Ask Lynn - This Week’s Column

When we die, each of us will leave our loved ones something different. Some may hand over the keys to an oceanfront estate or a first-floor condominium with lots of closet space. Others may pass along a modest Individual Retirement Account or binders of rare stamps that took years to lovingly collect.

Many Americans wisely spend a great deal of thought on how this sad transition will take place, which is why I write columns about such things as inherited IRAs and other estate planning issues. But regardless of someone’s net worth or the ability to hire an attorney or investment advisor to sort through these issues, there is a slip of paper that just about anybody should leave behind: an ethical will.

An ethical will is definitely not a legal document. It’s about as official as an envelope you might use to scribble down what you need to get at Von’s. An ethical will is simply a letter that you write that captures a part of you, perhaps your very essence, that won’t be found in any formal estate plan.

An ethical will provides you with the opportunity to leave a spiritual legacy to your family. In writing one, you can share your values and beliefs, as well as your regrets and the joys you experienced in your life. You may wish to remember family stories and jot down your aspirations for those who will ultimately read your letter. Some people also use an ethical will as a way to forgive others. An ethical will can also provide a sense of completion in the lives of those who create one.

One of the nation’s biggest proponents of ethical wills is Barry K. Baines, M.D., who is a hospice administrator in Minneapolis and the author of
Ethical Wills, Putting Your Values on Paper. Before he had ever heard of the term, Baines received an ethical will in the early 1990s from his father, who died of lung cancer. Over the years, he has read his dad’s letter repeatedly and each time he does, he can hear his father’s voice. In 1999, Baines launched a web site, EthicalWill.com, for people interested in creating their ethical wills. Visits to the web site exploded after 9/11 and have continued to skyrocket.

“An ethical will helps you identify what you value most and what you stand for, Baines says. “By articulating what we value now, we can take steps to insure the continuation of those values for future generations.”

Today, most of the people who tackle writing their own ethical wills are Baby Boomers and their parents. “The most fruitful time to write one, since it’s a very reflective process,” Baines says, “is at middle age and beyond when you’ve had life experiences that give you a chance to reflect and distill.” It can also be a cathartic exercise for soldiers heading overseas.

The genesis of ethical wills can be traced back to ancient times. In the Bible, Jacob’s deathbed pronouncements to his 12 gathered sons, is considered the first ethical will. In the beginning, ethical wills were delivered orally and largely involved fathers imparting to sons moral advise and blessings, as well as pragmatic burial instructions. The oldest written ethical will still in existence was penned in the 12th century. It was around this time that the documents began containing the writers’ values and beliefs, as well as personal stories. Historians have found ethical wills belonging to women in medieval times, who were prohibited from writing legal wills.

There’s no need to worry about how an ethical will should look or feel. Anything goes since there is no correct way to construct one. The letter is often just a couple of pages long, but a few sentences can suffice. Many people tuck the letter away with their regular wills, living trusts and other estate planning papers. You may, however, wish to share your letter long before you are gone.

For many, the biggest challenge in writing an ethical will could be getting started. Because staring at a blank piece of paper can be intimidating, experts suggest a variety of ways to jump start the process.

One method is to begin answering one or more of these questions or similar ones:

* What are the lessons that you’ve learned in life?
* What are you most proud of?
* What are your biggest regrets?
* What are your spiritual beliefs?
* What will you miss most when you are gone?
* What have you learned from the most important people in your life?
* If you only had a year left to live, what would you do?

If capturing the essence of your life into words intrigues you, don’t be discouraged if you have no immediate family to share it with. Supporters of the process suggest that creating an ethical will is a real act of faith that you matter and you are connected to the rest of the world even if you don’t have a nuclear family.

