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July 1994

Wink Tax Services

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IN THIS ISSUE . . .

COMMON QUESTIONS ABOUT MUTUAL FUNDS

Mutual fund investing has grown dramatically in recent years, making it important to know the answers to some common questions regarding mutual funds.

WHAT ARE MUTUAL FUNDS AND HOW DO YOU INVEST IN THEM?

A mutual fund is a pool of money, drawn from thousands of investors, that is invested in securities by professional managers. Mutual funds invest in a wide array of investment vehicles, including stocks, bonds, commercial paper, Treasury securities, real estate, gold, silver, etc., depending on the investment objectives of the fund. Mutual funds can be purchased through stock brokers or directly from investment companies.

HOW MUCH DO YOU NEED TO INVEST IN A MUTUAL FUND?

One of the many benefits of mutual funds is the small amount of money needed to invest. Most funds require an initial investment of no more than $2,000, with subsequent investments of as little as $100. IRA accounts can generally be started with even smaller amounts.

WHAT TYPES OF MUTUAL FUNDS EXIST?

There are a wide variety of funds to choose from. They are generally grouped by investment objectives and include aggressive growth, growth, growth and income, balanced, total return, income, bond, money market, overseas, index, and sector funds. The mutual fund right for you will depend on your individual situation and investment objectives.

WHO SELECTS THE INVESTMENTS FOR THE MUTUAL FUND?

Full-time professional managers watch the fundís portfolio, making all buy, sell, and hold decisions. These investment decisions must be made within the confines of the fundís objectives and investment parameters.

WHERE CAN YOU GET INFORMATION ABOUT THE FUNDíS GOALS, INVESTMENT OBJECTIVES, SERVICES, AND COSTS?

The fund prospectus provides a host of information about the fund, including investment objectives and policies, risk factors, fees, financial results, the portfolio turnover rate, and a description of shareholder services.

WHERE WILL YOU FIND A CURRENT LISTING OF THE STOCKS AND BONDS OWNED BY THE MUTUAL FUND?

Part B of the prospectus, called the Statement of Additional Information, contains a listing of the stocks and bonds owned by the fund. You must specifically request this portion of the prospectus. Make sure you are reviewing a recent listing since many funds change their portfolio frequently.

HOW DO YOU MEASURE THE PERFORMANCE OF A MUTUAL FUND?

There are generally three measures of a mutual fundís performance: 1) the change in its net asset value, 2) the yield, which is the amount of income distributed, and 3) total return, which factors in income, gains or losses, and expenses. The net asset value of a fund is calculated every day and equals the current market value of the fundís investment portfolio, minus operating expenses, divided by the number of outstanding shares.

WHAT TYPES OF EXPENSES DOES A MUTUAL FUND CHARGE?

Mutual funds can charge a variety of fees, including: front-end loads, which are up-front commissions paid to sales people; deferred sales loads, or exit fees, charged if you sell before a certain time period; redemption fees, which are exit fees charged regardless of how long you hold the fund shares; 12b-1 fees, which are annual fees for marketing expenses; and annual management fees. These fees will be detailed in the prospectus.

WHAT IS A FAMILY OF FUNDS?

Many mutual fund companies operate a variety of different mutual funds with differing objectives. In order to make their services more convenient to their investors, they allow you to switch money from one fund to another within the family of funds. Although a major convenience if you want to change investment objectives or time the market, keep in mind that you are selling one fund and purchasing another when you switch, which may result in a taxable transaction.

WHAT OTHER SERVICES ARE OFFERED BY MUTUAL FUNDS?

AUTOMATIC REINVESTMENT OF DIVIDENDS AND CAPITAL GAINS ó Dividends paid by stocks, interest from bonds, and capital gains from selling securities can be automatically converted to additional shares.

RECORD KEEPING ó Mutual funds regularly send statements detailing activity in your account. At year-end, the fund will send you a statement with information required for your tax return.

REDEMPTIONS ó Mutual funds generally make it easy to redeem your money Ė you can have a certain amount automatically transferred to your checking account every month, you can write checks over a minimum amount against your fund, you can have funds wire transferred to your bank account, or you can sell fund shares over the telephone. Mutual funds are redeemed at their then current asset value, which may be worth more or less than their original cost.

With popularity comes diversity. As mutual funds have become more popular, the choices and options have become more extensive. Feel free to call us at (248) 816-1240 if you need help with your mutual fund decisions.

