THREE SPECIAL REPORTS:The New Rules of Retirement-

2016Your 20-Minute Estate Plan:Building a Lasting Legacy

5 Easy Chair Portfolios to FundYour Retirement Dreams

By Bob Carlson

TheWorry-Free Retirement Library

Published by Retirement Watch, L.L.C., , 800-552-1152. Copyright 2008-2016 by Retirement Watch, L.L.C. The information in this newsletter is from sourcesbelieved reliable, but no guarantee or warranty is made as to its accuracy. The editor, owners, and publisher, as well as their clients, employees, associates and/orfamily may have positions in securities and instruments recommended or reviewed in this newsletter. The editor and publisher assume no liability for the reader's useof the information contained herein. Letters from readers are encouraged.

Dear Retirement Watch Member:

Thank you for becoming a member. This publication is part of your new member WelcomePackage. It includes, in one handy publication, all of the reports for one year membership. Inthe following pages you’ll find:

The New Rules of Retirement-2016, beginning on the next page

Your 20-Minute Estate Plan: Building a Lasting Legacy, beginning on page 22

5 Easy Chair Portfolios to Fund Your Retirement Dreams, beginning on page 31

These pages will introduce you to the essential principles of retirement and retirement plan-ning. You’ll learn how to better manage your IRA, invest for higher returns with less risk, planyour estate, reduce income taxes, generate guaranteed lifetime income, and more. You’ll learnhow to enhance your financial independence and the legacy for loved ones.

Each month in our monthly visits through Retirement Watch we’ll build on these insights.You’ll be on top of all the changes that affect your retirement security, whether the changes arefrom Congress, regulators, the markets, insurance companies, the IRS, or other sources. We’reconstantly studying and researching all the factors that affect your retirement finances andreporting to you with the results and recommendations. You’ll also find an abundance of infor-mation on the members’ web site at www.RetirementWatch.com, including back issues of thenewsletter and an Archive of past articles grouped by subject.

The reports are updated regularly and are available to all Retirement Watch members on theweb site. Look for the box on the members’ home page that says “Download Your FreeReports.” You’ll always be able to download the latest version of these reports.

I look forward to serving you for many years, bringing you the latest insights for improvingyour financial independence.

Cordially,

Robert C. Carlson

IntroductionWhat happens if you outlive your money? It's the

number one question on the minds of Americans in or nearretirement. And it's the most important one at that.

Once you stop working, the only money you candepend on is the money you have worked hard to save inyour IRA, 401 (k) and other retirement accounts. But eco-nomic forces outside your control are lining up to attackyour nest egg.

For example, Social Security benefits alone won'tcome close to providing you with a cushy retirement.Today, the maximum monthly payout is a little over $2,500at full retirement age… no matter how much money thegovernment took from your paycheck during your workingyears.

Since the 77 million baby boomers began turningage 65 beginning in 2011, serious changes to SocialSecurity are on the horizon. They could include ageincreases, means testing, benefit cuts--just to name a few.As a result, you could be cheated out of a good chunk ofthe Social Security income you may have counted on.

With the government and employers bailing onretirees, your savings and investments will bear most of theburden of seeing you through your retirement years.

But it's not just the greedy hands of the govern-ment you need to watch out for. The ongoing scourge ofrising inflation will continue to eat away at your nest egg.One of the fastest rising costs for retirees is medical costs.According to the Employee Benefit Research Institute,healthcare costs on average will be $300,000 in retirementfor a couple age 65 today.

Meanwhile, we've already seen prices for every-thing from gas to oil to food to clothing soar in the pastdecade. Imagine what the basics will cost 10, 20, 30 yearsfrom now when you are established in retirement and liv-ing on a "fixed" income?

Perhaps like many, you trust your investments willsee you through and provide you with much needed "infla-tion protection." Yet the stock market has taken us on apretty wild ride in recent years. It's been nearly impossibleto count on steady profits.

But if you were to try and sidestep this marketvolatility by moving your money into "safe" interest bear-ing accounts at today’s yields, you wouldn't even be ableto tread water, (especially with inflation hovering between2% and 4%.)

You also have to plan on making your retirementsavings last longer. More people are living longer, healthierlives thanks to new medical insights and breakthroughs.So if you're one of those lucky folks, you'll need to stretchyour portfolio even further - another 20, 30 years or more.That means the money you earn on your investments hasto work harder than your father's ever had to.

Fortunately, your IRA is still the most powerful —if not potentially the largest — tool in your retirement

arsenal. A well-managed IRA can help you achieve everyone of your much deserved retirement dreams … and over-come every one of these potential hurdles and challengesyou face.

But one simple mistake in saving for, investing in,or taking distributions from your IRA could be the differ-ence between a life of constant comfort and peace of mind… or a life of worry, sacrifice and increasing burden onyour children.

It's why I want to make sure you're maximizingyour IRA's growth and profits to constantly outpace infla-tion. But I also want to help you protect your wealth fromthe greatest threat to your IRA nest egg after inflation: acash-strapped government looking to pay for its spendingsplurges

It's why I wrote The New Rules of Retirement.This report is jam-packed with new strategies and bigsecrets that turn conventional IRA thinking on its ear. I'vepacked 20+ years worth of unbiased retirement answers,solutions, strategies and tactics into this report. It givesyou in-depth, step-by-step advice on putting the retirementsecrets I tell you about here to work, so you can safelybuild and strengthen your retirement security.

The secrets to a worry-free retirement are now inyour hands. The little-known strategies you're about todiscover can show you how to stop worrying about outliv-ing your money and enjoy every moment of your retire-ment years. So get settled into a comfortable chair and pre-pare yourself for some eye-opening reading!

Why Breaking the So-called "Tried-and-True"IRA Rules Can

Mean a Richer Retirement for YouIRAs seemed so simple when they started. Make

the maximum contribution, invest the money until retire-ment, and then take the money out over time to pay forretirement.

But managing your IRA in today's more complexworld gets tricky. Things change. The law. The economy.The markets. The trends. And for too many years, we'vebeen told the same old rules over and over again to preparefor retirement … rules that are no longer working.

Let's begin by talking about how much money youshould be saving in your IRA and other retirementaccounts. Any retirement spending estimate is better thannone. But for years at Retirement Watch we've beenresearching and developing the best ways to make reliableestimates of retirement spending and savings needs. Mostpopular methods of projecting retirement needs tend todramatically understate or overstate retirement spending.

Secret #1. Better ways to plan retire-ment spending.

The traditional retirement plan projects spending torise steadily each year in line with inflation. That modeldoes not work well for today's retirees. When retirementlasts 20 or 30 years or longer, a more realistic model ofspending and scheduled withdrawals is needed.

Unlike the projections in most models, retirement

spending does not increase in a straight line. It varies overtime. In addition, markets also do not move in a straightline. They are volatile and can have extended bear marketsand bull markets. These fluctuations in the portfolio valueshould influence annual spending.

Over the years I have found two models that accom-modate real-life retirement spending and portfolio fluctua-tions. They are more realistic than the straight-line modelsgenerally in use.

One model is to adapt the spending formula used bythe Yale University endowment.

The first step is to set the withdrawal percentage forthe first year of retirement. Most studies conclude that themaximum safe rate is just over 4% of the portfolio's value.After the first year, the distribution is determined by usingtwo separate formulas. The first formula is last year's dis-tribution plus the inflation rate for the last year. Multiplythat amount by 70%.

The second formula is your initial withdrawal ratemultiplied by the fund's value at the start of the secondyear. Multiply that result by 30%.

Add the two results together to get the distribution forthe year.

Here's an example. The withdrawal rate is set at 4.5%,and the initial portfolio value is $600,000. The first year'swithdrawal is $27,000. After the first year, the portfolio'svalue is $625,000, and inflation was 2%. Using the firstformula, 2% inflation is added to $27,000, then multipliedby 70%. That result is $19,278. Under the second formula,$625,000 is multiplied by 4.5%, and then by 30%. Theresult is $8,437.50. Add the two products together and thesecond year distribution is $27,715.50.

Under this formula, spending fluctuates with the mar-kets and inflation, but the changes are not as volatile as themarkets and inflation are. If the markets experience anextended decline, spending declines gradually. During bullmarkets, spending increases faster than inflation. Thatallows you to enjoy some of the excess gains of the bullmarket. But the spending does not rise enough to absorb allthe investment gains. The formula leaves a cushion againstthe inevitable market downturns.

The other model is based on the spending cycles thatoccur during retirement.

Spending varies by age. Even after retirement there areseveral cycles. For most people, annual spending peaksaround age 50 and then steadily declines, according to theDepartment of Labor's Consumer Expenditures in 2003.

There are additional fluctuations after 50. For manypeople, there is a bump in spending immediately afterretirement. There is a burst of spending on pent-updemands such as travel and recreation. After age 75,spending declines somewhat rapidly.

Retirees can plan for a three-stage spending cycle.The first cycle can be referred to as the honeymoon

period of the first few years. This is when the retiree haspent-up demands and also is relatively young and healthy.

After that period, the lifestyle becomes more normal andregular. Spending settles at a level that is lower than duringthe initial years of retirement.

Sometime after age 75, spending is likely to downshiftagain. The Department of Labor study indicates that spend-ing by those over age 75 is 25% or more below that ofyounger retirees. People simply become less active at somepoint, even when they are healthy.

There might be a fourth spending stage in which majormedical expenses or long-term care expenses are incurred.Often when this occurs other living expenses decline. Thetotal expenses incurred by the retiree during that perioddepend on the extent of insurance coverage.

Under this model, a retiree plans to spend more in thefirst years of retirement. Perhaps spending could rise to asmuch as the 8% of the portfolio that many pre-retirees saythey are planning. After a few years, the plan has a spend-ing decline, following by another decline in later years.

A variation of the spending cycle approach is to divideyour retirement portfolio into two portions. One portion is85% of the portfolio. You spend plan this amount in rough-ly equal installments until age 85. If you retire at 65, youcan spend one twentieth the first year, one nineteenth thesecond year, and so on.

In the meantime, the other 15% is invested in a portfo-lio designed to grow in value over the 20 years. At age 85,if you are still alive, this second portfolio can be spent orused to purchase an annuity.

These variable spending models recognize the realitiesof retirement spending, including that most retirees haveflexibility in their budgets. A number of expenses can bedeferred or eliminated, such as travel, auto purchases, andhome repairs or remodeling. Other expenses can beincreased or reduced from year to year, including diningout and entertainment.

Retirees should plan on flexibility in their spending.Adjust expenditures for inflation, portfolio volatility,health, and other factors. Varying spending and with-drawals from the portfolio increase the probability of hav-ing financial security through retirement and leaving aninheritance for heirs.

Secret #2. The #1 factor most peopleoverlook when deciding how muchthey can afford to spend.

What's the biggest mistake in retirement plans?From what I see, it is failing fully to factor inflation intotheir planning. Make this common mistake and you'llunknowingly drain your IRA and other accounts so fast itwill make your head spin.

Retirement these days often lasts 20 years or more.To be safe, you should plan on living to age 90. Over thattime inflation can make a safe, comfortable stream ofincome uncomfortably tight, even at low inflation rates.

For example, after 10 years of only 2% inflation,you need almost $12,200 to buy what $10,000 used to buy

(a 22% increase). After 15 years, you'll need almost$13,500. If inflation doubles to 4%, you'll need almost$15,000 after 10 years and $18,000 after 15 years. Here'sanother way to look at it. A 1982 dollar today has the pur-chasing power of less than 59 cents. A 1967 dollar equalsless than 19 cents today.

The inflation rate most cited is the CPI-U, theConsumer Price Index for Urban Consumers. There areother CPI indexes, but are any of these indexes a goodplanning tool for your retirement?

Your purchases almost certainly don't follow thebasket of goods in the survey. You likely spend more ofyour income on medical care, and perhaps on eating out,recreation, and other leisure activities. You also mightspend a higher percentage on the necessities, such as food,fuel, housing, and travel. You likely spend less on educa-tion, clothing, and work-related expenses, among others.

Another potential problem is that the CPI is basedon a survey of national prices. If you live in an area inwhich prices are rising faster, using the index could under-state your needs.

The ideal option is first to figure out your itemizedmonthly or annual budget. Then apply an inflation factor toeach spending item. For example, you can inflate yourfood expenses by the actual food inflation of the last fiveor 10 years (or your estimate for the future). Or you can goa step further and separate "food eaten away from home"and "food eaten at home," because restaurant costs havebeen rising faster than grocery store costs for several years.

Secret #3. Two FREE, incredibly usefulwebsites to help you more accuratelypredict your future spending.

You can get the national inflation factor for eachitem from the Department of Labor's inflation report onthe web sites www.dol.gov or www.bls.gov. Or you canget the Monthly Labor Review, available by subscriptionfrom the Government Printing Office and in manylibraries. The Bureau of Labor Statistics also has a fax-on-demand service that will fax the reports to you free.Call 202-606-6325 to have a directory of the availablereports faxed to you.

You also can use one of the regional price index-es that Labor issues. These are issued monthly, bimonth-ly, or semiannually, depending on the area. These index-es are available from the same sources as the regularCPI reports.

Secret #4. Why taking Social Securitybenefits as early as possible might nolonger guarantee you the most moneyfrom "Uncle Sam".

What is the best age to begin taking your SocialSecurity benefits? The answer might be changing.

As with everything else about retirement, the rightdecision changes over time and isn’t the same for every-one.

Most people know that the earlier you begin Social

Security benefits, the lower the payment will be. Beginbenefits before normal retirement age, and you receive areduced monthly benefit. The amount the benefit isreduced depends on how long before normal retirementage it begins. You can begin taking benefits as early as 62.Starting the benefits at age 62 results in a monthly benefitequal to about 75% of the normal retirement benefit.

But delaying receipt of benefits increases themonthly benefit. Delay benefits past normal retirementage, and the benefit increases by 6% to 8% per year.

The key is that the increase and decrease rates areset so that anyone who lives to life expectancy receives thesame lifetime payouts regardless of the age benefits begin.That makes the normal life expectancy the "breakevenpoint." Live beyond that point and you will benefit bywaiting to receive benefits. Your lifetime benefits willexceed what you would receive by starting at age 62.

But the increase and decrease rates were set in1983, the last time Social Security was reformed, using lifeexpectancy tables available at the time. Life expectancieshave increased considerably since then. About half of mencurrently age 65 will live past age 85.

Another factor is that the annual cost of livingincreases also increase the initial benefit for those whodelay benefits. If you actually wait until age 70 to beginbenefits, you should receive a higher benefit than the oneestimated when you were age 62, because of the cost ofliving factor.

About two thirds of beneficiaries begin their bene-fits early, and for many years that made a lot of sense. Butthe change in life expectancy is a reason many should atleast consider delaying benefits. If you have no reason tobelieve your life expectancy will be below average, thedelay might make sense. Since half of your age group willlive beyond life expectancy, and that life expectancy ishigher than what was assumed in 1983, most people willreceive a higher lifetime benefit by waiting.

Secret #5. For some people, takingSocial Security benefits early is thebest move.

Delaying Social Security benefits is not for every-one.

Some people simply need the income as soon asthey are eligible. They left their employment and areunable or unwilling to seek other work. They also do nothave enough savings to wait for benefits.

Another reason not to delay benefits is if there arehealth or other reasons to doubt a person will reach thebreakeven point of normal life expectancy. If that is thecase, there is no reason to delay benefits except perhaps toincrease benefits for a surviving spouse.

Some people who do not need the benefits stillwant to begin them early. Their reasoning is that they caninvest the benefits. They believe the return they earn willbe high enough to offset the higher benefits they wouldreceive from waiting. They might be right. But be sure toconsider all the factors. The benefit at age 70 can be twicethe age 62 benefit, after considering the age adjustment

and inflation increases. In addition, that higher benefit willcontinue for life and will increase with inflation. Therealso will be a benefit for a surviving spouse. It will takesome good returns to equal that package.

Secret #6. When you begin SocialSecurity benefits can affect yourspouse.

If you were the higher income earner and passaway first, your spouse's benefits after your demise likelywill be based on your benefits. Delay your benefits, andyour spouse's benefits will be based on the higher benefitsyou received. But take benefits early, and your spouse'scurrent and survivor benefits will be reduced. If you don'tneed the money, delaying benefits is an easy way toincrease your spouse's lifetime security. Many advisorsview delayed Social Security benefits as a very low-costform of life insurance. Your spouse receives a higher bene-fit that is indexed for inflation and guaranteed for life, nomatter how long that lasts. For the cost of foregoing SocialSecurity benefits for a few years that can be a good deal ifyou do not need the money early.

Secret #7. How to avoid the "means-testing" surtax hike on Medicare pre-miums.

This surtax has been around since 2007. It tripledin 2009! Now it increases steadily each year. In 2015Congress passed a law that will increase the premiums onsome higher-income beneficiaries beginning in 2019.Here's how you can use your IRA to lower its impact.

Medicare beneficiaries with higher incomes facehigher premiums in 2007 and thereafter. The premiums arenot fixed; future amounts can only be estimated. But bene-ficiaries have to factor these higher costs into their finan-cial plans.

The higher premiums, called surtaxes, are imposedon a sliding scale. They begin rising for single beneficiar-ies whose incomes exceed $80,000 and for married benefi-ciaries whose joint incomes exceed $160,000. Adjustedgross income, with some modifications, from tax returns isthe basis for calculating the premiums. The modificationsare that AGI is increased by tax-exempt interest, EE bondinterest used for education expenses, and any excluded for-eign earned income.

The IRS will give your tax return information tothe Social Security Administration. SSA will determine theyear's premiums for each Medicare beneficiary from the

tax return from one year earlier and inform them betweenmid-November and December how much their premiumswill be. For example, 2014 premiums were determinedusing 2012 tax returns, and beneficiaries were told theirpremiums in late 2013.

The premium decision can be appealed. If a per-son's financial situation has changed — say because of adivorce, death of a spouse, retirement, or reduced workinghours — SSA can be asked to consider a different incomefigure. Details about the reconsideration process and rea-sons that will be considered valid are included with thepremium notice.

A beneficiary can choose to have the higher premi-ums withheld from Social Security benefits as with theregular premiums or can pay the premiums separately.

Currently, the basic premium is set at a level thatwill cover 25% of total estimated Medicare spending forthe year. The other 75% is paid by the program. The sub-sidy will decline under means-testing so that the highestincome taxpayers eventually will pay 80% of the estimatedper capita cost.

The means-tested premiums are for Part B and PartD of Medicare only. Part A coverage does not have a pre-mium. The Part D surtax is listed in the table below. Youpay the premium set by the individual plan plus the surtax.

The surtax can be avoided or reduced only byreducing modified adjusted gross income. For future yearsMAGI can be kept low by limiting withdrawals fromretirement plans or annuities to amounts needed for spend-ing and those required by minimum distribution rules.Earning tax-exempt interest does not help, since that inter-est is added to AGI to determine premiums.

Capital gains planning becomes more important.Higher capital gains not only incur taxes but can increaseMedicare premiums. Retirees might want to make fewersales outside of tax-deferred accounts or be careful to off-set gains by selling assets with paper losses whenever pos-sible. Itemized deductions, such as for mortgage interest andcharitable contributions, do not help. But losses from busi-nesses and from capital assets do reduce MAGI.

Secret #8. Why Florida may not beevery retiree's dream tax haven.

Sure, paying no state income tax is nice, but hereare four overlooked states that offer you even juicier tax

breaks. State tax laws dis-criminate based onage, and that canbe a good thing forsome taxpayers.Even notoriouslyhigh tax states canbe tax havens forretirees. In fact,Florida and otherretiree magnets

Medicare Premium Means-Testing in 2016Married Filing Jointly Singles

When 2014 MAGI is: 2016 2016 When 2014 MAGI is: 2016 2016More than But not Part B Part D More than But not Part B Part D

over: Premium Surtax over: Premium Surtax$170,000 $214,000 $170.50 $12.70 $85,000 $107,000 $170.50 $12.70 214000 $320,000 243.60 $32.80 $107,000 $160,000 $243.60 $32.80

$320,000 $428,000 $316.70 $52.80 $160,000 $214,000 $316.70 $52.80 $428,000 $389.80 $72.90 $214,000 $389.80 $72.90

might not be the tax havens they are promoted as when thefull tax picture is considered. Florida has no income tax,but it does have high sales and property taxes (at least forsome property owners), and its high homeowner's insur-ance premiums can be considered a tax for living in theSunshine State.