My own mother would be surprised to learn that she left behind an ethical will when she died more than three years ago. Just hours after she had played tennis with dear friends during what appeared to be an ordinary winter day, she collapsed from a massive heart attack. After the funeral, my father handed me pages ripped from legal pads that my mom had used to write down her thoughts and memories. The penmanship of my mom, the consummate school teacher, was impeccable, but there were lots of cross-outs and false starts. My dad asked me to put the pages in some kind of order and type out her remembrances.

I read wonderful memories of my mother growing up in St. Louis, but what I found most touching was when she dwelled on the legacy she hoped to give to her five children. In one passage, she wrote, “To be honest, respectful, considerate, compassionate, giving and forgiving are values that were guidelines for me to live by and I have tried to pass them on. The most important of life’s challenges has been raising and passing on our values to our children. I think we have done this.”

I’m sure my father assumed that the most valuable possession I received from my mother after she died was her cameo ring, which I had admired for decades. But it was really my own mimeographed copies of these crumbled heartfelt papers.

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Ever wonder how personal finance magazines pick the mutual funds they enthusiastically recommend?

I can’t answer that question, but I can share a provocative research paper written by a couple of professors at Stanford University and the University of Oregon, who suggest that advertising dollars bias the magazines’ recommendations. Cynics might not find that too surprising. I didn’t. But loyal subscribers, who take their investing cues from these publications, should be especially dismayed by one of the researchers’ key conclusions: “Investors would do just as well picking funds at random.”

The researchers didn’t spot any blatant attempts to hype funds. When you flip to the ubiquitous cover stories that instruct readers on the best funds to buy right this instant, you won’t find writers praising the sort of bow-wows that even a Humane Society volunteer might have trouble loving. The bias is much more subtle, which of course makes it much harder, and realistically impossible, to spot for someone who has just paid $4.95 for a few hot investing leads.

The study examined the editorial and advertising content of five of the top six recipients of mutual fund ad dollars from 1996 through 2002. Those publications were Kiplinger’s Personal Finance, SmartMoney and Money magazines, as well as The New York Times and The Wall Street Journal. The researchers documented a positive correlation between what a fund family spent on advertising over the previous year and the likelihood that the magazines would give its funds positive mention. The researchers, however, drew no conclusions about whether this perceived bias on the part of the magazine staff was conscious or not. The professors didn’t find any link between the two newspapers’ advertising and fund recommendations.

Okay, you may be thinking, the professors burrowed into what may very well be a nasty industry secret. But does favoring deep-pocket advertisers hurt the investors who are subscribing to these magazines? You be the judge. The study documents that collectively, the recommended funds couldn’t even managed to outperform the average returns of their appropriate fund peer groups. That’s awfully underwhelming.

Maybe this wouldn’t matter if investors treated stories that hawk fund picks as harmless entertainment. If they put as much relevance into these articles as Court TV commentaries, nobody would get hurt. But the study suggested that readers, while pretty much ignoring the ads in the investing magazines, apparently believe that financial journalists are blessed with omniscient powers. They aren’t, folks. Still when SmartMoney’s recent issue recommended three stock funds as among the “best places to put your money now,” you can bet that plenty of readers scrambled to buy shares. Quite a few years ago, a gleeful fund manager told me that an article I had written about a REIT fund for the now defunct Mutual Funds Magazine had triggered a barrage of phone calls from eager investors. The firm was even getting calls in the middle of the night.

In fact, the researchers documented that magazine recommendations boosted the cash flowing into these highlighted funds. After controlling for a variety of factors, the professors determined that one positive mention of a fund was responsible for cash inflows that ranged from six to 15 percent of its assets during the next 12 months.

Of course, magazines will vehemently deny any bias. In the 1990s, an article in Kiplinger’s Personal Finance included statements from editors at various investing magazines, including Kiplinger’s, Money and SmartMoney, that insisted that advertisers hold no influence over their editorial content. What you won’t hear them saying is that lots of financial journalists think these fund recommendations are nuts. I’ve had plenty of conversations with financial journalists, who acknowledge that they invest their own money in low-cost index funds, as do I.