THE MYTHS AND THE REALITIES

Planning for retirement is a difficult process, made even more difficult by the large number of myths surrounding retirement:

Myth: You will only need to save for 10 to 15 years of retirement.

Reality: At age 65, the average man will live almost 19 more years, while the average woman will live another 22 years. (Source: 1992 Life Insurance Fact Book, 1992, p. 127). To make sure you have adequate savings, plan on living to at least age 90.

Myth: You will only need 60% to 80% if your pre-retirement income.

Reality: Although this a general rule of thumb, it is important to analyze your individual situation and desires for retirement. If you want to travel extensively or start expensive hobbies, you may need more than this amount.

Myth: Social Security and your pension plan benefits will provide enough income for your retirement.

Reality: Currently, Social Security and pensions replace 40% to 60% of the average retireeís pre-retirement income (Source: Your Best Money Moves Now, 1993, p.98). In the future, that figure is sure to decrease as the government makes changes to the Social Security system and companies move increasingly from defined benefit plans to defined contribution plans, such as 401(k) plans.

Myth: You can wait a few years before you start saving for retirement.

Reality: The amounts of money you need to save to ensure a comfortable retirement are staggering. The sooner you start, the smaller the amounts needed to reach your goals, due to the potent factors of time and compound interest.

Myth: Preserving capital should be the main objective for your retirement funds.

Reality: Your main objective should be to preserve purchasing power. Inflation can have a devastating impact on the amount of money needed to maintain your standard of living.

Myth: Taxes will capture a smaller portion of your income after retirement.

Reality: In 1994, retirees are faced with higher marginal tax rates and the fact that a larger percentage of their Social Security benefits may be subject to income taxes. It is far more likely that taxes will increase, rather than decrease, in the future.

Myth: The equity in your home can be used to supplement your retirement income.

Reality: Unless you sell your home and move to a smaller house, your home will probably not provide much in the way of additional retirement income. In addition, property taxes and the costs of maintaining your home are likely to rise over time.

Myth: You only need to plan for you and your spouse after retirement.

Reality: Many retirees are faced with adult children moving home or elderly parents that need care.

To plan successfully for retirement, you must forget the myths and remember the realities.

IS IT TIME TO SELL?

Although selecting a mutual fund from the scores of funds available may seem like the most difficult decision you have to make regarding mutual funds, many investors have much more difficulty trying to decide when to sell a mutual fund. Some factors that may indicate it is time to sell your mutual fund include:

Your fundís performance is poor. While it is not unusual for a fund to have a poor quarter occasionally, you should consider selling the fund if its performance is consistently poor for an extended period of time. The fundís performance cannot be evaluated in isolation without comparing it to the performance of other similar funds and to market indexes.

Your fundís performance is significantly greater than other funds of its type. Although this is generally considered a good trait, it may also mean that your fund is taking on more risk than other funds of this type. Review the investments carefully.

The fund manager leaves. How significant a change in fund management is depends on your fund. The impact made by the manager may not be significant for money market funds or many bond funds. Some funds utilize a team approach to managing a fund, making the effects of a single manager less significant. Many equity funds, however, give the fund manager a great deal of flexibility, which can have a major impact on the performance of the fund. Watch you fund closely after a fund manager leaves to see how the new manager runs the fund. It normally takes several months for the new manager to make significant changes to the portfolio of the fund.

You are uncomfortable with the fundís investment. Perhaps the current portfolio of assets differs significantly from when you first purchased shares of the credit rating of bonds in the portfolio has declined over time. Maybe a significant amount of money is sitting in cash equivalents or the asset portfolio is more aggressive than you first realized. If you are not comfortable with the assets in the fund, you should invest in a fund more consistent with your goals and objectives.

Your investment goals have changed. Over time, your investment goals will change, and you may require different funds to achieve those objectives.

Your fund has attracted too much interest from other investors. When a fund becomes popular, it is possible for significant amounts of new cash to enter the fund in a short period of time. It may then become difficult for management to find assets with attractive potential quickly.

None of these factors is conclusive evidence that you should sell a mutual fund. Like all investments, however, you must periodically evaluate your mutual fund investments to ensure that they remain appropriate for your portfolio.

WHY 59 Ĺ?