Forbes magazine a few years ago published a sur-vey of some surprising retiree tax havens.

Michigan, for example, exempts $81,840 of pri-vate retirement income per married couple plus SocialSecurity benefits from its income tax for people bornbefore 1946. Lower exclusions, generally $20,000 annual-ly, are available to younger retirees. That makes the statean overlooked tax haven for many retirees. Illinois,Mississippi, and Pennsylvania exempt 100% of private andpublic retirement income (including IRA distributions).These states impose neither a ceiling nor a minimum ageon their exemptions. Alabama and Hawaii have unlimitedexemptions for payouts from traditional pension plans butdo not provide any exemption for IRA distributions. Statetax laws change regularly, so be sure to check the latestlaw and any proposed changes.

Secret #9. Moving to a state with noincome tax will help your nest egg lastlonger, right? Wrong!

Five other taxes imposed by these "low-tax" stateswill gouge your retirement savings.

Social Security is your base retirement income.Determine if your state is one of the few that still taxes allor part of the benefits. Seven states piggyback on the fed-eral tax code and tax up to 85% of benefits. Eight statestax lesser amounts. The others exempt the benefits.

Pension and retirement account income might beexempt in full or in part. A few states fully exempt retire-ment income. Many have a partial exemption, but youhave to read the details. It is common for a state to exemptonly traditional defined benefit pension payouts, not IRAand 401(k) distributions. Some give government pensionsa bigger break than private pensions. A minority of statesgives IRA distributions or other nontraditional retirementsavings breaks similar to those for other pensions.

Take a look at how other income is taxed and atany miscellaneous tax breaks. Some states give seniorsspecial exemptions for investment income or allow deduc-tions for various expenses, including contributions to 529plans for the grandkids. Others effectively impose penaltieson retirees, for example by taxing capital gains and invest-ment income at higher rates than other income.

Real estate and sales taxes can be significantexpenses. Some states and localities reduce or defer prop-erty taxes for seniors. Others finance most of their govern-ment spending through these taxes, and they are high. Insome states, taxes on a home can jump significantly for anew owner.

Estate and inheritance taxes are a factor in only 19states and the District of Columbia in 2014. The taxes canbe higher than federal counterparts in many of these states,so study the effects carefully before moving.

State and local tax laws change. For details on thelatest tax law in a state, take a look atwww.RetirementLiving.com. Don't forget to look at countyand city taxes before deciding where to live.

Secret #10. What to do if you roll overyour IRA after the 60-day filing periodexpires.

Most people know the basic rules about IRArollovers. An account balance can be rolled over tax freefrom a qualified retirement plan (such as a 401(k) plan) toan IRA or from one IRA to another. There is no deadline ifthe balance is rolled over directly from one trustee toanother. If the account owner takes the balance from oneaccount, he or she has up to 60 days to get the sameamount of money deposited in the same or another retire-ment account to avoid taxes.

Mistakes often happen with rollovers. For exam-ple, a plan trustee might transfer an IRA to a taxableaccount instead of to another IRA. Or the trustee mightissue a check to the owner instead of transferring theaccount to another trustee.

In the past, the account owner had no remedy. Ifthe rollover was not executed properly, it was treated as ataxable distribution. The reason for the improper rolloverdidn't matter. The owner was stuck with the tax bill andperhaps a 10% early distribution penalty.

The 2001 tax law changed that. The IRS has thediscretion to grant waivers of the 60-day rule, allowingadditional time for the owner to deposit the funds in aqualified retirement account. The IRS explained theprocess for obtaining a waiver in Revenue Procedure 2003-16. The procedure also states that a taxpayer gets an auto-matic extension without having to apply to the IRS whenthe financial institution was the sole cause of the problem.

When an IRA rollover was not executed properly,do not assume that additional taxes and penalties are due.Consult a tax advisor and the IRS procedure. You mightavoid an expensive tax bill.

Secret #11. Why reaching age 70½changes everything and could forceyou to deplete your IRA too fast.

IRA owners over age 70½ are required to begintaking required minimum distributions (RMDs). That ruleis longstanding. But the IRS learned that many peopleeither don’t take their RMDs or don’t compute them prop-erly, so it is cracking down on them.

Be sure you take your RMDs and compute themproperly. Generally, you take your aggregate IRA balancesas of Dec. 31 of the previous year and divide it by your lifeexpectancy. You must use the life expectancy from one ofthe tables provided by the IRS in the back of its free publi-cation 590. The publication is available on the IRS website at www.irs.gov. We also posted the life expectancytables on the members’ section of our web site atwww.RetirementWatch.com.

Secret #12. Thinking of naming yourestate as your IRA beneficiary?

Think again! I always advise people not to eithername their estates as the IRA beneficiary or fail to name abeneficiary. Doing so can require the IRA to be distributedquickly, causing your beneficiaries to lose the tax deferral.If the estate is beneficiary or there is no named beneficiaryand you had not reached age 70½ and were not takingrequired minimum distributions, the IRA must be distrib-uted within five years within five years after your passing.The heirs are not allowed to stretch the distributions overthe life expectancies. If you already had begun RMDs, thedistributions can continue on your established distributionschedule, but not based on the beneficiary's life expectan-cy.

In the second case, some custodians make theproblem worse. They will not make distributions to theindividual beneficiaries. They will insist on paying theestate and let the estate distribute the money to beneficiar-ies. This requires the estate to remain open until the IRA isempty. These custodians do not understand that the IRAlegally can be assigned by the estate to the beneficiariesnamed in the will or other documents. There is no reasonto require the estate to be kept open for the stretch-outperiod.

The lesson is to be sure to designate one or moreindividuals as primary beneficiary of the IRA and also toname contingent beneficiaries in case the primary benefici-ary is not able to inherit the IRA. Otherwise, your lovedones will lose the valuable tax deferral of the IRA.

Secret #13. The one simple question toask your IRA custodian that could saveyour grieving spouse a world of anxi-ety and hassle.

Some custodians will not work with the executorof an estate. The IRA passes by the terms of the IRA bene-ficiary designation form, not by the will, and the IRAavoids the probate process. The executor really doesn'tenter into the picture, in their view. But the executor needsverification of the IRA's value to file the estate tax return.In addition, you might want the executor to relieve the bur-den of your spouse and other survivors by processing thepaperwork. Ask your custodian if it will communicate withand provide information to the executor.

Secret #14. How a common paperworkmistake made by your IRA custodiancan change who inherits your money.

IRS beneficiary designation forms decide whoinherits your IRA. Your will and other documents don’tmatter. If a custodian loses the form, it will consider theestate to be the beneficiary unless the estate or beneficiaryprovides a copy of the form. Lost forms are not unusualespecially after a firm undergoes several mergers orrestructurings. If you amend the beneficiary designation,ask the custodian if it will return to you the old forms sothat it won't have an out of date designation on file.

This also is a good reason to use a customizedbeneficiary form instead of the form provided by the IRAcustodian. An estate planner can draft a custom beneficiarydesignation form that directs the custodian to do exactlywhat you want. Not all custodians will accept such forms.But they are more likely to if the form includes a clauserelieving the custodian of any liability if it follows theform.

Whether you use the custodian's form or your cus-tomized form, be sure to keep copies and let your executorknow where they are.

Secret #15. Pay your IRA taxes nowinstead of later.

Some of you could substantially lower your taxbill in retirement by doing so. In fact, you could avoidpaying tens of thousands of dollars in needless taxes!

Here's what you must consider in order to carryout this strategy.

One of the most powerful tax-saving retirementweapons that should be in every retiree's arsenal is theRoth IRA. Their unique benefits are tremendous! No agelimit on contributions. No required minimum distributionat age 70½. And the best reason ever to open a Roth IRA:not one dime you withdraw from it in retirement is evertaxed. No matter how much your money has grown overthe years!

Many of my readers cannot open contributoryRoth IRAs, because their incomes are too high. CurrentlyRoth IRAs are unavailable to higher income tax payers.This means anyone with adjusted gross income of$160,000 or more ($110,000 for singles) is not allowed tomake a contribution. (The limits are adjusted for inflationannually.)

But since 2010 taxpayers of any income legal havebeen allowed to convert a traditional IRA to a Roth IRA.They are able to take advantage of the significant tax sav-ings Roth IRAs offer.

Taking advantage of this is easy. Simply build upyour traditional IRA and other tax-deferred accounts asmuch as possible. Then, convert your regular IRA to aRoth IRA (and consider doing the same with your 401(k)as well if you can roll it over to an IRA). You will paytaxes on the conversion, but it could be considerably lessin taxes then you'd be forced to shell out in the future.

Many people aren’t excited about paying taxesbefore they have to. But, unless your income tax rate isgoing to be lower in the future than it is now, it can make alot of sense to pay taxes now and shelter all the futuregains and income from taxes. I’ve explained the rationalefor this in some detail in my books and in articles inRetirement Watch that are available in the Archive in themembers’ section of the web site. This also is discussedbelow in #34.

Secret #16. How to take required mini-mum distributions when you own morethan one IRA.When you own multiple IRAs, you have flexibility. TheRMD is computed by aggregating the balances of all yourIRAs and dividing the total by your life expectancy. You cantake the RMD from the IRAs in any combination you want.Take it all from one IRA or take different amounts from theIRAs. This allows you to use the RMD to rebalance yourportfolio when it's out of balance or simplify your financesby drawing down one IRA at a time.

Secret #17. Over 70½? How to keepyour IRA pumping out cash for years— in spite of having to take requiredminimum distributions.

IRA owners over age 70½ need to take requiredminimum distributions from their traditional IRAs (as wellas other qualified retirement plans). The first RMD mustbe taken by April 1 of the year after the owner turns age70½. Subsequent RMDs must be taken by Dec. 31 of eachyear, including the year that the first RMD was required byApril 1. The owner always can take distributions exceedingthe RMD. Instructions for computing the RMDs are in IRSPublication 590, Individual Retirement Arrangements,available on the IRS web site at www.irs.gov.

It might be best to take the first RMD in the calen-dar year before it is required. Instead of waiting until theApril 1 deadline, take by the previous Dec. 31. That avoidshaving two RMDs on one year's tax return.

After that, it is best to take an RMD late in theyear. That allows the tax-deferred compounding to work aslong as possible. The exception is a year when the portfo-lio declines. If you can anticipate that all or part of theportfolio will decline during the year, take the RMD earlyin the year, converting the investments into cash. An RMDdoes not need to be taken in a lump sum. Periodic distribu-tions can be taken during the year as long as the total byDec. 31 equals or exceeds the RMD.

Secret #18. Want to convert multipleIRAs into one Roth IRA?

No problem. Follow these four easy steps to con-vert one or more IRAs or just part of an IRA into a RothIRA. First, select the IRAs or the amount of each IRA youwant to convert into a Roth IRA. Second, if you want totransfer specific assets, determine if they can be transferredto any Roth custodian, only a specific Roth custodian ornot at all. Otherwise, be sure there is enough cash in thetraditional IRAs to be transferred to the Roth IRA. Third,contact an IRA custodian and open a Roth IRA. Fourth,tell the Roth IRA custodian which assets or amount to con-vert from the traditional IRAs. The Roth custodian willtake care of the rest of the transfer.

Secret #19. How to take required mini-mum distributions from an IRA withoutliquidating a single share of stock or

mutual funds you currently own.RMDs do not have to be taken in cash. Most IRA

custodians allow you to set up a taxable account. Then,you can have specific shares or assets transferred from theIRA to the taxable account to satisfy the RMD. You stillwill owe taxes on the distribution as though it had beenmade in cash. The distribution amount will be the marketvalue of the assets on the day they were transferred. Butyou won't have to liquidate an investment you like or incurexpenses to buy and sell an investment just to make theRMD.

Secret #20. Common withdrawal mis-take that makes your Roth IRA vulnera-ble to a massive IRS tax grab.

Distributions from a Roth IRA are tax-free, but notall distributions. They must be qualified distributions. Tobe qualified, first at least five years must have passed sincea contribution was first made to a Roth IRA. The contribu-tion need not be to the same Roth IRA from which the dis-tribution is taken; the taxpayer must have made a contribu-tion to any Roth IRA at least five years before a distribu-tion is taken from any Roth IRA.

The five-year waiting period is a bit different forconverted Roth IRAs. Then, there is a separate waitingperiod for each conversion.

Second, the distribution must be taken after any ofone of the following: the Roth IRA owner is older than age59½, passed, away, or became disabled. Or the distributionmust be no more than $10,000 and is used for a qualifiedfirst-home purchase.

Secret #21. Have a 401(k)? When itmakes sense to convert it to a Roth401(k) — and when it doesn't.

A retirement plan account, such as a 401(k), nowcan be converted directly to a Roth IRA. But the 401(k)has to allow this option, and many don’t. Check with youremployer or 401(k) administrator to see if it’s allowed. Ifit’s not, you might still have an option. You might roll overthe 401(k) to a traditional IRA, and then convert the IRAto a Roth IRA.

Before executing this strategy, determine if arollover from the 401(k) will be viable. Generally, 401(k)amounts can be rolled over to an IRA only if the employeeleaves the employer due to retirement, a new job, or dis-ability. Some 401(k)s allow distributions or rollovers byany employee over age 59½. Check your plan's rules andthe tax law before deciding to ramp up contributions withan eye toward a conversion to a Roth IRA.

Secret #22. One little-known rule forgetting back every dime of taxes youpay on your IRA conversion.

A conversion is best when the taxpayer has cashfrom other sources that can be used to pay the incometaxes, so that the entire IRA can remain intact and maxi-mize the income and gains that will compound. In addi-tion, the IRA should be left alone for 10 years or longer sothat the compounding can make up for the taxes paid on

the conversion, assuming a 8% rate of return. A higherreturn means a lower payback period, and a lower returnmeans a longer payback period. If money has to be distrib-uted from the IRA to pay taxes on the conversion, then theRoth IRA should be left undisturbed for a longer period forthe conversion to reach the break-even point.

Secret #23. The order in which youdraw down the different retirementsavings accounts affect the amount ofafter-tax wealth in retirement.

Most people have more than one type of retirementaccount. There usually is at least one tax-deferred account,such as an IRA, plus a taxable account. The standardadvice is to draw down the taxable accounts and leavemoney in a tax-deferred account as long as possible to letthe tax-deferred compounding work.

My research shows that in many cases that tradi-tional advice is correct. The retiree's wealth will last longerif the tax-deferred compounding is allowed to work for aslong as possible. My conclusions are supported by otherresearch.

The results, however, depend on the assumptionsmade. For some people, retirement savings will last longerif the tax-deferred accounts are tapped first.

I have identified two scenarios in which spendingyour IRA first makes sense.

My research shows that if the annual return in yourtaxable account is atleast four percentagepoints higher than thereturn in your tax-deferred account (i.e.IRA), you should drainyour tax-deferredaccounts first. Why?Because the higherreturn in your taxableaccount makes up forthe lack of tax deferral.This money is likely

earning more for you than the money in your tax-deferredaccount. It might be taxed at the lower tax rate for long-term capital gains when it is time to spend the money.

The other scenario in which tax-deferred accountsshould be drawn down first is when it makes sense toempty one's IRA early. Consider this strategy if your IRAis more than you'll spend during your lifetime. See detailsin item #32 below and also in my book, The New Rules ofRetirement (Wiley). Details also are in the Archive on themembers section of the web site atwww.RetirementWatch.com.

Secret #24. The one investment youshould ALMOST ALWAYS sell whenyou start tapping your retirementaccounts.

Investments with paper losses usually should besold first. The realized losses offset any capital gains for

the year, including distributions from mutual funds. Lossesthat exceed gains offset other income up to $3,000 peryear. Any additional losses are carried forward to futureyears to be used in the same way until exhausted. You'llwhittle your tax liability to the bone by using this simplestrategy. In addition, you give the winning investmentsmore time to compound income and gains before they aretapped. The only exception to this rule is when you believethe losing investment is ready to turnaround and beginearning a higher return than the rest of the portfolio.

Secret #25. How to determine the bestinvestment to sell for the lowest possi-ble tax bill.

When it is time to drawn down taxable retirementaccounts, care should be taken with the choice of invest-ments to sell each year. Good tax management can makethe accounts last longer and provide greater after-taxwealth. The rule to follow is to sell first the assets with thelowest tax cost. I favor selling the assets with the lowesttaxes as a percentage of their value. To compute this,divide the taxes that would be due on the sale by the valueof the asset to be sold. Using this simple calculation incursthe lowest taxes each year. You will have to sell a lowervalue of assets, because less of the sale proceeds will beused to pay taxes, leaving more after-tax money for spend-ing.

Secret #26. Three little-known rules foroutfoxing the tax man when tradingstocks in your taxable investmentaccounts.

There are other strategies that will reduce taxes ontaxable investment accounts. Most retirees don't knowthese trading secrets of professional and institutionalinvestors. They could save each retiree thousands of dol-lars in taxes each year, and make the retirement fund lastthat much longer.

In the taxable account you want to minimize thenumber of trades made each year. Numerous trades meanshort-term gains, taxable at the top tax rate. Sell invest-ments only when one of these conditions is met:

The prospects for the investment are poor ormediocre. A higher return in another investment can makeup for the taxes you will pay to sell the first investment.

The investments are high risk. Your nest eggshould primarily have investments that have margins ofsafety. Most retirees cannot afford to see a large portion oftheir nest eggs decline in value.

There will be low taxes on the trade. The best wayto meet this requirement is to hold a security for more thanone year before selling, qualifying for the long-term capitalgains rate.

Secrets ##27 & 28. The one and onlytime it makes sense to hold stocks inan IRA. When to place an equity mutu-al fund into an IRA—and when not to.

Most investors own both taxable and tax-deferred

Which AccountTo Spend First?

Rate ofReturn

Tax-DeferredAccountFirst

TaxableAccountFirst

6% 15+ 18+8% 18+ 25+10% 24+ 51+

accounts. Some also own tax-free accounts, such as RothIRAs. Few investors consider which investments are bestheld in these different accounts. Yet, properly allocatingthe investments between the accounts can change theamount of after-tax income available for retirement.

A typical investor will hold stocks and equitymutual funds for the long term. The mutual funds will havelow annual distributions that are subject to taxes. For thisinvestor, the best advice is the conventional advice. Holdin a taxable account investments that already are tax-advantaged, such as stocks, equity mutual funds, and realestate. Gains from these investments will be taxed at thelong-term capital gains rate. If the investor incurs losses inthe taxable account, these can offset gains from otherinvestments in the account or other income.

If these tax-advantaged investments instead werein a tax-deferred account, the investor would be convertingtax-advantaged income into ordinary income. That isbecause distributions from an IRA are taxed as ordinaryincome. Long-term capital gains earned in the IRA wouldbe taxed at the ordinary income tax rate instead of thelong-term capital gains rate.

The conventional advice does not work for everyinvestor. Suppose an investor owns stocks and equitymutual funds but rarely holds them for more than one year.Or the mutual funds do a lot of trading and distribute a lotof taxable gains each year. The gains earned by this type ofinvestor would be taxed at ordinary income rates in a tax-able account because they would be short-term gains. Theinvestor could be better off holding those investments intax-deferred accounts.

Secret #29. The simple rule of thumbthat makes it a snap to avoid needlesstaxes.

Few people can hold all of their stocks and mutualfunds for the very long term. They need to sell at least afew investments each year, or the mutual funds make somedistributions. What is the break-even point? When does itmake sense to hold stocks and equity mutual funds in anIRA (where taxes on the gains are deferred but areimposed at the top ordinary income tax rate when distrib-uted) instead of in taxable accounts? Here is the rule devel-oped from my research: Stocks and equity mutual fundsshould be held in a taxable account unless at least 25% ofthe annual return from them is taxed at ordinary incometax rates.

