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					               Designing Our Future
                                                        Table of Contents




               Table of Contents

Chapter 1: The Future is Nearer than You Think                         5
   Knowledgeable Agents                                                5
   Acquiring Assets                                                    6
   Estate Planning                                                     7
   Wasted Dollars                                                      9
   Wishing our Way Into Retirement                                    10
   Goal Setting                                                       11
   Accurate Information Required                                      13
       Wealth Distribution                                            15
       Estate Control                                                 15
   All Estates Need a Will                                            18
   Determining an Asset’s Value                                       22
       Income Capitalization                                          24
       Reproduction-Cost-Minus-Depreciation                           24
       Comparative Sales                                              24
   Determining the Dollar Amount                                      24
Chapter 2: Will You Outlive Your Assets?                              27
   Buying Power                                                       27
   The Federal Reserve                                                28
   Permanent and Variable Portfolios                                  30
Chapter 3: Using Financial Tools                                      36
   The First Step: Record Keeping                                     37
   Establishing a Budget                                              38
   What Records and Where?                                            39
   Wills                                                              44
Chapter 4: Trusts                                                     47
   Defining a Trust                                                   48
   Irrevocable and Revocable Trusts                                   50
       Irrevocable Trusts                                             50
       Revocable Trusts                                               52
       Present Interest Trusts                                        57
       Crummey Trusts                                                 58
       Totten Trusts                                                  59
       Life Insurance Trusts                                          59
       Grantor Retained Annuity Trusts (GRAT)                         61
   Money Management Tool                                              62
       Probate Considerations                                         62
   Trust Language                                                     70
       Trust Creator                                                  71


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       Trust Types                                                     71
       Trust Distribution for Minors                                   72
   Selecting Trustees                                                  73
   Probate Protection                                                  74
       Proper Trust Use                                                74
   Not Everyone Needs A trust                                          76
   Taxation                                                            88
       Estate Taxes                                                    88
       Inheritance Taxes                                               88
       Bankruptcy Protection                                           89
       Medicaid Qualification                                          89
   Avoiding Probate Proceedings                                        90
       Estate Privacy                                                  90
       Generation Skipping                                             91
       Asset Management, Conservation, and Distribution                92
   In Conclusion                                                       95
Chapter 5: Life Insurance                                              96
   How Much is Enough?                                                 97
   The Life Insurance Trust                                           102
   Term or Cash Value?                                                103
       Term Insurance                                                 104
       Cash Value Insurance                                           106
       Whole Life Policies                                            108
       Universal Life Policies                                        109
       Variable Life Policies                                         109
       Endowment Life Policies                                        111
       Survivorship Life Policies                                     111
       Single Premium Whole Life Policies                             111
   Policy Options                                                     112
       Nonforfeiture Options                                          113
       Disability Waivers                                             113
       Cash Values                                                    114
   Insuring the Life of a Child                                       114
   The Agent’s Role                                                   115
Chapter 6: Annuities                                                  117
   Retirement Risks                                                   117
   A Payment of Money                                                 118
   Annuity History                                                    120
   Do Annuities Make Sense?                                           124
       Commission Surrender Periods                                   126
   An Estate and Retirement Planning Tool                             127
   Annuity Facts                                                      128
   Tax Deferred Status                                                130
       Time is Money                                                  131
   Periodic Withdrawals                                               132
   Annuitization Options                                              134

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   Annuity Models                                                      137
       Accumulation Deferred Annuities                                 137
       Single Pay Immediate Annuities                                  137
       Variable Annuities                                              137
   Investment and Insurance Component                                  138
   The Variable Annuity’s Introduction                                 140
       Wrap-Around Annuities                                           140
       CD-Like Annuities                                               141
   Retirement Advantages                                               141
   Estate Advantages                                                   142
   Competition                                                         146
   Investment Expenses and Loads                                       150
   Similarities                                                        153
Chapter 7: Retirement Funding                                          157
   Pension Plan Players                                                158
   How Much Money Will You Need?                                       162
   Inflation                                                           165
   Company Sponsored Pension Plans                                     167
   Defined Benefit Plans                                               169
   Defined Contribution Plans                                          172
   401(k) Plans                                                        175
   Collecting Pension Funds                                            176
   At Retirement                                                       183
Chapter 8: Other Financial Options                                     188
   Individual Retirement Accounts (IRA)                                188
   Keogh Plans                                                         189
   Simplified Employees Pension Plan                                   190
   Incorporation                                                       191
   S-Corporations                                                      196
   Estate Planning Tools                                               197
   When Death Occurs                                                   200
Chapter 9: Ethics and Other Myths                                      208
   Industry Knowledge                                                  211
   Due Diligence                                                       215
       Understanding the Products                                      216
       Catastrophic Loss on a Large Scale                              218
   Insurer Rating Companies                                            220
       AM Best’s Ratings                                               221
           Financial Size Categories                                   223
           Issuer Credit Ratings                                       225
       Fitch Ratings                                                   226
           Fitch Ratings Actions                                       229
           International Long-Term IFS Rating Scale                    231
           National Long-Term IFS Rating Scale                         233
           International Short-Term IFS Rating Scale                   236
       Standard & Poor’s                                               237

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        Insurer Financial Strength Rating Definitions                237
        Long-Term Care Financial Strength Ratings                    238
        CreditWatch                                                  240
        Short-Term Insurer Financial Strength Ratings                240
        Financial Enhancement Rating Definitions                     242
        Credit Ratings                                               243
        Long-Term Issue Credit Ratings                               245
        Short-Term Issue Credit Ratings                              247
        Active Qualifiers                                            249
        Inactive Qualifiers                                          250
        Local Currency and Foreign Currency Risks                    251
        Long-Term Issuer Credit Ratings                              252
        Short-Term Issuer Credit Ratings                             254
            Rating Outlook Definitions                               255
            CreditWatch                                              255
    Weiss Ratings                                                    256
 Continuing Education Requirements                                   257
    An Agent’s Personal Responsibility                               259
 Professional Reprensetation                                         261
    Appointments                                                     261
    Getting in the Door                                              262
 Making the Sale (Or Not)                                            265
    Product Over Commission                                          266
    Organization                                                     267
    Full Disclosure                                                  267
    Product Replacement                                              268
    Policy Application                                               269
    Product Delivery                                                 270
Yearly Reviews                                                       271
    Revisiting the Sale (Homework)                                   271
    Does the Product Still Meet Their Goals?                         272
 Errors & Omissions Insurance                                        272
    Agent Liability Risk                                             272
 Giving Our Clients What Is Due Them                                 276
    Criteria                                                         279
    Claims-Made Policies                                             279
    Occurrence Policies                                              279



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                 Eatonville, Washington 98328-8638
                           (253) 846-1155




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                           Chapter 1 – The Future is Nearer Than You Think



                               Chapter 1


             The Future Is Nearer
               Than You Think


  Americans are an optimistic group. We are constantly exposed to
financial information on the news, in magazines, and on television.
Despite the numerous articles on financial issues, a surprisingly small
portion of the United State’s population actually spend adequate time
planning for their financial future. The creation of an estate, especially
one that has been given adequate thought and preparation requires
the expertise of many people. Seldom is a single person equipped to
properly handle the entire procedure. Since one of those professionals
is likely to be an insurance agent, it is important that he or she
understand how estates must be set up. Even though part of the
process will not directly involve insurance products, the agent needs to
understand the process in order to perform his or her job completely
and professionally.

  Life insurance products usually relate directly to estate planning.
There are types of life insurance products that may be used for other
life goals, but preparation for death is the first and foremost use for
life insurance policies. For this reason, life insurance policies are often
included in estate planning.


Knowledgeable Agents

 Some agents may not see the need to understand anything beyond
their own immediate products.     As products have become more
sensitive to consumer needs and desires, however, agents are finding
that broader knowledge is beneficial. In some situations, broader
knowledge is even essential.

 Agents who understand current financial climates are always in
demand. Therefore, not only do the clients benefit; the agent does as


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well through increased earnings. Planning a client's financial future
can be extremely satisfying when you know you have done an
excellent job. Since financial planning is an ongoing affair, it cannot
simply be set down and filed away. Clients will rely upon their agent
for ongoing and changing goals. Do not confuse financial planning
with the financial vehicles used. Financial planning is NEVER the
products used.


Acquiring Assets

  There can be no estate if there are no assets. An insurance agent is
often the starting point in creating an estate through the use of a life
insurance policy. This is especially true for young families who have
not yet accumulated any other types of assets. As time goes by, the
young family will acquire assets beyond their life insurance policy.
Both the client and their insurance agent must recognize the needs
that develop as assets accumulate.

  Tax laws constantly change. It is unlikely that the general agent will
be educationally equipped to give tax advice so it is seldom wise to do
so. As a result of the complex role played by tax laws, an accountant
is a vital part of estate planning. With the phased-in dismemberment
of the Federal estate tax, it is estimated that around 95 percent (or
more, by some estimates) of all estates will be exempted from liability.
This does not mean that estate planning is no longer necessary or
advisable. The Economic Recovery Tax Act of 1981 did, however,
change the nature of much estate planning.

   The true financial specialist will consider tax reduction as
             merely one aspect of estate planning.
           Tax avoidance is seldom the main focus.

  Taxes are often the target of estate planning. Most Americans want
to pay less than they currently do. The point, of course, is to leave
larger amounts of assets available to the estate beneficiaries. The true
financial specialist, however, will consider tax reduction or avoidance
as merely one aspect of estate planning. Tax avoidance is seldom the
main focus. There is good reason for this: first of all, tax laws are
constantly changing. While the changes may not be extensive, any
type of change can distort the end result of the financial plan.


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Secondly, the goal must always be financial security. This is why tax
minimization is only one aspect of financial planning rather than the
main focus.

  In the past, wealthy clients relied on well known accounting firms to
be sure they invested within the bounds of the law. That can no
longer be automatically assumed. With the downfall of Anderson
Accounting (following the Enron scandal) and investigations of other
well-known firms in 2003 and 2004 following questionable use of tax
“loopholes,” we must recognize that each individual is accountable to
the IRS for their investments. Citizens do have the option of suing
their accounting firms, but that is a long drawn-out affair. It is better
to avoid the situation entirely.


Estate Planning

 It is very important to realize that estate planning is never the
products used. Rather, estate planning is the procedures used that
allows a person to transmit his or her property to persons of his or her
own choice in a manner that is satisfactory and appropriate. Using this
definition, it is easy to see that taxes are not a primary objective.

   Estate planning is the process of transferring property to
    others in a manner that is satisfactory and appropriate.

 Every person is an individual and will have individual needs or
desires. Therefore, the objectives are likely to be extremely varied
among clients. The client may wish to:
      1. Will property (assets) to the spouse without providing the
         recipient more wealth than he or she wants or needs or
         wishes to handle.
      2. Transfer property or income to children who may be in a
         lower taxable bracket.
      3. Transfer property or income to other relatives, friends,
         organizations or charities either in life or after death.
      4. Control how and when the beneficiaries receive the assets.




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                          Chapter 1 – The Future is Nearer Than You Think


  Estate planning involves many more goals than those listed above. It
is the professional's job to point out any dangers that may be
connected to such objectives and to also point out any alternatives
that may be more satisfying.

 There are always points to consider during estate planning. Some of
these include:
     1. The form or method used to transfer property.
     2. The method necessary to transfer stock from a closely held
        corporation.   Some options include buy-sell agreements,
        business continuation trusts, recapitalizations, and mergers.
     3. Following death, any circumstances that might alter the
        wishes of the deceased in relation to his or her estate.


  Estate objectives change over time. In the beginning objectives will
relate to family security; nearing retirement objectives relate to
financial security when employment income has ended. So many
factors change the direction of a person's life and all of these changes
may have an effect on the desires and objectives involved with the
estate. Initially, the client may want to buy a home, plan for college
for themselves or their children, and avoid or minimize taxes. As time
progresses a college degree is achieved, a home is purchased, and tax
avoidance or reduction may become less important.

 There is usually less money available in the early years of planning.
The first adult years are spent trying to set up a home, acquiring
personal property, and raising children.       Careers take time to
establish. Even so, many people will end up far wealthier than they
ever imagined. Additional wealth brings redirected objectives. One of
the most important factors affecting how we view our estate involves
the people we associate with. Some potential beneficiaries may die or
become distant (lose importance). New people with new needs may
enter our life. Such things as death, divorce, marriage, adoption, and
so forth bring about redirected goals.

Many people will end up far wealthier than they ever imagined
  but this wealth could be lost without adequate planning.




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                            Chapter 1 – The Future is Nearer Than You Think


 While estate planning has many advantages, one important
advantage is peace of mind. Having a goal is always a comfort and
reaching that goal brings great satisfaction. As one goal is reached,
another will take its place. Ultimately, the dedicated person will reach
and surpass many goals in their lifetime. These are the people others
may assume are financially gifted. In reality, they are simply goal
driven, doing what is necessary to achieve financial security.

 Estate planning is not always about growth of assets. Many times
the goal is providing for those who are unable to provide for
themselves. Certainly, financial considerations are still a major factor,
but merely as a means of completing a non-financial goal. It would be
impossible to list all the wishes that financial planning may involve.
They depend upon so many factors and emotions that the professional
will simply enter into each new encounter with an open mind and a
ready ear. It must be stressed that the art of listening is a most
valuable asset to the career agent.

           The art of listening is a necessary component
                        of the estate planner.

  Each individual has full legal control of their estate regardless of their
position in life. Sometimes one exercises that control by simply doing
nothing at all. In effect, that person "chooses" to be non-effective.
According to author Charles Givens, "When it comes to handling
money, you will end up either the victor or the victim." It is
unfortunate that so few Americans consider future financial needs,
preferring to spend rather than plan and save. The need for
materialism often blinds us to what should be obvious: we cannot live
today as if there will be no tomorrow.


Wasted Dollars

 Americans seem anxious to try anything. It has been estimated by
some that upper-income Americans waste as much as $20,000 every
year simply by participating in perfectly legal activities with a variety
of established institutions. These institutions include banks, brokers,
car dealers, insurance agents and their companies, credit card
companies, and the biggest taker of them all, the IRS. This money is
wasted because consumers do not take the time to plan financially.


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  Americans admire those that seem to be financially gifted, but the
term “gifted” is wrong.      These individuals are simply financially
educated, goal-oriented, and disciplined. When you combine education
with discipline, the combination is always a winner.


Wishing Our Way Into Retirement

  Most Americans prefer to simply wish, want, hope and pray for
financial success. Meanwhile, they are buying (often on credit) every
new trinket that comes along. It is hard to believe that anyone could
think they can retire comfortably without lifelong planning. Obviously,
Social Security is not adequate for retirement. Wishing, wanting,
hoping and praying will never accomplish financial security unless it is
followed by a firm plan. Successful financial planning comes from
direction and control. It rarely occurs by accident.

  Financial success comes from meeting goals, which follow a set pre-
planned path to some degree. Certainly there will be deliberate
changes in the financial plan, but a plan will still be followed. Financial
planning is not accidental or theory. Financial planning involves logical
ideas that work.

          Financial planning is not accidental or theory.
       Financial planning involves logical ideas that work.

 America is known for its poverty-to-riches stories, yet many
Americans believe they will always be poor because they are currently
poor. This attitude allows them to live without financial goals using a
“Why-try? I-can’t-succeed” mentality.       All of us will not end up
millionaires, but it is possible to improve our current financial status.
People do it every day.

  Since few citizens keep a written budget, few realize how much they
actually earn and spend in a lifetime. This casual attitude regarding
the income we have prevents us from using our money wisely.
Although day-to-day costs can be burdening, most people have no
idea where much of their hard earned money goes. Few people bother
to even make out a simple budget. It is common for a person to have



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                           Chapter 1 – The Future is Nearer Than You Think


$100 cash unaccounted for on a weekly basis. That $100 a week is
$5,200 per year and $52,000 over just ten years.


Goal Setting

  No one states a retirement goal of poverty. Many Americans never
even consider a retirement goal until the event is imminent.
Unfortunately, too many citizens have only immediate goals. We want
everything now. Goals often begin as dreams. Whether we call them
dreams or goals, however, a specific plan of action is necessary to turn
ideas or desires into reality. Day-to-day living takes a lot of energy
and can divert an individual from focusing on the financial direction
necessary to accomplish future goals. Setting up and maintaining an
estate plan is a daily ongoing affair. An estate begins in early
adulthood, not simply in the later years of life.

  Many of us are financially self-destructive. Expecting financial
security without planning and working towards it would fit into this
category. This attitude allows a person to do nothing other than wait
for the pot of gold to land in their laps. These individuals, while
dreaming of wealth or accomplishments, always wait for it to simply
"happen." These individuals may dream of winning the lottery, hitting
it big at the gambling table, or inheriting wealth. The real world
seldom delivers these desires. As a result, these individuals end up
wasting their time and resources. Even if such an individual were to
win a lottery or experience a large inheritance, their lack of financial
responsibility would simply waste the money away. Those who put too
much importance on “looking good” to others are unlikely to ever have
financial goals that succeed.      Looking good requires they buy
everything anyone else might have.

           Putting goals on paper makes them official:
                       more than a dream.

  Goals need to be written down and studied. Putting goals on paper
makes them official – more than a dream. Goals need to be specific. A
vague goal cannot be fully acted upon. For example: "I want to be
financially comfortable when I retire." While that is certainly a goal, it
is too vague. How much money is desired at retirement? It should be a
specific dollar amount. At what age is retirement desired? Again, it


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must be specific. An exact age should be written down. Thirdly, a
financial road map must be established. How much of the weekly or
monthly earnings will be set aside to achieve this retirement goal? An
exact dollar figure must be established and then acted upon. The
individual needs to be realistic, of course, so that the savings can
occur. A figure that is too high may only frustrate the person causing
no savings at all to be achieved.

  Putting money aside is never easy. Who wouldn’t rather spend than
save? We often hear people say that it takes every dime they make to
simply pay the bills. In many cases, it takes every dime because there
is excessive bills, some of which could be eliminated. That may mean
downsizing the entertainment budget, brown-bagging instead of
buying lunch each day, or cutting up the credit cards. It is imperative
to keep detailed bookkeeping records to track excessive or
unnecessary spending. A surprising number of people do not even
know precisely where their money is spent each month. Again, an
itemized expenditure list is always a first step for setting up goals. The
expenditure list should contain no less than three months worth of
figures.

  The following is a sample of what a monthly expenditure list might
look like:
Rent or  Phone & Car       All       Auto                 Food    Credit
Mortgage Utilities Payment Insurance Gas                          Card %
 $1,100      $250       $865         $150        $320      $500    $125

  Please note that the last column says "credit card interest." Only the
interest should be listed here, not the entire purchase price. If clothing
were purchased, for example, the purchase price would be listed under
clothing. Only the interest charged by the credit company (plus any
additional fees) would be listed in the credit card column.

  There is no set format for an expenditure list.          Whatever the
household spends money on regularly belongs on the chart. Some
additional items on the expenditure list could include clothing, lunches,
business expenses (such as motel costs), dry cleaning, entertainment,
plus any other item that seems to be a regular expenditure. If money
is spent for any item at least once per month, a column should be
made for it. This is the only way to track where money is spent. Once



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                           Chapter 1 – The Future is Nearer Than You Think


an individual knows precisely where the money is going, it is much
easier to add that most important category: savings!

          There is no set format for an expenditure list.
  Any category where money is spent at least once per month
   is a regular expenditure and earns a column on the chart.

  While the insurance agent performs several functions, one of the
most difficult can be clarifying the client's objectives. The agent may
realize that the consumer’s objectives are misdirected or unrealistic.
Obviously this can be awkward for the agent. Graphs, such as
pyramids, may allow an agent to bring forth realities without directly
confronting the client in a negative manner. If an agent makes a client
feel inadequate, he or she may fear making any decision at all or
resent the agent’s input.


Accurate Information Required

  Any type of plan must follow some recipe. Like good cooking, a
successful plan never happens by accident. The very first rule of
financial planning is simple: base your plan upon accurate information.
To do so requires careful attention to details. The plan developed will
only be as good as the information obtained.

                  A financial plan is only as good as
                 the information it was based upon.

 Information gathering can feel both awkward and time consuming.
Even so, it is a vital step in setting up a sound financial plan. The skill
of the agent during information gathering always shows. Information
set on paper generates consumer questions, which in turn allows the
agent to minimize misunderstandings and bring forth suggestions.
Skimming over this stage will affect all other areas of the financial
plan. It is necessary to fully understand the financial picture, as it
exists today, in order to determine how it will look in the future.

 Many financial planners prefer a pyramid as the basic format for
viewing a person's financial picture. A pyramid gives a solid sense of
order, which benefits both the consumer and the agent. It is also one
of the simpler graphical ways to show financial suggestions to a client.


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                           Chapter 1 – The Future is Nearer Than You Think


Degrees of risk are often easier to comprehend when a pyramid is
utilized, with the highest risk put at the top and the lowest risk placed
at the bottom. This order makes sense because the bottom of a
pyramid is broad and obviously the foundation for the rest of the
structure. Pyramids may be used to explain a multitude of ideas as
well as degrees of risk.

  If a pyramid is used to show a client's assets, the same general
format is used. Solid assets are placed at the bottom and less secure
assets are placed at the top. When used for cash flow, a steady
dependable income would be at the bottom, with such things as over-
time compensation placed towards the top.

  Since pyramids may be used in so many ways, there really is no right
or wrong way to use them, as long as the concepts are clearly
understood by the consumer. The main objective is to keep the graphs
simple, clear and understandable.

  Financial planning is very much the same as a road map. It involves
continual growing and changing financial goals as incomes shift
(hopefully upward), debts come and go, and family structures alter.
Since a map has both a starting point and a destination, so too must
the financial plan. The destination may change from time to time with
necessary adjustments to reflect those changes. The client, with the
help of his agent, must determine where he or she is now, and then
identify where he or she wishes to be at specific intervals in the future.
Along the way, various desired goals will be reached and passed. New
goals will replace completed goals.

 How those goals are arrived at, and the amount of risk taken
       to get there, must be determined according to
   each individual's level of comfort and financial ability.

  Achieving goals is not an easy task. Unwise choices could mean a
loss of assets. How those goals are arrived at, and the amount of risk
taken to get there, must be determined according to each individual's
level of comfort and financial ability.

 Whatever the financial goals of the individual may be, there tends to
be three phases to them:
   1. Accumulating wealth,


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                             Chapter 1 – The Future is Nearer Than You Think


   2. Preserving wealth, and
   3. Distributing wealth.

 The starting point of any financial goal is wealth accumulation.
Obviously it is not possible to meet a financial goal unless assets exist.
When wealth is successfully accumulated, it is certainly important to
preserve it. Some individuals thrive on risk and constantly subject
their accumulated wealth to the possibility of loss. For most of us,
however, preservation is as important as accumulation.

The starting point of any financial goal is wealth accumulation.

 Once the desired level of wealth is reached most people tend to
become more conservative in their financial personality. This may
even be true for the risk-takers. This is probably wise since the
accumulation period often consumes most of one's working years. It
would be foolish to risk losing what it took a lifetime to gather.


Wealth Distribution
  Distributing wealth can be a reward in itself. Since there are those
who have accumulated more than they will need in their lifetime, their
aim becomes one of sharing. Who they share with may range from
children to charities. If they are gifting to charities there are a variety
of ways to do so. This may even be done through insurance products.
The idea of being recognized publicly for their contributions, coupled
with tax benefits, is very inviting to many people. However, it would
be a mistake to give prior to death unless the individual is certain they
have enough money to last their entire lifetime. The day-to-day
activities of living can bring with it financial surprises. We have seen
stock market downturns that have wiped out huge portions of
individual savings. Enron taught us that we must not blindly trust the
institutions that handle our money. A person should never give away
excessively until they are very well established themselves.

Estate Control
 Although there are many things in life over which we have no control,
our estate is not one of them. Unless we choose not to, each person
has total control over the decisions made regarding their estates.




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                          Chapter 1 – The Future is Nearer Than You Think


  Insurance agents should have more knowledge regarding financial
goals and estates than would the general layperson. Despite this fact
it is common for agents themselves to fail to properly plan their own
financial future and estate. Examine your current financial picture:
would you find your own affairs in order if you died today? Would your
heirs need a psychic interpreter to figure out what you intended?

 Are your assets listed in an easy way to understand?

  Is there sufficient insurance or other provisions to take care of your
family and beneficiaries?

 Is insurance carried to finance taxes that might reduce your estate?

  There are some basics each of us must attend to. An estate has two
jobs to do:
  1. Give the person independence and security while living, and
  2. Give the surviving family members independence and security
     after the breadwinner has died.

  It is important not to get so involved in the mechanics and costs of
transferring property to beneficiaries that the first important step is
overlooked: establishing the estate.