My experiences mirror that of an anonymous journalist, who wrote a first-person story in Fortune a few years ago that carried the headline, “Confessions of a Former Mutual Funds Reporter.” In the article, she writes, “Mutual fund reporters lead a secret investing life. By day we write “Six Funds to Buy NOW!” We seem delighted in dangerous sectors like technology. We appear fascinated with one-week returns. By night, however, we invest in sensible index funds.” Of course, if magazines simply told readers to stop chasing hot funds and invest instead in those sensible index funds, where would the advertising dollars come from?

In the study, the researchers also compared the performance records of the financial magazines, which were bursting with glossy ads, with one that proudly refuses any advertising. That, of course, is Consumer Reports, which many people turn to when they seek an objective viewpoint when buying a car, purchasing a microwave or when they simply wonder what laundry detergent is the best at eliminating ketchup stains. As it turned out, Consumer Reports’ mutual fund picks were no better than the other magazines. (In the spirit of disclosure, I write personal investing articles for one of the magazine’s sister publication’s Consumer Reports MoneyAdvisor, as well as Kiplinger’s Retirement Report.)

For me, Consumer Reports’ failure at being a clairvoyant was hardly surprising. Why? Because nobody has devised a way to predict which funds will levitate above the market fray. Pundits and journalists can only tell us which funds have performed well in the past, which does no one any good at all.

If you’d like to read the entire study, which was written by Eric Zitzewitz of Stanford and Jonathan Reuter of the University of Oregon, just click here.

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Which is more important? Saving for your retirement or sacrificing to put your children through college?

This is a powderpuff question for most financial experts. They could answer that one while chewing gum and patting their heads and stomachs at the same time. Or something like that.

Here’s what they’d say: While it might go against maternal and paternal instincts, it’s best if parents make their future retirement priority No. 1. Nobody, after all, is going to lend aging parents money when they’ve retired with a nest egg that’s cracked and leaking. If you can only save for one goal, make it retirement. Kids, after all, can take out loans, work through college, pick up college credits during high school, earn scholarships and or enroll in junior college, the higher-education equivalent of a starter home.

The experts’ pragmatism is admirable, but it may strike some parents as excessively harsh and as unrealistic as telling a kid not to worry about studying for exams because he’s going to be Nike’s next endorsement phenom to emerge from high school. Obviously, there are many ways to juggle retirement without stranding the kids, which is why T. Rowe Price decided to take a look at some scenarios that parents might consider when saving for two of the biggest expenditures they will face in their lifetimes.

What T. Rowe Price did was examine four hypothetical scenarios during a 36-year investing window that would include saving for retirement and paying college bills. In the analysis, the number crunchers assumed that the sample couple earned a combined income of $100,000 a year and invested 6% of that income for 18 years prior to a child’s freshman year and 18 years afterwards. Money that was earmarked for college was invested in a 529 college saving plan. The cash for retirement was tucked in a 401(k) workplace plan that assumed a 50% company match, which is standard. In all four alternatives, the money earned a pretax 8% return and the couple’s income grew 3% annually.

Here are the four options the firm explored:

Option A: The couple saved exclusively for retirement for 36 years.

Option B: The parents stashed away retirement cash for 18 years. During the next decade, they diverted all their yearly savings to repay a college loan at 5% interest. For the final eight years, the couple reverted back to saving solely for retirement.

Option C: Mom and dad split their savings between college and retirement for 18 years and then spent the last 18 years stashing away retirement cash.

Option D: They dumped all the money into the college account for the first 18 years and then switched to building a retirement nest egg for the same number of years.

Using T. Rowe Price’s parameters, here’s what would have happened:

Option A: No surprise here. By ignoring the college years as they approached on the radar screen, the parents amassed the biggest retirement nest egg — $2,541,000.