Secret #30. Safest retirement accountfor "junk" bonds.

Interest earned on bonds is taxed as ordinaryincome, at the top tax rate. Junk or high-yield bonds earnhigher interest than other types of bonds. Bonds and otherinvestments that generate ordinary income should be heldin tax deferred vehicles when possible. Real estate invest-ment trusts also generate high ordinary income and gener-ally should be owned through tax-advantaged accounts.

If you also have a Roth IRA, generally the highest-returning investments should be held in the Roth, becausethat maximizes the amount of tax-free income down the

road.

Secret #31. The type of retirementaccount you should almost always taplast

When deciding the order in which to withdrawmoney from different types of retirement accounts, myresearch shows that Roth IRAs and any other tax-exemptaccounts should be tapped last. The combination of tax-exempt compounding and distributions maximizes wealthwhen the compounding is allowed to work for a long aspossible. As a general rule, the IRAs with nondeductiblecontributions should be allowed to compound longer thanfully taxable IRAs, since distributions from nondeductibleIRAs will be only partly taxable.

Secret #32. How to avoid takingrequired minimum distributions afterage 70½.

Owners of traditional IRAs are required to takedistributions from their IRAs each year. The amount of therequired minimum distributions is determined by an IRSformula. For a number of older Americans, the RMDsexceed their spending needs. It means they are takingmoney out of their IRAs and paying taxes on income theydo not need.

A solution for some people is to withdraw moneyfrom their IRAs before they need to. Pay income taxesnow so that future gains can compound in a taxableaccount and be subject to the long-term capital gains rateinstead of the ordinary income tax rate. My research showsthat there are people for whom it makes sense to do thisinstead of following the traditional advice of letting moneycompound in the tax deferred account as long as possible.

Briefly, there are people with sufficient assets out-side of their IRAs that they are not likely to need the IRAsduring their lifetimes, or at least not need the bulk of theIRAs. Yet, the tax law requires them to begin distributionsafter age 70½. These distributions are taxable as ordinaryincome and will increase as the individual ages. Whenchildren or other heirs inherit the IRA, they will oweincome taxes on distributions from the IRA.

In these situations, the investor could be better offtaking money out of the IRA early, paying the taxes at thecurrent value, and letting the after-tax amount compoundin a tax-deferred account. This is discussed more fully inthe Archive on the web site and in my books. You shouldconsider this option if you have a large IRA or significantassets outside the IRA so that you do not need the IRA tomaintain your standard of living.

Secret #33. Invest your IRA in realestate, privately-issued companystock, hedge funds, separately man-aged accounts and a host of otherassets in your IRA.

Most IRA custodians say that only publicly-tradedsecurities and mutual funds can be purchased through anIRA. This is not part of the tax law. It is their internal poli-

cy. Their systems are not set up to handle assets that arenot publicly-listed and traded. They also do not want tocharge the additional fees they would have to charge tohandle other types of assets.

Yet, you are allowed to own many of these assetsin your IRA. To do this, you may need a different IRA cus-todian who's willing to allow you the flexibility to set up aSelf-Directed IRA. Only a small number of IRA custodi-ans offer these types of IRAs. Some people call it theSuper IRA. Others call it the "Secret" IRA. Its more com-mon name is the Self-Directed IRA or true Self-DirectedIRA.

You can find them by going to any Internet searchengine and typing in "self-directed IRA."

Secret #34. Greatly expand the use ofthe Super IRA and reduce its costs.

One of the disadvantages of the true Self-DirectedIRA is that the custodians charge higher fees than othercustodians. In addition, there are paperwork requirementsand usually additional fees for every transaction the IRAmakes. These factors make the true self-directed IRAimpractical for small IRAs and for IRAs making a largevolume of transactions.

Even these disadvantages can be reduced or elimi-nated by taking another step that very few advisors knowabout. You can set up a limited liability company, and havethat wholly-owned by the IRA. Then all your investmentsand other transactions are made through the LLC. TheLLC is a separate taxpayer and investor, the IRA simplyowns the LLC the way a conventional IRA might ownMicrosoft or GE.

The LLC can buy any investment that is suitablefor an IRA. But it makes the purchases through its ownaccounts using its own funds. Some people refer to this asthe Checkbook IRA, because all the IRA investments aremade through the LLC's checkbook or brokerage account.

You might have to prepare a tax return each yearfor the LLC and have to pay attention to other details. Youshould not attempt it without an experienced custodian andan attorney to help set up the LLC. The LLC documentsmust have certain language to allow ownership by an IRA.Without the language, the plan could have big problems.

By using this strategy, you'll enjoy complete con-trol over your IRA assets. You can uncover a wide rangeof profit-making opportunities that most investors neverconsider for their IRAs. And you can better protect yournest egg from the ravages of a long-term bear market bymoving away from a traditional stock and bond portfolio.

Secret #35. How to safely add timber,gold, commodities, and other fast-ris-ing assets to your traditional IRA--with-out setting up a Self-Directed IRA.

The traditional retirement portfolio is mostlystocks and bonds, with an overweight to bonds and otherincome investments. Retirees need to move away from thetraditional stock and bond portfolio. The retirement portfo-lio should have assets that earn equity-like returns over the

long term but that are not tied closely to the returns of themajor stock and bond indexes.

Pension funds are starting to do this by addingcommodities, timber, and other investments to their portfo-lios. We offer several ways to achieve this result in ourportfolios.

The Core Portfolios use value managers whoreduce the effects of bear markets in their assigned assetclasses by avoiding the riskiest investments and investingwith a margin of safety.

In the Managed Portfolios we apply the margin ofsafety approach to the entire portfolio. We look for invest-ment classes that have margins of safety and are selling atdiscounts. When appropriate, we own investments that wewould not own in the Core Portfolios because of theirlong-term risks and volatility but that can generate strongreturns for extended periods.

Another alternative is the portfolio of "hedge fund"mutual funds that we update about every quarter. This port-folio contains mutual funds that use the strategies of thebetter hedge funds. These mutual funds historically haveearned high long-term returns. Even better, they have lowcorrelations with each other and with the stock marketindexes.

Finally, there are exchanged-traded funds (ETFs).Most ETFs are stock and bond index funds. But a numberof them own alternative assets such as commodities andtimber. Some own diversified commodity portfolios, whileothers own a single commodity.

A portfolio that is more diversified than traditionalportfolios and that adjusts its allocation based on extrememarket valuations will avoid the worst effects of sustainedbear markets in stocks. By considering the entire toolboxand using those tools that are appropriate for him or her,the retiree greatly increases the likelihood that the portfoliowill last through retirement.

Secret #36. Little-known IRA trap thatcan get you and your family membersin big trouble.

Even a true Self-Directed IRA cannot invested ineverything. There are six prohibited transactions betweenIRAs and related parties. The first four are specific, andthe last two are general. These prohibitions apply to allIRAs, whether they are true Self-Directed IRAs or thosewith traditional custodians.

The specific prohibitions are: a sale, exchange, orlease of property; a loan of money; furnishing goods, serv-ices, or facilities; a transfer to or the use of the income orassets of the IRA; and the transfer to or use of the incomeor assets of the IRA. The general prohibitions are: an actin which the related party deals with the IRA income orassets as his or her own; and the receipt of any benefit forthe related party's personal account in connection with atransaction involving the income or assets of the IRA.

The list basically can be summed at as, "no dealsinvolving the IRA and the owner or a related person." Thatsounds rather restrictive, but that isn't always true. It is

possible to engage legally in transactions that seem prohib-ited.

A related person is the IRA owner; anyone whomakes decisions for the IRA; anyone providing services tothe IRA; an ancestor, spouse, or descendant of the IRAowner, spouse, decision maker, or anyone providing servic-es to the IRA; a corporation, trust, partnership, or estatethat is 50% or more owned by any of the above persons;an officer, director, highly compensated employee, or 10%or greater owner of any of the above; and a partner of anyof the above.

Not included as related persons are brothers, sis-ters, step relatives, nieces, and nephews. Also not includedare friends and neighbors. A "significant other" to whomyou are not married also is not a related person.

What about Roth IRAs? They are subject to thesame rules as traditional IRAs and other qualified retire-ment plans. In addition, the IRS issued a notice in 2003 inwhich it stated that any transaction between a Roth IRAand a "related party" would be considered a tax shelter oran abusive transaction, and that requires registration withthe IRS. For this notice, the IRS considered brothers andsisters as related parties. (IRS Notice 2004-8)

Secret #37. How to avoid IRA penaltiesfor helping family members.

Here's an example of what you can do without apenalty once an LLC IRA is created.

Suppose you have a stepchild who is ready for col-lege. Your LLC IRA can lend the tuition money to thestepchild. Over time the stepchild pays back the IRA withinterest (perhaps using annual gifts from you). The loanplus interest goes back into your IRA, tax deferred. Inaddition, the interest might be deductible by the stepchild.This is how your LLC IRA can be used both to earnmoney and help a loved one. The transaction also worksfor brothers, sisters, nieces, and nephews.

Or suppose you help someone buy a home or otherproperty by having your IRA write the mortgage. The per-son gets a loan. Your IRA earns interest income as mort-gage payments are received. The loan is secured by theproperty, protecting your nest egg. And the borrower getsto deduct the interest payments.

These are just the tip of the iceberg. There aremany other interesting and profitable transactions IRAs areallowed to make.

Secret #38. How to buy your dreamvacation home using your IRA.

While the list of prohibited transactions is exten-sive, it is not absolute. The law requires the Department ofLabor to create a procedure for obtaining exemptions fromthe prohibited transactions rule. This has been done, andthe Department grants a number of exemptions each year.Here is a sample of exemptions granted over the years:

l An IRA owner sold real estate to his IRA. l An IRA owner sold stock to his IRA.l An IRA owner purchased stock from his IRA.

l An IRA owner purchased real estate from hisIRA.

l An IRA owner lent money to a corporation ofwhich he was the sole owner. That means when the loanwas repaid, the corporation paid tax deductible interest tothe IRA.

The Department of Labor, through its EmployeeBenefits Security Agency, reviews applications for exemp-tions. The office also grants "class exemptions." These areavailable to anyone meeting the qualifications stated in theclass exemption.

To be granted an exemption, you have to show theoffice that a transaction is administratively feasible, is inthe interest of the plan and its participants and beneficiar-ies, and that it protects the rights of plan participants andbeneficiaries. An individual exemption is put on a fasttrack to approval if you show that the transaction is sub-stantially similar to two or more exemptions granted in thelast five years.

The web site is revised regularly, but at the time ofthis writing, here’s how you can get full details of pastexemptions at the web site www.dol.gov/ebsa/. In the rightcolumn, click on "EXPRO Exemptions," "IndividualExemptions," and "Class Exemptions." For full detailsabout exemptions and procedures, get the booklet"Exemption Procedures Under Federal Pension Law,"available at www.dol.gov/ebsa/publications/-exemption_procedures.html

The possibility of an exemption widens your finan-cial options. For example, your IRA might be able to writethe mortgage on your next home or vacation home. Insteadof writing mortgage checks and paying interest to a bankor other lender, you will be making the payments to yourIRA. And the interest likely will be deductible. That's apretty good deal.

Secret #39. Simple way to maximizeyour cash flow — while preservingretirement capital.

One strategy we have recommended for some timeand that has been adopted by others is the emergency fundor cash reserve fund.

Set aside a portion of your portfolio equal to oneto three years of estimated spending. You choose theamount. Invest this part of the portfolio in super-safe assetssuch as money market funds and certificates of deposit.The rest of the retirement assets are invested for the longterm.

Interest, dividends, and sales of shares from themain portfolio are used to pay for living expenses whenthe portfolio is rising or stable. But when a bear marketknocks down the value of the portfolio, there is no need tosell assets at depressed prices. Instead, use the safety fundto pay for expenses. After the markets recover, profits fromthe main portfolio can be used to replenish the safety fundand again to pay for expenses.

The size of the safety fund depends on how bad abear market the retiree wants to defend against and on the

value of the total portfolio. Not everyone has a large enough retirement fund

to set aside several years of expenses in a low-yieldingsafety fund. An option for them is to put part of the retire-ment portfolio in immediate annuities paying a fixedamount for life.

Studies show that, on paper at least, immediateannuities extend the life of a retirement portfolio anddecrease the risk of outliving one's assets. I discussed thisin detail in my book, The New Rules of Retirement.

Secret #40. Be sure your heirs do notmake the #1 mistake with inheritedIRAs.

Heirs, often with the help of the IRA custodian,often make a big mistake when they inherit IRAs that trig-gers immediate and large tax bills. They lose the tax defer-ral of the IRA. The mistake they make is to change the titleof the inherited IRA to their names. This simple namechange triggers a rapid distribution of all the IRA's assets.This means your heirs could get whacked with an enor-mous tax bill and have to fork over 35% or more of theirinherited IRA in income taxes to the IRS!

To prevent this tax tsunami from swallowing upyour wealth, it's very important to tell your heirs this: Aninherited IRA needs 3 things in its title to keep it safe fromthe greedy clutches of the IRS …

1) The name of the owner who passed away2) The word 'IRA'3) The statement that it is "for the benefit of" the

heir. So an appropriate title for an inherited IRA would

be, "John Sample IRA (deceased), F/B/O Bob Sample,beneficiary."

These three simple title changes can provide iron-clad protection and the ultimate flexibility for your heirs.Now they can take distributions when they want to, NOTwhen the IRS decides. That means your heirs can stretchout their IRA distributions over a longer time horizon, min-imizing their tax impact.

Secret #41. Don't let heirs fall into thiscommon trap.

Required minimum distributions are required ofbeneficiaries who do not take all the money out of the IRArapidly and pay taxes on it. Fails to take the RMDs andthere will be penalties imposed. The key deadline is Dec.31, of the year after the year in which the original IRAowner died. By that date, the RMDs must begin. Heirsneed to know this and have their distribution scheduledestablished on time. Follow the rules and the heirs willhave a "stretch IRA," one that allows the tax deferred com-pounding to work as long as the law allows. Otherwise,there will be penalties and taxes.

Secret #42. How to be sure an IRAgoes to the loved ones you want toreceive it.

One of the easiest things you can do to ensure yourIRA custodian follows your wishes is to scrap their stan-dard beneficiary forms. Most of the mistakes made byIRA custodians are tied to this beneficiary form, whichIRA owners often spend a minute or less filling out.

But a little bit more of careful planning can save alarge portion of your wealth for your heirs and keep it outof the greedy hands of the IRS. That's why I recommendyou submit your own customized beneficiary forms withdetailed instructions. This simple step can prevent a lot ofheadaches and needless taxes.

It can also help you take advantage of opportuni-ties you might not be able to otherwise. For example, in arare burst of generosity, the IRS recently issued regulationsthat provide opportunities for IRA beneficiaries to extendtax deferral.

A customized beneficiary form can help your heirstake advantage of this opportunity to defer taxes and keepyour IRA custodian from messing up things. Most estateplanners have experience drafting customized beneficiaryforms and working with custodians to accept the forms.Customized forms should be considered seriously when anIRA is large, there are multiple beneficiaries, or it is notdesired to split the IRA equally among the heirs.

Secret #43. A mistake you don't wantan IRA custodian to make.

Here's another common mistake IRA custodiansmake. Most IRA custodians assume that multiple benefici-aries to your IRA are meant to inherit equal shares of it.But that may not be your plan. You may want one benefi-ciary to inherit a larger share than another.

Most standard beneficiary forms don't even consid-er your wishes in this. They don't even have enough spaceto designate different portions for each beneficiary. That'swhy customized forms are so important in order to makeyour intentions clear. If you are thinking of somethingother than an equal split of the IRA, consider having anestate planner draft a custom beneficiary designation form.An alternative: split the IRA into separate IRAs for eachbeneficiary.

Secret #44. A key issue about passingon IRAs that most estate plans ignore.

An IRA is going to be included in the owner’sestate, and estate taxes will be incurred if the estate is largeenough.

When estate taxes are incurred, the next issue iswho pays the taxes attributable to the IRA.Most standard wills provide that estate taxes are paid fromthe residuary estate or from the surviving spouse's share.Other estates apportion the taxes against specific assets orshares of the estate. If the IRA is a large percentage of theestate and taxes are paid from the residuary estate or sur-

viving spouse's share, the taxes could really shrink thoseshares of the estate.

Having the taxes paid by the beneficiaries of the IRAcould create problems. If the beneficiaries do not have suf-ficient other assets to pay the taxes, they will have to takea distribution from the IRA to pay the taxes. The distribu-tion will be included in gross income, so they will have totake an extra amount to pay the income taxes on the distri-bution they take to pay the estate taxes.

The best solution depends on the particular estate. TheIRA owner should take care to consider how much theestate taxes will be and which part of the estate will paythem or whether life insurance should be purchased to paythe taxes.

Secret #45. A little-known tax saverthat people who own employer stock intheir 401(k)s must know.

Many workers own shares of employer stockthrough 401(k) or other retirement plans. Few of theseworkers, or even their financial advisers, know the taxbreak that is available to substantially reduce the tax bur-den from selling those shares. With a little planning and byfollowing a few steps, workers can substantially reduce thetax burden on selling the employer stock and increase theirafter-tax retirement funds.

The tax break is known as net unrealized appreciation orNUA. The rules work like this.

If you sell the employer stock while it is in your 401(k)or other retirement account, you do not get the tax break.The proceeds from that sale eventually will be distributedto you (from either the 401(k) or an IRA rollover) and betaxed at ordinary income rates.

To maximize tax breaks, you do not want to sell employ-er stock while it is in your 401(k). There might be non-taxreasons for selling the stock. If you have doubts about thelong-term future for the stock or believe too much of yournet worth is in the stock, you might want to sell some orall of it. Otherwise, the shrewd tax strategy is to hold theemployer stock while it is in the retirement account.

To qualify for the tax break, you also cannot take anywithdrawals from the retirement plan before taking a distri-bution of the stock, even required minimum distributionsafter age 70½. If you do, you are ineligible for the taxbreak.

That is what not to do. Here is what to do when youretire or otherwise leave the employer to grab the taxbreak.

Take a lump sum distribution from the 401(k) plan. Thismeans that all of the account must be withdrawn from theaccount in the same calendar year. The rule is firm. Theentire account must be withdrawn within the same year. Itdoes not have to be distributed at once, but the full accountmust be distributed within the same tax year.

Have the employer stock deposited in a taxable broker-age account in your name. It usually is best to have theother assets rolled over to an IRA. The IRA rollover means

that those assets are not taxed until withdrawn from theIRA.

If you follow these rules, the employer stock receivesspecial tax treatment. You include in gross income in theyear of the lump sum distribution the original value or costbasis of the shares. No other taxes are due at that time, nomatter how much the shares appreciated since youacquired them.

As you sell the employer shares, long-term capital gainstaxes are due on the appreciation that occurred since youacquired the shares. The long-term gain treatment isallowed regardless of how long the shares have beenowned either inside or outside of the 401(k).

The treatment is the same whether you purchased theshares through your 401(k) plan or received them as amatching contribution from the employer.

Suppose you treat the employer stock the same as yourother IRA assets and roll it over to the IRA or keep it inthe 401(k) until it is distributed to you. Then, the value ofthe stock is taxed as ordinary income when distributed thesame as your other IRA or 401(k) assets.

The tax break is available even if the company's stock isnot publicly-traded. Many private companies periodicallydetermine a value for their stock. These values can be usedto determine the employee's basis in the stock. When theemployer stock is distributed to you, the employer shouldtell you its basis.

The NUA treatment also is available to heirs who inheritthe 401(k) account and take a lump sum distribution afterthe employee's death. It also is available to divorced spous-es if they received part of the retirement account under aqualified domestic relations order.