 Too many Americans become so focused on avoiding probate through
various schemes that they lose sight of the real purpose of planning:
developing assets and future security. What a shame that the same
energy is not being spent to create the estate. The best estate plan is
one that creates the maximum benefits for the right beneficiaries. A
bad plan is one that does anything less than that. Probate or no
probate is simply a side issue of lesser importance. In fact, for some,
probate is necessary to close access to assets. Many types of vehicles
that avoid probate provide continual access to the estate assets
whereas probate has a specific point of closing access.

 Although some people enjoy working towards a financial goal, for
many it is difficult path to stay on. Estate planning is the art of
designing a program for the effective management, enjoyment, and
disposition of property at the least possible cost and energy. The plan
must be one that can be followed. If the individual feels they have


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given up all enjoyment today to reach tomorrow’s goal, it is not likely
to be achieved.

   Estate planning is the art of designing a program for the
effective management, enjoyment, and disposition of property
           with the least possible cost and energy.

  Everyone needs some type of estate plan, no matter what our
current role in life. This includes both men and women whether
married or single. Every estate plan must include a will, even if the
individual plans to use some type of estate trust. Many people fail to
use an estate plan that will do the best job possible. In such cases, it
is often the will that provides the best security for the desired
beneficiaries. Even a badly written will is better than none at all.
However, a well-written will likely costs no more than a badly thought
out one.

 Unfortunately, very few estates are set up as well as they could be.
The reasons vary. Perhaps life takes so much time that the inevitable
death is ignored. Perhaps advice is taken from those least qualified to
give it. Perhaps the attorney used was not well trained in estate
planning. Whatever the reason, a poorly planned estate can affect
everyone involved.

     Most people get much less independence and security
    (both in life and in death) than they could have achieved
        with proper planning and finance management.

  Most people get much less independence and security (both in life
and in death) than they could have achieved with proper planning and
finance management. Stashing away enough money to survive, even
if your job doesn't, is the true meaning of independence. In today’s
uncertain economy no one has real job security. Taking financial
responsibility for our lives is not only important but also necessary.

 Gaining financial independence may be achieved in a number of
ways, but there are some basics involved:
  1. As much of your estate as possible should be in assets that are
     not dependent upon you or your business. Assets that produce
     income without your support are ideal. This can especially
     involve insurance agents since many of our businesses depend

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     upon our presence to continue. Each agent should take this into
     account when they set up their own estate.
  2. The best estate plan is one that assumes you are out of the
     picture and sets up your property now as closely as possible to
     the way you would like it set up for your family. In other words,
     your assets are currently in the condition you would wish them
     to be for the benefit of your family.
  3. Your estate objective, with Social Security and other income,
     needs to produce enough money for you and your dependents to
     live on both when you retire and when you die. This needs to be
     the target of your insurance and investment programs.
  4. On paper, figure out what will happen to your property when you
     die. This includes how you will pay debts, taxes, and expenses.
     It must also include what amount of money will be left and how
     much income that amount of money will produce each year. Your
     estate plan needs to keep this figure in mind while increasing
     and protecting your assets and yet have the flexibility to allow
     you to adapt to life changes.



All Estates Need a Will

  All estates require a will even if a trust or other vehicle is also
utilized. You will see this statement throughout this course because it
is such an important fact.       A will is simply the most basic of
documents. While holographic wills are usable in most states, it is best
to go to an estate-planning specialist. Such a specialist is usually an
attorney, but any person with specialized knowledge may be able to
provide the service. A holographic will is a completely handwritten
will. Even the date must be handwritten (January first, nineteen
hundred and ninety-two rather than 1/1/92). Naturally the document
must also be signed. Former President Calvin Coolidge's will stated
only: "I leave my entire estate to my wife, Grace, and request that she
be appointed executrix without bond." For very simple estates such a
will might suffice. However, in today's complex social structure few
estates are so simple.

       A will is the most basic estate-planning document.



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 Since preparing a good estate plan requires thought, it is generally
necessary to work with professionals including insurance agents,
attorneys and accountants.

  These are the steps typically followed:
  1.    List the people you will want to provide for. Consider their
        personal needs, but also their faults and capabilities. Consider
        what opportunities you wish for them to have (such as a college
        education), what responsibilities they could reasonably handle,
        and what burdens you wish to spare them. Also consider any
        possible weakness' you might wish to protect them against.
  2.    Review your assets. Obviously, the assets will determine the
        basic abilities of the estate. Usually an estate falls into one or
        more groups:
            a. A quantity of capital such as securities, real estate, etc.;
            b. A family business;
            c. A quantity of payroll rights such as profit-sharing rights,
               options, contracts, pension rights, or group insurances;
               or
            d. Accumulated savings, possibly supplemented by
               insurance policies.
        Any significant estate will fall into at least one and possibly
       several of these groups. Each asset must be examined to
       determine where they might fit - both now while you are living
       and later when you have died. The worth of each asset might be
       considered in each of these four ways:
          a. How much income and enjoyment are they giving you
              now?
          b. What is the asset worth today and, if sold, how much of
              the asset would you keep?
          c. What would their value be for estate tax purposes?
          d. How much cash would the asset bring at your death?
  3.    What is the best way to transfer each asset?
  4.    As your estate currently stands, what would it do for your
        family? Use some simple mathematics to compute taxes, debts
        and, most importantly, the amount that would be left after
        these things were settled.
  5.    What could you do now to cut down on any liabilities of your
        estate? For the most part, there are only two basic ways to do


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       this: transfer assets out of your estate now or take advantage
       of any available tax exemptions. Since tax laws change, a tax
       specialist is a necessary professional in estate planning.
  6.   How could you increase your estate and raise cash if
       necessary? Typically there are two primary ways to accomplish
       this:
         a. Buy life insurance, or
         b. Arrange for the most efficient accumulation of income,
             which is part investment and part tax-planning.
  7.   How can you set up assets for your family now? This would
       include such things as gifts, living trusts, insurance and
       annuities, and joint ownerships.
  8.   What would be the best way for your assets to be transferred at
       death? Consider probate, and perhaps its avoidance in some
       cases. Also consider what your will should cover, trusts, and
       tax savings. Consider giving up rights to some types of assets.
  9.   Do you wish to do something for charity? If so, could that be
       done now while you are living? Be cautious. Charitable giving
       should never be considered during life unless there are
       absolutely enough assets to last until death.
  10. Select those people that you will rely on to help make decisions
      and carry them out. This will likely include financial advice
      about your assets and their future and advice on taxation.


  In the final phase of implementation you are likely to need an estate-
planning attorney. Just as doctors specialize, so do attorneys. Look for
a person with expertise in the estate-planning field. Finally, pick an
experienced executor or trustee who you know for certain will have the
time and knowledge to give your affairs the attention they require.
People commonly select friends and relatives for this chore but that is
not necessarily the wisest choice. Friends and relatives may have a
personal view regarding your choices that can alter how they carry out
their duties. For example, there was a case in Washington where a
will directed the brother (who was the appointed executor) of the
deceased to transfer all of his assets to a specific nonprofit animal
group. The deceased’s brother was angry that no assets were given to
family members. Therefore, he put his son in the man’s house,
charging the estate $5,000 a month for “care-taking duties”. All
assets were handled in a similar manner. He did everything possible

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to delay settlement of the estate. When the estate finally settled, the
intended beneficiary received very little. Nothing the executer did was
illegal.

  Pick an experienced executor or trustee that you know will
           have the time and the knowledge to give
            your affairs the time they will require.

  When we think about our own personal property, we seldom consider
it in terms of our death. Yet, this is necessary for proper estate
planning. Ask yourself these questions:
  1. What value would be placed on each asset for estate tax
     purposes? This requires some simple mathematics: figure the
     approximate cash liabilities and deduct them from the estate
     value. Liabilities often require raising cash from the estate if no
     other avenue has been instituted. After all the estate is settled,
     what will be left for the beneficiaries?
  2. What does each asset do for your personal business, investment
     and future retirement needs?
  3. Do any of your assets need your personal experience and skill
     (such as your insurance business)?
  4. What is the liquidity value of each asset? In connection with this
     question, a second one will follow: how easy would the asset be
     to liquidate? Would it require time and great effort to sell?
  5. In the event of your death, what would each of your assets do
     for your family? Would they produce annual income, and if so,
     how much? Should an asset be moved into some other income-
     producing asset? Remember to consider your assets as though
     you had died yesterday and now you are your own executor.
     What role would capital gains play if an asset were switched
     today?


  Once you have looked at your assets through the eyes of an
executor, you will have a better perspective of what you must do with
each asset. This does not necessarily mean changing them, especially
if the asset is part of your life today. It may mean adding extra
insurance (key-man insurance, for instance) or taking some other
steps. When advising your clients, always ask them to think about


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their assets in terms of their own death. Everything becomes clearer if
they put themselves in the position of their own executor or trustee.


Determining An Asset’s Value

  All assets should be valued. Some assets require this for insurance
purposes, but even those that do not should have a known value.
Some estate planning requires a valuing of assets. Doing so allows
one to consider the effects of taxation and the time it would take to
proceed through probate. Often the probate process is ground to a
halt because the value of an asset is difficult to establish. Knowing the
approximate value of individual assets and what it would take to
liquidate it also allows a person to approximate the over-all value of
their total estate (a necessary step). If a person does not know the
financial size of their estate, it would be very difficult (if not
impossible) to make intelligent decisions for present and future
financial planning. Once approximate values are placed on each asset,
those values must be reviewed on a yearly basis. So many factors can
change the value of assets that it is necessary to continually update
them. Written evaluations by experts are best.

  Placing a value on an asset is not always easy. There may be
disagreement among several so-called "experts."            If an asset is
difficult for the owner to assess, you can imagine what could happen
at death. The Internal Revenue Service will desire a higher
determination while beneficiaries will desire a lower value. The
litigation could go on for years. When assets are difficult to place a
financial value on, it might be wise to consider selling or donating the
asset in order to take it out of the estate portfolio and ease the burden
of probate.

 The term "value" may have different meanings depending upon the
context. Webster's New World Dictionary defines it: "1. the worth of a
thing in money or goods; 2. estimated worth; 3. purchasing power; 4.
that quality of a thing which makes it more or less desirable, useful,
etc."

 The Federal taxing statutes term value as the "fair market value."
The courts have defined the term to mean "the price at which property
would change hands in a transaction between a buyer and a willing


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seller, neither being under compulsion to buy or to sell and both being
informed as to the relevant facts."

               The Internal Revenue Service says
              “value” means the fair market value.

  An individual might consider IRS’s fair market value to mean a
reasonable amount that the asset could be sold for. In fact, it may
have nothing to do with what a buyer is willing to pay. If the IRS
determines a collectible car is worth $25,000 but no buyer can be
found willing to pay that much, it might still be assessed at $25,000
even though it is eventually sold for only $15,000. When a verified
authority has previously deemed the value to be $15,000, it is much
more likely that the IRS will agree when death occurs.

   Not all transfers consider actual asset value. Some asset
   transfers may not be considered as fair market transfers.

  Not all transfers consider actual asset value. Therefore, some asset
transfers may not be considered as fair market transfers. Sales under
unusual circumstances many not hinge on either fair market price or
value. This could include such things as asset sales due to a divorce,
forced sales (which could occur under various circumstances), or sales
made in a restricted market.        It might also include transactions
between related or friendly parties, or corporations under common
control.

  Fair market value may mean nothing more than someone’s opinion.
It is fair to say that "fair market value" may have vastly different
meanings depending upon who is establishing the value. The buyer
may have a different view of an asset's "value" than would the seller.
Negotiations often settle differences of opinion. Fair market value
often changes from day to day, depending upon current market trends
and supplies. Book value is not necessarily synonymous with market
value. Certainly tax appraised values often do not reflect actual
market values.     At death market value is whatever the Internal
Revenue says it is, unless the taxpayer can prove in court that another
figure is valid.    Having verified values established can be very
important to the settlement of an estate.




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 When no previous value has been established or when there is a
difference of opinion involved in asset valuation, three techniques may
be used in part or whole to determine market value according to the
assets highest and best use. These techniques are recognized and
accepted in most cases by the courts. These techniques utilize income
capitalization, reproduction cost minus depreciation, and comparative
sales. In some cases, all three techniques may be used, but that is
not necessarily so. Which techniques the court may decide to use
depends upon the nature of the property to be valued.

INCOME CAPITALIZATION
 Income capitalization is generally applied to income-producing
properties such as apartments, hotels and so forth.

REPRODUCTION-COST-MINUS-DEPRECIATION
 This is generally applied only to buildings or other improvements. The
appraiser estimates the current replacement cost of the buildings and
then subtracts the estimated depreciation on the original cost of the
property.

COMPARATIVE SALES
 The comparative sales technique uses the price of recent sales of
property that are comparative to the asset in question. This generally
brings in current price trends for each given area or location. Of
course, the comparative sales must be recent sales to work effectively.


Determining the Dollar Amount

  Retirement will require enough money to live on for the duration of
one’s life. What is “enough” money? We have all probably heard the
saying "Whatever we earn, we spend" or "The more we earn, the more
we spend." Americans are known to be poor savers. Because saving
for retirement seems to be a lost virtue, putting money aside must be
treated as a bill rather than an option. Only then will retirement and
other financial goals have any chance of success.

Because saving for retirement seems to be a lost virtue, putting
 money aside must be treated as a bill rather than an option.




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 The dollar amount of “enough money” will depend upon the person.
Some people are much more materialistic than others or prefer
spending to saving (refusing to commit to future needs). Personality
and emotions are strong components when it comes to spending and
saving money. Certainly, the cost of living can vary from region to
region. There are so many factors that affect a person's feeling of
security that we, as agents, cannot presume to tell an individual what
amount of their earnings can be considered excess, and therefore
savable. What we can do is lay out their financial picture allowing
them to come to their own conclusions. In the end, the client will be
the one to make the decision to save or not to save. Agents are
merely the catalyst that brings forth the decision at all.

 It is actually fortunate that people vary so widely in their approach to
money (how they spend and how they save). Since there is a definite
quantity of money in existence, those that spend offset those that
save. If all of us wanted exactly the same things in life, the American
culture would be vastly different. One of the reasons our country has
prospered is our diversification – even in spending. Those who buy
excessively fuel our economy. Of course, we may end up supporting
those same people when they retire through our tax dollars.

         Those who buy excessively fuel our economy.
    Of course, we may end up supporting those same people
            when they retire through our tax dollars.

 There is a certain fascination to the dynamics of buying and selling.
For example, it is not possible for EVERYONE to spend more than he or
she receives, even if only for a short period of time, because one
person's expenditures is another person's income. One person's
purchase is another person's sale (thank goodness, or insurance
agents would not make a living!).

  Just as a point of reference, when this course speaks about money,
we are referring to U.S. dollars (versus types of trading or exchange).
The government could, of course, put new money into circulation in
any manner they wished to. When the gold standard was used to back
our currency, the printed dollar was backed by a real value. That is no
longer true. Now our currency has value only because people choose
to honor paper currency in the trade of goods and services. Money is
merely a token of trade. It has no real value. When we go to the
grocery store, the person at the counter has agreed to trade food for

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the token, which they then trade to their vendors.        All parties have
agreed to use money as a token of trade.

 In a manner of speaking, the government puts money into circulation
by spending money. Although the government spends on few things,
what they do spend on includes bonds and other debt instruments.
The government's purchasing agent is the Federal Reserve System,
which is a group of government-controlled banks, which have the legal
authority to create money. The new money is created when the
Federal Reserve buys bonds from bond dealers.

 Not only our government buys bonds, of course. So do individuals.
The difference lies in how the bonds are paid for. The Federal Reserve
System pays for the bonds by creating new money. You might say
they print money to buy back some of the government's IOUs. Their
purchases, and occasionally sales, of bonds adds new money to the
nation's supply.

 What all of this means is that the supply of money depends upon the
activities of the Federal Reserve System. The demand, or need, for
money directly reflects the cash-holding preferences of our nation's
population. One of the jobs of the Federal Reserve System is to avoid
causing inflation when they create new money.

 The Federal Reserve Board consists of a Board of Governors and
twelve Federal Reserve Banks. These banks hold much of the cash
reserves that U.S. commercial banks are required by law to keep.

 When the Federal Reserve buys a bond, it sends a message to the
dealer's local bank, instructing the bank to credit the dealer's checking
account for the amount of purchase. The Federal Reserve then pays
the bank by crediting the same amount of money to the bank's
account at one of the twelve Federal Reserve banks.

  It must be noted that providing the credit costs the Federal Reserve
System (FED) nothing since the deposit at the Reserve Bank is
"created." If the local bank should desire to withdraw the actual
currency from its account at the Reserve Bank, more currency would
simply be printed. Money is, after all, simply Federal Reserve Notes.

        Money is, after all, simply Federal Reserve Notes.


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                                Chapter 2


  Will You Outlive Your Assets?

  As we know, paper money merely represents a value for trade. That
value must be acceptable to others in order for the represented value
to allow trading of goods and services. Americans look at a one-dollar
bill and accept its worth as one dollar. In fact, that dollar may be
worth more or less than its face value depending upon where it is
traded. Since our money is a representation of value, the actual
spending power it has changes frequently, sometimes by the hour.


Buying Power

  There are many reasons why our money has more or less buying
power, but one of the most dominant reasons is inflation. Americans
are more likely to be aware of the results of inflation than they are the
inflation itself. Sometimes our dollars buy less than they do at other
times. When the dollar buys less consumers notice, although they
may not realize the reasons behind the loss in value.

  Money is influenced by existing supply and demand. Of course, all of
us want to have money, but that does not mean we have the ability to
obtain more.       Governments have the ability to obtain greater
quantities of money: they print it. When governments print too much
money they can actually cause the value of their currency to decline.
Therefore, the United States government is very careful when it comes
to printing new money. As money wears out it is destroyed and
replaced with newly printed currency. Putting additional currency into
circulation is done with great care in order to prevent rising inflation.

  In recent years, our inflation has been moderate. That is seldom an
accident. More likely, low inflation is the result of careful planning by
those who control the flow of money in the United States. Even when
inflation is low, however, it never totally leaves us. In fact, we hear so
much about the subject that many of us forget the importance it plays
in our economic lives. We have accepted inflation to the point that we
no longer notice how it financially impacts us. Most Americans know

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inflation is a negative influence but few of us could explain how it
affects our economy and ultimately our personal lives.

  Inflation impacts virtually every type of investment in some way,
even home-buying and selling. Everything from precious metals to
real estate is affected by inflation. Any institution that deals with
money is certainly affected. What many consumers may not realize is
that inflation can cause business people and investors to pay taxes on
phantom earnings. When buying power decreases taxes are paid on
income that is not actually there. In other words, we pay taxes on the
face value of our money but it is actually buying less goods and
services. We are paying taxes on the face amount of the money
rather than the buying ability of it. For those trying to plan their
retirement, inflation is the great unknown.

             For those trying to plan their retirement,
                  inflation is the great unknown.

  The investor must always factor inflation into any equation that
involves time. We may have an idea how inflation works, but few of
us factor that adequately into our retirement investing. Inflation and
interest earnings have lots in common. They work exactly the same
way with one very major difference: interest increases our money
while inflation decreases it.

  Inflation does not play favorites. It affects all types of investments.
Inflation can cause some investments to go up in value, but more
often it decreases values. Even real estate can be adversely affected
by inflation. This usually happens when pricing becomes over-inflated
for one reason or another. When the pricing comes back into line,
investors experience a loss. In fact, inflated real estate pricing is
considered a form of inflation. Those who invest heavily in real estate
know that what goes up may also come down so they invest in
multiple types of real estate to protect themselves from deflated
markets.


The Federal Reserve

  The Federal Reserve manages the creation of our money, but those
in power often benefit when additional money is printed because it


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causes the illusion of prosperity. That is why neither the Congress nor
the President has any control over such a decision. Even so, the
Federal Reserve has been known to be cooperative with those in
power. The Federal Reserve’s power comes from Congress. Its board
is made up of governors. Some have questioned whether this was a
wise choice since the governors may have future goals for themselves
that could be benefited by their willingness to cooperate with other
politicians.

       The Federal Reserve’s power comes from Congress.
               Its board is made up of governors.

  Our elected President appoints each individual governor. A full term
is fourteen years (two seven-year terms).         Unlike many other
appointed positions, the governors cannot be dismissed once they are
appointed to the Federal Reserve Board. Such job security was
designed to insulate them from political pressures, but many argue
that it still remains.

 One of the seven terms expires every two years. A president serving
eight years (two terms) will appoint four governors. Four governors
out of seven would give that president a majority holding. If a
governor resigns or dies, the replacement would serve only the
remaining term. At the end of that term, a replacement would still be
made. This keeps the order of the turnover consistent.

  It is likely that each president will appoint a governor that shares his
views. The president hopes to have governors on the board that will
accept his wishes. Of course, there have certainly been times when
the FED has said “no” to both the President and the Congress. Even
so, knowing that their power comes from Congress, the Federal
Reserve would prefer to say “yes” to requests when possible. Since
inflation never happens immediately, the time period that it takes to
show after printing excess money allows those actually responsible to
deflect blame.

 How quickly does rising inflation become apparent?          The stock
market is usually affected by changes in money supplies within
approximately one to three months. Employment downturns do not
show until about one year after the new money enters the
marketplace.   The strongest effect on price inflation is not seen until
18 to 24 months following the emergence of the new money.

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 The public tends to look at what immediately happened for the cause
of inflation. This allows those responsible to deflect the real cause
away from them. The public seldom realizes the true reason for an
upturn in inflation happened as much as two years previously. Of
course, even if the effects were immediate it is unlikely that most
people would realize the cause and effect. Who really knows when
additional money has been printed and put into circulation?

 Not everyone agrees that printing money causes inflation. Some feel
that tight money and high interest rates can also cause it.

  No investment specifically deals with inflation. Gold sellers often
advertise that precious metals, especially gold, is an inflation hedge,
but that is not necessarily so. Investment combinations are the best
hedges against inflation. This is good news for the professionals that
work with investments. It means there is a need for multiple types of
investment agents.


Permanent and Variable Portfolios

  Most professionals would agree that a successful investment strategy
typically includes both a permanent and a variable portfolio. As the
name implies, a permanent portfolio is intended to be permanent and
long-term.     Such investments are kept for many years and are
expected to yield best over a length of time (at least five years and
preferably no less than ten). Permanent portfolios are the type used
for long-term goals, such as retirement. Long-term investments are
not concerned with the ups and downs that would affect short-term
investments.

 Variable portfolios are designed for short-term investments.

  The variable portfolios are designed for short-term investments.
They are variable because they are flexible. Changes are expected as
goals are reached and new ones established. Short-term goals are the
most likely to be affected by inflation and other variables since such
investments do not have time on their side.




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  The division of investment funds between long-term permanent
investments and short-term variable ones will depend upon the person
investing and their goals. Their risk tolerance will also be a factor.
Few people have large sums of money to work with initially. Most
investors start small and save over a period of time. Therefore, it is
likely that short-term variable portfolios will be developed before long-
term permanent ones.

  As every agent knows, the hardest part is getting the individual to
begin a savings plan of any type. It is much easier to spend than it is
to save. In addition, if savings are not done prudently, inflation will
eat up any earnings that develop. The sooner that one begins saving,
however, the less they will need to save over time. Interest earnings
and time are a saver’s best financial friends.

  Baby boomers will be the next large group entering retirement.
Many are beginning to receive their pension nest egg in lump sums as
they leave work and enter retirement. The first and most important
thing, says Craig Brimhall, vice president of wealth strategies for
American Express Financial Advisors, is: “don’t spend it.” When a
lump sum is received there is the tendency to spend at least part on
items that would not otherwise be purchased (a motor home, a boat,
or a fancy car are favorites). All the money received will be needed in
retirement.

  The first baby boomers became 59 ½ in July of 2005. They will rely
heavily on 401(k) plans, individual retirement accounts, or other
pension savings plans that are outside of the traditional pension plans
their parents received through employment.          While many baby
boomers may have pensions, it may take more than that to make it
through retirement. In 2001 58% of all households were dependent
solely on defined contribution plans, such as 401(k) plans where the
amount received in retirement directly reflects what the individuals did
for themselves.1

                       For a couple retiring at age 65,
            at least one of them will statistically live to age 92.

 Retirees should not underestimate their life expectancy. For a couple
retiring at age 65, at least one of them will statistically live to age 92.

1
    Coming Up Short by Alicia Mummell and Annika Sunden

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The biggest danger to retiring is living longer than one’s assets can
cover. To prevent this a retiree should withdraw no more than 4% to
6% a year, which can be a tremendous challenge if insufficient funds
have been saved. Retirees commonly overspend by $20,000 per year
depleting funds that were intended to last for thirty years.

 Retirees should not give away any money or asset that may be
needed for their support during retirement. It is a mistake to give a
child or grandchild a big chunk of money too soon in retirement.