Option B: Curiously enough, this strategy didn’t hurt the parents’ retirement security as much as you might assume. The couple ended up with $2,042,000 for retirement, which is only 20% less than what they’d have pocketed in the first scenario. What’s clear is getting that early start, which unleashes the power of compounding, is critical.

Option C: The college fund would have peaked at $126,000, while the retirement account would have topped out at $1,650,000. The parents would have accumulated more than twice as much for retirement compared to the Option D.

Option D: If a couple focused exclusively on college first, they would have saved $253,000 by freshman orientation. The strategy, however, would have left the couple with considerably less spending money for themselves. Their final retirement tally — $759,000.

There is no one right answer to the retirement/college conundrum. But it’s important to keep in mind the effects of the trade-offs most of us must make. There are ways, however, to stretch the money you do manage to stockpile. While we can’t control our investment returns, but we can all feel empowered about controlling costs. No matter what your financial goal, making the decision to only invest in inexpensive mutual funds should boost your ending account balances.

Ironically, in the world of college savings, many of the most popular 529 plans, which each offer a menu of mutual funds, are among the most expensive and/or charge commissions. Why are people so eager to pay too much? Most parents rely upon a stockbroker or financial advisor to pick a college plan. You can shrink these costs significantly if you skip the middleman and invest directly with an inexpensive 529 plan. One of the best is the highly lauded plan offered by the state of Utah (800) 418-2551, (www.uesp.org), which offers a lineup of index funds. Another excellent source of index funds is the state of Nevada’s 529 plan (866) 734-4533, (www.vanguard.com)

Parents should also get in the habit of finding veins of spare cash to tap into. Until college, kids are most expensive at the beginning of their lives, when daycare and preschool can annihilate a household budget. When moms drop their little dears off on the first day of kindergarten, they may be crying into wadded up Kleenex, but inside they’ve got to be thrilled that somebody else is going to be picking up their kid’s education tab for the next 13 years. When those monthly daycare bills disappear or at least shrink, don’t let this freed-up money get sucked into your checking account’s black hole. Set aside some of that cash for college and or retirement through an automatic savings program. But you don’t have to wait until your child is on the verge of reciting her ABC’s to find spare cash. For instance, when my son graduated from diapers 12 years ago–a milestone that in my darkest hours I thought would never happen– I figured I would spend $35 less at Target every month. Consequently, I increased what I saved monthly in his college fund by that amount. I bet you can find your own examples if you just start looking.

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Does this make any sense to you?

An elderly couple buys an annuity that they’ve been promised will generate regular income, just like their Social Security checks. These payments, however, weren’t scheduled to start for 42 years. If the husband had lived that long, and he didn’t, he would have been 115 before he could have cashed the first check.

What would prompt intelligent Americans from sinking money into investments that so many of us would appreciate as horribly inappropriate? Some of the blame can certainly be placed on the nation’s free meal epidemic. Every morning, across the nation, investors are munching on cherry Danish and endless coffee refills. At lunch, hungry investors are polishing off club sandwiches and plates of chocolate chip cookies. As evening approaches, steaming lasagna and salads tossed in bowls the size of sinks are rolled out to guests. All this food is gratis.

You see, the best way to get Americans to buy investments that don’t make sense is to feed them first. It’s amazing what you’ll agree to do when your stomach is full and your guard is down. Which is one reason why so many people, especially those who are retired or nearing that milestone, are invited to financial seminars, many of which serve food.

What can be particularly dangerous about all too many of these financial presentations is that the true mission of the sponsors is hidden. Imagine what would happen if a seminar sponsor invited retirees to sit through a two-hour presentation on expensive annuities that carry stiff insurance and surrender fees. With this sort of candor, the folding chairs in the rented room at the local senior center would remain empty. But what if the sponsor promises that he will reveal foolproof ways to protect guests’ assets, avoid probate court or provide a risk-free investment that starts with an upfront 7% rate of return? With that sort of marketing appeal, he may run out of chairs even though his motivation is still to push the annuities.