An employee does not have to use the NUA treatmentfor all the stock in the plan. Shares that have appreciated alot can be distributed to the brokerage account and taxeson only the basis paid today. Shares that have not appreci-ated much can be rolled over to an IRA with other accountassets; taxes on those shares are deferred until the sharesare distributed.

If a person holds the shares until death, the heirs do notget to increase the tax basis of the shares. The heirs willowe capital gains on the appreciation when they sell theshares just as the employee would have.

The 10% early distribution penalty applies to distribu-tions of employer shares taken as part of an NUA distribu-tion. If the employee is at least age 55 and takes the distri-bution after separating from the employer, the 10% penaltyusually does not apply.

Secret #46. What every spouse shouldknow about inheriting an IRA.

A spouse beneficiary of an IRA has one big advan-tage. He or she can roll over the IRA to a new IRA that ishis or her own. It is treated as a brand new IRA, and noneof the restrictions on inherited IRAs apply. That means thebeneficiaries and required minimum distribution schedulecan be reset and there are no references to the distributions

taken by the original owner. This often is a good idea foran inheriting spouse. But non-spouses who are beneficiar-ies cannot rollover the IRA to a new IRA.

Secret #47. A deduction most heirs ofIRAs overlook or misunderstand.

Most taxpayers and even many tax advisers areunaware of the deduction for "income in respect of a dece-dent. But many people who inherit a substantial IRA areeligible for this deduction, which essentially is a deductionfor the estate taxes that were paid on the IRA. The deduc-tion is best explained with an example.

Suppose someone left a large estate with an IRA. Theestate tax accountant computes that the IRA was responsi-ble for 36.7% of the estate tax paid, and that the IRA'sshare of the estate tax was $175,000. When the beneficiarytakes distributions from the IRA, a miscellaneous itemizeddeduction (not subject to the 2% floor) of 36.7% of eachdistribution is allowed. This continues until the beneficiaryhas deducted a total of $175,000 over the years.

The estate tax accountant should determine the data forthe deduction. Details can be found in the IRS Publication559, Survivors, Executors, and Administrators availablefree on the IRS web site, www.irs.gov.

Secret #48. Your heirs and executorcan optimize the beneficiary selection.

The details of who should get an IRA can be left toyour executor who, along with family members, can deter-mine from both a financial and tax standpoint who shouldbe the beneficiary. The beneficiary does not have to beselected until Sept. 30 of the year following the year of theowner's death. The first required distribution does not haveto be made until Dec. 31 of that year. But the designatedbeneficiary must be one of a group of primary and contin-gent beneficiaries named by the account owner.

The way to take advantage of this provision is for you toname both primary and contingent beneficiaries. After yourheirs and executor decide who should inherit, those whoare ahead of that person in the beneficiary chain can dis-claim their interests.

There is a procedure in the tax law for making qualifieddisclaimers. Your heirs and executor should be aware ofyour intentions and this process, and you should give theexecutor guidelines for making the decision and advisingthe beneficiaries.

Secret #49. Escape your 401(k) beforeretiring—with no taxes or penalties.

Saving in a 401(k) plan can be a good deal, prima-rily because the contributions are tax-deferred and mostplans include an employer matching contribution. Therealso are disadvantages to 401(k)s. They tend to have highercosts than IRAs, and they have fewer investment options.Some plans have poor investment options and high costs.After retiring, of course, the account balance can be rolledinto an IRA.

What many people do not realize is that they might

be able to move their money out of the 401(k) into an IRAand continue working with the same employer. A penalty-free and tax-free rollover is allowed any time after reach-ing age 59½. There is no need to leave the employer. Notall plans allow a rollover to an employee who continuesworking at the firm. Some plans have more restrictive pro-visions than the tax law allows. But if the plan follows thetax code, a high cost plan with poor investment options canbe escaped after reaching age 59½.

Secret #50. An IRA can shelter someassets from creditors.

A bankruptcy law enacted in 2005 increased pro-tections for IRAs and other retirement funds from credi-tors. Retirement funds are exempt from the bankruptcyestate if they are exempt from federal income tax under taxcode sections 401, 403, 408, 408A, 414, 457, and 501(a).This covers all qualified retirement plans, including IRAs,Roth IRAs, and 401(k) plans.

IRAs and Roth IRAs have a $1 million limit ontheir exemption, which is adjusted for inflation. In addi-tion, the bankruptcy court can increase this exemption atits discretion. The court generally will examine the needsof the account owner to decide if a higher limit is warrant-ed. The limit does not apply to many rollover contributionsfrom employer plans to IRAs. Other retirement plans areprotected without limit.

Keep in mind that the protections of retirementplans apply only in bankruptcy court. Creditors might haveaccess to the accounts under state law in non-bankruptcyactions.

Secret #51. A key to successful retire-ment is having a plan for handling theinevitable surprises.

Financial surprises in retirement can blow a hole inyour plans. Particularly for early retirees surprises are verydamaging to well-laid plans.

The scenario occurs with frequency. A couple dili-gently worked up a detailed plan that covered all theexpenses of their desired lifestyle. They ventured intoretirement secure in the belief that they were financiallycomfortable.

Then, one or more major surprises surface.Unplanned medical expenses are a major shock to plans.Major home expenses, lower than expected investmentreturns, and family emergencies are other sources of sur-prise.

When paying for unplanned expenses retirees losenot only the cash paid for the expenses but all the futureincome it was expected to generate. Over a retirement of10 to 30 years, that income is quite a sum.

When the unexpected jolt to cash flow arises,retirees needs to know how to respond. Here are some keystrategies to consider.

l Plan for it. Annual spending in a retirement planshould include the irregular and even "unexpected"expenses. The spending plan should provide a place for the

irregular cash drains. I often recommend that the monthlyexpenses include "sinking fund" expenses. For example,someone who plans to purchase a new car every four yearswould list a few hundred dollars for automobiles in themonthly spending plan. That amount won’t be spent eachmonth. The sinking fund, however, ensures that when thespending numbers are run through a computer model theretiree has a better idea of whether enough really has beensaved for retirement. Sinking funds can be set up for homerepairs and even for unexpected emergencies.

l Save more. An alternative to the sinking fund isto establish a cushion in the retirement fund. Don't retireuntil the fund has $100,000 or more beyond what is neededto generate cash for your planned lifestyle.

l Cut spending. Most retirement spending plansare flexible. There are variable expenses that can be cut ordelayed. The typical retiree can spend less on travel, diningout, spoiling the grandchildren, and other discretionaryitems. The reduction does not have to be significant. A cutof 5% or so is enough to get most plans back on track.

l Back to work. Those who retired just a fewyears before the emergency often can return to work, evenon a part time basis. They might do something similar tothe work they retired from or seek other work to bring in afew dollars until the plan is back on track. More and moreemployers are "senior friendly," so returning to work is amore viable option than it used to be. Many retirees whotake jobs related to their hobbies instead of their old jobsfind that the employment increases their enjoyment ofretirement.

Retirees should expect the unexpected in theirspending. The best solution is to have built a cushion in theretirement plan that anticipates the occasional unplannedexpenses. Even when that wasn't done, there still areoptions that can get the plan back on track.

Secret #52. A reverse mortgage allowsyou to stay in your home and use itsequity.

Reverse mortgages are coming back. The numberof reverse mortgages insured by the federal governmentsurged for years, tapered off after the financial crisis, andhas been recovering for several years.

Several factors are behind the increase in reversemortgages. The aging population increases demand, asdoes the increase in home equity. Federal insurance of theloans and new protective regulations also make reversemortgages more attractive. Recent innovations by lendersand regulatory changes reduce costs and make the loansmore appealing.

The concept of a reverse mortgage is simple.A homeowner borrows money. The loan can be

distributed in a lump sum, as a stream of equal paymentsfor life, or through a line of credit. No payments are due aslong as the borrower is living in the home. The lender ispaid when the borrower moves from the home or passesaway. Proceeds from the sale of the home are used to repaythe loan plus interest and expenses. The amount due from

the borrower or his estate never can exceed the value ofthe home. If the lender is due more than that, it eitherabsorbs the loss or collects from the federal insurance, if itwas an insured loan.

For the loan to be federally-insured, the borrowermust be age 62 or older. The borrower must be counseledby an adviser who is independent of the lender andapproved by the Department of Housing and UrbanDevelopment. There is a ceiling amount on loans insuredby HUD, which varies by region and is based on medianhome values. HUD imposes these rules because it insuresthe loans.

It is important for the borrower to understand thecosts of reverse mortgages, because this is an expensiveway to borrow.

The loan carries an interest rate similar to that on a30-year mortgage, though the rate might be variableinstead of fixed. In addition, there are costs including anapplication fee, origination fee, closing costs, and a month-ly servicing fee, which usually is 0.5% of the loan balance.These costs often total to around 8% of the home's value.About two percentage points of this will be paid to the fed-eral government for insurance. The costs all are back-loaded; no payments are due until the home is sold, thoughyou can choose to pay some at the time the loan is issued.The interest on the loan compounds until the loan is repaid.

The amount that can be borrowed is limited,because the lender wants to be paid in full and the govern-ment wants to limit the loans it has to cover. The older youare, the greater the percentage of the home's value that canbe borrowed. But not many people are able to borrow morethan 50% of a home's value. To develop an estimate ofhow much you might be able to borrow, visitwww.reversemortgage.org.

Reverse mortgages above the HUD ceiling areavailable in what are called jumbo loans that are issued bylenders and carry no federal insurance. These loans mightbe for a higher percentage of the home's value than theHUD loans, but they also can have higher costs and inter-est rates.

A reverse mortgage is a way to use home equitywithout moving out of the home and without having tomake payments during life. But it is an expensive way toborrow and will reduce or eliminate any inheritance left forheirs. For these reasons, it should be a last resort. It shouldbe considered only after other financial resources andoptions are exhausted. The typical reverse mortgage bor-rower is a woman in her late seventies or older. Youngerpeople generally should not use reverse mortgages,because they will be able to borrow only a small percent-age of the equity. The rest will go to interest and costs.

There has been a trend recently of relativelyyounger homeowners using reverse mortgages to pay forvacations or other nonessentials. A person could be in quitea bind if he uses a home equity loan in the early years ofretirement to pay for nonessentials, and then later in lifeneeds money to pay for a nursing home, medical expenses,or home repairs.

Secret #53. Taking advantage of thenew look in some reverse mortgages.

After the financial crisis of 2008 several big playersdropped out of the reverse mortgage market, includingBank of America, Wells Fargo, and Financial Freedom. Butthere still are plenty of lenders offering mortgages insuredby the FHA. In addition, new types of reverse mortgagesapproved by the FHA can be very good financial manage-ment and cash management tools for retirees.

Traditionally I’ve recommended that reverse mort-gages be considered only as last resorts for people in theirlate 70s or older who need money and want to stay in theirhomes.

That advice still applies to traditional reverse mort-gages, also known as home equity conversion mortgages(HECM).

A recent innovation, however, potentially broadens theuses of reverse mortgages.

The HECM Saver substantially lowers up-front costscompared to the traditional HECM. The mortgage insur-ance premium is only 0.01% instead of 2%. In exchange,the lending limit on the Saver is about 10% to 18% lessthan for the standard HECM. Lenders also tend to chargelower fees for Savers than for traditional HECMs. Note:Fees and other terms can be changed at any time. Checkthe latest terms before making a decision.

In addition, the Saver is set up as a line of credit. Youdraw money only when you need it. You can repay themoney when you no longer need it if you want, restoringyour full line of credit. But you don’t have to pay the inter-est until you move out of the home or pass away. Or youcan pay the interest earlier if you want to and have thecash. You also can decide not to repay the loan and inter-est, leaving it to be paid when the home is sold or you nolonger use it as a principal residence.

When you set up a HECM Saver, you’re charged mort-gage insurance of 1.25% of the outstanding loan value asmortgage insurance on an ongoing basis. You’re alsocharged a variable interest rate.

In addition, as you age and don’t draw down the loan,the amount you can borrow increases.

Because of these features, many analysts believe it’sunlikely that a HECM Saver ever would be underwater,with the accumulated loan, interest, and fees totaling morethan a home’s value. That means heirs still are likely toreceive something from the sale of the home, even after thehomeowner benefits from the HECM Saver. With the tradi-tional HECM, however, it’s not unusual for the loan to beunderwater, meaning the heirs don’t receive anything fromthe home.

The lower costs and flexibility of the Saver provideseveral ways it can be used as a financial planning tool.

Suppose your investment portfolio’s value takes a dive.You don’t want to sell assets, because you expect them torecover. But you need cash to pay living expenses. Insteadof selling assets while they’re at a low, you can tap the

HECM Saver. Use the proceeds to pay living expenses fora while. As the portfolio recovers, you can stop drawingfrom the Saver and resume withdrawals from the portfolio.You can eventually use part of the portfolio to repay theSaver or you can let that loan be paid when you leave thehome.

Or suppose you suddenly incur an unexpected expense.It might be a medical expense, a repair for the home, or aneed by a loved one. You don’t have to sell portfolioassets. Instead, you can draw some money from the HECMSaver. Then, over time you can increase portfolio with-drawals to pay the Saver so it will be available in anotheremergency. Or you can let the Saver be paid when youleave the home.

Because a Saver can be used in such situations, youmight be able to keep less cash in emergency funds andinvest that money for a higher return. Some advisers rec-ommend more aggressive use of the HECM Saver, such aspaying for living expenses to delay receiving SocialSecurity retirement benefits so that you can qualify for thehigher level.

Some advisers believe a Saver would allow you to buyless life insurance or long-term care insurance, becauseyou could tap the home equity when the cash is needed.That might be a solution for a single person but it probablywon’t provide enough protection for a married couple,depending on the lending limit on the HECM Saver.

There’s a potential alternative to the Saver. You mightbe able to take out a Standard HECM and elect to have itbe a line of credit instead of a lump sum. You also couldelect a variable rate. Not all lenders will make these termsavailable. But if you seek this option you could have ahigher loan limit and a lower initial interest rate than theSaver.

The HECM Saver generally has a higher interest ratethan the Standard, so you probably don’t want to use aSaver for a large, long-term loan. But if you plan to repaythe loan, use the loan as a bridge or emergency fund, ordon’t draw down the maximum amount available, theSaver can be better than a Standard HECM.

With all types of reverse mortgages, the FHA andlenders are imposing tighter standards. They’re requiringpotential borrowers to show that they’ll have enoughincome to keep their insurance in place and real estatetaxes current. The loan agreements require the homeownerto maintain insurance and taxes. Failure to do so is adefault.

You can find details about the reverse mortgage loanson the web site of the Department of Housing and UrbanDevelopment (www.hud.gov), and AARP also has a goodpublication on reverse mortgages. The HUD site also haslinks to reverse mortgage lenders and counselors plus alink to a calculator that lets you estimate the amount ofyour loan.

Secret #54. State income and estatetaxes are a bigger threat to your plansthan before.

The most important tax audit of your life is likely

to take place either in the first few years of retirement orafter you pass away. It is a state residency audit and couldbefall anyone who moved to another state during retire-ment or who owns homes in at least two states duringretirement.

A number of low tax states are marketing them-selves to retirees who are seeking to reduce their expenseby cutting state taxes. One study found that about 1,000Americans per day move from states with income taxes tostates with no income taxes. The higher-tax states arefighting back with residency audits of former residents.They are aggressively targeting individuals who claim tohave changed their residences but retained significant con-tacts with their old states.

The residency audit is likely to occur at either oftwo times. One point is shortly after you stop filing incometax returns in the old state or start filing part-year residentreturns after years of filing full-time resident returns. Theother point is after death.

Income taxes are not the only target of the states.While the federal government has been reducing estatetaxes, 19 states and the District of Columbia had estate orinheritance taxes in place in 2014. These taxes often havelower thresholds than the federal estate taxes and can bemuch more significant than the federal taxes.

New York and California are the most aggressivein challenging residence status, but other states are active.

The problem for individuals is that residence anddomicile are nebulous, complicated concepts. The rulesand decisions often vary between the states and arereviewed only by their own courts. The states do not haveto make consistent decisions. It is not unheard of for twostates each to claim one person as a resident.

Most states have one bright-line rule. If you arepresent in the state more than 183 days (half the year) youare a full-time resident. The first step if you want tochange residence is to keep a log or other proof showingthat you were physically present in the new state more than183 days of the year, or at least that you were not in theold state more than 183 days.

While being in a state more than 183 days makesyou a resident, being out of the state more than 183 daysdoes not automatically make you nonresident. Contactswith a state and other subjective factors can determineyour residence.

Residency and domicile are defined as states of mind. Aperson is resident in the state he intends to be his perma-nent residence indefinitely. Facts and circumstances areused to determine a person's intent. You need to line up asmany facts as possible to demonstrate your intent tochange residence. Establishing the facts is important,because you won't be around to help in an estate tax audit.

Here are key steps to take.l Change any government registration or official

address. Change the address for your passport, driver'slicense, voter registration, and auto registration. File allfederal, state, and local tax returns with the new address

and file them with the office that is designated for resi-dents at your new address.

l Have all your financial accounts sent to the newaddress. These include bank accounts, brokerage andmutual fund accounts, credit card statements, and otherloan statements.

l Have all your mail sent to the new address.When you spend time at the other home, have mail held orforwarded only temporarily; do not register a change ofmailing address with the post office.

l If you travel a lot, whether between multiplehomes or on vacation, keep a log or diary of the travels.Leave for vacations from the new permanent residence.

l Execute a new will in the new state.l Shift memberships in clubs, churches, and other

organizations to the new state. Drop memberships in theold state or change them to associate, non-resident, orsome other part-time status.

l Sever fixed contacts with the old state. Mostadvisors believe it is best to sell the residence in the oldstate or rent it full time so that you are not able to staythere. If you want to maintain some kind of residence inthe old state, downsize and do not leave personal items thatindicate an intent to stay there, such as photos. Also, do notleave valuables or personal items in the old state. Somepeople leave their important documents, jewelry, and otheritems in storage or safe deposit boxes in the old state. Thatshows an intent not to leave permanently.

l If you maintain a residence of some sort in theold state, have all bills sent to the new state and conductany correspondence using the new address.

l Keep the evidence of your intent to move. In anaudit, the state might ask for diaries and calendars, creditcard statements, phone bills, and other information forthree years. Make sure your heirs and executor knowwhere this information is.

Secret #55. Maximizing the power of aRoth IRA conversion.

Converting a regular IRA to a Roth IRA can be ashrewd financial move. Now, we're going to discuss howto establish a plan that will multiply the benefits of a con-version.

There are two key rules that can be used to devel-op the most effective Roth conversion plan.

One rule is that an entire IRA does not have to beconverted, and all your IRAs do not have to be converted.You can convert an IRA in stages over the years, or con-vert only a portion of an IRA and no more.

The other key rule for a conversion plan is that aconversion can be reversed. The conversion can bereversed, known as recharacterization, any time before thedue date for the tax return for the year of the conversion,including extensions. The extension date can be used evenif the taxpayer filed the return by April 15. This means if

you converted an IRA in 2014, the recharacterization canoccur any time up to Oct. 15, 2015. If the 2014 return wasfiled and taxes on the conversion paid before the recharac-terization, an amended return can be filed to get a refundof the conversion taxes.

Once recharacterized, the IRA can be left as a tra-ditional IRA, or in the future it again can be converted to aRoth. The second conversion cannot be made in the sameyear as the original conversion. A second conversion alsocannot occur until more than 30 days have passed since therecharacterization.

Remember that when a traditional IRA is convert-ed to a Roth IRA, the amount converted is treated as a dis-tribution. It is included in gross income for the year andtaxed as ordinary income.

Secret #56. When it might pay toreverse a Roth IRA conversion.

The main reason to recharacterize is that the valueof the IRA declined after the conversion. The conversiontax is computed on the value of the converted amount onthe date of the conversion. If the value declines after theconversion, taxes still are paid on the previous highervalue. To avoid paying taxes on the higher value, the IRAcan be recharacterized. At a future date, the IRA can beconverted again. Reconversion is allowed the later of thenext calendar year and 30 days after the recharacterization.