  There will be many expenses that may not immediately be
considered. If the retiree or his or her spouse becomes ill, who will
care for them? If there is no child or grandchild available then some
type of insurance must be considered. When we ask if someone will
be available we mean for sure. The old “don’t-worry-I-will-care-for-
you” line can’t be taken at face value. Does the child work out of
necessity? If so, it is unlikely he or she can quit their job to care for a
parent. Does the child have the temperament to provide 24-hour care
seven days per week? It is not an easy job. Professionals only put in
8 hours per day and they find the work exhausting. Imagine trying to
care for an ill, frail parent around the clock – perhaps with no one to
provide a break from the routine.

  Retirees must plan on paying for their care even if a child or
grandchild has expressed their willingness to perform the service. A
promise made today may not be performed five or ten years later
when circumstances have changed. It is never wise to rely on specific
individuals for another reason: the type of care required may be
beyond the abilities of a family member to deliver. Some types of care
require schooling or abilities that family members may not possess.

                Too much money is always better
           than too little. Most people will wish, want,
              and pray themselves into retirement.

 It is always better to over-plan than under-plan. Too much money is
always better than too little. Most people will wish, want, and pray
themselves into retirement. They will have spent rather than saved; it
seems to be the American way. As a result we will tether our children
and grandchildren to mountains of debt paying for our care and the
care of millions of others who also failed to adequately plan for their
retirement.

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  There is no logical excuse for failing to save adequately for our
retirement. There may be reasons we lean on, but ultimately each of
us is responsible for saving sufficiently. After all, it is not something
we didn’t know would eventually arrive. Yes, it might mean taking on
a part-time weekend job in order to find those extra retirement dollars
to add to our 401(k) Plan at work. Yes, it might mean taking
advantage of available overtime at work, earmarking the additional
funds for our annuity account. Yes, it might mean we don’t buy a new
car every three or four years. Yes, it might even mean our children
will have to fund their own college education.

  The longer an individual puts off saving for retirement the more he or
she must save. Time is a powerful ally. It allows a person to save less
and still end up with more. If a thirty-year-old would begin saving on
a regular basis for their retirement, he or she would have to save far
fewer dollars than the person who waits until age 45 to begin
retirement saving.

            The ultimate goal is to have enough assets
                    to last until the day we die.

  The ultimate goal is to have enough assets to last until the day we
die. Since there is seldom any information available to tell us exactly
how long we will live, we must plan for a long life. After all, it is
always better to have saved too much money than too little.
Americans commonly outlive their assets. As a result, we must rely on
our children, and grandchildren (who should be putting their money
aside for their own retirement) to help pay our bills. Eventually, many
people will end up applying for government aid in one form or another.
This means tax dollars will support us, which (again) will be coming
from our children and grandchildren.

 While inflation will lessen the buying ability of whatever we save,
there must still be a starting point. How much money is currently
required to live on per year? Whether that figure is $20,000 or
$50,000 it is a starting point. Never expect to need less. Most people
have developed a lifestyle that they want to continue. In addition,
while there may be some expenses that disappear in retirement, there
will be others that develop (such as long-term care needs or general
health insurance). When inflation is added, today’s living costs may be
greater in retirement, not less.

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  If a household is currently living on $30,000 per year, the individual
or couple must multiply that by the number of years they expect to
live without earned income. Many professionals consider thirty years
to be a practical figure, but it may be wise to consider personal family
history. A person retiring at age 60 will need more retirement money
than would a person retiring at age 65. Like Social Security income,
waiting to retire means more money for retirement. That additional
five years of earned income will allow additional retirement savings
and it will mean additional time for interest income.

  It is always best to over estimate than under estimate the amount of
money necessary for retirement. We do not know what our health
status will be or what expenses may develop that we had not
considered. We do not know if we will be able to live twenty years
from now on the same amount of money that we currently live on. If
we have a modest lifestyle, $30,000 per year may be adequate
($2,500 per month before taxes). Thirty years multiplied by $30,000
equals $900,000. Thirty years multiplied by $40,000 per year equals
$1.2 million. Many experts feel that is a low figure since people are
living longer than ever before and inflation will erode buying power.

             Thirty retirement years multiplied by
    $40,000 per year retirement income equals $1.2 million.

 Our bills will also affect what we need for retirement income. If our
home is paid for that will greatly affect how much is needed in
retirement. There will still be maintenance costs, insurance, and
property taxes, however. These costs must still be factored in. Home
maintenance is especially likely since our home ages right along with
us. Pipes and electrical systems may need to be updated for safety.
Our home may need to be modified if wheelchairs or walkers become
necessary. A bathroom may need to be completely remodeled for
developing disabilities.    Our washer and dryer may need to be
replaced. These are the types of expenses that are often overlooked.

  Americans always believe that everything will work out. They believe
their home will become their retirement income; they believe their
Social Security will be adequate; they believe someone (perhaps the
government) will provide their retirement funding. What many do not
seem to believe is that they are responsible for their own retirement
income. Even if they sell their home, they must live somewhere. Who

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will pay the rent? Social Security has never been adequate and never
will be. In fact, as there are fewer taxpayers paying into the system,
it is likely that Social Security will be forced to find new ways to cut
payments. The government is always looking for ways to cut funding;
no one can realistically expect them to begin paying more.

  Will assets last until death? This is a question that deserves serious
consideration. It is not a question that should be considered on the
eve of retirement. It must be considered prior to age forty and the
earlier the better. Ideally, retirement planning should begin around
age thirty, although statistically it is reported that most people only
begin considering their retirement funding at age 45 (the age when
children are usually out of the home and on their own). If retirement
is not considered until age 45 there is only seventeen to twenty years
available for accumulation and interest earnings. As a result it is much
more difficult to amass the approximately one million dollars that will
be required for thirty years or more of retirement. Few people realize
the amount of money that will be needed in retirement, looking
instead towards company pension plans, Social Security income, and
the proceeds from selling their homes. Increasingly fewer people can
count on a company pension plan and unfortunately many workers
who could utilize their company’s 401(k) plans are failing to do so.
Those who are predicting increasing numbers of poverty stricken
elderly are probably correct. If that does indeed happen, government
funding of medical care and other retirement needs may be forced to
increase affecting all who pay taxes. The most profoundly affected are
likely to be poor children who will receive increasingly less help
through government programs. At some point there will simply not be
enough tax dollars to support other segments of the population as the
retired and impoverished elderly eat up America’s resources.

          Those who are predicting increasing numbers
         of poverty stricken elderly are probably correct.




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                                Chapter 3


            Using Financial Tools
 When a carpenter builds a house he must have specific tools to
enable him to do an adequate job. He must also know how to
effectively use those tools. Without this knowledge, many of the tools
would be useless. Possessing the tools is a necessary first step,
knowledge of tool use is the second step, but that still is not enough.
The carpenter must also know how to read the blueprint in order to
build the house. The blueprint lays out the structure in a manner that
will pass state codes and survive the elements of time.

 The same is true when it comes to financial planning. The investor
must have specific financial tools, possess the knowledge of how to
use them, and follow a financial blueprint so the investment plan will
survive the elements of time.

  Few goals come easily. Most require dedication and hard work. If
the carpenter worked on the house only when the weather was
favorable (not too hot, not too cold, not rainy or windy) the house
might never be completed. Just as the carpenter must sometimes
bear uncomfortable weather in order to achieve his goal and enjoy the
product of his labors, so too must investors bear some discomfort.
Reaching an investment goal could require doing without a luxury in
order to save, putting in extra hours on the job to earn enough to
achieve a financial goal, or learning the elements of a particular
investment strategy in order to succeed. If investing were easy,
everyone would retire financially secure. The reality is not difficult to
understand but it may be difficult for many to follow. Everyone can
understand that it is not possible to spend every dime and still save
adequately; that doesn’t necessarily mean that everyone will do so.
Unfortunately, too many people do not wish to put in the time and
discomfort necessary, so their financial “house” is never built. As a
result, they are not prepared for many of life’s financial requirements.
They may not be able to send their children to college, buy a house, or
live as they wish in retirement. It may even mean that taxpayers
must partially support them, pay for their daily medical care, or their
nursing home confinement. Since there are so many financial vehicles
available virtually anyone can do some type of financial planning but

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even the simplest of plans requires the individual to follow it –
especially when it would be easier not to.


The First Step: Record Keeping

  Many of us do an excellent job of following up on every detail at work
yet fail to keep even basic records at home. As a result, we overpay
our taxes, use credit needlessly, and waste hundreds of dollars each
year. For tax reasons alone it makes sense to chart our spending, but
taxes is only one reason for doing so. When we understand how we
spend, we can use that understanding to change current patterns,
identify wasted spending, find additional dollars for saving, or simply
make better use of our income.

 The Internal Revenue Service typically does not audit tax returns that
are more than three years old, but there can be exceptions. Those
who have used income averaging to minimize high-income years may
be audited for a longer time period. While not everyone agrees, most
experts suggest keeping tax records for at least eight years.

  Aside from the tax aspects, record keeping is a tool. Just as the
carpenter depends upon specific tools to do an adequate job, each
person requires tools to build their financial house. The most basic
financial tool is record keeping. Every person involved in developing
the investor’s financial future needs correct information. Otherwise,
their recommendations may be faulty. Imagine the plumber having a
different house blueprint than the electrician or carpenter. Everyone
must work from the same blueprint. The same is true when it comes
to planning our future.      We cannot provide our accountant with
different information than we give our agent or attorney. All must
work with the same information in order to build a strong future.
Investment records should be reviewed yearly, so the need for
complete record keeping never stops.

           Adequate record keeping is the foundation
                 for all other financial tools.




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Establishing A Budget

  The dreaded budget is always the basic tool of financial planning. It
is not hard to understand why so many people dislike establishing a
household budget: it means someone will have to curb their spending.
Why? Because it will become obvious where money is wasted on a
regular basis. Everyone wastes money from time to time, but when
money is wasted routinely something needs to change. It might be
that $5 mocha each morning and afternoon. At $10 per day, those
coffees add up to $70 each week and $3,640 per year. Over ten
years, not including interest, those coffees add up to $36,400. While
no one would advocate eliminating all pleasures, it is necessary to
determine which ones make sense and which ones do not.

  Although everyone wastes money from time to time, when
  money is continually wasted financial change is necessary.

  Beginning an investment program means looking at the types of
spending that an individual may easily overlook, such as the $5
mochas. Every dime spent must be recorded for a minimum of one
month (three is better). From this a budget will emerge. Some items
will be obvious of course, such as the house or rent payment, but
many more expenditures will come as a surprise. The daily lunch at
the corner café may add up to much more than anyone realized. The
cost of the weekly nail appointment may seem extravagant. Whatever
is determined from the list of expenditures, the goal is to minimize
financial waste and apply it to a savings plan.

  The budget must include a savings account for emergencies. While
that is not a financial or retirement goal, it will be necessary in case
life takes an unexpected turn. A total of three months income should
be acquired and kept in a readily available account, such as a money
market account. The worst emergency for most families is the loss of
a job. Having three months worth of income available allows the
family to weather such an unexpected event. Mental health experts
say the unexpected loss of a job is as mentally difficult as a death or
divorce. If the individual knows they have a financial cushion, it will
be easier to deal with the circumstance.




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  Another savings account (separate from the first) should be set up to
develop a pool of money for investing in short and long-term financial
vehicles that have a specific goal. The actual goal will depend upon
the person, but they often include such things as the purchase of a
first home or a college fund for children. The two accounts should not
be merged because each has a distinct purpose: (1) to cover family
emergencies, and (2) develop a pool of money for meeting a specific
goal. Neither account should be used for the day-to-day bills of living
(utilities, rent or mortgage, food, and so forth). Neither account
should be allowed to become a “put-and-take” account. A put-and-
take account is one in which money is deposited and then withdrawn
on a continual basis. As a result, no gain is made and the purpose is
lost. At some point, the goal of savings and investments will be
retirement, but the first goals are typically a home or college.


What Records and Where?

  Important documents should have a distinct location in the home. A
“distinct location” does not include kitchen drawers, shoeboxes on a
closet shelf, or a cardboard box in the garage. Household records are
as important to the family as they are to a business. No successful
businessman would keep his business records in the bottom of the
coat closet. Important records should be in a file stored in an
accessible location that is safe from fire and theft. A fireproof safe is
advisable for important records and documents.

         Important records should be in a file stored in
      an accessible location that is safe from fire and theft.

 Which records are important? Some, such as birth certificates and
marriage licenses, are obvious but others may not be. While there can
be variances from family to family, some types of records should
routinely be kept, including:
   1. Records concerning family members;
   2. Anything relating to property, including the residence;
   3. Anything financial in nature, such as stocks or bonds;
   4. Insurance records, such as the fire policy on the residence;
   5. Tax records, including important receipts;

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   6. Medical records; and
   7. Anything relating to legal matters, such as a pending lawsuit.


  There are many situations that require documentation or records.
Even signing up for Social Security benefits requires proof of age, for
example. If the Internal Revenue Service (IRS) audits a household,
any deductions that had been made will need documentation
(including cash receipts). Retirement accounts must be documented
at least until withdrawals are made or funds depleted. In some cases,
even important conversations must be documented and kept on file.
This would especially be true if it involved legal litigation or financial
services for clients.

  Documentation is a part of life for insurance agents. Anything we do
involving the finances of our clients must be documented and kept.
We never know what the future might bring. Such documentation
could prevent a lawsuit or help a client obtain some benefit they
deserve. When establishing a financial plan for our clients the end
result is only as good as the information it was based upon. While
agents generally accept their client’s word as proof, there are some
cases where it makes sense to ask for written confirmation. This might
especially be true when it comes to investments that could be affected
by misinformation. Asking for written confirmation is not an insult to
the client but rather a safeguard. All of us have been mistaken at one
time or another.

  We often overlook one very important reason for record keeping and
documentation: to help our families if we die unexpectedly. While it is
true that most of us will live an accident can happen to anyone. Even
if the accident simply leaves us incapacitated for a period of time,
having our finances and personal records together and complete can
only make it easier on those we love. A spouse or legal representative
may need to make major decisions on short notice. Certainly, we
would want those decisions made based on complete information.

     Major decisions may need to be made on short notice.
     Having complete and accessible records can be vital.

 Records should be filed in some type of order. For example, a
medical file may need to be established with subcategories for each
person in the family. Legal files may be classified by specific events,

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such as a pending lawsuit. However the records and documents are
categorized, it should be in some type of orderly fashion. Usually,
documents are filed with the most recent on top when it concerns an
ongoing situation. That enables a spouse or representative to quickly
assess the current status. Business and personal matters should
always be filed separately, unless some circumstance must bring the
two together. Even for home-based businesses personal and business
records need to be separated.

 Records are considered personal property. As property, they may
have a value. If an established value has been made, this should be
easily recognizable in case a spouse or legal representative must
become involved.

 While there is no required format for preserving records and
documents, most financial experts favor certain formats for keeping
them:
  1. Classify the records. All records relate to something, so this is
     always the first step. Classifications are often a personal matter,
     but some distinctions must be made. For example, it is either a
     personal or business document. Once that is decided, the record
     is categorized by what it relates to. For example, it may involve
     either a legal, medical, insurance, tax, or real estate entity.
     Records involving real estate tax should be classified together.
     Records involving the health of a particular child should be
     classified together, and so forth. Any cash receipt should also be
     kept and filed appropriately. This is especially important if the
     cash expenditure involves a business expense that may be tax
     deductible.
  2. Lifelong records belong together. By this we mean birth
     certificates, marriage licenses, military records and so forth that
     are always kept for the lifetime of the individual. Such records
     are used for so many reasons that it makes sense to keep all
     family documents of this type together in one file. A copy of the
     will should also be filed with them since this is a file that the
     family is likely to immediately refer to in the case of death or
     disability of a major wage earner.
  3. Inventory each item of value. If a theft or fire occurs, an
     asset inventory is important information for recouping losses,
     but it can also be important for other reasons. It becomes


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   important following an unexpected death, for example. Include
   any valuations made by licensed experts, even if they appear
   outdated. Authenticated valuations establish base values in the
   event of death. It can prevent time-consuming tax valuation
   issues during probate. Some specific information should be
   included:
         • Date of purchase
         • Price paid (include the receipt if possible)
         • Asset location (especially if out of state)
         • Motor vehicles should also have titles, VIN numbers,
            registrations and any other document pertaining directly
            to them.
4. Financial records should be filed by type. While all financial
   records would be together in the base file, there should be
   subcategories to divide the type of record.        For example,
   retirement accounts are different than savings accounts. Each
   person will decide what he or she wishes to group together. The
   important point is creating some type of order so that another
   person can understand how to find needed documents or
   records. Be sure to keep a list of all active credit cards,
   including account numbers, granting institutions, and addresses.
5. Insurance records. Although all policies relate to insurance,
   they should be separated by type: life, health, disability, auto,
   and casualty. This helps others to find the types of policies that
   may apply to an accident or death. It also helps others to
   submit claims to the correct company. This would especially be
   true of health claims. A written statement is especially beneficial
   to those trying to cope with an injury or death in the family. A
   simple format can be used on ruled paper. For example, it could
   be written as follows:
   Life:
   Company:     Agent:              Policy #:    Effective:   Amount:
   Prudential   Mary Jones          1226854      12/01/2002   $300,000
                (253) 111-1111
   Combined     Mark Smith          A553845      2/1/2003     Specified by
                (360) 222-2122                                accident
   Health:
   Company:     Agent:              Policy #:    Effective:   Policy Type:
   Blue Cross   Jennifer Wills      544-8663     6/15/2000    Major Medical
   CNA          Gerald Mack         7789935      1/5/2001     Nursing Home




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   6. Personal and business tax records in chronological order.
      It is often necessary for the spouse or legal representative to
      deal with the IRS following a death. Having past tax records
      accessible can make their job much easier. Although the IRS
      does not normally go back more than a few years, if they
      suspect fraud they have the legal ability to go back indefinitely.
      The names and addresses of accountants or other firms
      completing tax information on your behalf or on behalf of a
      company you own should be with the tax returns.

   7. Medical and health records of individual family members.
      Medical and health records are usually considered the private
      property of the person they pertain to. There are exceptions.
      Some records are the legal property of the physician. Keeping
      such records, especially if minor children exist, can aid family
      members or legal guardians when making medical decisions.


  Keeping records is not a time consuming or difficult job if set up well
in the beginning and maintained on a regular basis. If records and
receipts are continually thrown into a kitchen drawer it can become a
difficult job, but if each item is filed as it is received or periodically the
chore is a minor one. Many people prefer to file away receipts and
records once a month while others prefer to do so at the time they pay
bills. Whatever method is used, keeping current with the record
keeping is the key to success.

 Any items that are put into a bank security box should be noted in
the files. If family members are not aware that a security box exists
any documents within it will not do anyone any good. It is likely that
many legally drafted wills are not followed simply because their
existence is not known.

            It is likely that many legally drafted wills
     are not followed because their existence is not known.

 Some types of correspondence should also be kept and filed away.
Of course, not all correspondence will have any legal or monetary
value although it may have sentimental value. Legal or monetary
value will exist if it has to do with anything financial (involving
money), pertains to current or possible lawsuits, or is of a legal
nature.

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  Most records can be stored at home or at the business location.
Some feel copies should be kept at another location in case of fire.
Anything that is worth money or that could be difficult to replace
probably should be stored either in a bank safety deposit box or in a
fireproof safe. Again, if a bank box is used be sure to note its location
and all other pertinent information in the main file that a legal
representative would look through.


Wills

 Every individual of legal age needs a will. This is true even if other
estate vehicles, such as trusts, are used. A will is the most basic of all
estate planning documents and belongs in every financial plan.

           Every person of legal age should own a will.

  The will is the most recognized tool in any estate plan. A will
provides directions for the individual’s transfer of assets and expresses
personal wishes. If a trust is utilized, the will may simply defer to that
trust. Even if that is the case, however, it potentially covers any asset
that was left out of the trust or that was acquired after the trust
document was created. It is common for assets acquired at a later
time to exist outside of the trust, meaning it would have no directive in
case of death unless a will existed.

  A will does not automatically allow the testator to do as he or she
wishes. State laws do exist that cover some aspects of a will. Many
states forbid or require some aspects in the will. For example, it may
not be legal to exclude certain family members, especially a legally
married spouse. When a will does not follow state law, it may void the
entire will. Therefore, it is important to draft a will that follows the
laws of the state of residence. If residence changes to another state,
it is wise to have an attorney review the will and make any necessary
revisions or add a codicil to the existing will. A codicil is a supplement
to an existing will that changes or explains something within it. A
codicil must follow all laws that apply to the will itself.

 Some states recognize holographic wills. Most professionals do not
recommend use of these, but in the states that recognize them they


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can work well. Most laypersons are not familiar with state laws and
may draft a will that will be voided in court. It is not possible to void
only a portion of a will. If one portion is voided, the entire will is then
voided.

  Many types of assets do not rely on a will since they include
beneficiary provisions. Insurance policies, when a beneficiary has
been listed, will pass outside of probate for example. In all cases, it is
necessary to have a listed beneficiary. Obviously, proceeds cannot
pass on to another individual unless one has been specifically listed.
Trusts are the best-known way of bypassing probate. When a trust is
utilized, it remains an existing entity even after the testator has died
(unless its end has been stated within the document). As a continuing
entity, probate is not required for it to continue holding assets.
Unfortunately, a great many living trusts have not been adequately
funded. If no will exists and the assets have not been properly
transferred into the trust, the state will end up disposing of the assets
as they see fit.

   When a trust is utilized, it remains an existing entity even
    after the testator has died, unless otherwise directed.

 When a person dies without a valid will the state will follow the
procedures dictated by law, whether it follows the decedent’s wishes or
not. Although there are variances among the states, there tends to be
some basic steps taken when no will exists:
   1. Property will be distributed to the next-of-kin as established by
      the resident state.      Distinct rules of distribution will exist,
      including the legally married spouse (even if separated), legally
      recognized children, and in some cases, siblings. Parents will
      also be included in most cases. The division will depend upon
      the state, but each state does have a specific format to guide
      them. No thought is given to the beneficiary’s financial needs,
      abilities, or personal involvement with the deceased.
   2. Gifts made to the beneficiaries during the life of the decedent
      will not be considered. Therefore, if the deceased gave one child
      his or her inheritance as a gift during their life, this will have no
      bearing on how the assets are distributed following their death.
      No attempt will be made to equalize assets among those
      inheriting.


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  3. No consideration will be given to the beneficiary’s ability or
     desire to manage an asset. Many assets will simply be sold and
     the money distributed even though one beneficiary may have
     wanted the asset. This will be true even if the deceased had
     publicly stated that the asset should be given to a specific
     person (unless that statement were legally made in some way).
  4. Assets will be distributed as dictated by law even if a beneficiary
     is very old, ill or terminal. This means that assets may go to a
     parent, for example, whose will may be vastly different than that
     of their child.      Assets that were meant for specific family
     members or friends may go to the parent instead and then to a
     favorite charity as named in his or her will. The asset may end
     up with a person the deceased never even knew.
  5. A state court will name an administrator to handle the estate.
     That person may not have known the deceased, will have no
     insight to their personal wishes, and will not have any knowledge
     of who they were or what they desired. By law, the person
     named must follow the laws of the state, so any knowledge they
     had of the person would not matter anyway.


 Each living person has the right to decide how his or her assets will
be distributed not only during life, but also following their death.
However, having that right and exercising it are two different matters.
Unless they exercise these rights it will not matter what they desired.
There are many tools available to estate planners, but the first and
most basic of those tools is the will. Only through a legally valid will
can an individual be sure that their wishes will be carried out.

          A will is the most basic estate-planning tool.
 It is available to every person of legal age without exception.




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                              Chapter 4


                             Trusts

 Lately trusts have become much more popular. A living trust is
designed to do basically the same job a will does, but outside of the
public eye. A will names an executor or executrix to carry out the
creator’s wishes; a trust designates a trustee to do the same thing.

 Many professionals consider the trust one of the most versatile of all
estate planning tools when it is used for the right reasons and in the
appropriate manner. Insurance agents need to understand how they
perform for two reasons: first, the agent may find trusts merge well
with other estate planning strategies, and second, the agent will
prevent him or herself from selling trusts ineffectively. Unfortunately,
agents have been targeted to sell revocable trusts to everyone,
regardless of whether or not it improves their financial status. When
an agent is not personally educated on the uses of trusts, they may be
persuaded to market them to valued clients only to discover the trust
was useless. Product salespeople sell to agents, just as agents sell to
their own clients. Anyone who has a product or service to sell needs
salespeople. As a result, professional agents must learn all they can
about a product or service prior to presenting it. This would include
the company offering it.

 There is no doubt that a trust can carry out one’s wishes just as well
as a will (and outside of public scrutiny) but whether a trust does a
better job depends upon its intended purpose, who creates it, where
that person lives, and what accomplishments are desired. If asset
control or management is desired a trust can probably accomplish that
assuming it was properly created. A will would not be designed for
asset management.

