rely on them. Act sooner rather than later Going through divorce proceedings can be upsetting for your entire family. During this time you ll want the peace of mind of knowing that the proper heirs are provided for in the event of your death. For this reason, consult your advisor as soon as possible after filing for divorce to review and update your estate plan. n Which type of mortgage loan meets your needs? FIVE Few purchases during your lifetime will be as expensive as buying a home. Whether it s your primary residence, a vacation home or an investment property, how you choose to pay for it can have a significant impact on your financial situation over time. If you re considering a mortgage loan, understanding the main categories of mortgages fixed-rate and adjustable-rate and the situations they re best designed for will help you match the right type for your needs. Fixed-rate loans offer stability A fixed-rate mortgage, as its name suggests, is a loan whose interest rate remains constant for the life of the loan typically 15 or 30 years. One of the primary benefits of a fixed-rate loan is that it provides a measure of certainty about

6 your interest rate is fixed for the first five years and then will adjust every year after that. Paying less interest in the beginning frees your cash for other investments. You might also take advantage of an ARM if you re confident that you ll have more money in the future than you do today, or if you plan on selling your house before or soon after the initial fixed-rate period expires. When using an ARM, you ll need to assess your ability to keep up with potentially higher payments say, if the initial period expires and you re unable to sell the house, or if your income changes. SIX one of the biggest expenses in your monthly budget. With interest rates likely to rise after an extended period of historically low rates, you won t have to worry about potentially higher payments in the future if you select a fixed-rate loan. That said, if interest rates were to fall again, your fixed-rate loan would leave you unable to take advantage of the shift unless you refinance, which might involve fees. You re also paying a premium for the stability offered by a fixed-rate mortgage. You could consider a 15-year fixedrate loan, which would charge a lower rate than a 30-year loan, but the tradeoff will be higher monthly payments. ARMs provide flexibility Adjustable-rate mortgages (ARMs) typically offer a fixed interest rate for an initial period of years. This rate, which is usually lower than that of a comparable fixed-rate mortgage, then resets periodically based on a benchmark interest rate. For example, a 5/1 ARM means that For expensive properties, think jumbo Whether you re shopping for a vacation home in Hawaii or looking to settle in a luxury community, you may need to borrow more than is allowed by the conforming limits set by two governmentsponsored mortgage entities, Fannie Mae and Freddie Mac. In this case, you ll need a so-called jumbo mortgage. For a single-family home, your mortgage is considered jumbo if you re borrowing more than $417,000 in most parts of the country or $625,000 for high-cost areas such as New York City or San Francisco. One of the primary benefits of a fixedrate loan is that it provides a measure of certainty about one of the biggest expenses in your monthly budget. Jumbo loans are offered by banks, and they aren t backed by Fannie Mae or Freddie Mac. You ll need to meet more stringent financial qualifications, and banks have historically charged higher interest rates for jumbo loans than for conforming loans.

7 When considering a jumbo loan it s important to shop around. Each lender has its own requirements. And, because jumbo loans come in both fixed-rate and ARM varieties, lenders can help you find the right terms for your needs. Choosing the right mortgage You can fund the purchase of a second or vacation home with any of these mortgage types, though you ll face stricter financial requirements than if you re borrowing to acquire a primary residence. You may want to consider whether using home equity from your first home to borrow for your second home makes sense. Regardless of which type of home you re purchasing, having a basic knowledge of home loan types can help ease the buying process. Your financial advisor can help you evaluate the best mortgage for your needs. n Foreign accounts call for specific reporting requirements After consulting with his tax advisor, John decided that it was in his best interest to open an offshore savings account and deposit a portion of his wealth into the account. John s advisor informed him that it s important to follow the IRS s strict foreign accounts reporting requirements. In a nutshell, if you have a financial interest in or signature authority over any foreign accounts, including bank accounts, brokerage accounts, mutual funds or trusts, you must disclose those accounts to the IRS. To do so, check the box on line 7a of Schedule B ( Interest and Ordinary Dividends ) of Form 1040 regardless of the account value. If the total value of your foreign financial assets exceeds $50,000 ($100,000 for joint filers) at the end of the tax year or exceeds $75,000 ($150,000 for joint filers) at any time during the tax year, you must provide account details on Form 8938 ( Statement of Specified Foreign Financial Assets ) and attach it to your tax return. Finally, if the aggregate value of your foreign accounts is $10,000 or more during the calendar year, file FinCEN (Financial Crimes Enforcement Network) Form 114 Report of Foreign Bank and Financial Accounts (FBAR). File the form electronically with FinCEN no later than June 30 of the following year. SEVEN John s advisor cautioned him that failure to disclose his offshore account could result in substantial IRS penalties, including collecting three to six years worth of back taxes, interest, a 20% to 40% accuracy-related penalty and, in some cases, a 75% fraud penalty. This publication was developed by a third-party publisher and distributed with the understanding that the publisher and distributor are not rendering legal, accounting or other professional advice or opinions on specific facts or matters and recommend you consult with a professional attorney, accountant, tax professional, financial advisor or other appropriate industry professional. The hypothetical examples used are for illustrative purposes only and not intended to represent the value or performance of any specific product or to predict or guarantee actual results, which will vary PFPma15

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