Another reason to recharacterize is that somethingabout your financial situation changed. Perhaps you had anunexpected expense or other event, so you no longer haveas much free cash to pay the taxes on the conversion. Ormaybe your tax situation changed, so the cost of the con-version changed and made it less attractive.

Because things can change and you have an oppor-tunity to reverse (or recharacterize) the conversion, itmakes sense to keep monitoring your situation and reeval-uating the conversion decision until the deadline forrecharacterizing has passed.

Secret #57. How to receive steady life-time income with inflation protection.

One need of retiring Baby Boomers is for guaran-teed lifetime income that replaces old-style defined benefitplans. Another need is for that income to retain its purchas-ing power. There are several investments and strategiesthat might accomplish these goals, and more are beingdeveloped by insurers.

l Buy an immediate annuity and keep saving. Atraditional immediate annuity achieves the goal of lifetimeincome. The income payments, however, are fixed. Overtime inflation erodes the purchasing power of the income.An investor searching for reliable income should considerbuying an immediate annuity but not spending all the pay-outs. To support purchasing power over time, save andinvest some of the distributions.

l Buy an inflation-indexed annuity. These annu-ities make regular payments for either life or a term ofyears, just like immediate annuities. The payments, howev-

er, are adjusted to reflect increases in the CPI. There usual-ly is a maximum one-year increase of 10% or so.

The initial payment, however, generally is 20% to30% less than that of a standard immediate annuity. Theinitial reduction is less when there is a lower ceiling on themaximum one-year increase. (Inflation-adjusted annuitypayments generally can rise or fall with the CPI. Paymentswill not decline below the initial payment amount, but neg-ative CPI changes that are not reflected in the paymentswill offset future CPI increases.)

l Buy a variable immediate annuity. In variabledeferred annuities, the amount accumulated in the annuityaccount depends on the investment returns earned by theaccount's investments. In a variable immediate annuity thedistribution each year depends on the performance of theinvestments.

The VIA is fairly complicated. The owner selectsan assumed investment return (AIR) from among severalchoices offered by the insurer. The higher the AIR, thehigher the initial payment will be. Future income paymentswill vary based on how the investments selected for theaccount perform relative to the AIR. If the returns areabove the AIR, payments will rise, but if actual returns donot at least equal the AIR, the payments will decline. Youshould realize that if the account's return is positive butless than the AIR, the next year's payments will decline.

To avoid an income reduction, select a relativelylow AIR of no more than 5%. That reduces your initialpayment but makes future reductions less likely. MostVIAs also offer an option that eliminates income reduc-tions, but that costs about 1% in extra annual expenses.

l Buy a variable annuity with living benefits. Thisis a variable annuity with an option often called the guar-anteed minimum income benefit (GMIB). Such annuitiesprovide the opportunity for the income to increase with lit-tle risk of reduced income.

Let's say you invest $100,000 in one of theseannuities that has a 6% GMIB rate. The policy guaranteesyou $6,000 the first year, which you can take in cash orleave in the annuity. At the same time, you choose how theannuity account is invested. If the investments do well, theaccount value grows. Then, after 10 years, there is anannual option to convert the variable annuity into animmediate annuity.

If the investments lose money, you still aren't outof luck. When you switch to an immediate annuity, thepayout is based on the variable annuity's highest valueamong each of the anniversary dates of its purchase, lessany withdrawals taken. That means you can receive imme-diate annuity payments based on your initial investmenteven if your account never appreciated. Even so, the annu-ity payouts are not computed the same way as for standardimmediate annuities; your payout is likely to be less than itwould have been for a traditional immediate annuity. Withthese annuities be sure to invest for growth with reasonablerisk.

No matter which annuity you lean toward, reviewwhat the results would be under different circumstances.

Also, realize that the additional features cost money.Review the fees and how much your income is reduced.Most important is to compare redemption or cancellationfees. Often, it is difficult to exit one of these investmentswithout a steep cost.

Secret #58. Have a living trust? Don'tmake these two common mistakes.

Many people set up living trusts but neglect tofully implement them or update them as needed. Thereshould be successor clauses for beneficiaries and trustees.The trustee succession clause determines who controls thetrust after the initial trustee is unable to. The beneficiarysuccession clause effectively determines who inherits theassets. The clauses should be carefully written, updated asneeded, and the successors made aware of the situation.

Another detail often overlooked with living trustsis that ownership of assets must be transferred to them.Only the assets legally owned by the trust avoid probateand are controlled by its terms. Too many people do not dothe work of transferring the legal title of homes, vehicles,and financial accounts to their trusts, making the trusts use-less.

It also is important to check with financial institu-tions to determine if they need a copy of the trust on file. Anumber of financial institutions are hesitant to recognizesuccession clauses in a living trust unless a copy of thetrust agreement was filed with them by the trust creator orthey have other proof of the initial trustee's intent beforetransferring power over the accounts.

Secret #59. Increase cash flow byautomating your finances.

One of my goals is to simplify your financial life. Onereason is to reduce procrastination. I also don’t want you tohave to work full-time on your finances. The point offinancial security is to be able to spend time doing thethings you really enjoy. That’s why I constantly am search-ing for ways to simplify financial matters, and the bestways to do that are to consolidate and automate as much ofyour financial affairs as you can.

You start by having as few financial service providersas you can. The simplest structure is to have a discountbroker where you keep all your investment accounts (tax-able accounts and IRAs), checking account, and safetyfunds. Many brokers now have an affiliated bank so theaccounts are managed seamlessly and even issue credit anddebit cards.

An alternative, which is becoming more attractivebecause of technology changes, is to have your financialaccounts at different firms but aggregate the information ina central location. You can do this through either a web siteor computer-based software.

Don’t stop with consolidation. Many bills now can be paid automatically, and that’s a

good idea for recurring, regular payments such as utilities.You can have the provider draft the amount automaticallyfrom your checking or other account. An alternative is tohave it charged automatically to a credit or debit card.

When the amount is the same each month, you can set upautomatic payments through your checking account orthrough personal finance software such as Quicken. Apotential advantage of automatic payment through yourchecking account or personal finance software is youmight find it easier to cancel or change the paymentamount at any time.

Automatic payments mean you spend less time on yourfinances. You review things. You determine if the bills areaccurate and compare the bills received to your checkingaccount statement (either on paper or online).

Another way to simplify finances is to put all non-automated expenditures on a debit or credit card. Or youcan use different cards for different types of expenses. Theadvantages are you make only one payment per month (ornone if you use debit cards) and can see where all yourmoney went. You’re likely to avoid any late paymentpenalties and interest charges. You also can have the creditcard bill automatically drafted from your checking accountif you want.

There are other advantages to making payments on acredit card. You might earn points in a reward program.You also receive some consumer protection, because acredit card company intervenes in disputes with merchants.

When you’re still working, have saving and investmentdecisions made automatically to the extent you can.Amounts should be deducted regularly from your paycheckor checking account to be invested in your 401(k), IRA,and taxable account. Most people have automatic 401(k)contributions, but not the others. It’s better to have invest-ments made automatically instead of waiting for you tofind the time to transfer money from checking to theinvestment accounts.

When money is transferred to your investmentaccounts, it should be invested right away according toinstructions you set in advance, not kept in a money mar-ket account waiting for you to make changes. Most fundfamilies and brokers let you set up automatic investing.You always can change automatic investing plan on shortnotice or move money after it is invested.

Automating your finances doesn’t mean ignoring them.It means having most of the routine moves performed inthe background by others. That frees your time to focus onreviewing, planning, and making changes.

Procrastination is reduced when you set up automaticalerts or reminders about actions that need to be taken. Youcan do this the old-fashioned way by making notations onyour calendar. Web sites or software usually allow you toset alerts that are either e-mails or alerts that pop up on thescreen when you open the program or log on to the site.

You should have reminders to review your accounts inthe middle and at the end of the month. Be sure all thetransactions were made as they were supposed to andreview your overall financial status.

Secret #60. Curbing the high cost ofretirement medical care.

The cost of medical care continues to rise and to be the

wild card in retirement plans. Reports and studies updatetheir estimates of the cost of retirement medical care eachyear. They show the cost to be high and also very unpre-dictable for individual retirees and couples. The studiesfocus on average or median costs. You have to be awarethat individual costs vary greatly because of differences inpersonal health, geography, and insurance coverage. Yourretirement medical costs can be substantially higher orlower than the forecasts.

We’re talking about out-of-pocket costs, those expens-es that aren’t covered by Medicare. People on averageincur higher medical costs than these estimates, butMedicare picks up some of the costs.

A couple retiring in 2013 and incurring median drugexpenses during retirement would need to save $151,000 tohave a 50% chance of covering their lifetime costs for pre-scription drugs only, according to the 2013 study from theEmployee Benefit Research Institute. Those who incuramong the highest medicine expenses are likely to needover $220,000. The good news in the report is that the pre-scription drug expense estimates are lower than in the pastbecause of a reduction in the rate of growth of medical anddrug costs.

Remember those estimates are only for prescriptiondrug costs. To have a high probability of paying all non-covered medical costs after age 65, EBRI estimates a cou-ple age 65 in 2013 with a high level of medical expenseswill need savings of $360,000.

How will these costs be paid? EBRI estimates thatMedicare covers about 62% of medical costs for benefici-aries. (I’ve seen other reports estimate that Medicare paysonly about 50% of costs.) Another 13% comes from pri-vate insurance and about 12% is paid by the retirees. Therest is paid by state programs, employer retirement bene-fits, and other sources.

There are steps you can take to reduce both the out-of-pocket medical costs and the uncertainty of your exposureto the medical costs.

• Those not already retired should establish goodhealth habits, including participating in any employment orcommunity wellness programs.

• When you’re eligible for a health savings account,take advantage of the option and fund it with the maximumamount each year. Contributions to HSAs are deductible ifmade by you and excluded from gross income if made byyour employer. Earnings on the account compound withouttaxes, and all amounts withdrawn from the account are tax-free when withdrawn to pay for qualified medical expens-es. It’s a good way to build a tax-advantaged retirementfund for medical expenses.

• Enroll in Medicare when first eligible. You pay apenalty for life if you decide later to sign up for Medicareor Part D Prescription Drug Coverage after your initialenrollment period expires.

• Sign up for Part D Prescription Drug Coverage. Thisis private insurance that is partially subsidized by the gov-ernment. Prescription drugs are the largest medical expensefor most of those age 65 and older. A good policy reduces

your out-of-pocket costs and the uncertainty of how muchyou’ll pay should you have an above-average or cata-strophic need for medicine.

When you don’t have much need for prescription drugsat the start of retirement, sign up for a barebones, low-costpolicy. You always can switch to a more robust policy dur-ing a future open enrollment period if you need it and willavoid the premium penalty for signing up for Part D late.

• Consider a Medicare Supplement policy. Whenyou’re in traditional Medicare (not Medicare Advantage),there are a number of deductibles, copayments, and cover-age gaps. A Medigap policy will cover some of them andreduce your uncertainty. There are 10 different Medigappolicies to choose from, so you can look for the right tradeoff for you between premiums and better coverage.

• Shop around. I can’t stress this enough. Recent stud-ies have found that premiums for identical coverage for thesame person can vary by 100%. There are people payingtwice as much for Part D and Medigap policies than theyshould because they didn’t shop around. The insuranceindustry counts on a combination of inertia and people dis-liking insurance shopping. It costs people a lot of money.

• Have flexibility. A retirement plan needs a cushionand some flexibility because of the uncertainty of medicalexpenses. You should minimize fixed expenses so thatspending changes can be made in case uncovered medicalexpenses arise.

• Plan for long-term care. Medicare won’t cover muchof any long-term expenses you incur, and most of youwon’t qualify for Medicaid. You probably don’t want torely on Medicaid for long-term coverage anyway, becausethe level of care by facilities accepting Medicaid usually isconsidered to be of lower quality than at others.

I recommend most people plan on using severalsources to pay for LTC. Part of the cost can be fundedfrom savings. There probably are expenses you incur nowthat you won’t if you need LTC, and that money can beused to help pay for LTC.

To pay for the bulk of the coverage, you should con-sider obtaining either a standalone LTC policy or an annu-ity or life insurance policy with a long-term care rider. Oryou can combine both types of coverage. Tapping the equi-ty in your home through either a reverse mortgage or a salecan be a good way to plan for extended long-term careexpenses. By using all these tools, you’ll have a solid planto cover any LTC you need.

The estate tax finally was made permanent in 2013. Nomore temporary provisions, expirations, and the like. Thelifetime exemption was kept at $5 million (indexed for infla-tion; $5.45 million in 2016), and the top estate tax rate wasraised to 40%. Though most estates now are exempt fromthe federal estate tax, estate planning still should be a keypart of your financial planning. Estate planning is aboutmuch more than taxes.

Estate planning is easier than most people believe.That's because most estate planning experts shroud the topicin complex tax, legal, and insurance jargon. Most peoplecan't get interested in discussions of probate, reversionaryinterests, split interest trusts, and related topics. Maybe theexperts want to add some mystery to the process, or perhapsthey don't know how to communicate in plain English. Thereason doesn't really matter. What matters is that most pre-sentations on estate planning cause people either to avoidplanning their estates or to put together hurried, inadequateestate plans.

That's why I've put together this simple guide I callthe "20 Minute Estate Plan." It provides simple, practicalexplanations that will help determine the right elements ofyour estate plan. This isn't a complete self-help guide,because you'll still need to meet with an estate planner. Butyou'll know how to work with an estate planner and intelli-gently discuss your options. That will save time, money, andfrustration and also result in a superior estate plan.

More Than MoneyA few years ago this discussion would have began

with taxes. Non-tax factors in estate planning would havebeen discussed only after taxes. It’s different now. We’ll dis-cuss tax reduction later. That’s because estate planning isabout more than taxes, and even people without a poten-tial estate tax burden need full estate plans. The focus ofestate or inheritance planning is on wealth. But there aremore elements to a good plan than tax reduction.

Your plan should contain a durable power of attor-ney or revocable trust to ensure your assets are managed incase you are disabled. There should be a health care proxyor power of attorney so that it is clear who will make healthcare decisions on your behalf. You also should consider aliving will or other instructions regarding your medical care.You need to ensure that your estate has enough cash and liq-uid assets to pay taxes, debts, specific bequests, and otherobligations. Otherwise assets will have to be sold in a hurryto meet obligations.

That's inheritance planning in a nutshell, and we’llflesh it out in the coming pages: the 20 Minute Estate Plan.You’ll have an organized way of making your estate plan-ning decisions and putting together a comprehensive plan

that meets your goals. You’ll also know enough so that youcan discuss the issues with an estate planner, and that willsave you both time and money. Each month in RetirementWatch we discuss more about estate planning. We stay up todate on the latest changes and strategies and learn how toadapt to the coming fluctuations in the law.

Estate Planning BasicsWhat is estate planning? It's not avoiding taxes or

probate. Estate planning is deciding how your wealth shouldbe transferred to the next generation (or other heirs of yourchoice), then determining which legal tools to use to meetthose goals. Only after establishing how you would like theassets distributed do you consider ways to reduce taxes,avoid probate, and other goals. Lawyers and others like tocall the process estate planning, but it really is best to thinkof it as inheritance planning. That puts the true purpose ofthe process in the forefront.

To begin the inheritance planning process you needto take these steps:

l Make a list of all your assets and liabilities. Youcan't prepare an effective inheritance plan without this infor-mation. And a professional, no matter how skilled, can't doanything without this starting point. Don't forget frequentlyoverlooked assets such as pension plans, life insurance poli-cies, trusts of which you are a beneficiary, and inheritancesyou are likely to receive. Your heirs will inherit only yournet assets, so you'll need to compile a list of all your debts,including whether or not the debts are secured by certainproperty.

l Decide how you would like the assets distributedin the future. The traditional goal is for major assets to beinherited first by the spouse if he or she still is alive, then bythe children, usually in equal shares. Smaller amounts orspecific items might be designated for special friends orother relatives. Of course, you don't need to follow the tra-ditional route. You might want to favor one child over oth-ers, or you might want the bulk of your assets to go directlyto your children instead of your spouse. Many people decideto give a portion of their estates to charity. The only real lim-its placed on your choices are that a spouse cannot be com-pletely disinherited (unless there is a valid prenuptial orpostnuptial agreement) and children can be completely dis-inherited if the intention is made clear in the will.

As part of this step, you'll have to consider second-ary goals. For example, would you like your spouse to inher-it everything but only so that the property could not subse-quently be inherited by a second spouse or family instead ofby your children? Would you like to leave property to yourchildren and grandchildren but with strings attached so that

Your 20-Minute Estate Plan:Building a Lasting Legacy

they don't waste the property or have to reach certain goalsbefore getting the property? There are ways of accomplish-ing both your main and secondary goals, as long as youmake the goals clear.

l How much do you want to give now, and howmuch later? It's easier to reduce taxes and other costs if youare willing to part with some of your wealth now. Some peo-ple want to do that, others don't want to or can't afford to.

l Work with one or more estate planning profes-sionals to develop an estate plan that achieves your goalsand also takes into account estate taxes, probate, and otherconcerns. An average middle class individual might need towork only with an estate planning attorney. Other individu-als might need to add a life insurance agent, businessappraiser, trustees, and other professionals.

l Implement the estate plan after you fully under-stand it. Many people have great estate plans designed byskilled professionals, then they fail to fully implement theplans. They don't set up trusts recommended by their plan-ners or fail to transfer assets to the trusts. Maybe life insur-ance is not purchased as planned, annual gifts to children arenot made, or each spouse does not have title to enoughassets to take advantage of the lifetime exemption equiva-lent. Don't let any of that happen to you.

l Let your heirs know what you have decided andhow things are set up. You can meet with them directly. Youalso should put together a letter of instructions that givesbasic information such as where your will is kept, who yourfinancial advisers are, and summarizing your assets and lia-bilities. This document should be updated at least annuallyand be accompanied by recent tax returns and an outline ofyour estate plan, at the minimum.

As you can see, from your point of view an inheri-tance plan really involves people more than law, life insur-ance, trusts, and other legal tools. Your focus should be onhow you want to provide for people both now and after youare gone, and also how you want people to remember you.Then you should communicate your decisions to the peopleinvolved.

Eight Key Estate PlanningQuestions

Estate planning is not only about reducing estatetaxes. That always was the case, but few people realizedthe importance of the non-tax factors until recently, andmany still don’t.

Every estate plan, regardless of the estate’s size,needs to address certain issues. Ignore these issues, andyour heirs will be worse off than they need to be. Taxissues, if there are any, should be considered only after thefollowing issues are confronted.

What is the estate? Estate planning is gettingassets to one’s objects of affection in the most efficient andlowest cost-way possible, and in the most appropriate own-ership form. The first step is to develop a complete, cleardescription of your assets and liabilities. The estate also

cannot be administered efficiently unless the executor oradministrator knows what is in the estate. Frequently, itcosts too much and takes too much time to administer anestate because the administrator is searching for detailsabout the estate.

Prepare a statement of your assets and liabilities.List all your assets, including intangible assets, such astrusts of which you are a beneficiary and life insurance.Describe the property clearly, estimate its value, and statewhere your records on it are kept. Update the list at leastannually. Be sure your estate administrator knows where tofind the list.

Who is in charge? An estate needs an administra-tor or executor. The name depends on the state, but the jobessentially is the same. This person is legally responsiblefor getting the estate through the probate process, payingdebts, selling assets as needed, and distributing the proper-ty as directed by the will.

Traditionally your estate planning lawyer is namedthe executor. But in most states that entitles the executor toa percentage of the estate, regardless of the amount ofwork involved. To keep costs low, the best choice often isa responsible family member or friend of the family whowill waive any fee or work for a reasonable fee. An attor-ney can be hired by the hour to handle the difficult or tech-nical work.

This is an important appointment and should becarefully considered.

Who should share in the estate? Usually it is aneasy choice to give the bulk of the estate to the survivingspouse and then to the children and perhaps grandchildren.But that isn't always the case.

