Macabre investments

A brief story on death bonds appeared in this week's BusinessWeek. It gives a succinct description of what they are:

The business model is straightforward. Policyholders, usually people over 65 holding multimillion-dollar plans, agree to sell their insurance to investors, often at a third of its value. The new owners pay the premiums and ultimately collect the death benefit. Those speculators are ghoulishly betting that the former policyholders will die sooner rather than later, creating an early payout and a tidy profit.

No surprise, Goldman is getting into these exotic instruments, and even creating an index for them:

As a precursor to offering death bonds, Goldman in December launched a "mortality index" that tracks the life expectancy of 65-year-olds with policies. The index, which would allow investors to buy derivatives pegged to it, means they could hedge against the risks of people living longer than anticipated. That's a key tool for marketing these products to institutions and other buyers.

The article also delves into issues Goldman is having with the bonds, and they haven't actually issued one yet. I don't think I'll be investing in these, but they are interesting nonetheless. There's a graphic that's only in the print magazine that states the market for unwanted life insurance policies has increased from $8 billion in 2005 to $15 billion now.

Kiddie tax

An article in this week's Baron's goes over kiddie tax changes for 2008. The basics from the story:

Under kiddie-tax rules, a child's unearned income of more than $1,800 (up from $1,700) is subject to the parents' tax rates of up to 35% on interest and short-term capital gains, and 15% on long-term capital gains and most dividends. The first $900 of the child's unearned income is tax-free; the second $900 is taxed at the child's rates. Most children are in the 10% or 15% income tax bracket, and they would typically be subject to the lowest capital-gains tax rate, which this year has dropped to 0%, from 5%.

Keep in mind this special tax treatment is for unearned income, not for earned income kids make by working. The real kicker is that the maximum age of children the kiddie tax applies to is rising to 18, or 23 for full-time, dependent students (it wouldn't apply to children not claimed as dependents on someone else's return). This will obviously effect your ability to lower capital gains taxes by gifting investments to children, and the article explains the ramifications.

I want to bring up one uncommon situation that I think makes this tax change really unfair. (Admittedly, it's far fetched). Let's say you are a full time student in college, under 24 years old, and you are a whiz at the stock market. All you do is pick winners. If you have capital gains of over $1800, and your parents have a higher tax bracket than you do, you'll pay taxes at a higher rate and are therefore penalized.

529 plans are not subject to the kiddie tax, and I'm using them to my advantage. Much more information on child tax rules are in IRS publication 929.

Investing a lump sum of cash

Invest a lump sum all at once, in one fell swoop, says a recent Money magazine Ask The Expert column.

So I’m going to break ranks here and recommend what I believe is a better strategy - namely, settle on a blend of stock and bond funds that makes sense given your risk tolerance and investing time frame, and invest it in that mix all at once.

I completely disagree with this approach. Any lump sums that I've ever received I've invested over time. The potential to buy right at the top of the market is too much of a risk for me, so I prefer to invest lump sums in stages. In a rising market, I will give up potential gains with this approach, but I'm more than willing to make that risk/reward trade off. I can always find cheaper investments after a big market run up that leaves me behind, but there is no way short of waiting for a recovery to get back any losses from buying at the top.

IRA changes in 2008

Vanguard sent me a letter that nicely lays out the legislative changes to IRAs for 2008. Some of these are the result of the Pension Protection Act of 2006.

Direct non-Roth 401(k) to Roth IRA rollovers

Previously, you could roll over a non-Roth 401(k) to a traditional rollover IRA, and then convert the traditional rollover IRA into a Roth IRA. Now you can skip the step of having to roll over into the traditional rollover IRA, and roll over and convert at the same time. There are still tax consequences from converting the pre-tax non-Roth 401(k) into the post-tax Roth IRA. There are income limits of $100,000 as well. More details can be found in the IRS publication, Notice 2008-30.

Q-1. Can distributions from a qualified plan described in § 401(a) be rolled over
to a Roth IRA?

A-1. Yes. The rollover can be made through a direct rollover from the plan to the
Roth IRA or an amount can be distributed from the plan and contributed (rolled over) to
the Roth IRA within 60 days. In either case, the amount rolled over must be an eligible
rollover distribution (as defined in § 402(c)(4)) and, pursuant to § 408A(d)(3)(A), there is
included in gross income any amount that would be includible if the distribution were not
rolled over. In addition, for taxable years beginning before January 1, 2010, an
individual can not make a qualified rollover contribution from an eligible retirement plan
other than a Roth IRA if, for the year the eligible rollover distribution is made, he or she
has modified adjusted gross income (“MAGI”) exceeding $100,000 or is married and
files a separate return.

I won't be doing this anytime in the future, for tax diversification purposes.

Starting in 2010, anyone can convert a traditional IRA (or 401(k)) into a Roth IRA

This year and in 2009, your MAGI, as described above, has to be $100,000 or less to do a traditional to Roth conversion. That limit goes away in 2010. I do plan on doing this in 2010. I feel my traditional, non-Roth 401(k) assets are enough to keep me tax diversified. I'll eventually write a post on how I'll be doing this, as I've been planning it since the laws changed in 2006.

Traditional and Roth IRA income limits increase

The income limits for full deductibility of a traditional IRA increases to $53,000 for single filers and $85,000 for joint filers. The income limits for full contributions to a Roth IRA increases to $101,000 for single filers and $159,000 for joint filers.