  Trusts have been used in estate planning for many years. When
used appropriately, trusts can be a valuable financial tool. Setting up
a trust is one way of leaving money to children, other individuals, or
charities while controlling how assets may be invested, spent, and
distributed. Testamentary trusts are established in one’s will and
take effect upon the death of the trust creator. The creator can make

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modifications while he or she is living. Because testamentary trusts
are part of one’s will, they do not avoid probate.

  A living trust, also called a revocable living trust, is also in effect
while the trust creator is alive. The trust creator uses this type of trust
in all ways – he or she can deposit, withdraw, spend, sell, or give away
the assets within it. The person who contributes the assets to the
trust is called the grantor. These trusts do not avoid taxation in any
way. A common use is asset management.

 An irrevocable trust may also be used while the trust creator is
alive. As the name implies, it is irrevocable, meaning it may not be
changed or revoked once created, unless the trust document has made
provisions to do so. Irrevocable trusts are commonly used to remove
property and the property’s future income and appreciation from the
estate. Why would a person want to remove assets from their estate?
Saving estate taxes is commonly the reason but there may be various
personal reasons for doing so as well.

  A living trust should not be confused with a living will. The living
will, often referred to as a “right-to-die clause”, is a legal document
that directs those in charge of one’s health care to allow death when
maintaining life would require extreme measures. In most states, the
living will must be drafted prior to the knowledge of a terminal or
serious medical condition. Why? So that those who might profit from
their early death (prior to using up assets for healthcare) do not have
the ability to pressure the individual into signing such a legal directive.

    A living will is also referred to as a “right-to-die” clause.


Defining a Trust

  A trust is an arrangement under which one person or entity holds
legal title to real or personal property for the benefit of another person
or entity, such as a charity. The trust will establish the rights and
responsibilities of each involved party. A trust is a legal document that
potentially continues to exist even though the individual creator may
have died. A trust allows an individual to distribute his or her assets
at death while still maintaining use of them during life. How long that
trust continues depends upon the terms that were stated at its


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creation. A trust may be set up to accomplish virtually anything legal,
but it is not necessarily the answer to everyone’s financial dreams.

  A trust allows an individual to distribute his or her assets at
      death while still maintaining use of them during life.

 Trusts are often misunderstood. Some individuals believe trusts can
accomplish anything they desire. Like all financial tools, trusts have
specific abilities that, properly used, are beneficial but they do not fit
the needs of everyone. Aside from a written plan, trusts are perhaps
one of the most useful personal financial tools available as long as
they are used appropriately and for the right reasons.

 Trusts are often used to avoid probate. While this is not sensible for
all individuals, it is useful in many circumstances. It is important to
note that some professional people should have their estates go
through probate since it closes the window on the filing of lawsuits
after a specific time period has passed. Assets in a trust continue to
exist without a closure date, so the legal ability to sue continues to
exist.

  Essentially, a trust is an arrangement whereby a creator transfers his
or her assets to a legal entity (the trust) created in a separate
agreement to be administered by an individual or institutional trustee
for a specified beneficiary. The beneficiary can be anyone, including
the trust creator. The trust creator may wear multiple hats: he or she
is the creator, but may also be the trustee and the beneficiary. Well-
written trusts can be a valuable financial tool. A poorly written trust is
a waste of money no matter how little it cost to create. Appropriately
written trusts can save time and money associated with the probate
process, moving assets into the hands of designated beneficiaries
more efficiently. Assets need not wait for the creator’s death to be
transferred; they may be transferred prior to death if so desired by the
trust creator.

  There are multiple types of trusts. An inter vivos trust (usually
known as a living trust) operates while the trust creator is alive. The
testamentary trust goes into effect after the trust creator’s death
and is linked to the will. A revocable trust’s provisions can be
changed while an irrevocable trust cannot be materially modified. It
should be no surprise that people prefer the revocable trust because it
is possible to change the legal ownership of assets while still

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maintaining control over them. The asset ownership merely changes
from the trust creator to the trust document, which he or she controls.
Most states allow the trust creator to name himself or herself as both
trustee and beneficiary. Because the trust is “revocable” the assets
can be returned to the trust creator at any time.           Most trust
documents can also be amended at any time, although this right must
be granted at the time of the trust creation.


Irrevocable and Revocable Trusts

  While there are various types of trusts the two primary categories are
revocable and irrevocable. As the names imply, one can be changed
and the other cannot. Both categories of trusts can be valuable asset
management tools when appropriately used. Trusts can be set up to
exist for generations or the trust may direct the trustee to make
partial and final distributions to specified beneficiaries at specified
times. Once all assets are distributed, the trust either lives on as an
empty vehicle or is ended, depending upon the terms of the trust. An
empty trust serves no purpose unless there will be some future use for
it. An empty trust is typically referred to as a nonfunded trust.

        The trust may direct the trustee to equally fund
     each child’s trust based on his or her individual needs.

  Trusts are very versatile. That is one reason they are used so often.
In the right hands, a trust can do virtually anything within the law that
is desired. For example, if a person has several children, a family trust
may be created that divides the assets into equal shares. Each share
becomes a separate trust for each child. The trust may direct the
trustee to equally fund each child’s trust based on his or her personal
needs. For example, if one child has already completed college while
another has not, the trust could equalize the cost of college funding
prior to distributing remaining assets. The trust would, in effect, fund
comparable benefits prior to asset distribution.

Irrevocable Trusts
  An irrevocable trust may not be changed or revoked once created,
unless this aspect is specifically granted within the trust document. An
irrevocable trust is usually created to remove property and its future
income and appreciation from an individual’s estate. Present interest
and Crummey trusts are typically irrevocable trusts.

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               Present interest and Crummey trusts
                  are typically irrevocable trusts.

  Irrevocable trusts are often used for controlling how a beneficiary is
able to withdraw or use trust assets. Many parents use irrevocable
trusts to prevent a child’s spouse from having access to the trust
assets should a divorce occur. A beneficiary who constantly has
problems meeting their bills may also benefit from an irrevocable
trust. While creditors could reach the income generated, they could
not attach the asset itself.

  It is often assumed that assets in an irrevocable trust will be
removed from the grantor’s estate value, but this is not necessarily
true. It depends upon how the trust is drafted. If the grantor retains
certain interests or powers in the trust, such as a life income interest
or the power to affect asset distributions, the value will continue to be
taxable to the grantor’s estate. Assets transferred to an irrevocable
trust may be subject to gift tax when all control of them is relinquished
so either way taxation may occur. The gift tax exclusion may shield a
portion of the value, but the Internal Revenue Service is determined to
collect all the taxes that are due – one way or another.

  It is possible to reduce taxation and remain within the law. For
example, the gift tax may be less than the estate tax would be. An
irrevocable trust created for the benefit of one’s children may provide
a limited income tax benefit. The amount of this benefit depends upon
how much other income the children already receive and whether the
kiddie-tax applies to them. It is important to receive professional tax
advice since many parents have inadvertently caused financial harm
by transferring assets to their children prematurely.

  Very strict rules minimize the type of control that an individual or
their spouse may keep over trust assets without causing the income to
be taxed to them. Income will be taxed if it is used to pay for an item
that a parent or guardian is legally obligated to provide as support for
the beneficiary. In other words, a parent who is legally responsible for
a child may not arbitrarily move assets into the child’s name to avoid
taxation.




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Revocable Trusts
  Revocable trusts are the most commonly used type of trust. Most
people want to keep control of their assets, which is why they select a
trust that allows this. Also known as a living trust, it is created
during one’s lifetime and may usually be amended or revoked at any
time for any reason.      Poorly written revocable trusts sometimes
overlook the inclusion of an amendment provision allowing change, in
which case it would have to be revoked and rewritten if a change were
desired.

  The trust provisions direct how the assets will be held and
managed during the creator’s lifetime. Like a will, it can also direct
how assets are to be distributed upon the creator’s death. The
primary characteristic of a revocable trust is the power retained by its
creator. He or she has full ability to use his or her assets in any way
at any time. A revocable trust does not permanently commit the trust
creator to anything during his or her lifetime since there is the ability
to change or revoke the trust at any time. Once death occurs, it will
carry out the directives within it. Upon death, it could be said that the
revocable trust suddenly becomes irrevocable since the creator is no
longer available to make changes or revoke it. If he or she gave these
powers to trustees, the trust could move this ability on to another
person or entity, however.

  Assets within a revocable trust are included in probate values, though
not in the actual probate proceedings. All income and deductions
available in the trust property flow back to the creator, so no gift taxes
are ever incurred. Gift taxes could be triggered, however, if the
creator gives up his or her power to revoke or amend the trust, or if
income or principal is paid to someone else.

        There are no tax advantages in a revocable trust.

  There are no tax advantages to a revocable trust. There can be
other advantages, however. It certainly avoids the process of probate
and ancillary administration. It may also avoid legal guardianship. If
the creator should become incapacitated, the assets kept in the living
trust would be managed automatically by a trustee named in the trust
document, assuming the attorney was wise enough to list a contingent
trustee for such situations. If no contingent trustee was listed, the
courts might assign an individual, so listing one is always a wise


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decision. In fact, a good attorney will probably draft a durable power
of attorney at the same time a will or trust is drafted.

  If a trust creator wishes, he or she can relieve themselves of the
responsibility of managing their assets when creating a trust. If this
were their desire, the trust creator would use an independent trustee
immediately upon trust creation to manage the assets or investments
placed into the trust. This trustee would do all that was necessary,
including payment of bills and taxes, for a fee.

  As with most things, there are disadvantages in utilizing a revocable
trust. There are legal fees and expenses, little or no financial savings,
taxation of gifts made directly by a trustee, and title issues for some
types of assets, especially real estate. Once assets are moved into a
trust, personal business affairs must be conducted through the trust.
While this is not difficult, it can be cumbersome, requiring more steps
than would otherwise be necessary.

  Once assets are moved to a trust, personal business affairs
            must be conducted through the trust.

  Except for assets that allow a stated beneficiary, such as life
insurance policies and annuities, anything outside of the trust will be
subject to probate. A major mistake commonly made by creators of
trusts is the misconception that a will is no longer necessary. Every
individual of legal age should draft a will, even if a trust has
been created.       We will be stating this fact numerous times
throughout this course because it is very important.

      Example:
        Jeremy drafts a trust so he does not consider it necessary
      to also draft a will. His mother does have a will that leaves
      all her assets to Jeremy. Jeremy’s mother is unexpectedly
      admitted to the hospital. On the way to the hospital
      Jeremy is involved in a car accident and is hospitalized.
      His mother dies the next morning and her assets legally go
      to Jeremy upon her death. Jeremy dies two days later.
      Since Jeremy did not have a will and his mother’s assets
      were not included in his trust, all the property he received
      from her must go through probate. With no will, Jeremy’s
      inherited property will be distributed according to the laws
      of his state – not according to his personal wishes.

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  Revocable trusts may be ended at any time or they can continue until
all assets have been depleted. If that never happens, the trust can
continue indefinitely. Everything depends upon the language of the
trust (which is why they are so versatile). Trusts are often used to
control assets when the beneficiary is seen as someone who is not
trustworthy to control the wealth personally. While this is often the
case for minor children, it can also apply to an adult who lacks the
financial skills necessary to handle large inheritances.

  Trusts are often used for minors, since they can financially care for a
person over time. A will does not have this ability. A trust allows the
appointed guardian greater ability to apply funds as the parents would
have wished. Without a trust, the guardian would have to qualify each
child, giving bond (guaranty with surety) to secure performance of his
or her duties. Most states restrict how assets may be spent for
minors, usually restricting it to land, government bonds and other
legals. Each state will have specific laws regarding the use of funds on
behalf of minors. Most states do not allow a guardian to use up
principal, even for the purpose of education, without the approval of
the court. Of course, these laws are for the protection of minor
children. A poorly set up trust could provide the guardian extensive
authority, enabling him or her to deplete funds intended for the long-
term use of the children. Even if the depletion were not intentional the
negative effect would still cause financial harm. State laws attempt to
prevent the misuse of funds intended for minors, but that is a difficult
task. Therefore, it becomes especially important to draft a trust that is
appropriately worded when minor children are involved.

  A trustee under a trust is typically paid more than a guardian would
be under a will and the cost of this must be considered. Before
choosing to use a trust the testator must be certain that enough funds
exist to pay the trustee and still accomplish that which is desired.
Inadequate trust funding may financially benefit the trustee more than
the intended beneficiaries. This is not the fault of the trustee. All
professionals charge a fee for their services. Professional trustees
clearly state their fees for trust management. Those fees are unlikely
to be reduced even when trusts are poorly funded. Inadequately
funded trusts could experience trust fees taking the assets intended
for beneficiaries.




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  Most trustees have specific fees for trust management that
    may not change even when trusts are poorly funded.

 Even though a trust might be preferred, if there are not enough
assets, a will might be the wiser choice. Under a will income producing
assets left to minors generally would be given outright to the child
when legal age is obtained. Legal age will depend upon the state in
question. The testator may not feel an 18 to 21 year old is wise
enough to manage some types of assets making a trust seem prudent
but, unless adequate assets exist, it may not be a viable alternative.

  Trusts are often used in cooperation with life insurance policies.
When used together, the proceeds from the policy are made payable
to the trust rather than a named person. This allows the proceeds to
be available for payment of debts, funeral expenses, administration,
and taxes. Having life insurance proceeds available for such purposes
avoids the forced sale of assets to cover obligations.

 When trusts are utilized, individuals often direct pension and profit
sharing benefits to the trust. Though not required, it often makes
sense to do so since there are already trustees involved that can
manage the funds.

  The use of trusts is available to anyone of legal age. However,
interest has primarily come from older people with large estates. It is
common to name one or more of their children as trustee or co-
trustees. Many professionals recommend naming more than one
trustee in case one individual is unable or unwilling to serve in the
position. Some trusts stipulate that two or three trustees must exist,
prohibiting a single person from having sole power over distribution of
assets. Some trusts combine a family member with a professional
trustee, with the hope that each will contribute different perspectives.

  While there may be many reasons to select a trust, a common reason
has to do with legal residences. It is now common for retired people
to move to warmer climates away from their children. When the trust
creator lives in a different state than the intended beneficiaries a trust
may bridge state laws easier than a will would. That is because a will
must be probated according to the domicile state’s laws; a trust does
not have the same restrictions.



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 Probate proceedings are public hearings. Some individuals desire
more privacy than afforded by a will. It is possible to file a will in a
different county and this does afford some privacy, but it will still be a
public hearing. For those who wish privacy, a trust is recommended.
Trusts may also avoid some types of delays that would exist with a
will. Delays often happen in probate due to assets that are not easily
valued or transferred. The same difficulties will exist if the asset is
placed in trust, however, since the problems come not from probate
but rather from the asset itself. The trust may be instructed to hold
an asset until a more favorable market exists for the difficult-to-value
asset, but this is not necessarily an advantage for anyone, including
the beneficiary who may want the value immediately.

  It is common to set up a trust but not fund it. A trust that does not
contain assets is referred to as a non-funded or empty trust.
Technically a trust does not actually come into existence until it is
funded. It is the assets that make the trust viable. Trusts might be
non-funded intentionally (waiting for insurance proceeds, for
example), but more often it is a lack of practical experience that allows
this to happen. The testator simply did not know how to legally fund
their trust. If the testator thought they had funded the trust, but did
not complete the asset transfer, he or she has created a very difficult
situation for those who must deal with his or her estate. If a will does
not also exist, assets will have no legal protection.

             It is the assets that make a trust viable.

  Establishing a revocable trust is more expensive than creating a will.
Trusts usually cost more to establish and more to maintain. Attorney
fees and fiduciary fees are likely to be equal between a trust and a will
when settling the estate.

  Consumers often expect trusts to do anything they consider
desirable. In reality, while trusts can be used in many ways, they do
not achieve everything desired. Revocable trusts do not save taxes.
Taxation will be the same whether the estate is settled through
probate (using a will) or through a revocable trust. Unfortunately
revocable trusts have been sold because the purchaser thought it
would act as a tax avoidance vehicle. In 1990, several states brought
legal suit against insurance agencies and other organizations for this
reason. Since then, those selling trusts have had fewer complaints


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regarding misrepresentation, but consumers continue to expect to
save taxes through a revocable trust.

Present Interest Trusts
 Some types of trusts work well when giving gifts to minors, including
the present interest trust. Congress enacted special rules to provide a
well-defined method of making gifts to minors that qualify for the
annual exclusion. The Internal Revenue Code provides that a gift to a
qualifying trust established for a child under the age of 21 will be
considered a gift of a present interest and thereby qualify for the
annual gift tax exclusion. The trust instrument must provide that the
gift property and its income:
        •   May be expended for the benefit of the beneficiary before
            reaching age 21, and
        •   To the extent that it is not expended, will pass to the
            beneficiary upon becoming age 21.

 The child must have the right to receive trust assets by age 21. Even
so, trust assets are not required to automatically be paid to the child
when he or she becomes 21 years old. As long as the child is notified,
the trust may give the child the ability to withdraw everything for a
period of 30 or 60 days. Once the withdrawal period ends, if the child
did not withdraw them, the property stays in the trust and is
administered according to the terms of the original document. Should
the child die prior to the age of 21, funds must be payable to the
child’s estate or under the terms of appointment.

     Trust assets are not required to automatically be paid
       to the child when he or she becomes 21 years old.

 The Internal Revenue Code establishes the age standard of 21, so it
applies to trusts for children under that age even if state law has the
age of majority as less than that.

 A Present Interest trust works well when accumulating income for
non-tax reasons. It may not be suitable for large gifts due to the
requirement that trust funds be payable to the individual at age 21, or
at least provide that option. Not every parent or grandparent may
want the funds available at that age since the child may not be able or
willing to use the money in a positive manner. Additionally, if the


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funds remain in the trust, it is likely that the taxation level will
dramatically increase after age 21.

Crummey Trusts
  Also designed to receive gifts, the Crummey Trust is different than
the Present Interest trust since an individual can transfer property and
have the gift qualify for the annual gift tax exclusion.             The
distinguishing feature of the Crummey trust is that it gives the
beneficiary the right to demand annual distributions from the trust
equal to the lesser of either the amount of the contributions to the
trust during the year or a specified amount. The specified amount
may be stated as either a dollar amount or a percentage of the total
trust value. The beneficiary or the beneficiary’s legal guardian must
be notified of the power to withdraw the trust corpus, although the
power is permitted to lapse or terminate after a short period of time,
such as 30 days. If the beneficiary does not make a withdrawal
demand during the stated period following deposit, called the window
period, the right lapses for that year’s contributions. Since the
beneficiary or his or her guardian has the right to demand distribution
of the year’s contribution, that contribution is considered a present
interest, so it qualifies for the annual gift tax exclusion.

    If the beneficiary does not make a withdrawal demand
     during the stated period following deposit, called the
 window period, the right lapses for that year’s contributions.

 In theory, the minor beneficiary or his or her guardian is not likely to
demand distribution since it is assumed that no further contributions
would be made in subsequent years. The gifts might stop if the funds
were withdrawn and spent. Because of this assumption, these types
of trusts are often called “broken-arm trusts.”

  Crummey trusts can be very flexible. Once the withdrawal power has
lapsed following the window period each year, the trustee can be
required to accumulate income until the child reaches a specified age.
The trustee can be restricted to using trust assets and income for
specific purposes, such as school expenses. The trust may also
perform as a vehicle for permanently removing assets from the
parents’ gross estate. The Crummey trust’s income is taxed to the
beneficiary who allowed their withdrawal right to lapse. Therefore,
once the beneficiary is over the age of 13, the income will be taxed at
their rates, which will avoid the punitive tax rates applied to trusts.

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Totten Trusts
  The Totten trust is referred to as an “in trust for” account or trust. It
is created when the donor deposits money into a bank account for the
benefit of a minor, then names him or herself as trustee. This is an
informal and revocable arrangement under certain states’ laws. Upon
the donor-trustee’s death, the funds avoid probate and pass directly
on to the minor. The trust is not considered a separate entity for tax
purposes because the donor retains complete control over the assets
in the trust. Accordingly, the donor will be taxed on the income as if
the trust were not in existence. Assets in the trust will be includible in
the donor’s estate.

             Under a Totten trust, the donor will be taxed
          on the income as if the trust were not in existence.

Life Insurance Trusts
  According to Ernst & Young’s Personal Financial Planning Guide1, next
to one’s home, life insurance policies are often an individual’s most
valuable asset. What many people do not realize is that life insurance
proceeds payable to one’s estate will be included in the gross estate
for estate tax purposes. Merely retaining even one of the incidents of
ownership will cause the proceeds to be included in the estate,
regardless of who the policy’s beneficiary happens to be. In order to
minimize estate taxation, someone other than the insured should own
the policies. All incidents of ownership must be transferred to children
or a trust for the family’s benefit. This will bring about significant tax
advantages. To be effective, however, it must be properly executed.
The gift must be made more than three years prior to death. The
three-year waiting period may be avoided on a new policy if proper
steps are taken to have someone else, such as the trustee of an
irrevocable trust, apply for the policy. One way to do this is to apply
the annual gift tax exclusion to cover contributions of money made
each year to the trust for the purpose of paying premiums. The trust
can therefore be used as a powerful way to leverage the annual
exclusion to get insurance proceeds to the heirs without income, gift,
or estate tax.



1
 Third Edition, by Robert Garner, Robert Coplan, Martin Nissenbaum, Barbara Raasch, and Charles
Ratner

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  We often hear that trusts do not prevent the payment of taxes and
this is generally true. However, how trusts are used can save on the
types of taxes an individual must pay. Life insurance proceeds are
free from income taxes when they are paid to beneficiaries. However,
the death benefits are included in the insured’s estate and this impacts
the beneficiaries. If there is considerable life insurance, the taxable
impact is great. It can increase the taxable rate to as high as 55
percent of the entire estate. An irrevocable life insurance trust avoids
estate taxes because it is a separate legal entity in which the insured
has no financial or ownership interest. Once the life insurance policy is
transferred to the trust, the insured has no control or rights of
ownership in the life insurance policy. That is the reason there are no
resulting tax liabilities. This may also be accomplished by turning over
the rights of the policy to the beneficiaries, usually children, but this
lacks the planning flexibility offered by a life insurance trust.

    Under a life insurance trust, the trustee manages the life
  insurance trust, maintaining the policy during the insured’s
      lifetime by paying the premiums as they come due.

  Not planning for estate taxes is a major error made by most people.
Even with the higher unified tax credit, life insurance can easily push
an estate past that mark. Under a life insurance trust, the trustee
manages the life insurance trust, maintaining the policy during the
insured’s lifetime by paying the premiums as they come due. At the
insured’s death, the trustee receives the policy proceeds and follows
the directives of the trust. The trust may immediately disperse the life
insurance proceeds or pay specific amounts at specified intervals,
depending upon the trust directives. In addition to saving estate
taxes, the death benefits are paid to the survivors without the costs
and delays of probate or estate settlement.

  Establishment of a life insurance trust is not difficult, but it must be
done correctly. Otherwise, there will be no tax advantage. A life
insurance trust may be created by transferring an existing policy to an
irrevocable trust. The transfer is considered a taxable gift, but the tax
is calculated on the surrender value of the policy, which is usually less
than the death benefit. Term policies may also be transferred with the
gift amount being only the amount of the current year’s premium paid
in as of the transfer. The tax cost of transferring a policy during one’s
lifetime could be much less than the estate taxes due at death. Again,
it is important to note that transfers made within 3 years of death will

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still be included in the taxable estate, so it is not wise to wait until
illness or injury exists.

  Once a life insurance policy is placed into an irrevocable trust, all
rights to the policy are lost. The insured cannot cancel or amend the
trust or withdraw the assets. Even the beneficiary designation may no
longer be changed. Therefore, it is very important to use only those
who understand how such a trust should be drafted. The trustee must
be an individual who also understands the importance of the goal.
These selected individuals must have tax and estate planning
expertise. There will be costs involved in setting up and administering
the trust, but these fees can be more than offset by the tax savings.

Grantor Retained Annuity Trusts (GRAT)
 Some types of assets are more difficult than others to transfer.
Those having a fair market value that is easily measured, such as
securities, do not present a problem but others that must have their
values established can cause delays in distribution or transfer. Some
values, such as a business interest, can be very difficult to value.

        Assets with a fair market value are easily valued
         but others must have their values established.

  A GRAT can enable a business owner to transfer a large amount of
stock or an interest in a partnership to another person at a reduced
gift tax cost. Grantor Retained Annuity Trusts are typically used for
transferring interests in a closely held business, but it may also work
well for publicly traded stock or real estate that is expected to
appreciate significantly.

  When using a GRAT, the individual transfers property to a trust for a
fixed term of years. During the trust term, the beneficiary would
receive a fixed stream of annuity payments. When the term expires,
any property remaining in the trust would pass on to the owner’s
children.