Sometimes serious thought is given to leaving achild out of the estate. Many families have a child whosebehavior concerns the others. In most states a child can bedisinherited completely. First, consider two other options.One option is to leave the property in a trust. Another fam-ily member or friend can distribute income and principalaccording to the trust guidelines. We have discussed suchtrusts in past visits. Another option is to leave the individ-ual less than a full share of the estate. Provide in the willthat this individual loses even that amount if he or shechallenges the will and loses. The trick is to find anamount the individual won't want to risk losing.

Blended families also present dilemmas. Oneexample: Should stepchildren be included in your will?Are they already provided for by their biological parents ordo you not want to include them in your estate?

Some people consider putting special friends orcharities in the will. In that case it is key to let other natu-ral heirs know about the choice. They should not be sur-prised by the will, so they will not misunderstand the rea-sons for your actions.

Should shares be equal? It is natural to leavechildren equal shares of the estate. Some parents want toleave less to children who have had more financial successthan other children on the theory that they do not need themoney. Unfortunately, if this intention is not clearly

explained ahead of time, they often view it as being pun-ished for success or an indication that the parents had moreaffection for the others. An option is to equally split about80% of the estate and put the rest in a reserve trust. Let thetrustee distribute that money according to needs or otherstandards you set. Another issue is whether higher lifetimegifts or other help for one offspring should be offset by theinheritance.

Leaving equal shares can be difficult when a fami-ly business is involved. There often are conflicts betweenthe children who are running the business and those whoaren't. One solution is to provide life insurance benefits forthose children not running the business or that enablesthose in the business to buy out the others. Another optionis to give the children not in the business equal shares ofequity and income but no voting interest.

How much to give now? The old estate tax put apremium on using lifetime gifts to reduce an estate. Now,fewer estates need lifetime gifts to keep the estate tax billlow.

Lifetime gifts still can be valuable. Loved oneswon't have to wait to use your wealth to improve theirlives, and you get to see the results. Some people use life-time gifts to see how loved ones will use the money. Thiscan help determine if the estate will be given outright or ina trust.

The traditional approach is to leave the bulk of theestate to your spouse with the children inheriting later. Butthe children might have needs in the meantime, such aswedding expenses or the down payment on a home. Youmight want to provide the children cash for such expensesif that can be done without depriving your spouse.

Lifetime gifts take many forms other than straightgifts of cash or property. You can pay tuition bills, con-tribute the down payment on a home, help start a business,or pay medical expenses. A popular gift is to pay for all orpart of a family vacation.

When making lifetime gifts, be sure to retainenough to maintain your standard of living, including pos-sible emergencies. You need to assume that at least onespouse will live well into his or her eighties.

Should there be controls or incentives? When anheir is too young or otherwise unable to handle wealthresponsibly, it is appropriate to give the property through atrust or with other restrictions. You need to decide whichgifts and bequests should be made in this way, what therestrictions should be, and when, if ever, they should belifted. If some heirs will receive unrestricted bequestswhile others do not, you should explain this in advance.

In the last decade or so, incentive giving becamemore popular. Generally, property is left in trust and doledout to heirs as they meet certain goals. Distributions mightoccur upon graduating from college or staying employedfor a minimum time. Some people believe incentive trustsresolve the dilemma of how to give while ensuring chil-dren become responsible citizens.

Others, however, believe incentive trusts are toocontrolling or inflexible. If you use this tool, be sure the

effect is not to channel children into activities they don'treally like or that are unsuitable for them. In addition, beaware that at some point the children likely will resent andfeel stifled by the restrictions. An incentive trust should notbe set up to last forever.

What about special assets? You might have a col-lection, personal mementoes, or other assets that mean alot to you but not as much to your loved ones. Or the lovedones might not have the time or expertise to continue car-ing for the property or even to ensure receiving maximumvalue from selling the asset.

Give careful thought to such assets. Some peoplefind it best to sell the asset themselves. Others line up acharity or someone else who eventually will buy or receivethe asset.

Personal mementoes and effects, even when theyhave no real financial value, often cause the worst estatedisputes. Be sure to establish a plan for how such assetswill be distributed among your heirs. We have discussedalternatives in past visits, and these are available on theweb site Archive.

Is it good enough? Some people never finish a willor estate plan, because they do not find the perfect answersto these questions. It is better to complete an estate plan instages than to not have nothing in place while you wait forthe ideal solution.

How to Leave a LegacyEstate planning is the process of building a legacy.

When people think estate planning is about money, proper-ty, and death, they tend to ignore the process. When theyrealize it is about values and other elements of buildingand living a legacy, they are more interested in making aplan.

This was made clear in a survey done for AllianzGroup. The survey asked Baby Boomers and their parentsquestions about inheritance and related issues. It found thatthe non-financial aspects of planning are at least as impor-tant to both groups as are the assets and finances.

What are those nonfinancial issues that need to beconsidered?

Values and life lessons are a key part of leaving alegacy. In fact, most Boomers in the survey said that thiswas the most important part of a legacy. (Yet, about 40%of the parents believed that leaving financial assets isimportant, even an obligation.) Both the Boomers and theirparents believed that conveying this information occursthroughout life, not just in an estate plan.

This part of legacy building is enhanced by alsoleaving some kind of values statement. Sometimes this iscalled an ethical will, a document in which the writerexpresses hopes and values and imparts words of wisdomto loved ones. This can be part of the letter of instructionswe discussed last month or it can be a separate document.

Instructions and wishes also are important as wediscussed last month. While it is important to leave this

information in writing, it also is key to discuss it inadvance with the affected people. That provides an oppor-tunity to answer questions, respond to objections, and per-haps change the instructions. It also gives people an oppor-tunity to get used to your plan.

Personal possessions are a prime cause of estatedisputes, though few people believe that when preparingtheir estate plans. Items of seemingly little financial valueseem to have a strong emotional value to someone, or arean excuse to air unrelated, simmering grievances.

A good estate plan provides a way to disperse thepersonal items without triggering a dispute. Ideally, thedisposition of the personal items is made clear in advance.The decision can be made jointly by everyone affected, orthe parent can decide and let people know the decision.

Communication is vital to an effective dispositionof personal property. The older generation needs to com-municate with the younger generation its thoughts aboutthe property and also needs to learn which items of person-al property are of intangible value to which members ofthe younger generation.

The financial assets are the final key to the plan.The parents need to decide how these will be divided andlet the children know the general scheme.

One interesting aspect of the survey is that bothBaby Boomers and their parents in general agreed thatinheritances should not necessarily be equal. A majority ofboth groups believed in some kind of performance-basedallocation, especially for a child who took care of the par-ent. Parents were more likely to believe that less wealthshould be left to the more financially secure children or tothose who share fewer of the parents' value or who are lessfinancially responsible.

Indeed, over a third of the seniors believe thatinheritance decisions are an important source of power andcontrol. The decisions allow the estate owner to base inher-itances on the achievement of certain goals, milestones, orother behavior.

Whatever parents decide about dividing the estate,they should convey the general scheme to their children.Otherwise an unequal division, especially disinheritance,will trigger a dispute over the estate.

The survey also found that Baby Boomers aren’tlikely to know the extent of their parents' wealth. Thismight provide difficulty for the Boomers when the inheri-tance comes through. Some will end up with less than theyanticipated. Most likely there are a number of Boomerswho are basing their saving and investing decisions on anestimate of the wealth they will inherit. If the inheritancefalls short, these Boomers will be looking to retirementwith less money than they anticipated. Some Boomers willinherit more than they expected and will be unprepared tomanage the sum.

A successful plan considers all the aspects of estateplanning, not just the division of the dollar amount. A goodplan also involves soliciting ideas from the heirs over someissues, and communicating in advance the basic plan to allinvolved.

Popular Strategy Ruins EstatePlans

Many people naively undermine their estate plans,creating nightmares for their heirs and potential bonusesfor the taxman. The situation is easy to cause, but also iseasy to fix.

The problem is that few people realize the impor-tance of the wording of the legal title to their assets. Yet,this simple decision, often made without much thoughtwhen an asset is purchased or an account is opened, cannegate all the good features of an estate plan.

Most married couples buy assets and openaccounts jointly with right of survivorship. It seems fair, isconvenient, and gives security to the spouse with lowerincome. But it can disrupt many of the goals of an estateplan.

When a spouse passes away, full legal title to theproperty automatically goes to the surviving spouse. Noneof the jointly-titled assets go to any other beneficiariesnamed in the will. A jointly-titled asset also cannot betransferred to a trust through the will. The result can beboth tax and non-tax problems.

There can be estate tax problems for the survivingspouse in large estates. He or she will have full title to allthe assets and will have to do all the planning once bothestate tax exemptions are used.

The opportunity to increase the tax basis of assetsalso can be lost. When property was held jointly, the sur-viving spouse retains his or her original tax basis in halfthe asset. Only the half that is inherited from the firstspouse has its basis increased to fair market value.

On the other hand, if the first spouse to die hadsole title to an asset, then the inheriting spouse couldincrease the basis to its current fair market value. Therewould be no capital gains taxes imposed on the apprecia-tion during the first spouse's lifetime.

There also are potential non-tax problems.If the marriage is a second one, then joint title pro-

vides no protection for children of the first marriage. Thesurviving second spouse will get full ownership of thejointly-held assets. The children of the first marriage mightend up with no assets from the estate.

Joint title offers some protection of assets fromcreditors, making joint title a fairly common asset protec-tion strategy for those in high-risk professions, such asdoctors. But the strategy could backfire. Suppose the sur-viving spouse is the one with the creditors. Then, on thedeath of the first spouse the creditors can lay claim to allthe assets. The opportunity is lost to have the first spouseleave assets in trusts so that they are protected for the nextgeneration.

A better strategy would have been to give thespouse without creditors full title to the assets, then in hisor her will they would be transferred to a trust for the ben-efit of the other spouse, the children, or both.

Another potential problem with joint title of finan-cial accounts is that either owner can empty the account atany time. This frequently happens when a divorce is con-templated. One of the spouses decides to take title to allthe assets in the account. It also can happen if one spousedevelops a problem such as substance abuse or gambling.

A related common estate planning strategy is foran older person to add an adult child to the account as jointowner with right of survivorship. These arrangements haveseveral virtues. The assets avoid probate and are automati-cally transferred to the adult child. Also, the adult child isable to write checks and otherwise manage the financesshould the older person become unable to.

Again, in these arrangements the joint owner cantake the entire account whenever he or she wants. Thechild really needs to be trustworthy and sensible for thisarrangement to work. Another shortcoming of the strategyis that the account is subject to claims of the child's credi-tors. The creditors are not a problem in many states whenthe joint owners are a married couple. But when the jointowners are not married, the rules are different. All or partof the account can be claimed by creditors of one jointowner. The rules vary from state to state.

Also, adding a child's name to an account or assetcould trigger a gift tax liability or use up part of the life-time gift tax credit. This is especially true if a child's nameis added to the title for a valuable asset such as real estate.

Another titling mistake involves revocable livingtrusts. These generally are set up to avoid probate and alsoto provide for management of assets in case of incapacity.The problem is that many people do not transfer title oftheir assets to the trust. The living trust has no effect unlesslegal title to assets is shifted to the trust. The trust creatormust change the titles on all financial accounts, real estate,automobiles, and other personal property. Many don’t dothis.

One reason joint accounts and living trusts arewidely used is that people believe these tools will saveestate taxes. They will not. We already discussed the taxeffects of joint title. With a living trust, all assets in thetrust are included in the estate of the trust grantor when heor she dies.

Ensuring the optimum legal title for assets is animportant part of an estate plan. Failure to properly titleassets can result in assets going to the wrong person, inad-vertent disinheritance of loved ones, higher estate taxes,unexpected gift taxes, theft, and loss of assets to creditors.Here are some guidelines to follow:

n When there are children from a first marriage,assets that are intended for them should not be held in jointtitle with the current spouse.

n A financial power of attorney should be used toname the adult child or other person who will take chargeof the finances when the parent is incapable. Joint titleoften is not a good substitute.

n Joint title should not be used with a spouse oradult child who is at risk to creditors, gambling problemsor substance abuse.

n Remember that beneficiary designations onIRAs, qualified pension plans, and other financial accountssupercede anything stated in a will. Whoever is named asbeneficiary will inherit the assets.

n Highly appreciated assets probably are besttitled in one person's name, so that whoever inherits canincrease the tax basis to current fair market value.

Reducing The Tax BurdenOnly after goals are established do you consider tax

reduction. Once your goals are clear, an estate planner usu-ally can give you several options to accomplish those goalsand compute the different tax effects of each option. Thenyou decide how to merge the tax plan with the personal planto come up with one plan that comes closest to meeting yourpersonal goals at the lowest possible tax cost.

The estate tax really is fairly simple. First, all theassets in which you have an ownership interest are compiledand valued. The total value of all the assets is known as thegross estate. From the gross estate, several deductions areallowed. Your debts are deducted, as are the administrativeexpenses incurred by the estate, such as lawyer's fees, pro-bate costs, and similar expenses. Another deduction is themarital deduction. The final deduction is for charitable con-tributions.

After the deductions are taken, the remainingamount is your taxable estate. To this you add back lifetimegifts, and compute the tentative estate tax on that total. Thenyou subtract prior gift taxes paid, the unified estate and gifttax credit, and any state death tax credit (though the creditgenerally is repealed). The result is the estate tax payable.There also might be a generation skipping tax for gifts madedirectly to grandchildren.

From this computation, you can see that there areseveral basic ways to reduce estate taxes:

n Get assets out of the gross estate or reduce thevalue placed on assets.

n Maximize the use of deductions, such as the mar-ital deduction and charitable contribution deduction.

n Use the lifetime estate and gift tax credit.n Don't reduce taxes. Buy life insurance to pay the

taxes or provide an inheritance.All the estate planning tools you hear about spring fromthose four strategies. Some tools can combine two or moreof those strategies. Now let's take a look at the more com-mon strategies so that you'll be able to discuss them withyour estate planner.

Basic Tax Reduction StrategiesOnce you have decided on the personal goals of

your inheritance plan and have estimated the estate taxesthat would be paid if no tax reduction measures were taken,it is time to consider tax reduction strategies. Many of youwon’t have to worry about federal estate taxes and can skipthis section. If you live in an estate with estate or inheritance

taxes, you need to plan to avoid that. If your estate is nearing$5 million and is likely to grow in value over the years, youshould consider estate tax reduction. Your estate plannerwill ask you to consider some of these basic strategies:

� Full use of the marital deduction. This involvesleaving all the property to your spouse. The marital deduc-tion will fully eliminate estate taxes. The problem with thisstrategy is that it simply defers the taxes until your spouse'sdeath. Then your spouse must decide how to reduce estatetaxes without benefit of a marital deduction or your estatetax exemption equivalent.

� Maximize the lifetime estate and gift tax credit.Everyone gets a lifetime estate tax exemption equivalent inthe form of a tax credit. This exempts up to $5.45 million forestates of those who pass away in 2016 and increases forinflation after that. Previously to take full advantage of thiscredit each spouse had to have property in his or her nameat least equal to the value of the credit. The estate taxexemption was a “use it or lose it” benefit. A spousecouldn’t take advantage of the unused credit or a spousewho predeceased him or her.

Now, we have portability of the estate tax credit. Asurviving spouse receives the unused exemption of the firstspouse to die, if the estate executor makes an election on theestate tax return. This portability makes it easier for a mar-ried couple to fully exempt $10 million (indexed for infla-tion) in assets without having to change title to the assets.Some people are saying portability means estate plans nolonger need to include credit shelter trusts (see below). Thatisn’t the case for most estates. There still are good tax andnon-tax reasons for credit shelter trusts, even for estate thataren’t big enough to be hit with federal estate taxes.

� Make lifetime gifts. You can give any person upto $14,000 worth of property in 2015 without incurring gifttaxes, and you can make these annual gifts to as many peo-ple as you want. (The amount is indexed for inflation.) Ifspouses gives jointly, the exempt amount is $28,000 annual-ly. That means if you have three children and you and yourspouse give jointly, you can get up to $84,000 out of yourestate annually without incurring taxes. You can make directgifts of the property or put it in a trust, and you can giveaway more if there are grandchildren. These gifts are inaddition to the lifetime estate and gift tax exemptionamount.

� Make large lifetime gifts. The full $5 millionlifetime estate and gift tax credit can be used against eitherestate taxes or gift taxes or a combination of the two. If youcan afford to be without the property, it is better to use thecredit now with large gifts than later through your estate.That's because estate and gift taxes are based on the value ofproperty. If property is appreciating, your heirs get more taxfree wealth if you give it away now rather than giving itaway later when the taxes will be computed on the appreci-ated value.

� Use a credit shelter trust. This trust accomplish-es several goals. It ensures that you take full advantage ofthe lifetime exemption equivalent if you haven't done soalready. The trust also allows your spouse full use of theproperty and its income during his or her lifetime, but

ensures that any remaining property will go to your children(or other beneficiaries you designate) rather than to a poten-tial second family or other objects of your spouse's affec-tion. The credit shelter trust simply involves leaving proper-ty up to the exempt amount to a trust of which your spouseis beneficiary for as long as he or she is alive, then has yourchildren as beneficiaries after your spouse's death.

� Use irrevocable trusts. Property that is trans-ferred to an irrevocable trust is excluded from your grossestate if you are not a beneficiary of the trust. You'll proba-bly owe gift taxes when the trust is set up, but that should becheaper than paying estate taxes down the road. Or you canput just enough into the trust each year to take advantage ofthe annual gift tax exemption. With an irrevocable trust, youcan give gifts with strings attached. That protects heirs fromthemselves and also from being spoiled or otherwise dam-aged by an inheritance.

� Use life insurance to pay taxes or provide aninheritance. Life insurance benefits are included in yourestate only if you have any ownership interests in the policy.Life insurance can avoid being included in your gross estateif the policy is owned by either an irrevocable trust, a limit-ed partnership, or another individual. With life insuranceyou might be able to leave your heirs more after-tax wealththan you could otherwise, especially if you and your spouseare covered by a joint life or survivorship policy.

� Give to charity and heirs. There are variousstrategies, such as charitable remainder trusts and charitablelead trusts, that allow your estate to take advantage of thecharitable contribution deduction while providing income orproperty to your heirs.

� Family limited partnerships for businesses.Many business owners have found that family limited part-nerships let them reduce gift and estate taxes, keep the busi-ness intact, and still retain control of the business duringtheir lifetimes.

� More sophisticated strategies. People with morewealth than $10 million or with complicated assets such asfamily businesses should meet with an estate planner to dis-cuss strategies such as family loans, intentionally defectivegrantor trusts, personal residence trusts, and others.

More Estate Planning Tips(Mostly About IRAs)

How to make your beneficiary designa-tion form air-tight.

Mistakes and over-sights by IRA owners preventtheir heirs from maximizing the after-tax benefits of theaccounts. As we have discussed the source of many prob-lems is the IRA beneficiary form, a document to whichmost IRA owners devote only a minute or so. This formshould be an important element of an estate plan, and someIRA owners should skip the standard forms offered by theIRA custodian and submit their own customized benefici-ary forms.

Shrewd IRA owners will take the following steps:l Be sure beneficiary designations and the desig-

nation form are key elements of your estate plan.l Review the beneficiary designations regularly to

determine if changes need to be made.l Don't hesitate to have your estate planner draft a

custom beneficiary form and submit it to the custodian. Ifthe custodian will not accept the customized form, searchfor another custodian.

l Keep copies of the forms and be sure beneficiar-ies and the executor have access to them.

l After making changes in a beneficiary form, askthe custodian to return the old form so that there will be noconfusion in the custodian's records. Some advisors alsorecommend that you send two copies of the new form andhave one copy stamped "received" with the date andreturned to you.These five simple steps practically guarantee your IRAcustodian carries out your instructions to the "T". The "magic" word you should ALWAYS puton your beneficiary form.

After making changes in a beneficiary form, askthe custodian to return the old form so that there will be noconfusion in the custodian's records. Some advisors alsorecommend that you send two copies of the new form andhave the custodian stamp one copy "received" with thedate and returned to you.