Deceptive marketing techniques have not gone unnoticed by regulators. The California attorney general and the state insurance commissioner, for instance, filed a $110 million-plus suit against the operators of some of these seminars. According to the authorities, the offending firms located in San Diego, Los Angeles and elsewhere, reeled in customers by ostensibly selling living trusts that the backers claimed would avoid probate and reduce estate taxes. The real intent of these living-trust mills was to sell the victims annuities, which was never adequately disclosed.

It’s not just senior citizens who are getting lured into presentations. After I wrote a column criticizing equity index annuities, a reader sent me an email about a seminar he had recently attended on leveraging home equity. The married, middle-aged dad with two kids was on the verge of ditching his 30-year fixed mortgage with a 5.25% interest rate and swapping it for a risky interest-only loan. He was going to sink the money that this refinance would free up into an equity index annuity. An insurance agent at the seminar had urged him to make this move. In fact, the agent was going to present the man with the paperwork the next day for his signatures. My immediate reaction, after reading the email, was to blurt out loud, “Oh, my God!”

How do you protect yourself from falling for slick marketing? The simplest way is to eat at home. Don’t attend financial seminars. And that includes free real estate seminars that are typically aimed at softening up attendees to buy expensive tapes and books that promise to share the secrets of amassing a real-estate empire. It’s amazing how fast these tapes end up on eBay.

I’m not suggesting that all financial seminars are worthless. There are reputable financial speakers and firms that sponsor seminars that impart solid information. But how are you supposed to tell the difference? A safer way to learn more about investing is to lay on the couch and read some good books.

If the lure of free food proves irresistible or you’re simply curious, take precautions. Before the day of the event, ask the sponsor to send you a biography of the speaker(s) and the firm. The material should include how long the person has been in the financial industry, his or her area of expertise, as well as a list of credentials and education. And for heaven’s sake, don’t provide your host with any of your financial information. During the presentation, listen for buzz words like “guaranteed,” “sure thing,” and “risk free.” There are no such things. Also pay attention to promises made by the speakers, especially when a graph or chart indicates what will happen to an investment years from now. If somebody starts talking about tripling or quadrupling money or making similar claims, it’s time to stop listening. No one can predict what returns an investment will generate in the future.

Once the seminar is over, remain resolute. That’s because you will inevitably receive a follow-up phone call from the guy who paid for the donuts or the spaghetti. He’s probably going to ask to meet you for a complimentary follow-up session where your financial situation will be explored. This time, don’t bite.

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Baby boomers aren’t optimistic about their chances of inheriting much money from mom and dad. Most Boomers, according to the AARP, don’t expect anything. And those who have already had free money dumped into their laps have pocketed about $48,000. You could blow that amount by making eye contact with a salesman on a car lot.

Most of us aren’t going to inherit a Trump-sized windfall, but that doesn’t mean that what we inherit can’t be financially invaluable. If you’re familiar with the Biblical story of the loaves and fishes, you can appreciate the possibility of turning something that could rattle around inside a shoe box into something that’s exponentially monstrous. You can pull off your own financial miracle if you are ever lucky enough to inherit an Individual Retirement Account.

Here’s the beauty of an inherited IRA: The money nestled inside one of these cocoons can potentially keep growing for decades after the original owner has died. All the IRS requests is that a beneficiary make a modest withdrawal each year. When the money is left largely undisturbed and sheltered from taxes, it’s amazing how fast those dollar bills can replicate.

To appreciate the beauty of an inherited IRA, you need to understand its potential. Let’s suppose that a 45-year-old woman inherits a $50,000 IRA from her mom. Rather than cashing in the IRA and paying income tax, she chooses to stretch her required withdrawals over the next 38.8 years, which is what the IRS says is her life expectancy. If the IRA grows at an average annual rate of 8%, she’d pull out $303,113 before the IRA is depleted.