 A GRAT should be set up as a grantor trust for income tax purposes,
regardless of the type of property intended to fund it. This is very
important when the transfer will be S corporation stock since a grantor
retained annuity trust is qualified to hold such stock. Grantor trust
status prevents capital gains from being triggered if some of the trust
property is used to satisfy the annuity payments. All income and

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capital gains will still be reported on the owner’s income tax return. If
the owner dies during the trust term, the trust property will be
includable in his or her estate. If this were to happen, the owner
would be in approximately the same position whether such a trust had
been created or not.


Money Management Tool

  Trusts provide a valuable money managing service. By transferring
assets into a trust it is possible to assign a trustee or trustee company
to the duties of managing money and assets. Asset management is
often desired when grantors feel their beneficiaries are not capable
money managers. Banks and trust professionals will certainly charge
a fee for performing these duties, but if the beneficiary is likely to
mismanage the money or assets, that fee may be money well spent.

 The trustee does not have to be a professional. Any person may be
designated as a trustee. It should be noted, however, that no matter
how good a friend might be, he or she may not have the time or
expertise to properly manage the trust assets. This should certainly
be taken into consideration before assigning these duties to them.

            Any person may be designated as a trustee
            (even if he or she is not qualified to do so).

Probate Considerations
 Asset arrangement is just as important as the vehicles used to
distribute them. Poorly organized assets or assets that are difficult to
value can be very difficult, as we have said, to distribute. While every
American of legal age needs a will, there are some aspects of probate
that must be considered and that may indicate the need for a trust (in
addition to a will – not in place of).
   1. Distribution under a will becomes public record. Anyone can
      find out what an individual owned, whom money was owed to,
      and how property was distributed. Filing the will in a different
      county can minimize this, but it still remains a public document.
   2. If a will is not properly drafted, or if values of assets are difficult
      to ascertain, property may be tied up for part or all of the
      probate period. This can be avoided by a properly drafted will


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  with assets designed to provide living expenses for the
  beneficiaries during the probate process or a trust can be used in
  conjunction with the will.
3. The assigned personal representative will not know as
   much about the assets as the decedent did. If proper
   instructions and organized information is not readily available,
   neither a will nor a trust will progress properly. It again comes
   down to organizing assets in a manner that can readily be
   transferred.
4. Some estate planners feel that a public document, such as a will,
   encourages claims against the estate. Those who might not
   otherwise have come forward will read the estate records and
   then file a claim. While this could happen, the claim would have
   to be legitimate for it to be paid. Of course, no administrator
   wants to spend their time fighting bogus claims. However,
   under a will, at some point claims against the estate do close,
   which may not happen with a trust if it continues indefinitely.
   Depending upon the state, a will typically closes (allowing no
   additional claims) between three and six months following death.
   Some individuals may want the closure of probate. An insurance
   agent’s estate should have such closure because the threat of
   lawsuits exists as long as there are existing policies. Since a
   trust continues to exist after the testator has died lawsuits can
   continue to be filed.
5. Some trust advocators feel estate fees might be higher under a
   will than a trust. This really depends upon numerous factors. A
   will can experience high expenses if it is challenged or contains
   complicated or unusual assets. A trust may go smoother since it
   is harder to challenge and can allow longer periods of time to
   work with assets.
6. Probate courts follow state laws. Laws may require probate
   courts to designate appraisers and/or guardians to protect the
   interests of minor children or handicapped adults.       Such
   appraisers and guardians must be paid from the estate. Trusts
   can designate their own guardians, although payment would still
   apply.
7. Taxes can only be minimized by surrendering the property
   during life. Many states do not have death taxes. In those
   cases, only federal taxation would be a concern. Smaller estates

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      would not be affected by federal taxation. Revocable living
      trusts do not save taxes. At most trusts might delay payment of
      taxes; not prevent them.


          Revocable living trusts do not avoid taxation.

  Trusts absolutely make sense in specific cases. Even when trusts
should be utilized, however, a prudent estate planner still drafts a will
for their clients (yes, you’ve heard it before but it bears repeating).

 There are alternatives to probate including:
   1. Create a revocable living trust to hold and distribute the
      property at a specified time or at death. A trust covers only
      those assets that have been transferred into it. No trust covers
      any item that has not been addressed by the trust or transferred
      into it.
   2. Give the property to an irrevocable trust during one’s lifetime.
      An irrevocable trust, as indicated by its name, is permanent. It
      is possible to allow changes to the trust, but often no such
      provision is made. Assets given to an irrevocable trust are
      distributed (given away). Unlike the revocable trust, the creator
      of the irrevocable trust gives up access and use of the assets.
      As a result, they are removed from the person’s estate.
   3. Give the property or assets directly to the beneficiaries during
      life. This might especially be wise if the beneficiary is a tax-
      deductible charity. One caution: no one should give away so
      many of their assets that they cannot live comfortably for the
      duration of their life. We cannot predict our life span. Even if
      currently ill, unexpected life duration may occur. Medicaid has a
      “look-back” period so that assets given away may affect
      eligibility.
   4. Transfer property to family members or friends in return for their
      agreement to make annual payments to the testator during his
      lifetime. This is known as the Private Annuity method of
      property transfer. It would be wise to check with a tax advisor
      prior to doing so.




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   5. Put real estate, securities, bank accounts, and other assets into
      joint ownership. This allows the surviving owner to continue
      using the assets after the death of one of the parties.
   6. Purchase life insurance and annuity contracts with part of
      the assets. It is important that beneficiary designations be kept
      current.


 In those states having community property agreements, transfer
of property will go to the surviving legally married spouse. Community
property agreements may vary from state to state but they have one
basic similarity: when one spouse dies assets pass to the surviving
spouse. Even when community property agreements are used, a will
should be drafted in addition to it. No matter what the financial
vehicle a will is needed.

     Even when community property agreements are used,
           a will should be drafted in addition to it.

  Some estates combine a revocable and an irrevocable trust, putting
some assets into each. Some assets do not do well in a trust because
the costs of administering the assets eat up their value. For example,
an automobile should not be put into a trust. Some types of real
estate also do better under a will. Trust records must be kept, so this
is an ongoing expenditure.

 Smaller estates generally do best under a will. However, it is still a
good idea to minimize probate time and expense. Smaller estates can
cost a larger percentage of the total estate to settle than large estates.
This is especially true if assets have not been well managed or
organized. The most practical steps are:
   1. Put as many assets as possible into joint ownership.
   2. List a direct beneficiary on any asset that allows one. Obviously,
      this would include life insurance policies and annuity contracts.
   3. For married couples in those states that allow it, have a
      community property agreement drawn up by an attorney.


 Joint ownership does create risk.



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     For example:
       Jackie is a widow.      She puts her grown daughter,
     Margaret, on her checking account. Margaret has the right
     to spend Jackie’s money – even if it doesn’t belong to her.
     A year later Margaret’s marriage is having problems and
     there are more bills than income. Already stressed by her
     marital problems, Margaret uses her mother’s money to
     pay personal bills. She intends to repay her mother’s
     account, but as we know, that seldom happens. Since
     Margaret was already short on funds, she had no way to
     catch up and repay her mother. Each month finds her
     short of funds so Margaret continues to dip into her
     mother’s money.       Eventually Jackie notices what her
     daughter is doing but by then it is too late. Most of her
     funds that were intended for her retirement are gone.
     Additionally, Margaret’s marriage has ended and she has
     no way to repay her mother. Even though Jackie may
     have chosen to help her daughter financially, she was not
     given the choice. Because Margaret had legal access to
     the funds, Jackie has no legal recourse even if she would
     have chosen to pursue one.

  It is very important to give joint ownership some thought before
proceeding.     Even though Jackie trusted Margaret she could not
foresee the results of her financial decision. This is true even when
there is no intent on the part of the parties.

           It is very important to give joint ownership
   sufficient thought prior to initiating this financial option.



     For example:
       Mark names his son, Andy, as joint owner of his annuity.
     A few years later the IRS levies Andy. Because Andy has
     joint ownership, the annuity is attached for payment.

 While joint ownership certainly has some estate advantages it should
not be used without careful thought beforehand.




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 Many estates will be relatively simple to settle. Taxation will not be a
consideration due to the assets involved or the size of the estate. The
net taxable estate will consist of:
   1. All property that is owned at its value on the date of death.
   2. All or part of any property that is owned with a spouse as a joint
      tenant with rights of survivorship.
   3. Life insurance and annuity proceeds. Even though the proceeds
      may pass outside of probate, their value must still be stated in
      the probate proceedings.
   4. Pension and profit sharing benefits payable to the estate.
   5. Certain other types of assets (it depends upon the state of
      settlement, which is not always the domicile state.).


 From these total assets will be some deductions:
   1. Debts, including taxes,
   2. Funeral expenses, and
   3. Costs of administering and settling the estate.


 In those states that impose inheritance taxes, life insurance is
sometimes exempt from the tax if the policy named a specific
beneficiary. If a trust was used, it is generally acceptable to simply
name the trust as the beneficiary.

          In those states that impose inheritance taxes,
        life insurance is sometimes exempt from the tax.

 Lump sum pension and profit sharing benefits generally are not
subject to the federal estate tax as long as it is payable to a
designated beneficiary.

      A survivorship clause requires the beneficiary to live
   a specified amount of time before collecting the proceeds.

  A survivorship clause is included in many wills, even those that cover
few assets. A survivorship clause requires the beneficiary to live a
specified amount of time before collecting the proceeds. That time

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period is usually 60 days past the time of death of the decedent. The
aim of such a clause is to keep the assets within the family. This is
usually referred to as keeping them “within the bloodline.”

     For example:
      Richard marries Sally. It is the second marriage for both
     of them. Both have children from their previous marriage.
     Each wants to include the other in their will but they also
     want to protect their own children. If Richard and Sally
     were to be in a common accident, one might die shortly
     before the other. To prevent assets from going to one
     spouse and then on to that person’s beneficiaries a
     survivorship clause is included in their wills.

       Unfortunately, they are riding together in a car that is
     involved in a traffic accident. Richard is killed instantly.
     Sally survives the accident although she is seriously
     injured. Sally is taken to the hospital where she lingers in
     a coma for a week before finally dying. If no survivorship
     clause were listed in Richard’s will, his assets would go to
     Sally. When she died a week later, the assets would then
     go to her beneficiaries as listed in her will (rather than to
     Richard’s children as both of them intended).          Sally’s
     children would now receive both her assets and Richard’s.
     Richard’s children receive nothing.

  Given the same scenario, but with the addition of a survivorship
clause, Richard’s assets would be frozen for 60 days. If Sally lives
beyond 60 days, she would receive his assets, even if she died on the
61st day. Since she died one week later than Richard, his assets will
go to his children, as directed by Richard’s will. Sally’s children will
receive her assets, as directed by her will.

 Richard could have elected to give Sally his assets during her lifetime
with a clause that his assets then go to his surviving children. That
would keep any remaining assets of his within his bloodline, no matter
how long Sally might live.

  When minor children or disabled adults are the intended
beneficiaries, guardians are named. There are two types of guardians:
for people or for property.


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 Although the same person can be the guardian of both people and
property it is seldom wise to do so. There is greater protection when
one person is the guardian of minors and a different person is the
guardian of the property that funds their support.

  The best physical guardian is usually a family member who has a
warm loving relationship with the children. This person may not be
suited to also monitor the finances, no matter how well meaning they
may be. The person best suited to handling assets may not have a
loving relationship with the children. Often a bank is designated as the
property manager and a relative is designated as the physical
guardian. Having two guardians, even if both are related, often is the
best financial protection for the children.       There is the added
protection of two people watching out for their well being instead of
one.

           The person best suited to handling assets
      may not have a loving relationship with the children.

  All wills name an executor or executrix. An alternative is also named
in case the first choice is unable or unwilling to perform the required
duties. The alternative performs the function only if the first named
individual is not available. Some states require that the executor be a
state resident. With the mobility of our society, it is important to
update wills at least yearly so that the estate does not end up without
a legal executor available.

 Parents with minor children often find that trusts work well for them.
A trust gives the parents, even after death, more control. This is
because:
  1. A trust often provides more flexibility in the types of
     investments that can be made on behalf of the children. Since
     funds must last longer when children are involved, a diversified
     investment plan is usually preferred.
  2. In states where trusts are not under court supervision, an out-
     of-state trustee may be named. This is often desired when
     children are involved. Aunt Bess may be the best financial
     guardian, but she lives in a different state. A trust will allow her
     to control the funds.



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  3. Money that is not intended for the children’s support may
     continue to be held by the trust for them even after they reach
     legal age. It is not unusual for a trust to hold funds until the
     minor reaches the age of 25 or more.
  4. A trust permits the property to be distributed for minor children
     according to their personal needs. This allows the estate to
     follow the desires of the parents.


  A trust is a very versatile estate tool. Consumers should concentrate
less on turning the trust into a tax avoidance vehicle while looking
closer at its versatility.

        A trust permits the property to be distributed for
        minor children according to their personal needs.


Trust Language

 Everything involves language. From the time we are born we depend
upon our communication skills. Whether it is a child seeking comfort
or an adult seeking a promotion, language is how we communicate our
desires. Those who develop this skill find it a rewarding benefit in
their personal relationships and their profession.

  Language is based upon several components, one of which is the use
of words. For the insurance agent, terminology may seem very boring
but use of language involves use of terms. Of course, it is how we use
the language (words) that either achieves or fails to achieve our
objectives. Those who love language, such as politicians and actors,
have learned to develop not only the words but also the elements that
go along with them, such as voice inflection and body movement
(referred to as body language). Any individual can learn these skills
although some seem to come by it naturally.             Language and
presentation is very important to the actor or politician, but any
person who develops these skills benefits in some way. Most of us
know someone who is unusually articulate, such as the woman who
campaigns for animal rights or the man who speaks at our church.

 Language plays an important role in any salesperson’s life. One
element of communication is the ability to bridge education gaps. The


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agent has knowledge not possessed by the layperson, but it is
important that the layperson understand what is being presented for
use in a financial plan.

 Terminology is very important in the use of trusts and other legal
documents. Whether it is a life insurance policy or a trust the client
must have a basic understanding of what they are accomplishing (or
not accomplishing in some cases). It is not possible to have a basic
understanding of trusts unless industry terminology is understood.

       The trust beneficiary does not have to be a person;
          it can be an organization, such as a charity.

Trust Creator
 The person who sets up the trust is known by multiple names, but
usually he or she is called the grantor or settlor. Although it is
possible to set up a revocable living trust solely for the grantor, this
makes little sense. Usually the trust is set up for the benefit of specific
beneficiaries. The beneficiary does not have to be a person; it can be
an organization, such as a charity.

Trust Types
  There are multiple types of trusts. A testamentary trust is created
under the directions of a decedent’s will; a person who is still alive sets
up an inter vivos trust. The principal in the trust is commonly
referred to as the corpus. The trustee may also be referred to as the
fiduciary.

  A trust that must distribute all of its income, without any discretion
on the part of the trustee is called a simple trust. When the trustee
has the power to accumulate income or to exercise certain discretion it
is called a complex trust. A reversionary trust is set up to allow
the principal in the trust to go back to the grantor under specific
conditions or after a specified time period has passed. Therefore,
although the grantor may no longer have any interest in the trust
property or income, he or she may have a reversionary interest.

 Financial planners love trusts for their versatility, a quality not
offered by most financial tools. Because a trust is a legal document
that may be drawn up in a variety of ways there is no “right” way to
set up a trust, although it must follow the laws. In other words, while
a trust is versatile, it may not do anything that is restricted by law. It

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has become popular to use a generic trust. Originally these were
made up of an assortment of forms that the private individual filled out
themselves, but now they are more likely to be a computer program.
These are purchased by anyone who wishes to set up his or her own
trust. Like the tax preparation programs, the user enters their home
state and follows the format of the trust program. Of course, such
programs are not likely to allow for personal needs and many
professionals feel they accomplish very little in the way of financial
planning.

     Trustees typically have the power to distribute income
                and principal as necessary for the
      health, education, and support of any minor children.

Trust Distribution for Minors
  Trustees may be given broad or limited powers, depending upon the
provisions of the trust. Trustees typically have the power to distribute
income and principal as necessary for the health, education, and
support of any minor children. The exact powers to distribute income
and principal will always depend upon the provisions of the trust, but
when minor children are involved that is usually the intent of the trust
document.

  Trusts can do whatever the grantor intended (within the limits of the
law). A trust may be set up to provide each child with a proportionate
share of the estate. The needs of each child may be individually
considered, allowing for one child’s needs separately from another.

  In a spray trust the entire principal is available to support the
children until the youngest reaches a specified age. The trustee
determines the needs of each child individually as long as they are
minors. A spray trust terminates when the youngest child no longer
needs to be supported. The exact age varies depending upon the
situation and the provisions created by the trust. Once the youngest
no longer needs or is allowed support, the balance of the estate is
typically divided equally among the children. Of course, it is not
mandatory that proceeds be equally divided. As always, it will depend
upon the trust provisions. Spray trusts usually also address how funds
will distribute if one of the children becomes deceased, with options of
dividing that child’s portions among the remaining children or allowing
their portion to go to that child’s specified heirs.


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        A spray trust terminates when the youngest child
                no longer needs to be supported.


Selecting Trustees

  Simply naming a person to act as a trustee does not mean he or she
will accept the position. Selecting a trustee is an important decision
and must be given great thought. Many professional money managers
prefer that an institution, such as a bank or trust company, share the
position with a private individual, such as a relative. The trust creator
has no way to know if the private individual will be willing to serve,
able to serve, or serve appropriately. Having an institution whose sole
job is acting as trustee provides the expertise that may be necessary
to handle the job legally and responsibly. Having a private person also
serve keeps the personal desires of the creator highlighted in all trust
decisions. A personal friend or family member acting as trustee is
especially aware of the appropriateness of decisions affecting minor
children.

            It is seldom wise to have a family member
                   or friend act as a sole trustee.

  While it is not necessary to have co-trustees (two or more people
performing the role), many professional planners always advocate two
or more in the trustee position. Especially if the trustee is given broad
powers, having more than one unrelated person performing the job is
likely to prevent abuse that could rob the beneficiaries of their rightful
income. It is seldom wise to have a family member or friend act as a
sole trustee. While we think we can rely on those we love, that is not
necessarily true.

  Each state will have specific laws governing trust documents. Of
course, the federal government will govern federal tax treatment of
trusts.   A trust will not generally be recognized for federal tax
purposes unless steps have been taken to avoid the dangers involved
with revocability, reversionary interests, or retained powers. It can
reasonably be argued that any trust that may be revoked by its
grantor belongs to the grantor. In other words, a grantor who can put
property into the trust and take it back out obviously still owns the
assets involved. Additionally, a grantor who can create the trust and


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also terminate it still owns the assets involved. Therefore, the trust
provides no tax benefits. Tax benefits would exist only if the grantor
terminates his or her rights to the assets involved. As long as the
grantor retains the power to revoke the trust, the value of the
property (assets) is includible in his or her gross estate at the time of
death.


Probate Protection

 Couples that wish to protect each other from what they perceive to
be a potentially difficult probate process often create trusts. In such
cases both of the people will probably serve as trustees for their trust.
They could even be the beneficiaries.


      For example:
        John Jackson and Julian Floyd live together as a couple.
      Although they have not legally married, they act as a
      married couple would with the same loyalty and
      responsibilities. They do not plan to have any children.
      John and Julian want to financially protect each other but
      because they have not married they are concerned that
      probate may not achieve what they wish, so they create a
      trust. In the trust they name themselves as both co-
      trustees and beneficiaries. Their intent is to allow each
      other to receive all trust assets should one of them die and
      to manage the assets if one becomes disabled. They also
      want to have use of their assets during life and be able to
      make changes or perhaps even end the document if they
      wish, so the trust is a revocable trust. Each person also
      drafts a will, naming the other as his or her beneficiary.


Proper Trust Use
  Trusts are a very flexible estate-planning tool, but unless they are
properly drafted little may be achieved. The most common mistake is
failing to properly transfer assets into the trust. In some cases, assets
are placed in the trust that should not be since the trust makes use or
sale of the asset more difficult. Despite these possible problems, trust
documents are often used since they have the ability to solve many
financial concerns. Revocable trusts typically allow the trustees to

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direct and control income and principal within the trust, move assets in
and out as desired, and distribute assets as desired at death or even
long after the creator’s death. Since a trust document does not die
with its creator (unless specified to do so) it has the ability to continue
to manage assets long after the trust creator’s death. A trust is so
flexible that the possible choices are endless.

  Many agents have become involved in selling revocable living trusts.
It is necessary to know what is being sold in order to avoid lawsuits.
Unfortunately, many agents have sold trusts at vastly inflated prices
only to discover that little was achieved for his or her client. For the
career agent, this is a deadly mistake. Clients who once trusted their
agent will cease doing so. It is important to note that Errors and
Omissions liability insurance will not cover a trust lawsuit since trusts
are not insurance related. Although they may direct funds from a life
insurance policy, that does not make the trust an insurance document
– it is merely an instrument used to direct insurance funds.

 There is much conflicting information regarding trusts and what they
can accomplish. Some of the conflict may be attributed to differing
opinions or state laws that are not uniform. In our view, some of the
difference of opinion depends on the context of the information: an
author who wishes to sell his book may state different views than an
attorney who is considering specific laws within his or her state or
specific use of assets within the trust. While trust sources may
express different views, those wishing to use a trust must do so with
correct information based on the laws of their state. Therefore, it is
very important that the creator seek out professional legal advise for
any use of a trust that is not traditional. Never should a selling agent
express personal views or give advice on using trust documents unless
he or she is certain they have correct information. There are too many
variables involved, including IRS taxation.

    Some types of professionals need the closure of probate
              so that their legal liability ceases.

 Not every individual needs a revocable trust, despite what those
selling trusts may tell you. While trusts do perform well in many
cases, for some it simply is not necessary. When a trust is not
necessary, purchasing one is wasted money.           Some types of
professionals need the closure of probate so that their legal liability
ceases. Such is the case for insurance agents, for example. If assets

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remain in a trust following their death, the ability of their clients and
their client’s heirs to sue remains as long as the trust is in effect
(unless the trust transferred the assets to someone else). Therefore,
the closure of probate may be preferable to a trust. In all cases, an
individual considering the purchase of a trust should seek out a legal
trust professional with experience in the type of trust being
considered. Selling revocable living trusts does not make the person a
specialist in the field. A specialist has legal training, understands
various types of assets, understands how life insurance may work with
trusts, knows the laws of the state, and understands how taxing
authorities will view trust assets and their distribution. This course will
not make an agent a trust professional. It will allow him or her to
understand agent limitations when offering professional advice and
may encourage him or her to seek additional training.

  Trusts have a long history, but their popularity seems to be rising in
recent years. Consumers often make poor choices, however, based on
faulty information. Trusts exist when a person transfers legal title of
assets to the document. As we said, revocable trusts still allow the
trust creator to make any desired changes to the document while an
irrevocable trust takes away the ability to amend or terminate the
trust, except within the terms of the trust document. Since most
people want to retain control of what they own, the revocable trust is
most often utilized rather than the irrevocable trust.

  Since most people want to retain control of what they own,
           revocable trusts are most often utilized.

Not Everyone Needs A Trust

  The value of trusts has been overstated to the public. In fact, some
states have actually taken legal action against agents and others who
have misrepresented the value of trusts. Some of the claims made
include:
      •   Claim: A trust will protect assets from the delays and
          expense of probate. While this is true, what is then
          assumed is not true: that probate will somehow overlook the
          assets within the trust. If it is a revocable living trust all
          assets, including trust assets, must be included in the total
          declared value for probate purposes. Additionally, a trust
          provides no protection for assets left outside of it. It should

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    be noted that a life insurance policy listing a beneficiary
    accomplishes the same thing. Revocable trusts have many
    worthwhile uses, but it will not protect asset values.
•   Claim: A trust will be less expensive than the cost of
    probate. This may or may not be true, depending upon the
    state of residence. Not all states have difficult probate
    proceedings, but even when a person lives in a state that
    does he or she must still draft a will. Every person of legal
    age needs a current will – even if a trust has been created.
    For those who want everything distributed via a trust, a
    simple will that “pours over” into the trust will probably be
    adequate. Of course, attorneys charge a fee to draft a will,
    but it is absolutely vital that one exist. Trusts have many
    costs besides the initial fee to create the document. There
    will be costs to change titles and in many cases, it is not
    advisable to put specific assets into a trust. Additionally,
    there are ongoing administrative costs with a trust that will
    not exist with a will.
•   Claim: Assets will distribute quicker through a trust
    than a will. Again, this may or may not be true, depending
    not only on the state but also on the assets involved.
    Uncomplicated assets, such as cash, Certificates of Deposit,
    and assets with an easily determined worth are likely to
    distribute just as quickly with a will (assuming the will is not
    challenged). Complicated estates will be complicated with or
    without a trust in many cases. Complicated estates often
    require the services of both an attorney and an accountant.
    Since they must prepare and file two death-tax returns (one
    for state and one for federal) the length of time involved will
    not vary much between a trust or a will. In simple estates,
    the process should go quickly regardless of which is used.
    What can complicate and slow up probate are assets whose
    value are not easily determined or a challenge to the will
    itself. It is much more difficult to challenge a trust, although
    any American has the legal right to challenge just about
    anything. It is more difficult to challenge a trust since it is
    not a public document so it is unlikely that an individual
    would be aware of its existence. Even the beneficiary has no
    legal right to view the trust document unless the creator
    granted that right.