Two questions to ask your IRA custodian ifyou want to name a trust as your beneficiary.

If you are considering naming a trust as the IRAbeneficiary, does the custodian allow this? The tax lawallows it, but the rules are complicated. An experiencedestate planner is needed to be sure the trust complies withIRS requirements. Some custodians don't want to botherwith the details. Be sure to ask the custodian: Do youaccept trusts as beneficiaries of IRAs? If so, what are yourrequirements? Many custodians want the trust agreementon file ahead of time, and some want their IRA experts toreview it. Some want the agreement or an affirmation thatthe trust still is valid submitted each year.

The one beneficiary you can name whoNEVER pays a single dime in distributiontaxes.

Unlike when other assets are inherited, benefi-ciaries of an IRA pay income taxes when they take distri-butions from the IRA. The beneficiary pays the sameincome taxes on distributions that the owner would havepaid. These taxes cannot be avoided, and the fact of themmight influence who is named beneficiary of the IRA orhow much is left to different beneficiaries.

A non-IRA asset is more valuable to an heir thanan IRA of equal value, because there will be income taxeson distributions from the IRA. The non-IRA asset can besold and no capital gains taxes would be due on the appre-ciation that occurred during the owner's holding period.

The income taxes due on IRA distributions are a

reason to consider making charitable gifts with the IRArather than with other estate assets. The IRA will beincluded in the estate, but there will be an offsetting chari-table contribution deduction, for no net tax. A charity thatis named beneficiary of an IRA will not owe income taxeswhen it takes distributions. If there is an inclination tomake charitable gifts through the estate, it often is better tomake the gifts through an IRA and maximize the non-IRAassets left to other heirs.

Special exception that lets you take an IRAdistribution before 59½ for any reason withNO penalty.

IRA owners who take distributions from an IRAbefore age 59½ face two consequences. They owe incometaxes on the distributions. In addition, they owe an earlydistribution penalty equal to 10% of the distributions. Whatmany people do not realize is that the 10% early distribu-tion penalty does not apply to beneficiaries of an IRA. Infact, beneficiaries are required to begin taking distributionsfrom an inherited IRA. They owe income taxes but not thepenalty, regardless of their age.

Two entities you should NEVER name as yourIRA beneficiaries.

The goal of most IRA owners is to allow their ben-eficiaries to continue benefiting from the tax deferralpower of the IRA. They do not want beneficiaries to beforced to take distributions on an accelerated schedule andhave to pay income taxes on the distributions. If that isyour goal, be sure to name individuals as primary and con-tingent beneficiaries. There are two beneficiaries you defi-nitely should not name. One is the estate. Name the estateas the beneficiary (or fail to name a beneficiary) and distri-butions will be required on an accelerated schedule. Thetax deferral power of the IRA will be lost.

Likewise, a living trust should not be named asbeneficiary. Owners of living trusts are told to put all oftheir assets into the trust. But only assets that will be sub-ject to probate should be put in the trust. An IRA willavoid probate. If you name the living trust as beneficiary,the estate will be considered the beneficiary and accelerat-ed distributions will be required.

Have a business you want to pass on? Thereis at least one strategy that will drasticallyreduce estate taxes, provide cash for theestate, and allow the owner to stay in control.

Business owners often put off estate planning, andas a result the business does not survive for the next gener-ation. The key issues for many business owners are that toreduce estate taxes they have to give up some ownership orcontrol today. There is at least one strategy, however, thatwill drastically reduce estate taxes, provide cash for theestate, and allow the owner to stay in control.

A strategy that probably is not used enough is theemployee stock ownership plan (ESOP). The tax law pro-vides a number of incentives to use an ESOP.

In a typical ESOP, a small business owner createsthe ESOP and a related trust. The company borrows moneyfrom a bank and in turn lends that money to the trust. The

owner sells some or all of his stock to the trust. Over time,the company makes annual contributions to the trust,which are deductible. The trust uses the money to repaythe loan from the company, which the company uses torepay the loan from the bank.

Special tax breaks allow the company to deductboth the interest and principal it pays on the loan. It alsogets to deduct contributions made to the trust as well asdividends paid on stock owned by the trust.

The owner also gets tax breaks. Gain from the saleof the stock are deferred if within a year the owner usesthe proceeds to purchase securities issues by domesticcompanies and meets other restrictions. Taxes are due onlyas the owner sells those investments. The owner can sellwhatever percentage of his stock he wants. In manyESOPs, the owner still retains a majority share of the com-pany.

An ESOP is best for an owner whose children donot plan to run the company and do not want to own it.The ESOP gives a share to each employee and must meetnondiscrimination rules; the owner cannot pick and choosewhich employees get greater shares in the ownership distri-bution. When an employee leaves the company, he receivescash equal to the value of his ESOP account. Employeesgenerally are allowed to vote on major corporate changes,such as mergers and acquisitions.

The ultimate "feud fighter".The most unexpected events can cause a will to be

challenged. A carefully planned estate becomes a mess aslegal fees lay waste to the family wealth and acrimonydrives members apart. It doesn't have to happen. In mostcases, a will contest and related lawsuits could have beenavoided with a few preventive steps.

Most people believe a will is likely to be contestedonly if they leave significant assets to someone outside theimmediate family, especially to a mistress, or to a secondspouse instead of to children from the first marriage. Thoseacts are likely to trigger a battle, but those are not the onlyor even most common causes of disputed wills.

A no-contest clause is the old-fashioned way ofblocking contests. Most estate planners recommend that nopotential heir be left completely from the will. Instead,leave the unfavored heir an amount that will be meaningfulto him or her. Then, include the no-contest clause, whichstates that anyone who challenges the will loses his or herinheritance if the contest fails. That way, the disgruntledheir has something to lose and cannot count on the modestinheritance to pay the legal fees. The heir has to risk losingboth the legal fees and the inheritance.

The no-contest clause is very simple. It simplystates that any beneficiary who challenges any term of thewill is not to receive any bequest under the will if the con-test is unsuccessful.

How to audit-proof your estate tax return.Planning an estate and implementing the plan don't

end the job. To meet your goals, take another step andensure that the estate will prevail in an audit. These stepsaren’t essential for as many people now. But if your estate

might be subject to federal or state taxes, then you’ll wantto read this next section.

Few people realize that the audit rate on estate taxreturns is far higher than the rate on income tax returns.The greater an estate's value, the more likely it is to beaudited. An estate tax return can be 10 or 20 times morelikely to be audited than an income tax return, dependingon the individual's wealth.

An estate audit often addresses issues beyond theestate. It is not unusual for an estate tax auditor to con-clude that prior income or gift tax returns need to be restat-ed. Add penalties and interest, and the stakes in an estateaudit can be quite high.

Keep the potential for an audit in mind during theplanning process. There are issues that make an aggressiveestate tax audit more likely, and steps you can take toavoid adverse results from an audit.

Valuations. The top targets for the IRS are returnson which the value placed on property can be questioned.The estate and gift tax is based on the value of assets. TheIRS increases tax revenue each time it successfully arguesthat the value of one or more items listed on the tax returnis too low.

When a large portion of an estate's value is in realestate or a nonpublicly-traded business, the IRS takesnotice. Art, antiques, and collectibles also can draw theIRS's interest. For all these items, there is no public marketprice. The value is subjective unless the property is sold toa willing, independent buyer.

The IRS has appraisers to challenge the valueplaced by the taxpayer's appraiser. The auditor will exam-ine how the value was determined by the estate and decideif the result should be challenged.

Gift challenges. An effective and frequently-usedestate tax strategy is to make gifts of property. If propertyis out of the estate, it is not taxed. There might be gifttaxes, or they might be avoided because of the annual andlifetime exemptions. In either case, the future appreciationis out of the estate.

The IRS challenges gifts in two ways.One challenge is to the value placed on the gift.

Suppose a corporation owner each year gives his childrenstock with a value that does not exceed the annual gift taxexclusion. Over time he is getting the value of the businessout of his estate without owing estate or gift taxes.

In this case, the IRS might challenge the valueplaced on the stock each year. It might argue that insteadof giving $10,000 of stock to each child each year, he gaveaway $20,000 of stock. The owner's estate and childrenwould have to establish the value of the stock for each yeara gift was made.

The second challenge is that a gift was not made.To make a legal gift, the owner might give away all benefi-cial interests in the property. Often, a wealthy individualwill purport to give away property without legally givingup control. The IRS loves to see that. If the owner retainseven partial control or some of the benefits of ownership,

the IRS will say that the entire value of the property isincluded in the estate.

For example, an individual has his lawyer changethe deed to a house or vacation house so his children arelisted as the owners. But the owner continues to make fulluse of the property and pays all the bills. Perhaps the chil-dren aren't even told the title was transferred to them.

Another common example: A business owner givesor "sells" the business to his children. But he retains a con-sulting contract or other arrangement that requires the busi-ness to pay him most of its income each year for life. TheIRS will say that there was no gift or sale, because therewas a side deal to pay the parent most of the income forlife. Often, there is evidence that the parent continues tomake most of the significant business decisions, indicatingthat he retained control.

Life insurance. If the insured retains any beneficialinterest in a policy, the life insurance proceeds are includedin his estate. To effectively give away a life insurance poli-cy, not only must the gift be complete but the gift must bemade more than three years before death.

An auditor will closely examine life insurancearrangements. If there is a life insurance trust, the docu-ments will be reviewed for any forbidden powers. Forexample, if the insured retains the right to change the bene-ficiary, the policy proceeds might be included in the estate.If a business owned life insurance, the arrangement will beexamined to see if the insurance benefits can be includedin the estate. Many estates overlook group term policiesoffered through the deceased's employer. The benefitsshould be included in the estate.

Missing property. The IRS expects that people whoown assets of a certain value also will own certain othervaluable assets. For example, if someone owns a milliondollar house, the IRS expects the furnishings to be worth asignificant amount. If a lesser amount is listed on the taxreturn, the auditor will want proof that really is how thehouse was furnished. The auditor will get a copy of thehomeowners' insurance to check the stated value of thecontents. The auditor also will look for riders coveringother valuable property, such as art, antiques, furs, col-lectibles, and jewelry.

Past income tax returns also might be examined. Ifproperty taxes for a boat are deducted, the boat better belisted on the estate tax return or proof of sale produced. Ifthe auditor believes the personal assets are understated, hemight even review the checkbook, credit card statements,and other records for evidence of purchases, repairs, orstorage of valuable assets.

Here are some steps that will protect your estateand heirs from an adverse estate tax audit.

File gift tax returns. When a gift tax return is filed,the IRS normally has three years to challenge the return. Ifno return is filed, there is no statute of limitations. Don'tfile a return, and your heirs might be forced to defend thevalue placed on gifts made 20 years earlier.

After making gifts, file a gift tax return. File areturn even if the gift qualifies for the annual gift tax

exclusion, especially when the value of a gift can be ques-tioned. You might not need to file a return for gifts of cashor publicly-traded property that are well-documented. Butfor business interests, real estate, collectibles, and similarassets, file a return to get the statute of limitations running.

Get quality appraisals. Be sure all your appraisalsare done by someone who does qualified tax appraisals andis experienced with IRS appraisals. The appraisal docu-ment should have an extensive explanation of how thevalue was determined. The exact format and length willdepend on the type of property valued. When hiring anappraiser, pretend you are an IRS auditor. Question theappraiser's training and experience in detail. Don't haveany broker or realtor appraise the real estate.

Remember the three-year rule. Life insurance andbusiness interests that were owned within three years ofdeath generally are included in the estate. If you want theassets out of your estate, sever all ties from them.

Keep great records. The IRS's favorite estates arethose in which the owner knew everything about everyitem of property, but all the information was in his head.When he dies, the IRS has a field day finding all the assetsand including them in the estate. It is up to the estate toprove that the assets should be excluded. Keep personalfinancial statements and past income and gift tax returns.Let your executor know where the files are that show thehistory of each asset.

At Retirement Watch we offer an array of portfolios forour readers. Unlike some, we don’t pretend there is a one-size-fits-all portfolio, and we don’t put forward a menu ofinvestment ideas and leave you to build a portfolio. Instead,I craft portfolios that are appropriate for different investors.

Our strategies have been successful. You don’t have totake my word for it. The Hulbert Financial Digest has beentracking our investments since 2000. It consistently rankedus among the top mutual fund newsletter and found that ourreturns exceeded the S&P 500 over that time with one-thirdless risk than the index. It also found that Retirment Watchis one of the best bear market performers. Higher returnswith lower risk. Those are our goals, and we’ve been able todeliver them for a long time. We don’t beat the index all thetime, but in the long-term our strategies earn higher returnswith less risk.

Let’s review how you should select from this choice ofportfolios.

There are three different investment approaches that canwork: strategic, tactical, and momentum. Most investorsshould use at least two of these strategies: strategic and tac-tical.

A strategic approach basically is a long-term buy-and-hold portfolio. Our strategic approach is the TrueDiversification strategy. True Diversification means thatparts of the portfolio do well in almost any market environ-ment. Investors can earn higher returns with lower risk usingthis portfolio instead of traditional portfolios.

A tactical strategy involves increasing the holdings ofsome assets and reducing others as economic and marketconditions and valuations change. This reduces risk,because you are selling or reducing assets that have donewell and are approaching excessive valuations. With timelypurchases of undervalued assets the strategy also can earnhigher risk-adjusted returns than buying and holding. It’snot a market timing or short-term trading strategy. We buyassets with the expectation of holding them for one to threeyears, though it doesn’t always work out that way.

We offer four different tactical strategies, that I call ourManaged Portfolios, because investors have different risktolerance and return goals. The Sector, Balanced, andIncome Growth strategies usually hold the same or most ofthe same assets but in different proportions. The Sectorstrategy carries the most risk or volatility and sometimesholds assets that aren’t in the others. The Income Growthportfolio carries the least risk. The Retirement Paycheckstrategy is for investors who primarily want above-averageincome with some capital gains to protect purchasing power.

The Invest with the Winners strategy is our momentumor short-term strategy. We invest in the best-performingexchange-traded funds.

How an investor chooses among these three basicinvestment approaches depends largely how much time andenergy he’d like to spend on investing and how much riskhe’s willing to take. I believe every investor should have atleast a portion of his portfolio in a strategic approach, and Irecommend our “hedge fund” strategy. Someone who wantsto minimize the time spent investing can put his or her entireportfolio in the “hedge fund” strategy.

Allocating Your AssetsI believe a typical or average investor should have about

half his investment portfolio in a strategic approach.Investors who are willing to put some time into their invest-ments each month and are willing to take higher risk in pur-suit of higher returns can use one of our tactical or managedportfolios for a third to half of their assets. As I mentioned,they have different levels of risk, and the Income Growthstrategy is designed to generate more income than the othertwo.

Finally, for someone willing to take more risk and putsome time into their portfolios at least weekly, there is ourIWW strategy. Because it buys the hottest recent performers,it has the potential to earn high returns but also the potentialto suffer sharp declines when market trends change quickly.

I don’t recommend more than 10% of your investmentsbe in a strategy such as IWW unless you have a substantialamount of guaranteed income through Social Security, pen-sions, annuities, and other sources.

Investors have different goals, including the amount oftime they want to spend investing. They’re in differentstages of life, and have different needs. We have a diversereadership at Retirement Watch, and I regularly am in touchwith readers. I try to provide portfolios that meet the needsand goals of the main types of investors.

At one end of the spectrum are the buy-and-holdinvestors, those who say, “Don’t make me spend too muchtime on it.” For them, there’s our “hedge fund” mutual fundportfolio. You can put all your investments in this portfolioor use it for a portion of your assets.

There’s also the “give me income” investor. He or shewants regular cash distributions that don’t require sellingshares and tapping principal. They should consider theRetirement Paycheck portfolio.

There also are investors who say, “Earn me more, but

5 Easy Chair Portfolios toFund Your Retirement Dreams

don’t risk losing a lot.” They tried the traditional portfoliostrategies and don’t like the way those strategies rack up biglosses in bad markets. For them, not losing money in toughtimes is more important than earning the highest returns ingood markets, but they still want to take advantage of mar-ket opportunities for higher returns.

These investors should use our Managed Portfolios.They can choose from the Sector, Balanced, and IncomeGrowth portfolios, depending on how much risk they arewilling to take. We don’t take a lot of risk in any of theseportfolios, but we take more risk in Sector and the least riskin Income Growth.

These investors also can invest part of their portfoliosusing the Invest with the Winners strategy. This involvesmore trading and risk than the others, but it still is risk-con-trolled.

You aren’t restricted to using only one of these strate-gies. A typical investor would have about half his portfolioin the True Diversification portfolio and 40% to 45% in aManaged Portfolio. The rest would be in the IWW strategy.Let’s look at the portfolios and strategies in more detail.

The Core Or Foundation PortfolioThe large bottom section of the investment pyramid is

the Core or Foundation. For most investors, I believe thisshould be the largest portion of the total investment portfo-lio or at least half of the portfolio. For a number of investors,the Core Portfolio will be their entire investment portfolio.The Core Portfolio is a fixed, diversified, and balanced port-folio.

The Core Portfolio is constructed with the idea that theprimary goal of every investor is to avoid large losses. Eventhe more aggressive investors should want to avoid largelosses. Large losses matter to investors in or planning forretirement. Capital preservation over the intermediate termis a goal of every portfolio, though many investors can with-stand some shorter-term losses. The aim of the CorePortfolio should be steady, solid returns, and there alwaysshould be a margin of safety in the portfolio.

The best Core Portfolio is my True Diversification port-folio of mutual funds. This is a collection of diversifiedmutual funds that use strategies or investments typicallyused by the best institutional investors. It’s a portfolio withtrue diversification, not the improper diversification presentin many of today’s portfolios.

Most portfolios, even those that are considered to bediversified, are heavily correlated to the stock market andrequire strong stock market returns to meet their goals.About 90% of the returns and volatility of these “diversi-fied” portfolios depends on the stock indexes. Encounter asecular bear market or even a mediocre market the 10 yearsbefore retirement or early in retirement, and you have aproblem.

That’s why at Retirement Watch years ago we adopted apolicy of balancing risks. This is a concept that pensionfunds and large institutional investors started to consider inrecent years. The idea is a buy-and-hold portfolio should bebalanced among investments that do well in different eco-nomic environments. Most investors believe they have

diversified portfolios, but the bulk of their investmentsdepend on positive economic growth, low inflation, and ris-ing stock markets.

The portfolio with what we call true diversification alsobalances the risk or volatility of the different investments,not the capital allocations. You want less capital in theinvestments with a lot of volatility and more in low volatil-ity investments.

The True Diversificaiton portfolio holds no-load mutualfunds with reasonable expenses. The funds either use invest-ment strategies employed by the better institutionalinvestors or invest in sectors with good long-term returnsbut a low correlation with the U.S. stock indexes. It's prettymuch a buy-and-hold portfolio. The funds have low correla-tions with each other and with the stock indexes, so youdon't have to make portfolio changes to avoid major losses.Almost always, some funds are doing well while othersaren't. That's how true diversification works.

I review the True Diversification portfolio in detail inRetirement Watch every three months and in less detail eachmonth. Our regular review show the strategy achieves itsgoals of beating the S&P 500 over time with much less riskand volatility. The performance is long term, not a short-term wonder. The portfolio already exceeded its 2007 peakby the end of 2010. The worst 12-month return was a nega-tive 24.56% for the period ending February 2009. The port-folio's standard deviation (a measure of volatility) is abouthalf to one-third that of the stock index. The beta (a measureof correlation with the stock index) is less than 0.50, roughlymeaning its movements correspond with the stock index lessthan half the time. The beta also is declining as the financialcrisis fades.

As should happen with a diversified portfolio, the port-folio trails the stock indexes during major stock market ral-lies. But it still earns a solid return during those periods.Lagging during bull markets is a small price to pay for out-performance in down markets and flat markets, leading tohigher long-term returns with less risk.

