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Big Windfalls & Structured Settlements – What They Are & How to Handle Them
By the Financial Planning Association |
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If you’ve received a financial windfall, it might sound like you’re fixed for life. The reality is that your financial life has changed drastically, and you need to plan for it.
A structured settlement is a way of receiving partial payments for a major amount of money you’ve won or received in a lottery, a court case or an insurance case. You hear a lot of commercials on the air for getting cash from structured settlements, but it’s important to understand what they are and how they should be handled if you’re ever the recipient.
A good place to start is by consulting your Capital Advantage financial advisor who can assist with the investment making decisions. You will also need other professionals: an attorney and/or structured settlement consultant who has significant experience dealing with payment structures and a certified public accountant to help determine the best distribution option. When there is big money at stake, it’s prudent to have all three professionals on your advisory team. Some ideas:
First, the definition: A structured settlement is structured like an annuity. It is a contract written by an insurance company that provides periodic payments to a winner in a lottery, a lawsuit or some other settlement arrangement over time. Amounts can be paid out weekly, monthly or yearly.
The benefits: Structured correctly – and with the right oversight going in – a structured settlement annuity provides a payment stream that may be tax-free over a period of time during the winner’s lifetime and remaining payments may be bequeathed to his or her survivors after death.
The pitfalls: One should never accept a structured settlement agreement without vetting it against their own tax situation or estate needs. Also, it helps to have an expert who understands these agreements well enough to know whether certain fees or charges connected with that settlement are appropriate to the overall size of the award. Keep it in mind that the structured settlement must be purchased by the person or company that is at fault or is making the award. This is why it’s particularly important to have an expert watching over that selection process from the moment the award is announced.
The lump sum alternative: If a winner chooses a lump sum payment over a periodic payment based on the full amount of the award, that payment will likely be handled with an insurance contract that physically pays the lump sum but at a much heftier chunk of the full total – they get a big payoff for giving you a big one-time payoff. Keep in mind that the lump-sum payoff idea may not be worth pursuing unless it’s large enough to throw off substantial investment income in the future and that you have talented management making sure that lump sum makes money over time. This is why it’s always a good reason to confer with tax, financial and investment experts on the best way to go with either a lump sum or a periodic payment from the moment you’ve been informed you won the money.
Keep in mind that others get an advantage, too: Many attorneys are also structuring their fees that are taken directly out of a court award. This allows them to postpone receiving their share of an award on a tax-deferred basis so they can build their own retirement funds. There’s nothing wrong with this, but it’s important to know who else in the process might benefit from any decisions that get made.
The above article was produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided and revised by Capital Advantage, Inc., a local member of the FPA.
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Bank-Owned Real Estate May Be Plentiful, But Learn the Ropes Before You Invest
By the Financial Planning Association |
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Last month, RealtyTrac, a leading online market for foreclosure properties, reported that over 3.16 million foreclosure filings were made in 2008, up 81% from 2007 and up 225% from 2006. There was one more stunning fact – that 1 in 54 U.S. housing units received at least one of the following -- a default notice, auction sale notice and/or full-scale bank repossession – during the last year.
For those with money to invest in real estate, this is an exciting but extremely risky time. Those who consider investing in foreclosure properties should not only understand foreclosure and the importance of cash in the process, but the emotional element unique to this kind of investment. After all, each foreclosure represents someone who has lost a home.
You’ll hear many advertisements telling you how easy it is to invest in foreclosures and make a fast profit. But those who deal regularly in foreclosures know that making a profit can be tough, and that’s true even for individuals with lots of cash, close ties to lenders and public officials, and plenty of experience. Here’s a look at the foreclosure process and how it works.
What is foreclosure?
A foreclosure happens when a buyer defaults on their payments and the lender takes formal legal action to seize the property. Foreclosures have accelerated not only due to a downturn in the economy that’s affected home sales, but because many homeowners were tripped up by adjustable-rate mortgages that moved to higher payment levels that they could not afford. State rules govern this process, but generally, when a lender decides to foreclose on a property it files a notice of default or a lis pendens (Latin for "lawsuit pending"). This document is a public record, and for buyers – including other lenders -- it's the first step in locating a property in foreclosure. A buyer looking for foreclosures can look online for lists of properties in default, but it’s particularly important to double-check these listings.
Do all troubled properties have to be in foreclosure to be sold? Actually, no. You will hear about “pre-foreclosure” or “short sale” properties put up for sale by lenders who have entered into agreements with troubled homeowners who elect to give up the property to avoid a foreclosure on their credit report. You will also hear about such sales being done by intermediaries who claim to deal in these transactions. Some are legitimate, some are not.
How do people invest in foreclosure properties?
There are three primary ways this happens. First, you will see buyers coming in at the “pre-foreclosure” stage. Second, you will see buyers going after “REO” (real estate owned) properties – literally foreclosed real estate still on the books of a lender. Third, you’ll see foreclosures auctioned off at a local government building or in private auctions, depending on how the lender wants to market such properties to get them off their hands. Each process has its own conventions for inspecting the properties – sometimes prospective buyers get time to inspect what they might buy, other times little or none. That’s where the risk comes in – it’s not uncommon for owners losing their property to neglect it or damage it on purpose on the way out. Repairs can be costly.
Cash or loan?