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        •     Claim: A trust will save taxes. No, it won’t. Unfortunately
              this claim never seems to go away. There are no income-tax
              savings attributable to earnings of the revocable trust. Since
              the creator has full access to all assets within the trust and
              could revoke the trust at any time, taxes will be levied
              against assets both in and out of the trust at death and
              during life. For federal estate-tax purposes, all assets in or
              out of the trust must be declared and are usually subject to
              any death taxes that exist. The tax-saving provisions that
              trusts utilize may also be utilized by a will that has been
              properly drafted. The words “properly drafted” are true of
              both a trust and a will. No matter how cheaply a legal
              document was to have drawn up, if it was incorrectly done it
              was too expensive. It should be noted that price does not
              indicate quality. Some of the trusts that have been peddled
              to unsuspecting consumers were both inferior in quality and
              expensive by normal standards.


    Typically, consumers are not directly lied to about trusts
       but rather they are given information in a manner
                that allows incorrect assumptions.

  As long as there is money to be made by selling trusts to the public
there will continue to be claims made that are not true or only partially
true. Typically, consumers are not directly lied to, but rather they are
given information in a manner that allows incorrect assumptions.

 Living trusts may also be called grantor trusts since they are
created for the grantor’s lifetime. Living trusts may be appropriate for
many reasons:
   1.       Beneficiaries who may not be capable of handling a quantity of
            wealth at one time will benefit from a trust that distributes
            income in a specified manner (such as a set dollar amount
            per month). Parents often use this method for children who
            have demonstrated an inability to properly handle money for
            example.
   2.       In some cases a trust may be used to reduce federal income
            taxes. This may involve a transfer of income-producing assets
            to a fiduciary for some other party’s benefit, such as a charity.
            In order for this to reduce taxes the trust must be a separate

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     taxable entity. This allows the trust to be taxed at a lower rate
     than the creator would have been. Several trusts may be used
     to benefit multiple parties, such as children or other heirs. Any
     time the goal is tax reduction, the grantor must be aware that
     the IRS has attorneys working for them, too. Many grantors
     who thought they were avoiding taxes found out they were still
     responsible for any taxes that were due even though the assets
     were given to others. The result? They gave away the assets
     and still paid current taxes. The grantor might avoid future
     taxation so if that is the goal it may still be a viable process. In
     all cases, an experienced trust professional should be sought
     out. Again, a trust salesperson is not necessarily the proper
     authority to give advice. Only an experienced, trained trust
     professional will have the knowledge required to make such
     judgments and even they are sometimes wrong when it comes
     to taxation.
3.   A trust does avoid the procedures of probate.             It is
     important to note we said the “procedures of probate.” Trust
     assets may still be included in the values used during probate
     for taxation purposes.      Trust assets will avoid probate
     settlement fees, but taxation includes all assets that were
     available to the decedent.
4.   A trust is a private document, while probate is a public
     procedure by necessity. Probate must be public because it
     allows persons and companies to request payment for sums
     they are owed by the decedent. Without this process, creditors
     would have no way to collect sums they are due. Many like the
     privacy of a trust because it prevents the public from knowing
     what assets were involved, how assets were dispersed, and
     whom they were dispersed to.           Even the beneficiaries
     themselves are not able to view the trust document. Only the
     trustees have this right and they must act in a fiduciary
     capacity, meaning they do not have the right to discuss the
     document with anyone not having the legal authority to know.
5.   Every person has the legal right to challenge any document.
     Having that right does not mean the challenge will be
     successful. Trusts are very difficult to challenge primarily
     because they are a private document. It is nearly impossible to
     challenge a document that cannot be viewed.           When a
     document cannot be examined, there is no way to assess


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     whether it was properly written, no way to determine if
     beneficiaries were properly represented, no way to determine
     the appropriateness of it. As a result, few trust documents are
     challenged. This makes the trust very useful in cases where an
     individual is likely to challenge the decedent’s wishes, such as
     in asset distribution (the most likely reason a document would
     be challenged).
6.   Trusts are often used to support or reward an individual.
     Money may be set aside to ensure the support of a child or
     even someone who is not related to asset owner. Trusts are
     often used to ensure the financial safety of a person that would
     not be considered a normal beneficiary. People often use the
     trust to repay a person’s performance or care during a
     decedent’s life. For example, Mr. Burns has a wife and children
     but the person he most wants to give financial security to is the
     neighbor who came over daily to care for him during his illness.
     Mr. Burns sets up a trust for the neighbor and deposits $25,000
     in it. Upon his death the trust turns over the money to the
     neighbor. Even though his wife and children would object if
     they knew, it is likely that the asset will merely move to the
     neighbor without the family even being aware of the transfer
     (because the trust is a private document).
7.   Trusts can control assets for a specific length of time. Trusts
     are sometimes used to support an individual until they graduate
     from college or remarry.
8.   As many agents know, trusts are often used to hold insurance
     policies. In this case, the insured would be the grantor, but
     the trust would pay the premiums and make decisions
     regarding settlement options. If the grantor has correctly
     transferred all of his or her interest in the policies irrevocably
     to the trust, the cash surrender value of the policies usually
     cannot be reached by creditors. Why? Because the policy does
     not belong to the grantor. It legally belongs to the trust and is
     controlled by the trustees. It must be stressed that the grantor
     must have given up all personal control of the insurance policy
     in order for this to be true. Generally, even the IRS cannot
     attach these funds if they are properly assigned to the
     irrevocable trust. Since the life insurance premiums must be
     paid (unless it is a paid up policy) some income-producing
     asset must also be assigned to the trust. If the grantor is


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     paying the premiums from outside of the trust, both creditors
     and the IRS may have claim to the funds upon his or her death.
9.   An irrevocable trust may be set up for the benefit of the
     grantor. If this were the goal, the grantor would transfer his
     or her assets to the trust for the purpose of providing for his or
     her own needs. By making the trust irrevocable, he is guarding
     the assets from his own poor judgment or poor perception of
     character. Why would a grantor feel this was necessary? If Mr.
     Burns knew he was in the early states of dementia or
     Alzheimer’s disease he may wish to protect himself from those
     who would take advantage of his increasing inability to make
     sound judgments. By placing his assets in an irrevocable trust
     no one could persuade him to change the terms of the trust as
     could be done with a revocable trust. Nor could others access
     his assets for their own good. The trustees would bear the
     legal responsibility of acting on behalf of Mr. Burns and could
     do only that which the trust document granted them powers to
     do. Therefore, Mr. Burns must also consider the powers he
     gives to his trustees when drafting the trust.
10. Trusts can preserve principal while still allowing interest
    earnings to be distributed. If the principal is never distributed
    and the trust has no termination date, it could continue forever
    if that is the desire of the grantor. We see this type of trust
    used for such things as college grants and charities. In the
    case of a college fund, the grantor establishes a fund that is
    designed to help specific students (music majors for example)
    receive college funds. The grantor may consider this to be his
    or her legacy, so the desire is for a perpetual trust.
11. Trusts may be used to support dependents without having
    the principal subject to claims of creditors. When this is
    the case, these trusts are often called spendthrift trusts. Not
    all states recognize the validity of spendthrift trusts so a person
    considering the establishment of this type of trust will want to
    check the laws of their domicile state. The spendthrift trust is
    considered by some states to be a form of fraud against
    creditors. Even where these trusts are legal, assets may not
    necessarily be protected since creditors have a legal right to be
    paid. Spendthrift trusts are never protected from taxation or
    federal tax claims.



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12. A well-known use of trusts is providing for minor children.
    This may be accomplished in multiple ways so the type of trust
    can vary widely. How such a trust is used will depend upon the
    ages of the minor children, the amount of money available to
    fund the trust (this is often achieved through a life insurance
    policy), and the variables that exist in all families. There is no
    one type of trust that always works best in this capacity.
13. Trusts are used when voting powers are involved and the desire
    is to keep the voting powers intact regardless of the
    grantor’s personal circumstances. The trustee or co-trustees
    hold the stock and exercise voting power in a block, giving
    voting trust certificates without voting power of comparable
    amount to the beneficiaries. Parents who own a company and
    wish to distribute their shares to multiple children often use this
    trust avenue. Again, state laws must be considered when using
    a trust for this purpose since state laws regarding perpetuities
    may effect how this type of trust may be used.
14. Trusts are used to keep specific types of assets intact
    (prevent having them divided or sold in order for the value to
    be divided) upon the grantor’s death. The grantor’s goal will
    vary, but usually this is done to preserve the asset’s value or
    for the use of future beneficiaries, such as grandchildren.
15. Trusts are used to avoid conflicts of interest. We often hear
    of those running for public office putting specific assets into a
    trust during their term of public service.        The assets are
    maintained outside of the grantor’s control by independent
    trustees in order to avoid a potential conflict of interest should
    they be elected. For example, if a politician owned part or all of
    a business that sought government contracts it would be a
    conflict of interest for that owner to also hold a public position.
    It could be perceived to give his or her business an unfair
    advantage.
16. Multiple trusts are used to prevent individual beneficiaries
    from knowing what percentage they receive of the total
    estate. While a will can give beneficiaries different amounts of
    the estate, it would be a public document. Each beneficiary
    would know if they received a larger or smaller share than
    someone else. By using trusts, beneficiaries would not have
    access to that information. Grantors often do this to prevent


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       hurt feelings or problems between family members that do not
       receive equal shares of the estate.

  While there are typically three roles involved in a trust, one person
may play all three of them. Those roles are (1) the trust creator, (2)
the trustee, and (3) the beneficiary. One person may fill all three
positions in some types of trusts. When the creator is also the
beneficiary it is likely that he or she believes the trust may be
terminated during his or her lifetime. Many types of trusts play a
sophisticated financial planning role and require several people to
operate correctly.

         A common reason for creating a trust might be
               to bypass probate proceedings.

  Since trusts are private documents, there are few statistics to tell us
how the majority of the vehicles are used. However, it is likely that
the most common reason for the creation of a trust is to bypass
probate proceedings. Again, assets in a revocable trust are still
included in the estate values of probate. Therefore, a revocable living
trust does not prevent payment of taxes that will be due at death.

   The word “probate” means: “to prove the will.” That is precisely
what it does. The most recent will is presented to the court and the
court rules it legal and sufficient to meet the state’s laws (or rules it
illegal and insufficient which would void the document). Probate is the
court supervised transfer of assets to the decedent’s heirs or listed
beneficiaries. Because this process requires several professionals,
there are costs associated with it in addition to any taxes that might
be due. Depending upon the laws of the domicile state and the assets
involved it may be a quick and inexpensive process or it may be a
costly drawn out affair. Surprisingly, the size of the estate is not
always an indication of cost. A much more likely indicator of cost and
time are the assets involved and the quality of the will. Many small
estates have no will at all because the deceased did not think he or
she had any assets of importance. All individuals who are considered
legal adults need to draft a will, whether they have any assets or not.
Today it is possible to purchase software that will allow an individual to
draft their own will according to their domicile state’s laws. When no
or few assets exist and there are no special circumstances that must
be addressed these basic wills are often sufficient. Wills need to be
reviewed and updated periodically.

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                Probate means: “to prove the will.”

  The costs of setting up a trust are nearly always more than drafting a
will. In addition, most trusts will have ongoing costs to administer
them. Some trusts must produce income, such as those funding a life
insurance policy. Trust creators should not work with a middleman,
but rather with the attorney who actually drafts the document. Using
a salesperson or other individual as the go-between not only is
awkward but also more expensive since both individuals must be paid.
Nor should a trust creator work long-distance with the attorney. This
may happen when a salesperson initiates the process for a company
that mass-produces trusts.        Although the trust may be properly
prepared it is not likely to reflect the individual creating it. Therefore,
his or her actual goals may not be addressed appropriately.

 It can be very difficult determining who is actually best qualified to
draft a trust. While many different people can perform the task that
does not mean they will be competent to address the issues that need
addressing. Since a trust is a private document that even the stated
beneficiaries have no right to see, a poorly drafted trust can be very
difficult to correct – sometimes even impossible to correct.

      For example:
       Mildred wanted to protect her son’s children. Although
      her son had never married her grandchildren’s mother
      Mildred wanted them to be cared for. She knew their
      mother had few assets and was not likely to ever be in a
      position to provide them with a college education. Her son
      no longer had contact with their mother and seldom saw
      his children.

        When a living trust salesperson came to her door Mildred
      thought she had found the answer to her desired goal.
      Her only contact was the salesperson. While he wanted to
      do his best, he was not aware of the total situation. The
      attorney, who resided in another state never spoke with
      Mildred. The irrevocable trust was drawn up. She choose
      an irrevocable trust because she wanted her wishes
      fulfilled even if she became ill and unable to make sound
      judgments regarding her finances.         The salesperson
      assumed she would want her only son to be the designated

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      trustee. The attorney gave him full powers to use and
      distribute the assets as he saw fit. Although Mildred had
      informed the mother of her grandchildren that the children
      would have college funds no authority was given her in the
      trust. The trust never specified that the assets were to be
      used for college for the grandchildren; it merely stated
      that the assets were to be used for their general benefit.

        When Mildred died and her son realized that she had left
      nearly all her assets to children he seldom saw and did not
      feel close to he became angry and resolved that they
      would see little of the money. Since the trust made no
      specific parameters regarding his pay, her son paid himself
      handsomely and distributed funds in ways that benefited
      him more than the children. Although the children did
      receive modest benefits, they never received enough to
      fund college.

  Neither the salesman nor the attorney realized the situation they had
created. Both assumed they set up a trust that would accomplish
what Mildred desired. Had Mildred worked face-to-face with the
attorney her goals would probably have been reached. The attorney
would have learned that Mildred had already supported her adult son
most of his life, he would have learned that the children’s mother
seldom received help from the father of her children, and he would
have learned that Mildred valued education far more than the feelings
of her spoiled child. It is seldom possible to adequately address all
issues without talking directly with the attorney or other individual who
is drafting the trust document. Consumers are much less likely to
confide in a salesperson. Consumers are likely to fully disclose all
necessary information with a professional who must meet professional
privacy standards. It may not even have anything to do with whether
or not Mildred would have told the salesman everything. Salespeople
often do not know to ask all the questions that are necessary. The
person actually drafting the trust is much more likely to cover the
possibilities simply because he or she is experienced in such matters.

 Even though the children’s mother realized that Mildred’s intent was
not being followed there was little she could do. Neither she nor her
children were allowed to view the trust since it is a private document.
Her attorney advised her that it would be very difficult (perhaps
impossible) to break the trust since they could not force Mildred’s son

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to allow access to the document. Without the ability to read the trust
the attorney had no way to know if it could be broken.

   Some trusts are purposely not funded for a period of time,
             waiting for a specific event to occur.

  There is no specific trust format, although all trusts must follow any
laws pertaining to them. Some trusts are purposely not funded for a
period of time, waiting for a specific event to occur. Many trusts
remain nonfunded in error. Even if assets were partially transferred, it
is unlikely that the trust will protect them. In most cases, funding
must have been legally completed in order for the trust to activate.
Should a person die with a nonfunded trust, assets will be distributed
under the terms of the decedent’s will. If no will exists, the assets will
be distributed according to the laws of the domicile state. Some states
accept the assets as transferred if they are merely listed under the
trust, even though legal transfer was not completed. There are no
guarantees that partially transferred or listed assets will be considered
as trust assets, however. When assets are not completely and legally
transferred, the courts could decide that the creator had not
necessarily decided to put the assets into the trust. If someone
challenges the asset transfers it is especially likely that he or she
would win unless the assets had been legally put into the trust. Again,
the argument would be a simple one: if the creator had actually
intended to transfer the assets into a trust, he or she would have
properly and completely done so. The fact that the creator did not do
so indicates that he or she had not fully made that decision.

  Since any attorney may draft a trust, are all attorneys competent to
do so? There is some controversy regarding this. A trust is actually a
pretty simple document, but that does not mean that every attorney
has experience drafting them. A trust may be a single page or as big
as a novel. Length of the trust document seldom, if ever, indicates
quality. Trusts have been so disorganized that trustees have had to
hire expensive legal council to understand their rights of distribution or
trust directives. Obviously, any expenses of this type come from the
trust assets, which directly affects trust beneficiaries.

 Attorneys who are experienced in trusts realize          that simplicity is an
advantage for trustees. While some trusts may             warrant more detail
than others, even detailed trusts need not be             complicated. Well-
written trusts generally contain subtitles and            a summary of the

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contents so that trustees can quickly understand the trust content and
refer to it easily. While the trust is a legal document requiring legal
wordage that does not mean the language needs to be difficult to read
or understand. If the trust is difficult to read and comprehend it is a
reflection of the attorney’s lack of experience or his desire to appear
important to the trust grantor.

  Some trusts will be complicated due to complicated goals. Legal
language does not need to be complicated, although it must be
complete to achieve that which is intended by the grantor. Such trusts
will probably be irrevocable trusts rather than revocable. Seldom
would a revocable trust be used to accomplish complicated goals.

Trusts must cover not only circumstances that exist at the time
    of drafting, but also those that may develop over time.

  Trusts must cover not only circumstances that exist at the time of
drafting, but also those that may develop over time. This would
include such things as births, deaths, marriage, divorce, adoption, or
any number of other events. Depending upon the intent of the trust
document, it may even be expected to perform into the next
generation of beneficiaries.

  Most trusts are revocable. In fact, it is estimated that 90 percent of
the trusts written are revocable. Figures are difficult to come by since
only a few people may know the existence of these private documents.
Revocable trusts may be called by other names, including a “family
trust,” a “changeable trust,” an “inter vivos trust,” or a “grantor trust.”
All of these names signify that its creator can change the trust
document at any time for any reason.             Change would include
termination of the legal document.

 Why has the revocable trust become so prominent in recent years?
Many professional estate planners feel they are most often sold in
order to earn a fee for the trust drafter or salesperson. Others feel
their prominence is the result of people wanting to achieve unrealistic
goals. Whether or not either of those are true, it cannot be denied
that trusts can perform many worthwhile estate planning goals if they
are properly executed.




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Taxation
  Trusts may or may not prevent payment of taxes. In most cases,
taxes will be paid at some point, although the creator may be able to
transfer who pays them from one person to another. It is important
to realize that trusts have seldom been intended to prevent payment
of taxes. They have many worthwhile uses, but tax avoidance is
seldom one of them. The Internal Revenue Service employs many of
the best attorneys in the country. Why would anyone believe that IRS
attorneys would allow an individual to avoid taxation?

  Estate taxes come under federal law rather than state law, although
states may also tax an estate in some capacity. Estate taxes are
federal taxes on the values of property left behind by the deceased. A
revocable living trust allows the creator to use the assets within it so
all assets in such a trust are included in the values that will be taxed.
It is true that assets in a revocable living trust will not go through the
proceedings of probate, but all asset values will be included for the
purposes of probate (which includes estate taxation).

  Inheritance taxes are paid by the estate and are typically
considered to be state taxes rather than federal taxes. A few states
do not have inheritance taxes, but most do. Inheritance taxes will be
levied in any state where real property is located and taxes are
applicable. Therefore, if the deceased had legal residence in a state
that did not levy inheritance taxes but owned real property in a state
that did, that property would still be taxed by the state in which it was
located. The domicile state does not affect or prevent taxation by
other states. There are two types of property: real and personal.
Real property would include land and any items permanently
attached to it, such as buildings or crops. Personal property is
everything else, such as clothing, art, jewelry, furniture, and so forth.
The location of personal property will be taxed based upon its location,
with only a few exceptions.

       There are two types of property: real and personal.

Creditor Protection
 Creditors may make claims against a trust as well as a will. The
difference has to do with creditor knowledge. Since a will is public
whereas a trust is private creditors may not know a trust exists so
may not make claim to funds due them.


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  In many circumstances there is less protection from creditors with a
trust than would have existed under a will. Why? Because the will has
a specified time period during which creditors must file claims. Past
that point, no additional claims may be filed regardless of how valid
they may be. Under a trust, claims may continue to be filed for as
long as the trust is a valid document. Many trust creators do state a
trust termination date, which would also close claims against it (if no
trust exists, no claims may be filed). State laws may restrict time
periods for filing creditor claims against the trust, but usually the
periods stated are several years in length allowing much more time
than would a will. This is why many professions that constantly face
lawsuits, such as doctors, prefer the use of wills over trusts: they want
the closure of probate. If the professional has incorporated, the use of
a will may only apply to their business, allowing personal use of trusts.

Bankruptcy Protection
  Many attributes are given revocable living trusts that do not actually
exist. One of those are asset protection should bankruptcy be filed.
Since the trust is revocable, allowing its creator full use of all assets
within it, there is no protection from the procedures of bankruptcy. It
is important to also understand that bankruptcy is a federal procedure
rather than a state procedure. This means that rules are based on
federal law. Assets put into an irrevocable trust may be protected
from bankruptcy attachment, but only if all asset income and rights
have been terminated. If income exists, creditors may attach it
although the asset creating the income may have protection in some
circumstances. Most people do not want to give away their assets
during their life, so irrevocable trusts are used far less often than
revocable trusts. It cannot be stated too often: assets in a revocable
trust receive no special protection. They still belong to the trust
creator in every way.

Medicaid Qualification
  Medicaid is often referred to as Title 19 qualification. In the past it
was easier to qualify for Medicaid since merely moving assets to adult
children allowed qualification. As nursing home and other medical
costs have soared, states and the federal government are no longer
willing to absorb costs for those who could pay for their care
personally through use of their assets. Even moving assets into the
names of their children no longer means automatic Medicaid
qualification. There is a period of time called the “look-back period”
for Medicaid qualification. If any assets were transferred to another

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person or entity (such as a trust), that individual will be disqualified for
the period of time the asset would have covered their care. For
example, if Bernice transfers her beach home valued at $50,000 to her
son, Jerome, and the local nursing home charges $5,000 per month to
care for Bernice, she is not eligible for Medicaid benefits for 10 months
($50,000 divided by $5,000 = 10). This look-back period is currently
five years. It had previously been set at three years, but as the states
and federal government experienced increasing costs it was increased
to five years.

  An irrevocable trust would face the look-back period but a revocable
trust would not since the assets would still be available to the trust
creator. Assets in a revocable trust are considered to belong to the
trust creator since they are available for use.


Avoiding Probate Proceedings

  Trust assets do avoid probate proceedings. They do not avoid
probate valuation for taxation purposes when the trust creator retains
asset control. In other words, if the trust creator could use, sell, or
otherwise control any asset within the trust during his or her life then
that asset value is included in the probate proceedings. What may be
gained is quicker availability for the trust beneficiaries. Since the
assets do not need to go through the probate proceedings, assets are
made available to beneficiaries very quickly, unless assets turn out to
be difficult to value. In some cases, this can delay distribution even
from a trust. This would especially be true if a buyer must be found
for the asset before it can be split among beneficiaries. An asset that
is merely transferred to the beneficiary intact would not have a time
delay since selling it is not required. Some trusts may not require any
type of asset transfer since it continues to be the holding entity. Many
trusts live on even after their creator has died.

  If the trust creator could use, sell, or otherwise control any
   asset within the trust during his or her life then that asset
          value is included in the probate proceedings.

Estate Privacy
 Privacy is the reason many people prefer using trusts over wills.
Although it is possible to file a will outside of the resident’s county, it


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still remains a public document. Anyone who wants to take the time
to find out where a will has been filed can view its contents. Only
those who have a role in creating the document or overseeing,
dispersing, or receiving trust assets will know a trust exits. As a result
it is a very private document. Both a will and a trust may be legally
challenged, but since few people will be aware of the trust’s existence
it is less likely to face that possibility. Even if a person is aware a trust
exists he or she has no right to examine it making the trust very hard
to challenge.

Generation Skipping
  Revocable living trusts do not have to end when its creator dies. It
may continue on for many generations. Generation skipping is often
an overlooked benefit of the revocable trust. The creator is able to
skip his or her own children and leave assets to their grandchildren
instead. This may not be possible through a will since many states
have mandated inheritance laws. In other words, a state may require
that a minimum portion of an estate be awarded to each child as well
as a legally married spouse. A trust can hold assets for grandchildren
enabling the creator to bypass the legal requirements of a will. Each
state may differ on inheritance laws so it is important that a trust
creator use an attorney or other trust professional that is aware of
individual state laws.