The age 59 Ĺ carries special significance. Withdrawals made before that age from individual retirement accounts (IRAs), simplified employee pensions (SEPs), Keogh plans, or employer saving plans require a 10% tax penalty, unless you qualify for certain limited expectations. The age limit for a 10% tax penalty also applies to investment earnings on annuities. Additionally, lump-sum pension distributions received before age 59 Ĺ cannot use forward averaging.

Why did Congress select age 59 Ĺ as the age for all of these events? When creating Keogh plans in 1962, Congress chose 59 Ĺ as the age participants could start withdrawing money without paying penalties. That age was selected as compromise between the typical corporate early retirement age of 55 and the age for receiving full Social Security benefits (65). Although you might have expected them to select the mid-point of age 60, Congress followed actuarial tradition, which deems that age 60 begins when you turn 59 Ĺ since you have lived more than six months of your 60th year.

IS IT WORTH THE PRICE?

Whether youíre currently writing tuition checks or simply contemplating how much the tuition check might be when your child reaches college age, the massive sums required are sure to make you ponder whether your child really needs to go to college after all. The following statistics should give you some comfort that the sacrifices are worthwhile:

Two Princeton economies found that, on average, income increased 16% for every year of education beyond high school. (Source: Keys to Financing a College Education, 1993, p. 1).

The median income for college graduates is more than 75% higher than for high school graduates. The gap widens further by adding a masterís degree or a doctorate. Over a lifetime, the difference in earnings can be worth over $1 million. (Source: Grow Rich Slowly, 1993, p. 112).

In 1991, the average salary of men with a high school education was $26,218 while male college graduates earned $42,367. Women with a high school diploma earned $18,042 while women with college educations earned $30,393 (Source: Making The Most Of Your Money Now, 1994, p. 141).

In 1992, 15% of individuals who had not graduated from high school were unemployed, compared to 8% of high school graduates and only 4% of college graduates (Source: Making The Most Of Your Money Now, 1994, p. 141).

Just keep reminding yourself of these facts as you write those large tuition checks.

NEWS AND ANNOUNCEMENTS

WHAT HAPPENS TO YOUR INDIVIDUAL RETIREMENT ACCOUNT (IRA) WHEN YOU DIE?

After your death, your beneficiary will have several choices for receiving the proceeds from your IRA. The 10% penalty tax does not apply to these distributions, regardless of your age or your beneficiaryís age. The distributions are subject, however, to income taxes, except for amounts that represent a return of nondeductible contributions. Thus, how your beneficiary receives the proceeds can have a significant effect on their tax bill.

If you had started taking required distributions because you were over age 70 Ĺ, your beneficiary can continue to take periodic distributions on the same schedule. In the event that distributions had not begun, the relationship of the beneficiary to the owner will determine how the funds can be withdrawn.

The greatest number of options are available to surviving spouses. Your spouse can cash in all or part of the IRA without paying the 10% penalty. Alternatively, your spouse can rollover the IRA to his/her own IRA, making the money subject to the same rules as their own IRA. Thus, he/she would pay a 10% penalty tax if funds were withdrawn before the age of 59 Ĺ and withdrawals must start by age

70 Ĺ. Another option is to allow the funds to remain in your IRA. The funds can remain in your IRA until the year you would have turned 70 Ĺ, at which time your spouse would have to start taking distributions based on his/her life expectancy.

If your beneficiary is not your spouse, he/she has two basic options. All funds can be withdrawn from the IRA within five years or the beneficiary can start to take withdrawals within one year of your death, based on his/her life expectancy.

It is important that you name a beneficiary for your IRA in order to make these options available to your heirs. If you donít and someone inherits your IRA under a will, their only option is to cash in the entire balance in the IRA within five years.

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We do not offer legal advice. All information provided on this website is for informational purposes only and is not a substitute for proper legal advice. If you have legal questions, we recommend that you seek the advice of legal professionals.

Tax Disclaimer: To ensure compliance with IRS Rules, any U.S. federal tax advice provided in this communication is not intended or written to be used, and it cannot be used by the recipient or any other taxpayer (i) for the purpose of avoiding tax penalties that may be imposed on the recipient or any other taxpayer under the Internal Revenue Code, or (ii) in promoting, marketing or recommending to another party a partnership or other entity, investment plan, arrangement or other transaction addressed herein.

Copyright © 2017 Wink Tax Services / Wink Inc.
Last modified: January 30, 2017