Borrow to buy a foreclosure property? With today’s credit environment, don’t count on any lender to stake you no matter how attractive your credit rating is. This is risky stuff. There’s also a second reason. While the typical purchase of a home or business property involves mortgage financing that takes weeks to secure due to credit checks and other factors, the sale of foreclosure properties is typically a fast-moving process that requires no-strings financing. Bottom line, a lender marketing foreclosed property likes cash. There’s another good reason to enter this process with cash instead of debt. Even sophisticated foreclosure investors often discover ugly surprises when buying – property with greater damage than they anticipated, for example – and they may not have the flexibility to borrow to fix those unexpected problems after they borrowed to buy in the first place.
Where to learn more?
Begin with some solid advice about your personal finances and your tax situation. If you are a client of Capital Advantage we can help; just contact one of our advisors (John, Gary, or Donna) to discuss your circumstances and see how prepared you might be for this risky form of investment. Beyond that, it’s a process of learning how various lenders in your community deal with pre-foreclosure and foreclosure property and how public officials and private auction houses in your area handle the auction process for such property. Generally, this is knowledge that will take time to obtain since all the parties involved in this process are busy and besieged by other potential investors who want to learn. Be patient, take the proper time to study the process and don’t spend a dime until you do.
This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided and revised by Capital Advantage, Inc., a local member of the FPA.
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Thinking About Munis?
Make Sure You're
Making Wise Picks
By the Financial Planning Association |
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Municipal bonds have long been a safe haven for higher-income investors looking for safety and greater tax efficiency. The credit squeeze put the municipal bond market through its paces like other competing markets this year, but it may be time to take a second look at both municipal bonds and muni bond funds.
Let’s start with a definition of what a municipal bond is. A municipal bond, or muni, is a bond issued by a local government or their agencies to raise funds for a host of reasons tied to keeping the government going. The potential issuers may include cities, counties, redevelopment agencies, water and sewer projects, school districts, publicly owned airports, seaports and other transportation entities. They pay for everything from immediate government expenses to new roads and various public projects. Municipal bonds come in two flavors—general obligation bonds and revenue bonds. General obligation bonds are intended to raise immediate capital to cover government expenses; revenue bonds are the ones that fund infrastructure projects.
As an incentive for investors to buy these bonds, interest income is often exempt from federal income tax as well as the income tax of the state in which they are issued. Mutual funds that invest in municipal bonds also offer the same tax treatment.
This year has held lots of excitement for muni investors and those who were hoping to be. The credit crunch sucker-punched funding sources for public projects as well as private investments–many municipalities ended up dropping certain projects because investors weren’t there to buy the paper and other sources of financing had dried up as well.
Who’s fled the muni market? Hedge funds, issuers of structured notes and municipal bond mutual funds were trying to keep up with redemptions from tapped-out investors. Right now, the best sources of demand for munis are individual investors who can account for only so much business.
Keep in mind that even during the Great Depression, no state defaulted on its general-obligation bonds, and while some munis have defaulted, overall, such defaults are very, very rare.
In the fourth quarter of 2008 most bonds plunged, while some municipals late last year were offering long-term, tax-free yields of five percent and above, which translate into the equivalent of nearly seven percent for taxpayers in the 28% bracket and nearly 8% for someone in the top 35% bracket when the tax exemption is considered.
Currently, Capital Advantage believes that the opportunity in California state issued municipal bonds has passed, at least for the time being. Our recent research of California issued bonds in both the secondary market and new issues market both indicate that yields have dropped significantly due to a recent run up in bond prices.
Before you buy, here are some things to know and steps to follow:
Are munis right for you?
The first call you make shouldn’t be to a broker. It should be to your accountant and/or your Capital Advantage financial advisor - both can take a look at your entire taxable investment portfolio (there’s no point in putting tax-exempt munis into tax-exempt accounts like IRAs or 401(k)s) and determine whether they’re the right approach to take for your investments.
What munis are in trouble?
There are some governments who issued a hybrid muni known as a variable-rate demand note. These were sold mainly to institutions with maturities of up to 30 years that were paying at rates reset as frequently as once a day. During the crisis, the rates on these notes shot up to double-digit territory, putting the municipalities that issued them under particular strain due to short-term interest rates that can be reset daily.
Keep an eye peeled for the AMT:
While most munis pay interest that’s free from federal income taxes, some may pay rates that are subject to the alternative minimum tax, known as the AMT. It’s a little more complicated than we have space for here, but this is absolutely why you need to talk to your tax professional or financial planner before making a move into munis.
Don’t forget to ladder:
“Laddering” is a portfolio structuring term. To ladder bonds means that you are buying them with maturities occurring at regular intervals, so when they mature, you’ll have money to reinvest at those same regular intervals.
Watch those ratings:
Yes, the main private investment ratings firms–Moody’s and Standard & Poor’s for example–have been in the doghouse for rating many battered investments high, not just munis. But most municipals rated AA or AAA are generally safe to consider. It’s also important to check the issuer’s long-term ratings history. If they’ve been consistently highly ranked over decades and the municipality has no financial scandal (something that can be checked through news archives on the Internet), that’s another good way to research a bond issuer before making a purchase.
This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided and revised by Capital Advantage, Inc., a local member of the FPA.
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