The value of an inherited IRA is even more stunning when someone receives a jumbo IRA. If the same hypothetical daughter inherited a $500,000 IRA, she’d withdraw a whopping $3,031,136 before it was finally emptied. A grandchild who inherited that IRA and took withdrawals over her life expectancy, would make the $3 million look like the change you’d pocket after ordering a Big Mac.

Unfortunately, many Americans, when they inherit an IRA, don’t appreciate what they’ve got. They ransack the account, pay the taxes and return to bitching about not having enough money.

Whether you expect to inherit an IRA or give one away, here’s some advise to ponder:

Convert to a Roth. Last week I praised the Roth IRA as the superior IRA choice. When you pull money from a Roth during retirement, you won’t owe any taxes. And if you’d rather leave the cash alone, you can. Not so with a deductible IRA. With one of these, you must pay taxes on all withdrawals and you’ve got to start tapping into the account not long after reaching 70 1/2.

Not surprisingly then, a Roth is an infinitely better parting gift for your loved ones. It’s true that a Roth beneficiary will have to make yearly withdrawals–the IRS won’t wait forever for this money to be recycled. But your kids, grand kids, or whoever inherits the cash won’t pay any taxes on the withdrawals. In contrast, anybody who inherits a traditional IRA, will owe income taxes.

If you don’t need your IRA cash and the money is just parked inside one until the kids inherit it, you may want to consider converting it into a Roth. Converting a deductible IRA into a Roth requires that you pay income taxes on whatever amount you decide to convert. You can’t convert to a Roth if your gross adjusted income exceeds $100,000 during the year of the conversion. The same ceiling applies to singles and married couples.

Name the right beneficiaries. Make sure you leave your IRA to the right person! This seems obvious, but people blow it all the time. When you established an IRA at a financial institution, you filled out an IRA beneficiary form. Remember? Actually, most people forget about the form, but it’s important because this piece of paper dictates who receives the cash inside this account when you die. Failing to update the beneficiary form can be disastrous. If you never remove a former spouse from your IRA, for example, it’s the ex who will collect the money. The same thing can happen if you established an IRA years before getting married. If you named your parents or siblings and never changed the designation, your wife or husband won’t get squat. Don’t expect your will to bail you out of this whopper of a mistake. It can’t and won’t.

Roll cash into an IRA. When leaving your job, pack up your 401(k) when you’re emptying out your desk. If the cash is sitting in an IRA, children and grandchildren, who inherit this money, as mentioned earlier, can stretch their withdrawals over their lifetimes. If the money remains in a 401(k), that could be the end of the party. You may have to cash in the account far sooner than you’d like. A widower or widow, however, can transfer 401(k) money into his or her own IRA.

Don’t fumble an IRA hand off. Trying to discern the logic in great swaths of the IRS Code can drive a person into therapy. And here’s one of the code’s great head scratchers: If you inherit an IRA, you must leave the giver’s name on the account. If you substitute your name, the IRS can consider the IRA cashed out and you’d owe applicable taxes on the whole splattered mess. There is one significant exception to this IRA booby trap: If you inherit your spouse’s IRA, you can roll it into your own IRA.

When inheriting an IRA from someone other than a spouse, simply add your name and Social Security number to the account. Be careful if you wish to move mom or dad’s old IRA to the place where you keep your investments. Your parent’s financial institution may suggest cutting you a check, but if you cash the check and then move the money, the IRS will conclude the IRA has been disbanded.

Read more. Hard to believe that someone could write an entire book about IRAs–or would want to. But Ed Slott, a CPA in Rockville Centre, NY, who undoubtedly knows more about IRAs than anybody else I’ve ever interviewed, has done it more than once. You can learn a lot about inheriting IRAs by reading his books, including The Retirement Savings Time Bomb and Parlay Your IRA into a Family Fortune Grab the toothpicks and start reading.

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