The portfolio holds mutual funds with different stylesand strategies. There are funds that invest primarily instocks; funds that tactically shift their portfolios over time;funds that invest in high-yield bonds and real estate; andothers that balance the portfolio.

The secular bear market that began in 2000 convincedmany people that buy-and-hold investing doesn't work. Thefact is, buy-and-hold does work but it's the buy-and-holdstrategy used in traditional portfolios that doesn't work.When the portfolio has true diversification and a low corre-lation with the stock indexes, buy and hold works.

Simple Core PortfoliosThere are alternative ways to set up a Core Portfolio for

those who can’t meet minimum investment requirements orhave other restrictions.

The investor simply can purchase a balanced fund thatinvests in different assets. Balanced funds usually invest instocks and bonds, though some add other assets. Some bal-anced funds keep a fixed allocation between stocks andbonds. Other funds will change the allocation based on mar-

ket conditions. The balanced fund is an especially goodchoice for the small investor, the new investor, or theinvestor who doesn't want to spend much time managing aportfolio. My recommended balanced funds are Dodge &Cox Balanced, Vanguard Wellesley Income, VanguardWellington, Oakmark Equity & Income and T. RowePrice Capital Appreciation.

Another option is to invest in a mutual fund that makessome tactical changes on its own. We have several of thesefunds in the True Diversification portfolio. Pick one or moreof them and hold them.

Some investors might not want to look beyond the CorePortfolio. They don't want to do any more work than thisportfolio requires and are content with its long-term returns.There's nothing wrong with that. The portfolio is designed toachieve solid long-term returns and to avoid big losses inbear markets. Investors who are willing to spend more timeon their portfolios and who seek higher returns with poten-tially higher risk of loss, should consider the next levels ofthe pyramid.

Managing Shifting Investment RegimesThe next level of the pyramid is what I call the Managed

Portfolio. This is where we can meaningfully increaseinvestment returns and reduce risk.

The Managed Portfolio essentially begins with the sameallocation as the Core Portfolio. Then, different assets areoverweighted or underweighted based on the investmentoutlook for the next one to five years and on the valuationcycle. Investments that are not included in the CorePortfolio can find their way into the Managed Portfoliowhen they seem to be undervalued.

Market timing does not work. This portfolio does notinvolve market timing and is not a frequently-traded portfo-lio, though it does involve more changes than are made inthe Core Portfolio. The intent is not to try to capture short-term trends in the markets or to respond to the latest head-lines and market noise. Instead, the strategy for this portfo-lio is to sell assets that are overvalued and buy assets that areundervalued or that are likely to benefit from what seems tobe the next phase of the valuation cycle.

The valuation cycle is the most important and most-overlooked factor in investment success. Each asset has along-term cycle during which investors swing from extremeoptimism to extreme pessimism and back. In U.S. stocks, afull cycle can take decades. For other assets, the cycle mightbe shorter. The valuation cycle exists for all types of invest-ments. In addition, the cycle exists within sectors of thestock market and other markets. For example, large capital-ization and small capitalization stocks each has a separatevaluation cycle. So do growth stocks and value stocks. Allof us have seen this in action. We know that there will beextreme bull and bear markets of each asset in each genera-tion. We also know that at the same time some investmentswill be in bull markets while others are in bear markets.Parts of the stock market can be in bull markets while othersare in bear markets.

An investor cannot determine the exact top and bottomof a cycle in advance. That is not important. What is impor-

tant is to capture the intermediate trends lasting from one tofive years. During the intermediate trends, some invest-ments will earn more than their long-term averages and oth-ers will earn less than their averages. An investor who cancapture some of the good intermediate trends and avoidsome of the bad trends will increase long-term returns withless risk.

Valuations are an imperfect investment tool, so we usemore than information than that. Over the years I’ve refinedthe data we use to what I believe are those things that matterto the markets. We filter out the white noise and superficialinformation. The things that matter to the markets are mon-etary policy, the economy, inflation trends, valuations,investor and consumer sentiment, and market momentum.

While the Managed Portfolio should earn above-aver-age returns, the idea is not to seek the next hot investment ormutual fund. Instead, the approach should be to reduce riskby limiting exposure to investments that seem overvaluedand at risk of tumbling. Eliminating the high-risk assets andseeking those with lower risk automatically avoids the likelybig losers. It also positions the portfolio in the assets that arelikely to do well over the next few years. The strategyreduces the risk and volatility of the portfolio.

Reducing risk and losses in this way increases returns inthe long run.

Additional strategies can be put in place to avoid largelosses from such mistakes. One strategy I frequently use inRetirement Watch is the sell signal. Most investors shouldtry to limit losses to 5% to 7% of the initial purchase price.When I recommend an investment in the Managed Portfolio,often I establish a sell signal, or stop loss signal. If theinvestment, despite what appears to be a low valuation,declines too far, the investor should admit a mistake, sell theinvestment, and reassess the situation.

Also, in the Managed Portfolio, I rarely put 50% ormore of the portfolio in one fund or asset class. I look forsome diversification and balance to limit the effects of mis-takes. The most appealing asset will get the largest portionof the Managed Portfolio, but other investments also will beincluded in the portfolio.

For those who are willing to do the additional monitor-ing and trading, the Managed Portfolio can increase returnsand reduce risk. My approach to the Managed Portfolioswas best described in the lyric of a song that was popular inthe 1990s. The lines are: "Some days you're the bug; somedays you're the windshield." My goal in advising investorsis to ensure that they and their portfolios are the wind-shields. Let others risk becoming bugs by seeking the high-est returns, following the latest fads, or ignoring the risks intheir portfolios.

For More Aggressive Investors There are only a few ways that an investor can add

value. By adding value, I mean doing better than the averageinvestor or a simple buy-and-hold strategy without increas-ing risk. One way is to select investment managers who beattheir indexes. Another way is to be different. By this I meanhaving an asset allocation that gets you into the better per-forming assets for the period and out of the lower perform-

ing assets. We try to do this in the Managed Portfolio byshifting out of over-valued assets and into under-valuedassets.

The final way to add value is through some form ofaggressive investing. An aggressive investment strategy, ifsuccessful, can generate high returns.

Because of its potential for high returns, I add a finalsection to the investment pyramid, called the AggressivePortfolio. This is the top portion of the pyramid, making itthe smallest portion.

Many investors will not have an aggressive portion intheir total portfolios. It takes significantly more time tochoose an aggressive strategy and implement it. An aggres-sive strategy also will involve more short-term risk, thoughif successful it will generate higher long-term returns.Aggressive investments also might be illiquid. That meansthey cannot be sold at a day’s notice and converted to cash.

Whichever aggressive method is selected, it will involvemore risk than the rest of the portfolio. That's why if youwant to add this investment strategy to your mix, it shouldbe done with a small portion of your total portfolio. An allo-cation of 5% to 10% is appropriate for most investors,though a few can justify an allocation of up to 25%.

Retirement Watch offers an aggressive strategy calledInvest With The Winners.

This strategy has a long history, and we’ve adapted it tochanging markets over time. Originally the strategy usedonly what I call Classic Mutual Funds. But as many fundsbegan to impose trading restrictions or redemption fees, itbecame harder to execute. I added additional strategiesusing the Rydex and ProFunds families of mutual funds.

We’ve now settled on using the IWW strategy only withexchange-traded funds (ETFs).

Invest With the Winners is an automatic investing sys-tem that, with only a few minutes work each week, keepsyou invested in the top-performing funds and cuts losseswhen a fund's performance changes course. All you have todo is follow my simple buy and sell signals. My fund rank-ing system does the rest of the work.

I rank a diversified collection of ETFs each month. TheETFs represent most of the investment opportunities avail-able. I exclude new ETFs and most of those with very lowtrading volumes. I also exclude the ETFs that use leverage.I found these funds are too volatile to develop good tradingrules and sometimes don’t match up well with an index’smoves.

In each issue of Retirement Watch I publish details aboutthe funds at the top of the rankings. This ranking and theautomatic buy and sell signals are the keys. We just followthe markets.

To use Invest with the Winners strategy, invest an equalamount in each of the top-ranked funds when you begininvesting. How many you buy depends on how much youwant to diversify. For many years I’ve used the top twofunds in my model portfolio. After additional research, thenumber of recommended funds increased to up to four, ifthat many meet the purchase rules.

But buy a fund only when it meets my buy signals. Thefund can’t have a negative return for the most recent fourweeks (or for one week if you want to be conservative). Alsoits price at purchase must not be more than 7% below itsrecent closing high. (I sometimes recommend a range higherthan 7% for volatile funds such as emerging market stockfunds.) I go back one month to determine the recent closinghigh. Conservative investors also should incorporate mov-ing averages in the buy signals and not purchase a fundwhen it is below either its 10-week or 50-week moving aver-age. Note that I use only closing prices to apply the rules.

When a fund doesn’t meet the buy rules, it’s importantnot to look further down the rankings for a fund that doesmeet the buy signals. For many years I’ve recommendedthat when a fund doesn’t meet the buy signals, that fund’sportion of the IWW portfolio should be kept in cash. Aftermore research I changed the rule and now recommend thatthe money be divided equally among top-ranked funds thatdo meet the buy rules. If none of the top-ranked funds qual-ify for purchase, then the entire IWW portfolio should bekept in cash. We’ve had a number of months when IWWwas in cash because the markets were in transition and notop-ranked funds did not meet my buy rules.

Hold a fund until it gives a sell signal, and sell signalsare the key to making the system work. You want sell sig-nals that will avoid your making a lot of transactions, willpreserve gains you've earned, and will avoid large losses.The signals also should help you make decisions betweenthe monthly issues. Here are the signals I recommend:

l Sell a fund when it drops below a pre-determinedrank. I suggest selling when a fund drops below rank 15when the monthly issue is published.

l Sell a fund when the return over the last four weeksis negative. Investors who want to reduce the number oftrades can use the 13-week period instead. Conservativeinvestors could sell after one week of negative returns, but Ithink that will result in too much trading and a lot of whip-saw trades.

l Sell a fund whenever its closing price drops morethan 7% from its recent closing high, or 12% for volatilefunds. This signal allows you to act when there are majormarket changes between the monthly issues. You need tofollow the closing high each day when a market is trendingdown. This rule is especially important when the portfolio isinvested in volatile funds such as long-term bonds, smallcompany growth stocks, or emerging market stocks. TheInternet makes it easy to track the recent closing high of afund. Again, to reduce the number of transactions, you canhold a fund until it drops more.

When you sell a fund between the monthly issue, keepthe proceeds in a money market fund until you receive thenext monthly issue and the new rankings. Then you start theprocess at the beginning.

This automatic investing system works best when youinvest through a discount broker, such as Charles Schwab,Fidelity, or TDAmeritrade. It also is best through a taxdeferred account, such as an IRA, or tax-free accounts, suchas a Roth IRA, so that taxes do not take away part of yourgain each time there is a sale.

The system will take care of generating gains as long asyou keep track of when funds need to be sold. If you are notable to take a few minutes each week to check on the per-formance of your funds, then don't use this strategy. The sellsignals are key to limiting losses and making the systemwork. But if you want an automatic system that requires asmall amount of your time, then consider putting part ofyour portfolio in this strategy.

Investors who are interested should find an aggressiveapproach that is compatible with their investment philoso-phy and the risks they are willing to take. They should notchoose a strategy they do not understand, even if someoneelse will be executing it for them. Also, because of the high-er risk and volatility inherent in an aggressive strategy, theexpected return from the strategy should exceed the returnfrom stocks by at least several percentage points annually.

The Easy Chair ManagedPortfolios

Those are the basics of the Retirement Watch investmentstrategy. For the Managed Portfolio level of the investingpyramid, I offer four different recommended portfolios.That allows you to choose the portfolio that is best for yourgoals and risk level. In each issue of Retirement Watch thereare clear buy and sell instructions for each fund in the port-folios. After determining which type of investor you are, fol-low the recommendations for it in each issue.

The Sector portfolio is designed for investors whowon’t need to spend from the portfolio for 10 years or longerand who can tolerate monthly volatility while seekingabove-average returns.

The Balanced portfolio is for investors who seek above-average returns over time with less monthly volatility thanboth the overall stock market and the Sector portfolio.

The Income Growth portfolio is for investors who pri-marily want an annual income yield of 3% to 5% of theircurrent principal, and who also want the cash income andportfolio principal to increase over time to keep pace withinflation.

The Retirement Paycheck portfolio was introduced inlate 2009. Our old Income Portfolio was designed for moneyyou might need sometime in the next five years and need tokeep safe. In this era of low interest rates that restriction leftfew options for the portfolio. Money you may need in thattime frame should be invested for safety in short-term treas-ury bonds, certificates of deposit, similar assets, and perhapssome intermediate bond funds. Safety of principal, ratherthan income, is the main goal.

The Retirement Paycheck Portfolio is designed forthose who want above average interest and dividend yieldswith the likelihood that both the income payments and theprincipal value will increase over time. It is for people whoplan to use the portfolio to fund their regular spending.

If your mailbox and e-mailbox are anything like mine,you receive a series of ads for newsletters promising steadyincome yields of 10% and more annually. Of course, the

only way to achieve such high yields is to put principal athigh risk, and the recommended investments took steepdives from 2007 through mid-2009. They’ve taken sharpdives at other times. In the Retirement Paycheck Portfoliowe aren't seeking the highest yields, because we don't wantto take the highest risks. We continue our policies of riskmanagement and margin-of-safety investing.

The Retirement Paycheck Portfolio seeks above-aver-age yields by taking more risk than a safety-first incomeportfolio but not the high risk of "yield hogs." The primaryrisk in the portfolio should be that prices of the investmentswill fluctuate, but we shouldn't be risking significant perma-nent losses of capital the way yield hogs do.

We have investments that benefit from different eco-nomic scenarios. Most income-oriented portfolios rely onone economic trend, low inflation and low or falling interestrates. When interest rates and inflation rise, their high-yield-ing investments go in the tank. You'll see more diversity inthis portfolio most of the time, and we'll make changes asthe valuations and risk of the investments change as well aswhen the economic environment changes. This is not a buy-and-hold portfolio, and we won't have a core of permanentholdings. We'll make changes as necessary.

To earn the higher yields we use traditional mutualfunds as well as closed-end funds, master limited partner-ships, exchange-traded funds, and perhaps a few individualstocks. You'll pay commissions to buy some of them, so con-sider using a discount broker.

These portfolios make it easy for investors to achievethe returns they need to meet their goals and to earn morethan most other investors.

A Few Questions and AnswersThere are some other aspects about our investment

advice in Retirement Watch that are best addressed in a ques-tion and answer format. Here are the issues raised most fre-quently by new subscribers.Do you have investment advice other than the portfo-lios?

I've always recommended that investors simplifymatters by consolidating their mutual funds at either a dis-count broker or at one or two fund companies. Many ofthese firms also let investors save money by offering to tradefunds with no transaction fees (NTF programs). I regularlylist the funds I recommend in each investment category thatparticipate in a major NTF program and also funds from themajor fund families in my “One-Stop RecommendedPortfolios.”

This way, my readers get the convenience of usingone toll-free telephone number or web site and receivingone comprehensive account statement while getting the ben-efits of no load investing. And they can do all this while fol-lowing my advice. Not all of the funds I recommend have agood alternative at each major fund family or in the NTFprogram, but I list them when they exist.Do you tell me when to sell my investments?

Absolutely. There's no point in generating positive

if you don't keep your profits. I follow each recommenda-tion I make and give specific sell advice. I continue to pro-vide updates on long-term recommendations until I say tosell them. When I think it is close to the time for selling aninvestment, in each issue I list a specific price at which itshould be sold if it falls to that price between issues. Thisallows you to protect your profits in case there is a big mar-ket move between issues.How do I get started following your recommendations?Should I sell my current investments and immediatelyadopt your portfolios?

I'm rarely in favor of wholesale changes in a portfo-lio. Take the time to look at how your portfolio is structurednow and how you think it ideally should be structured.Decide which of my recommended portfolios is for you andsee how close your current asset allocation is to my recom-mendations.

If your allocation is significantly out of balance,begin by selling your worst-performing assets in each cate-gory and dump any below-average mutual funds you'vebeen holding. If you are going to sell something for a capitalgain, look for losing assets you can sell so that the losseswill offset the gains and reduce taxes. If something has donewell for you but is not on my recommended list, hold it untilit starts to falter. Then consider selling. When you sell aninvestment, replace it with my recommended investments.Over time your portfolio will resemble my recommendedportfolios and you'll be on your way to earning above-aver-age profits with safety, simplicity, and a margin of safety. Irecommend taking about six months to get your portfolioresembling one of my model portfolios.What if I have less than $10,000 to invest?

I recommend that you get started with a CorePortfolio first, and develop a Managed Portfolio as yourinvestment portfolio increases. If you don't have enoughassets to assemble my True Diversification portfolio, I sug-gest you start with one of the all-weather balanced funds Irecommended earlier. I don't recommend many funds in thiscategory. Most balanced funds try to engage in market tim-ing and end up taking risks that conservative balanced fundinvestors did not expect. Part of my investments are in my 401(k) plan at work.This plan does not offer your recommended mutualfunds. How can I follow your recommendations with my401(k) plan?

The most important contributor to investment per-formance is your asset allocation. Usually it is more impor-tant to be in the right type of fund than in a specific fund. Soyou can follow my recommendations by using whateverfunds your 401(k) allows in each category.

If your 401(k) does not offer consistently goodfunds or doesn’t offer funds in each category, decide whichare the best and worst offerings in the plan and invest in thebest. For example, if your 401(k) plan offers good U.S.stock funds but bad or no bond and international stockfunds, do most of your U.S. stock investing through the401(k) plan. Invest in the other assets outside the 401(k)plan.

An alternative available in many plans is a brokerwindow. This allows you to pay an extra fee and invest inalmost any fund or other investment through a brokerageaccount at a broker selected by the plan sponsor. Many401(k) offerings are so bad that you’re better off paying theextra fees to get in different funds. What is the biggest mistake you see in portfolios youreview?

Most investment portfolios are much too complicat-ed. It is not unusual for an investor to own more than adozen mutual funds that were accumulated over the yearsand then forgotten.

Also, most investors have their money disbursedover several mutual fund companies and brokers. In thesesituations, most of the time that is put into investing is spentsimply collecting and analyzing the paperwork to find outhow the portfolio is invested. The real work of deciding howthe portfolio should be invested is given less time. Often, thetime involved in collecting the information then shiftingfunds among different mutual fund companies and brokersis overwhelming. Procrastination sets in and nothing isdone.

I recommend that investors simplify their financiallives, as I described earlier. Invest in mutual funds througha discount broker or limit your investments to one or twomutual fund families.

Alternative Funds and ShareClasses

All of the funds I recommend are not available to allinvestors, at least the way they want to buy them. A fundmight have a higher minimum than you can afford or mightnot be available through your broker. Or you might not wantto pay a transaction fee to buy the fund. Some funds or sharecloses are closed to new investors, though I’ve been recom-mending to my readers since before they were closed.

For these and other cases I establish a list of alterna-tive funds and share classes and maintain it on the members’web site. Click on the “Extras” tab on the home page, andthen click on “Alternate Investments and Share Classes.”This should guide you to a share class of the same fund or adifferent fund that is a good substitute for my recommendedfund. You also can view the “One-Stop RecommendedPortfolios” box in each issue that offers lists of NTF fundsand funds at the major fund families that are alternatives tomy recommended funds. Not all funds have good alterna-tives but I list those that are appropriate.

* * *Those are the basics of how you can use Retirement

Watch to achieve the kind of retirement you desire. Detailsand updates will be in each monthly issue along with myadvice on estate planning, life insurance, annuities, savingmoney, health care, and other vital retirement financialissues. You’ll also have access to the members-only web siteat www.RetirementWatch.com. I welcome you to the grow-ing family of Retirement Watch members and hope that youwill get started on your journey to an independent retire-ment.

Bob Carlson’sRETIREMENT WATCH800-552-1152www.RetirementWatch.com