  There may be taxation as a result of generation skipping. It is called
a generation-skipping transfer tax.      This tax applies to gifts or
bequests that skip a generation, so there can be many variables
regarding it. An example of a generation-skipping transfer is a gift of
property directly from a grandparent to a grandchild. This skips the
intervening generation, which prevents the IRS from collecting tax
they would otherwise receive. The generation-skipping transfer tax is
designed to impose the equivalent of the gift or estate tax the
intervening generation would have otherwise paid. On a direct gift
from a grandparent to a grandchild, the generation-skipping tax
generally represents the amount of tax that would have been owed if
the property has first been transferred to the child, who then died,
leaving the asset to the grandchild.

 While the estate tax has a progressive rate structure, the generation-
skipping transfer tax is imposed at the maximum estate and gift tax
rate. It would be payable in addition to any estate or gift tax
otherwise due. It is important to note that gifts to grandchildren that

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qualify for the annual gift tax exclusion are not subject to the
generation-skipping transfer tax. Payments of tuition and medical
expenses that are not gifts also are not taxed under the generation-
skipping transfer tax.    Fortunately for those wishing to skip a
generation, each person is also entitled to an aggregate exemption of
more than one million dollars from the tax for lifetime transfers and
transfers at death. Since married couples may split their gifts, each
transferring assets to grandchildren, the lifetime exemption is
effectively doubled.

              Important items like as wills and trusts
                 should be periodically reviewed.

  For the very wealthy who may be interested in transferring greater
amounts to their grandchildren, there are many ways to set up trusts
to avoid the generation-skipping tax. Anyone who established their
will and trusts prior to the passage of the 1986 Tax Act will want to
review them and make any necessary changes in order to avoid this
generation-skipping tax. Of course, such important items as wills and
trusts should be periodically reviewed with or without the possibility of
this tax.

Asset Management, Conservation, and Distribution
 Asset management, conservation, and distribution are a major
reason cited for trust use. A trust can do anything conceivable within
the law. All the trust requires are assets to fund it, someone wise
enough to draft the document effectively, and trustees who can carry
out the goals of the creator.

  Assets may be managed in any way desired by the trust creator.
They may be distributed or held within the trust for generations,
distributing only interest earnings. Any goal may be carried out by the
trust, regardless of whether or not it treats heirs or beneficiaries
equally. In fact, the trust has little concern for equality unless that is
a provision within it, which is why many people choose a trust.
Trustees may do only that which the trust document allows. The trust
may grant broad trustee powers or very limited trustee powers. It can
even prevent trustees from correcting obvious errors, which is why it
is so important that the document be properly drafted.

                 Both beneficiaries and property
               must be clearly identified in the trust.

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 Both beneficiaries and property must be clearly identified in the trust.
A charity that merely lists “the humane society” may leave trustees
with the power to distribute to a group far from the organization
actually desired by the creator. Stating a beneficiary as “my Aunt
Amy” may leave a trustee trying to figure out whether the creator
meant his Aunt Amanda in Pennsylvania or his Aunt Mandy in New
Jersey.

  Property should be identified by legal descriptions when possible. If
property contains such things as artwork or antiques, pictures should
be included to eliminate any doubt as to the piece intended. When
assets are not clearly identified it can hold up settlement of the estate.
From a legal standpoint, no trustee may distribute property that is not
clearly identified. Additionally, if there are multiple beneficiaries, there
may be family quarreling over which asset was intended for which
person.

             From a legal standpoint, no trustee may
         distribute property that is not clearly identified.

  Most trust professionals feel all trusts, even irrevocable trusts, should
have some provision within them for change (these are usually
referred to as amendable provisions). Inexperienced attorneys may
not realize the importance of this so they may not ask the creator if he
or she would like to do so. If the creator decides to make a change,
without an amendable clause, he or she may have to terminate an
existing document and draft an entirely new one. This, of course,
causes needless additional expense. Once the creator has died, it
should state whether trustees have the right to amend the trust
document and, if they do, the exact circumstances under which they
may do so. For example, the creator might give the trustee the right
to include any additional grandchildren that might be born after the
creation of the trust. It should never be a vague provision. Consider
the following:

      Myra Jones creates a trust and includes one of the
      following provisions:

      “I grant the trustee power to add any grandchild to my list
      of beneficiaries that may be born following my death.”


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      “I grant the trustee the power to add any grandchild to my
      list of beneficiaries that I have omitted from my trust
      document.”

      “I grant the trustee the power to add any grandchild that
      may have legal claim by right of blood to me as a
      beneficiary under this trust. The child may claim no more
      than his or her equally divided portion of all living
      grandchildren.”

  Following the death of the trust creator, Myra Jones, James comes
forth claiming to be a grandchild of the creator. This position is
claimed on the basis of marriage between his mother and the son of
the trust creator following her death. Although James is not a blood
relative, he is the grandchild by virtue of marriage. Would he have a
claim to part of the trust estate?

  Under the first statement James would be eliminated as a grandchild
if he were born prior to Myra’s death since her statement clearly says
the grandchild must be born after her death. It is likely that Myra was
thinking of an additional child born to one of her children, although she
might have wanted to include James had she considered the situation
when drafting the trust. James could challenge the trustee’s decision
to exclude him. In that case a court would make the final decision,
but they are likely to exclude James based on the wordage of the
clause.

  James would likely be included under the second statement since the
provision simply said “any grandchild that I have omitted” should be
included. This statement is much broader. Other beneficiaries may
argue that she intended only grandchildren by blood be included.
Even if Myra had openly stated this, however, the courts would
probably include James based on the statement that was made in the
trust document.

 The third trust provision is much more detailed. Here it states “any
grandchild that may have legal claim by right of blood to me” should
be included. Myra has specified that the grandchild must be a blood
relative of hers. She has also included the requirement of legal claim,
which would mean the child would have to prove blood relationship.
This, of course, would exclude James since he is related not by blood,
but by marriage.

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   Although any element of a trust can be legally challenged
                when the clause is very specific
        there is less chance of a successful challenge.

  In many ways, the more detailed the provision the easier the
trustee’s job is since it provides specific instructions of inclusion.
Under the broader clause, trustees may make judgment calls, which
might be challenged.       Of course, any decision made could be
challenged but when the clause is very specific there is little chance
that a challenge would be successful. The most important reason to
make a clear directive is so the creator’s wishes can be carried out in
the manner he or she desires. Without a clear statement it will be the
trustees who decide how assets are distributed or maintained.


In Conclusion

  Trusts have many valuable uses and are a significant estate-planning
tool. However, trusts cannot do everything. The agent that makes
such promises is either uneducated or wearing a “sue me” sign on his
forehead. Trusts are not necessarily appropriate for everyone or every
goal, although they are very versatile. Trust sales are not covered by
the agent’s E&O liability policy. Therefore, when agents market trust
documents they must be well trained and knowledgeable. Never
should an agent make an “educated guess.” A mistake may not be
realized until it is too late to correct it. Agents must always be aware
that they are personally and professionally responsible for their actions
and their errors and omissions liability policy will not cover non-
insurance errors/omissions. What does this mean? It means the
agent’s personal assets guarantee their actions and recommendations
when selling or promoting trusts.




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                              Chapter 5


                   Life Insurance


 Although many forms of insurance are used in the United States it is
the life insurance policy that typically creates the first asset in our
estates. Young families seldom have accumulated sufficient assets
outside of their life policies. Even if they are in the process of
purchasing their home, equity is usually low in the beginning.

  Life insurance products typically relate in some way to estate
planning. Many life insurance products are purchased for the wrong
reasons. They should always relate to actual need or performance.
While we say life contracts buy “peace of mind” the actual reason for
purchasing such insurance is financial security for the beneficiaries.
Most life insurance is purchased to protect a person or family against
loss of income due to the death of a wage earner. There are other
reasons for purchasing a life insurance policy, but the primary purpose
of life insurance is protection from the risk of income loss.

  A life insurance policy is a contract between the insurer and the
policyowner based on the risk of premature death. As such, life
insurance is pretty basic: for a guaranteed loss (the premiums paid)
an individual is protected from the potential larger financial loss
(future income earnings) resulting from premature death. The peril
being insured is the premature loss of the wage earner.

  Individuals and families did not always feel they needed to insure
against the peril of premature death. Large families and even friends
could be counted on to help if disaster struck, whether that was a barn
that burned down or a family who lost a wage earner. Grandparents
could be counted on to help raise children if the wife entered the work
place. Aunts and uncles might even take in children and raise them.
It was an informal understanding that families could count on.

 While we may still have the intent of helping friends and family we
know how impractical it is in today’s society. Grandparents are often
wage earners themselves and in no position to take care of their

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grandchildren. Families live all across the country and tend to be
highly mobile. Our families are also much smaller than they used to
be so there are less family members to lean on. As all of these factors
developed over the years, it became common to purchase life
insurance.


How Much Is Enough?

 The types and amounts of insurance an individual purchases are
usually based on several factors: marital status, types of beneficiaries,
and family financial stability. Other factors and specific circumstances
may also affect how the purchase of a policy is viewed.

                 The potential financial loss is the
                peril or risk that is insured against.

  There are two basic insurance terms no matter what type of policy
seems appropriate for the circumstances. The guaranteed systematic
loss is the premiums paid. Premiums are usually a guaranteed loss
with no means of their return. There are some policies, however, that
do return premiums if no claims are made and specific conditions are
met. The potential financial loss, which insurance protects against, is
the peril or risk that is insured against.

  There are many variations of life insurance, including mortgage
insurance and other types that relates to the death of the insured
person. Most life insurance products relate to security against an
unexpected loss of income. Even though a life insurance product may
generate a large lump sum settlement, it should never be considered a
financial windfall. The reason is obvious: it involves the death of the
insured person.

  The primary considerations at the point of policy purchase are
supplying financial needs for the immediate moment of death and for
the long-term practicalities of life. In other words, there must be
funds for burial, taxes, medical bills, or other immediate needs and
funds for the costs of raising children, paying the mortgage each
month, as well as property taxes, and meeting other day-to-day needs
of those still living. While views may vary, most professionals feel the
amount of the policy should at least meet the basic needs of the family


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members for ten years. There may be other considerations, such as
sending the remaining parent to college or technical school enabling
him or her to better their personal income. The family may also want
to factor in the cost of sending their children to college.

  Income consideration will depend greatly upon the source selected.
Some professionals believe all contingencies should be included in the
amount of life insurance purchased while others feel the goal is merely
to get the family on their feet and become self-supporting. Perhaps
the easiest way to decide how much insurance is necessary is to make
a list of current obligations and a list of expected future obligations.
These lists might include:

  Today’s Monthly Expenses                   Future Monthly Expenses
Item                 Cost                  Item                 Cost
Mortgage             $1,000                Mortgage             $1,000
Property Taxes          100                Property Taxes          100
Food                    500                Food                    750
Clothing                200                Clothing                300
Child Care                 0               Child Care              600
Utilities/Fuel          500                Utilities/Fuel          700
Medical Premiums       1200                Medical Premiums       1200
Auto Premiums             56               Auto Premiums             75
Auto Loan               300                Auto Loan               500
College Expenses           0               College Expenses       1000
Miscellaneous           500                Miscellaneous           500

  While it may not be possible to know exactly what future monthly
expenses will be, such lists will provide estimation for life insurance
purposes. Families who have utilized a monthly budget will find this
an easier process than those who have not. Once the monthly figure
is achieved it will have to be multiplied by 12 to get the yearly figure.
That figure will have to be multiplied by the number of years the
income will be needed. Most families are shocked by the resulting
figure, perhaps even questioning the correctness of the figure.

  It may not be necessary for the life insurance policy to provide all the
income.    Families may receive Social Security benefits, Veterans’
benefits or other types of income. Some incomes, such as Social
Security benefits have limitations. This should be factored in. If both



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spouses are already working, it may only be necessary to cover the
lost income if expenses are not expected to dramatically change.

              Some incomes, such as Social Security
                    benefits have limitations.

 If the surviving spouse has not been in the job market for several
years, it is important to be realistic as to his or her chances of finding
a job that pays a meaningful wage. If childcare would require the
majority of the income, would it even be worthwhile to take a job?
Perhaps funds for college or technical school would be a better choice.

  Some consumers may consider the cost of adequate life insurance
more than they are willing to pay, even for term. If this is the case, it
is important that they purchase an amount they can afford, try to cut
current expenses, and save more for future use. It might even be
wise to begin putting the spouse through school now so that he or she
is better equipped to handle the death of a major wage earner.

  Many agents have traditionally used a multiplication rule of current
income to establish life insurance needs. While this does simplify the
process, it is often inaccurate. Quadrupling or quintupling an annual
income may present a general figure, but it has no personal
characteristics of the people involved.

  Once the list of income is compared to expenses, the difference is the
figure that will be considered for life insurance purposes.        That
difference is called a “capital gap.” It should be assumed that more
would be needed than the capital gap reveals. In most cases, families
have more needs than they anticipated.

  It is common to name the spouse as the primary beneficiary and
children as the secondary beneficiary. If the children are under legal
age this is often a mistake. It may be better to list a trust as the
secondary and set up such a trust with detailed instructions with a
trusted and experienced trustee in charge. It may be best to pay a
professional trustee rather than leave the funds in the hands of a
friend or relative. It is impossible to know what future circumstances
may change the relationship with the person named as trustee.

      It may be best to pay a professional trustee rather
    than leave the funds in the hands of a friend or relative.

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  It is likely that individuals will continue to need life insurance even
after their children are older and their spouse more financially
independent. The life insurance will simply be needed for different
reasons.

 A life insurance policy is either written on the life of the policyowner
(one’s own life) or on another person that will not own the policy
(someone else’s life). In either case, it is important that a beneficiary
designation exist. Since life insurance has the ability to pass outside
of probate proceedings, not stating a beneficiary takes away one of the
major advantages they possess: avoiding probate delays. Even if the
policy is placed into an irrevocable trust, it is likely that the need to
state beneficiaries will continue to exist.

      Life insurance is necessary when a financial hardship
           would result from the death of an individual.

 Life insurance is not always necessary. Typically it is necessary when
a financial hardship would result from the death of an individual. In
this context, life insurance may not be necessary for single individuals
with no dependents, for nonworking spouses, for children, or for
retired persons currently living from the proceeds of past investments
and income. Of course, not all agree with this. For example, even if a
spouse does not produce income from a job, he or she may be
contributing to the family in other ways. Their death could mean the
surviving spouse would suddenly have additional expenses, such as
childcare. Therefore, each case must be individually considered.

  Statistically, few children die prematurely. If insurance is desired on
the life of a child, most professionals recommend no more than $5,000
to $15,000 in benefits (or enough to cover the expenses of burial).
Children do not typically produce income so that is seldom a
consideration. If a person wants to give something of a financial
nature to a child an annuity could be a better choice since it would
benefit the child in his or her life, rather than pay only at their death.
The cost of an annuity would seem higher since the individual would
have to put in either over time or all at once a significantly larger
amount than the premium of a life policy would be, but the financial
potential is much better.



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  The biggest decision relating to the purchase of a life insurance policy
is basic: how much is enough? Not everyone agrees on how to
arrive at this figure. Some suggest multiplying a set number of years
of potential income (five years, for example) by the amount that would
have been earned had he or she lived: five years multiplied by
$60,000, for example, would equal $300,000 in life insurance. A
straight formula such as this one would not take into account inflation
or wage increases. Nearly everyone agrees it is better to have too
much than not enough insurance. Therefore, if $300,000 is considered
a base figure, it might be wise to add an additional amount of
coverage to this. How much additional? This is typically an individual
choice based on individual needs (such as college tuition or medical
costs).

  Most life insurance proceeds are paid out in one lump sum upon the
insured’s death. This often leads to errors on the part of beneficiaries.
For example, the surviving spouse might be persuaded to pay for a
grandchild’s college education, leaving her with insufficient funds to
cover her life’s needs. Many professionals advocate life insurance
proceeds be paid out through installments, if available. If the life
insurance policy does not allow this option, it may be wise to take the
full lump sum payment and purchase an annuity. The annuity would
have multiple payout options available, including a guaranteed lifetime
income for the beneficiary if that is appropriate.

     Many professionals advocate life insurance proceeds be
    paid out through installments rather than in a lump sum.

  Since life insurance is designed to replace lost income, the age of the
survivors will impact how proceeds should be paid. If there is enough
life insurance to cover five years of income, for example, it might be
appropriate to receive five payments over five years or monthly
payments for a five-year period. While an annuity is not always the
best vehicle since the age of the beneficiary would impact payout, it is
a consideration for older beneficiaries. Younger consumers may want
to consider the payout options offered by the insurer prior to
committing to one company or another or prior to committing to one
particular product being offered.

 Even when beneficiaries receive large sums from the policy, many
errors are made by those receiving them. The lump sum settlement
can seem so vast that little consideration is given to the amount of

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time that it must last. Studies show that insurance money is often
gone in less than five years due to bad investments, expenditures that
would not otherwise have been made (new cars, furniture, and so
forth), persuasion by family and friends (that grandchild’s college
education), or simple lack of financial wisdom. If the surviving spouse
or other beneficiary has no reasonable way of earning their own
income, misuse of insurance proceeds has serious consequences.

             Estate planning is the use of procedures
                  that best suits those involved.

  Estate planning is never related to the products used. Rather estate
planning is the use of procedures that best suits those involved. This
may mean the use of a life insurance trust, proper payout of insurance
proceeds, or even utilization of a guardian. In all cases, however,
there must first be assets before there can be a trust or other plan. A
life insurance policy is often how the assets are created.


The Life Insurance Trust

 Life insurance trusts distribute funds provided by a life insurance
policy. While there may be variations, usually the insurance trust
creates a continual stream of income for the designated beneficiaries,
often a spouse and children. The goal is to ensure adequate income
over a specified period of time, such as five or ten years. Sometimes
the goal is to provide income for the beneficiary’s lifetime. Typically,
the income is distributed monthly, just as the insured’s earnings would
have been received.

  Life insurance trusts may have other goals besides replacing lost
income, including:
  1. Controlling from the grave how insurance proceeds are invested.
  2. Preventing one or more of the beneficiaries from acquiring the
     insurance proceeds in a lump sum, which might be a threat to
     future needs of day-to-day survival.
  3. Enabling the life insurance proceeds to flow into another trust,
     removing them from the estate for tax and probate purposes.




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 Trusts, including life insurance trusts, are always legal documents.
Therefore, it is necessary to designate a trustee or multiple trustees
(whichever is desired). Simply naming a person to be the trustee does
not guarantee that he or she will accept the position. As a result, it is
necessary to name an individual or institution that is actually able to
perform the task.

         Simply naming a person to be the trustee does
      not guarantee that he or she will accept the position.

  The beneficiaries of a trust are still the heirs even though a trust
exists. The trustees are required to perform their duties according to
the laws that exist and according to trust instructions, if possible. If
no trust instructions exist, then the trustees will perform their duties
following fiduciary requirements of the position and to the best of their
personal abilities.


Term or Cash Value?

  Unfortunately there are many who try to convince the public that life
insurance unfairly robs them. Life insurance is seldom an investment;
rather it is intended to financially protect others in the case of one’s
death. It is not the policies that rob the consumer, but rather poor
choices in the types of insurance bought. Whether to buy term or cash
value products depend upon several things, with no one specific policy
designed for everyone’s needs. Cash value policies are generally
called permanent insurance. Each type of policy has a value in
specific circumstances. There are several general rules used when
deciding which type to purchase, but like all general rules they may
not always apply to all situations.

  One general rule that we often see or hear is “Buy term and invest
the difference.” This makes sense when the buyer is young and new
in their career or just beginning their family. It makes the most sense
when the “difference” is actually invested rather than spent (which is
what typically happens). Especially at younger ages, term is much
less expensive than permanent insurance, supplying the same face
values. Even when the difference is spent rather than invested, at
younger ages term insurance may be the best choice since finances
are likely to be tight while need is great.


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  Another general rule is: buy term insurance for “term” needs and
cash value insurance for “permanent” needs. As is so often true of
general rules, there is validity to them, but their simplification may
lead to critical mistakes in estate and retirement planning. In this
case, it is doubtful that most people would have any idea what a term
or permanent need is. While it can be different from person to person,
usually “term” refers to a financial need that will end at some point
while a “permanent” need continues for a long period of time,
sometimes until death.

Term Insurance
  Term insurance covers the insured for a specified period of time, such
as ten or twenty years. As long as premiums are paid as required, the
insurance company will pay a benefit if the insured dies during that
time. The primary advantage of term insurance is its low cost. Term
insurance offers no other benefit, such as savings or investment
features. Its only function is to insure the life of the individual named
in the policy.

 There are both annually renewable term and level premium term
policies. In annually renewable term contracts, the policyowner
pays the premium and the policy remains in force. The benefit
(amount that would be paid at death) stays level but the cost of the
protection goes up every year.      Such policies are “age rated.”
Annually renewable term is the most common type purchased.

 Level premium term contracts cost more per year initially than
annually renewable term policies.        The premium stays level for
specified time periods, such as five, ten, fifteen, or even twenty years
or more.      While annually renewable products will use “current
premium” or “maximum guaranteed premium” in their policies, level
premium term contracts are locked into rates so they have no need for
such things. There may be physical exam requirements in order to
receive the steady premium. If the exam is failed (meaning the
applicant is not in prime health) the cost will be greater.

      Many term policies allow the policyholder to convert
    from term to cash value without evidence of insurability.

 Many term policies allow the policyholder to convert from term to
cash value without evidence of insurability, but this is not guaranteed

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in all policies. Having the ability to convert has great value since no
one can be sure how their health will be in ten or twenty years.

     For example:
       Jon purchased a term policy when his children were
     young. Now, at age 40, he has diabetes and related
     health conditions. Since his wife, Susan, has not worked
     for most of her life he knows that she would be unable to
     find meaningful employment. Jon’s term policy allows him
     to convert to a permanent policy. Because he is concerned
     that his term policy may not renew or be the best financial
     avenue he converts his policy (without evidence of
     insurability) to a permanent policy to protect Susan’s
     future needs.

  Jon was able to convert his policy, but it is important to note that
many term policies have specific time periods during which the
conversion must be made. Once this time period has passed it is no
longer possible to make the conversion.

 Term policies have many variances, including declining, decreasing,
or reducing coverage that diminishes the death benefit over time. A
common use of such declining values is to insure a house or
automobile, since the remaining mortgage or payment declines with
each payment that is made.        Term policies may also include a
disability waiver (for additional premium) that would automatically
make the payment of the premium if the policyowner becomes
disabled.

         If there is a conversion clause in the policy,
       a wise insured will investigate the possibility of
   converting to a permanent policy prior to the term’s end.

  Guaranteed level term policies guarantee a ten to thirty year lock in
on premiums. Over the period of time, these policies are almost
always less expensive than term policies that increase in cost each
year. Of course, it is doubtful that the insured will be able to renew
his or her policy at the same price when the guaranteed time period
ends. If there is a conversion clause in the policy, a wise insured will
investigate the possibility of converting to a permanent policy prior to
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classification it was purchased under. All policies are not the same so
it is always important to refer to the actual policy for details.

 Many state insurance regulators are concerned that 15-year fixed
premium policies are straining some insurance companies’ surpluses
and reserves. As a result, many state authorities are moving to
reduce the attractiveness of this product option.

 An annually renewable term policy that contains a conversion option
may still be a good choice for those who plan to convert their term
policy to a permanent life policy. Even though the premium will climb
yearly, if it is converted before the rates become too high it can allow
the policyowner to establish his or her finances under the lower rate
and then convert their policy when they can afford to do so.

  Most term policies are convertible, although some convert more
cheaply than others. Anytime health becomes an issue it is probably a
good idea to convert the term policy to a permanent policy. Obviously
someone who may die is likely to want to convert to permanent
coverage. Even when health is not an issue, however, an individual
may want to convert their term to permanent coverage. One reason
for doing so is strictly financial: if the insured realizes he or she has
need for life insurance past the 15- or 20-year term period, the cash
buildup and tax advantages from a cash value policy may be an
advantage while enabling the insured to keep the premium level.

                    Most term policies are convertible,
             although some convert more cheaply than others.

Cash Value Insurance
 Cash value insurance is initially more expensive than term but it
offers a wide variety of options, including savings, investment, and
payment options. It is more likely to be purchased by those who can
afford the higher premiums. Ernst & Young compare it to renting or
buying a home. Term insurance is analogous to renting a house, while
cash value is more like purchasing a house and having a monthly
mortgage.1

 Young families with limited incomes are likely to prefer term. Once
there is more discretionary income, cash value policies are often

1
    Protecting Your Family and Assets Through Life Insurance, Page 131

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preferred since the consumer feels it will return at least part of the
premium if the insured lives so his family does not collect the death
benefit.

  Those who have long-term life insurance needs may do better with a
permanent policy since, over time, the premiums might be less costly.
This depends upon the insured’s age, the type of policy purchased, and
other factors. A cash value policy usually requires at least 15 years to
develop enough after-tax cash surrender value to beat a buy-term-
and-invest-the-difference approach.      As a result, assuming the
difference was in fact invested rather than spent, those who will need
life insurance for less than 15 years may want to choose term
insurance while those who believe they will need life insurance for
more than 15 years may want to purchase cash value policies. Some
professionals use 20 years rather than 15 years for this equation, but
it often comes down to personal opinion.

  For long-term life insurance needs, whether one uses 15 or 20 years
as the marker, most professionals recommend permanent insurance
over term. The actual cost of the premiums will be no more with
permanent insurance over that time period and may actually be less.
When the surrender value is factored in, it is certainly less over long
periods of time. Considering that people often do not invest the
difference in premium, let alone invest it well, term proponents often
fail to meet their own declaration, having spent just as much in term
premiums and having no investment to show from the difference
saved in early premium years.

 Considering that people often do not invest the “difference,”
           nor invest it well when they try to save,
  term proponents often fail to meet their own declaration.

 There are three basic kinds of cash value policies:
        • Whole life;
        • Universal life; and
        • Variable life.

 Like annuities and IRA’s, cash value insurance policies grow on a tax-
deferred basis. The accrued value is not taxed until it is withdrawn.




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Whole Life Policies
  Whole life policies (also called ordinary life) are the traditional cash
value products that we often see. Their name comes from their
intention: to cover the insured for his or her whole life, with premiums
also being paid for his or her whole life. Whole life policies have both
advantages and disadvantages over term products. Advantages
include:
   1. There is a fixed premium for the life of the policy.
   2. There are automatic savings built into the program for the
      policyholder.
   3. The owner can borrow from the cash values.
   4. The cash values grow on a tax-deferred basis.
   5. Premiums can be paid from the accrued cash value or dividends
      within the policy.
   6. There is the option to convert cash value to an annuity upon
      retirement.

 The disadvantages include:
   1. Premiums are higher in the beginning years of the policy.
   2. A long-term commitment is necessary, reducing flexibility by
      locking the owner into continual premium payments.

 There are multiple whole life formats.         One of these is the
participating whole life policy where the insurer may pay dividends to
the policyholder. Dividends are not guaranteed, however. When
dividends are paid, there is no guarantee as to the amount that will be
received.

 Another whole life format is the interest-sensitive policy. These
contracts often look and work the same as the participating type. Any
returns paid above the guarantees are called excess credits.

              Any returns paid above the guarantees
                     are called excess credits.

With indeterminate premium whole life policies, there may be lower
premiums than with other kinds of whole life, but the insurance


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company retains the right to increase premiums up to a guaranteed
level stated in the policy. There are no dividends and no excess
credits available.

 Premiums in whole life policies may be structured in various ways.
Participating and nonparticipating policies often use level premiums.
Another method is the modified premium, in which the premium might
be a set amount for the first 15 years, but change in the 16th year to
as much as double the original amount. There may also be a graded
premium, one that would increase for a certain number of years.
Some whole life policies are paid up after ten or twenty years or by
age 65. At such points, the policy has contractually received the entire
premium needed to provide the insured with coverage.

Universal Life Policies
  Insurance companies respond to consumer trends. Insurers felt the
pressure of those advocating the purchase of term insurance for
example. In the 1970’s and 80’s insurers developed the universal life
insurance policy. This was partly due to the high interest rates of that
time as well as those who felt term presented a better option. This
policy was designed to provide insurance and invest within a single
financial vehicle. The policy shows the actual cost of the insurance,
the rate of interest credited to the cash value, and the amount of
expenses against the cash value.          Under whole life policies, the
consumer is not able to see any of these factors, which is a major
reason whole life policies often face criticism.

  Universal life policies are appreciated for their flexibility in
determining face amounts and premium payments.            Annual reports
keep policyowners up to date on present and projected insurance, cash
values, fees, and so forth. The flexibility of these policies allows
policyholders to determine their own premium within specified limits.
Obviously enough premiums must be paid to keep the policy active.
In fact, this is a disadvantage of universal life policies: policyowners
must keep a watchful eye on their policy to prevent its lapse should
insufficient premiums be paid. Additionally, paying a lower premium
will mean paying premiums longer, perhaps even longer than would
have been paid under a whole life policy.

Variable Life Policies
 Variable life contracts allow policyowners greater investment choices.
Unlike whole and universal life policies where the insurers manage the

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investments backing the policies, variable life contracts allow the
policyowner to invest in various combinations of stock, bond, and
money market funds. Investment choices are not limitless, however.
Investments must be made within the separate accounts available
through the insurer. Some companies use only their own funds while
others may have as many as ten or more separate outside funds to
choose from.

  Variable life insurance may be a form of variable whole life or
variable universal life. Many professionals prefer variable universal life
since they feel it allows flexibility while giving investment choice.
Many consumers require the ability to determine their own premium
through changing financial times. Therefore, variable universal life
meets their needs and allows investment flexibility as well. These
contracts allow people, within specified limits, to put more or less
premium into their policy in a given payment period. In addition, they
have a much higher degree of input over where their investment share
goes.

  As with all things, variable life insurance policies are not perfect.
Fees are higher than for other types of insurance because there is
more administrative complexity. Some say these policies allow those
who purchase them to make grave financial errors since they may
have unrealistic expectations for the investment portion of their
premium. While this type of life policy does have an investment
aspect, it certainly cannot be considered all that is necessary to
achieve a secure retirement. Additionally, some may underfund their
policy due to unrealistic investment expectations. There is seldom an
income guarantee. If the investments selected do not perform the
policyowner may have to pay more premiums than he or she expected
to. All of these elements must be considered.

   While variable life policies do have an investment aspect,
                it certainly cannot be considered
     all that is necessary to achieve a secure retirement.

  Variable whole life and variable universal life policies are more
complicated than other types of life contracts. Variable products
require more attention than non-variables do. If the policyowner is
not prepared to spend more time monitoring these policy investments,
he or she may be better off purchasing a more traditional life
insurance product.

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Endowment Life Policies
  Endowment insurance is not widely used anymore. The primary
characteristic of endowment insurance is that the contract pays the
face amount at the sooner of either the time of “endowment” (the
maturity date) or at the insured’s death if prior to the endowment
date. Endowment policies have long been considered a type of forced
savings, especially since the protection aspect of the policy is relatively
low. Pension plans often have variations of endowment plans within
them. Those in high tax brackets may still seek out endowment
policies since they can build up values on a tax deferred basis.

  Those in high tax brackets may still seek out endowment
policies since they can build up values on a tax deferred basis.

Survivorship Life Policies
  Also called, Joint-and-Survivor life insurance, survivorship contracts
are used to insure two or more people under a single policy. The
death benefit is not paid until the last of the two or more named
insureds have died. At that time, the full death benefit goes to the
named beneficiaries. There are many variations in survivorship policies
but most of the contracts use whole life products. They provide for an
increase in cash values upon the first death of the insured persons. If
the policy were a participating policy paying dividends, the dividends
would then also increase. Depending upon policy terms, the premiums
may continue until the survivor’s deaths. Some contracts may no
longer require premiums once the first person dies, since there may be
a policy option that pays up remaining premiums.

 As with other types of policies, there must be an insurable interest on
the individuals insured. This type of policy is typically used between
spouses, parents and their children, or related business owners.
Survivorship life insurance contracts are effective in easing federal
estate taxes on those who would be subject to such taxes and have
elected to take maximum advantage of the marital deduction, which
would have taxes due upon the survivor’s death.            There is no
requirement that all those insured be policyowners. The policy may be
owned by a single person while insuring several people.

Single Premium Whole Life Policies
 Single premium policies, as the name indicates, have only one
premium payment. The initial premium is paid up front with no further

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premiums required. Even though there is only a single payment
made, the policy still builds up cash values that may be borrowed on a
tax-free basis.    Face values would still be distributed to listed
beneficiaries upon the insured’s death.

 Single premium life policies may offer similar advantages seen in
whole life policies:
  1. Money contributed to the policy builds up tax free through policy
     cash values.
  2. Policy owners may borrow available policy cash on a tax-free
     basis, just as a loan would be from a bank. Many policies do not
     require that the loans be repaid, although that would reduce the
     settlement values available in the policy.
  3. The proceeds from the policy (the face value which is different
     than the cash surrender value) at the death of the insured would
     go to the beneficiaries’ income tax free.
  4. The policy’s settlement values would bypass the procedures of
     probate, although values would still be reportable during
     probate.

 Single Premium policies are often selected for their immediate cash
value. Individuals who have received large settlements from various
sources may desire this type of product to conserve the funds,
producing continuous income for a long period of time. Values may be
accessed through policy loans or even by surrendering the policy at
some point in time. Insurers are likely to have surrender penalties for
surrendering the policy prematurely, however, so it is important to
give suitable consideration to this policy feature.

        Values may be accessed through policy loans or
     even by surrendering the policy at some point in time.


Policy Options

  All life insurance policies are not created equal. Whether the policy
type is term or cash value or a combination of the two, there are some
options to consider, such as the nonforfeiture option. Insureds have



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certain legal rights when a policy is purchased. While the exact rights
will vary from state-to-state, the basics will be similar.

Nonforfeiture Options
 Nonforfeiture options guarantee the policyowner will have some
value at a given moment during their policy term. Any cash value
product must offer the consumer specific nonforfeiture options, which
may be taken as cash value and applied in certain ways.

 In a participating policy that pays dividends there are typically
several options for applying them:
  1. They may be taken in cash;
  2. They may be applied against future premiums that would
     otherwise be due;
  3. They may be used to purchase additional paid-up insurance
     within the same policy;
  4. They may be used to purchase term insurance.

 Paid up additions are small, single-premium policies that are bought
at net rates without commissions. They have their own cash value and
death benefits. Paid-up additions pay their own dividends.

Disability Waivers
 Some life insurance policies offer the option of adding a disability
waiver, which would continue paying the life insurance premiums if
the policyholder develops a qualified disability. Disability waivers are
not all the same so it is important to understand how the one being
considered works. In some policies the waiver is for the entire
premium while others simply waive the cost of insurance during the
disability period, enabling the policy to remain active even though
premiums are not being paid.

  Disability waivers are not all the same so it is important to
      understand how the one being considered works.

  The term “disability” may also vary among policies. Some require
the policyowner to be totally disabled, unable to perform any job,
while others may only define it as being unable to perform one’s usual
job.


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Cash Values
  Every life policy is based on the term policy even though cash
benefits may be involved. After all, the primary reason for a life
insurance policy is to pay a benefit should the insured die during the
contract term. That is what a term life policy does. Every policy
provides a death benefit in exchange for premiums, and every policy
must cover the insurer’s administrative expenses.

  Despite what many would have us believe, people need life insurance
for a variety of reasons. Whether one decides on term or permanent
is merely a side issue, although making that decision can affect the
total cost over the term of a policy, whether there is money set aside,
or whether one’s family is adequately cared for.

  Those with high incomes often find permanent life insurance vehicles
helpful. They are able to use cash-value vehicle to provide survivor
protection while utilizing the cash value portion for tax-deferred
income earnings. He or she may be able to take out the cash value in
various tax-free ways at retirement.

  For those who really will “invest the difference” it may be best to buy
term insurance even though rates increase each year. The discipline
required to consistently invest the premium savings has traditionally
been the problem for most people. They may invest initially but fail to
continue doing so on a regular basis. Many professionals recommend
that individuals who are against purchasing permanent insurance
consider buying term and setting up an automated payment program
for investing.   In this way, both protection and investment is
guaranteed.


Insuring the Life of a Child

  Buying life insurance for a child has traditionally been discouraged by
professionals and for valid reasons. Statistically, the child’s parents
are far more likely to die than is the child. If there are limited funds it
makes sense to place those premium dollars where it will be most
beneficial – on the wage earners. That doesn’t mean that children
should never be insured. There are situations that may warrant it.
For the majority of children, however, most agents feel life insurance
is not likely to be a financial need.

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      A policy taken out in childhood may end up allowing
         coverage as an adult when a medical condition
              would not have otherwise allowed it.

  As we know, professionals often hold different opinions, even when
viewing the same set of facts. Some agents do take a different view
on insuring the life of a child. Life insurance on children can lay the
groundwork for insurance as an adult. While most of us expect to
remain healthy into old age that doesn’t always happen. A policy
taken out in childhood may end up allowing coverage as an adult when
a medical condition would not have otherwise allowed it. Most child
policies have conversion rights to larger amounts of coverage at
specified ages. Therefore, if a policy is taken out on a child, it may be
important to view future conversion rights.

  If an individual is considering insuring a child, however, it must be
stressed that this should only take place if the child’s parents are
already adequately covered. Never should premium dollars be diverted
to other policies until there is adequate protection for the family.

  Never should premium dollars be diverted to other policies
      until there is adequate protection for the family.


The Agent’s Role

  Agents are often made to feel that his or her role in the decision to
purchase a life insurance product is somehow unethical or cloaked in
self-interest. How unfortunate this is. Without the services of a life
insurance agent, many families would go unprotected or under-
protected. Too often it is the appearance of an agent at someone’s
door that prompts him or her to take this necessary step to protect
those they love. The role of the insurance agent should never be
minimized or overlooked. Unfortunately, not all who call themselves
an agent are professional. It is important that agents understand their
profession; it should not be taken lightly since incorrect or misleading
advice is not only detrimental to the image but to the consumer as
well. A misplaced policy robs the consumer not only of their dollars,
but more importantly the protection they thought they had.



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  The public is increasingly moving to the Internet for their insurance
needs. Needless to say, this is not good news for agents. Consumers
do not always understand the products they are buying and may make
errors that will greatly impact them at retirement or when their estate
is settled. A professional agent is worth their commission considering
the number of consumer mistakes they prevent.

 There are a growing number of individuals who charge a fee (not a
commission) to research the products available and make informed
suggestions. Buyers pay a fee for the time and effort required to
research products for the consumer. Whether or not the individual
actually buys any product is not a concern of the researcher.

 Some types of insurance may be more easily purchased without an
agent than others. In the life insurance field, the majority of policies
are still sold through an agent. Few consumers feel confident enough
of their knowledge and skills to complete a purchase. Additionally,
most life contracts require an initial medical evaluation that must be
set up and followed up. Agents still seem the most practical way to
handle the life application and complete follow-up services.

  Life insurance agents provide a valuable and worthwhile service.
While it may be possible to go online and decide for oneself how much
insurance is necessary, consumers often do not consider the full
picture. Agents provide the guidance necessary to purchase correct
amounts and correct types of products. As such, the professional
agent earns every commission they receive.




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                               Chapter 6


                          Annuities


  An annuity is a contract between the annuity owner and the
insurance company.      The insured is called the annuitant.       The
annuitant (the investor) invests in the contract by paying in a sum of
money either in one lump payment or through a series of payments.
At some point, often retirement, the insured begins to withdraw the
principal deposited and the interest earned. Interest earned in an
annuity accumulates on a tax-deferred basis, meaning no tax is due on
the interest earnings until they are withdrawn from the contract.
When money is withdrawn, the IRS considers the first money out to be
interest rather than principal. Therefore, there will be taxes due on
the interest earnings withdrawn.


Retirement Risks

 We know there are many risks associated with retirement:
        •   How long will I live?
        •   How long will my spouse live?
        •   Have I saved enough money to live on after I retire?
        •   Have I planned adequately for special needs, such as
            prolonged care in a nursing home?
        •   What costs might develop in retirement that I may not
            have considered prior to retirement?
        •   What will it cost to live at the same standard in ten, twenty
            or thirty years (inflation)?
        •   Will the annuity that is paying five percent today be far
            below the rates paid in the future (investment risk)?

 There are ways to estimate some of the previous factors, but there is
no way to know for certain what elements may affect our retirement
years. It is possible, for example, to estimate how long an individual

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will live by considering current statistics and family history. If most
family members lived past eighty years old, it is likely that others in
the family will do so as well. Therefore, family members can plan
based on that lifespan but with the realization that he or she may die
sooner or live much longer.

  Statistically, about 11 percent of men and 7 percent of women who
live to age 65 will die prior to their 70th birthday, but 6 percent of men
and 14 percent of women will make it to their 95th birthday. Everyone
else will fall between those two extremes.

  The longer an individual lives the more money will be needed over
the span of retirement. Certainly, it is better to save too much than
too little and it would be safe to say most of us would prefer to be the
individuals that live to age 95 and beyond. Even modest increases in
living costs can erode the ability to live at the same standard of living
throughout retirement. While many individuals probably continue
working for other reasons, at least some of those who do so must
work because they did not adequately save. If costs rise by only 3
percent per year, it will mean that $100 today will be worth only $74
in ten years. After 25 years the same $100 would be worth only $45 –
less than half the same value. Obviously a fixed income, such as a
pension or annuity, cannot adequately fund the costs of living when
inflation erodes their value to this extent.

        While many individuals probably continue working
       for other reasons, at least some of those who do so
        must work because they did not adequately save.

  Social Security income will protect against inflation to some extent
since it offers costs-of-living increases, but seldom are they adequate
say the recipients. Since most retirees do not want the volatility of
stocks or other risk investments, what are their options? Perhaps the
best option is the most basic: save as much money as possible for
retirement.


A Payment of Money

 Annuity means “a payment of money,” which is an adequate
description. Insurers designed annuities to function in the same way a


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pension fund would: a vehicle to distribute funds in a periodic manner.
Initially annuities were thought of as a distribution vehicle but today
they are more often used as an accumulation vehicle, since people
often do not ever annuitize (withdraw the funds on a contractual
basis).

  Depending upon the source quoted there are either two or three
types of annuities: immediate and deferred or immediate,
deferred, and accumulation.
        •   Immediate: an individual deposits a lump sum of money
            into the annuity and then immediately begins withdrawing
            income, usually on a monthly basis. There are variations
            on the withdrawal provisions with the policyowner
            selecting the type of withdrawals based upon their needs
            or desires.
        •   Deferred: an individual deposits one deposit, but
            payments are postponed for some future date. The actual
            date does not have to be stated and many of these
            annuities are never annuitized at all. Upon the annuitant’s
            death the funds will pass on to the listed beneficiaries.
        •   Accumulation: An individual pays into the annuity
            account on a systematic basis over a period of years. At
            some point it is assumed that withdrawals will begin (after
            age 59 ½ to avoid IRS penalties).         The shift from
            accumulation to monthly payout is called annuitization.
            During accumulation, periodic withdrawals may be made,
            subject to the terms of the contract. Usually, up to 10
            percent is allowed without insurer penalties, although
            younger policy owners would be subject to IRS penalties.

  Annuities provide two elements that are favorable to long-term
investing for those who are risk adverse: (1) deferred taxation and (2)
growth without undue risk.

              The Single Pay Deferred Fixed Annuity
                   is the oldest type of annuity.

 The oldest type of annuity is the Single Pay Deferred Fixed Annuity.
The owner deposits a lump sum into the annuity (most insurers
require at least $5,000) but does not immediately begin withdrawing.

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The contract owner may add to the initial deposit prior to the start of
annuitization. Once annuitized, deposits are no longer allowed.

 The annuity payout rate rises based on the insured’s mortality risk
and the rate of return that the annuity contract earns on the invested
assets. As a result, younger individuals earn more because there is
more time allowed for growth.


Annuity History

  Annuities are sometimes called “reverse life insurance” since the goal
is to provide lifetime income for the insured while he or she is still
living rather than provide income to beneficiaries upon their death.
Some types of annuities do not have accumulation periods, such as
the single premium immediate annuity, but they were designed with
accumulation and then payout in mind. Annuity business for insurers
was a small share of the market until the Great Depression. According
to the Temporary National Economic Commission (TNEC), from 1866
to 1920, annuity premiums averaged only 1.5 percent of life insurance
premiums. The Great Depression and the financial panic that followed
led many investors to seek reliable investment vehicles for their
savings. The long, stable history of annuities was the answer to their
long-term savings goals. As a result annuities experienced tremendous
growth in the 1930’s, with the majority occurring between 1933 and
1937. From 1934 to 1936 the premium income on newly issued
individual annuities exceeded that of newly issued ordinary life
insurance policies for the 26 companies TNEC studied. Small investors
were able to receive higher earnings in annuities, compared to other
options that were difficult for small investors to navigate. Even the
severe surrender penalties that existed at that time for those who did
not allow their annuities to mature did not prevent the rapid expansion
of the deferred annuity market in the 1930’s.

      The annuity business for insurers was a small share
           of the market until the Great Depression.

 Annuity sales continued throughout the postwar period. Individual
annuity sales increased almost every year. Eventually, their popularity
declined, but resurfaced in the 1960’s, with much of the renewed
growth continuing from the 1970’s through today.


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  The Gallup poll in 1996 asked some questions specific to annuity
products. Data shows the owners of nonqualified annuity products
have an average age of 64. Half of these policyholders were retired.
Less than one-quarter was under the age of 54. More than 80% of the
annuity owners had annual incomes of less than $75,000 per year.
The majority of those owning annuities said they planned to use them
for retirement income at some point.

             Data from 1996 shows the owners of
   nonqualified annuity products have an average age of 64.

 The poll also saw increased knowledge regarding annuity products.
While individuals reported a variety of reasons for owning an annuity,
about three-quarters of the insureds knew the tax laws regarding them
and reported this as being a major consideration.            Safety and
reliability were a major reason for buying an annuity. More than half
of the owners indicated that the long-term aspect of annuities was also
important to their decision in purchasing it. Nearly half of the annuity
owners said they bought their annuities with a one-time income event,
such as an inheritance.

 Metropolitan Life Insurance Company pioneered the group annuity
market in the early 1920’s. It was linked to corporate defined benefit
pension plans. Most early corporate pensions were financed on a pay-
as-you-go basis.     Usually employers made deposits from current
earnings. In 1921 Metropolitan began to write small contracts to
manage corporate pension programs, with contributions being
collected from their current workers, towards the goal of paying out
benefits once they retired. In 1925 Metropolitan introduced its own
retirement pension program and began to actively market group
annuity contracts in 1927 for use as structured pension plans. Only 30
contracts were sold that first year, covering less than 40,000 people.

 Annuities suffered low investment returns leading to losses on
annuity contracts in the early 1930’s in both the group and individual
markets. This, coupled with the passage of the Social Security Act of
1935 (promising workers a minimal retirement benefit) led to loss of
annuity popularity. By 1941, only 269,101 people were covered by
group policies with Metropolitan Life Insurance Company.



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  The typical policy during this time required employers and employees
to contribute during the employee’s active work service. Employees
could begin receiving income at age 65, with some provisions for
retirement at other ages. Once retired, the employee could choose
between a lump-sum payment of his total contributions, or a “paid-up
option” in which a life or joint life annuity was purchased. Employer
contributions were generally applied to purchase an annuity. The goal
of most group annuity plans was to provide an income in retirement,
in addition to that supplied by Social Security.

      The goal of most group annuity plans was to provide
     an income in retirement in addition to Social Security.

  Group annuity sales grew rapidly in the late 1940’s through the
1950’s as retirement plans were often used to attract and keep key
employees. In 1958, 3.9 million workers were covered in some type
of group annuity plan. This number grew to 38 million by 1988 and to
nearly 45 million by 1993. At one time most group annuity plans were
associated with defined benefit pension plans, though not all defined
benefit pension plans used annuities. Today annuities are more likely
to be used in conjunction with defined contribution plans, as defined
benefit plans become increasingly expensive to maintain.

  Group annuities have variations in form. The first type to achieve
popularity was the deferred group annuity contract. The employer
purchased the contract and made periodic payments to the issuing
insurer. These were applied to the purchase of deferred annuities for
the covered workers.     The purchase price was specified by the
employer’s contract with the insurance company, so the insurer
indemnified the employer against changes in rates of return, mortality
risk, and other factors that might alter pricing. These could be
structured so that the employer received a dividend from the
insurance company if mortality experience or investment returns
proved more favorable than the initial contract anticipated.     The
employer would not pay more, however, if supplying deferred annuity
contracts turned out to be more expensive than the insurer had
thought. This type of contract covered 71 percent of the workers with
group annuity contracts in 1950 but declined to only 48 percent a
decade later.

 Employees were given a sense of security in knowing they would
have a certain pension income that was guaranteed by the insurance

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company that wrote the policy. Companies knew they had met their
future pension obligations in full. Since some workers would not stay
with the company long enough to collect a pension, fully-funded
deferred group annuity contracts required employers to set aside funds
for future pension liabilities that may not immediately materialize.
These contracts gave employers little flexibility in choosing the funding
level for their pensions.

 The deposit administration contract was the second type of group
annuity contract. It grew in popularity during the 1950’s. This offered
more flexibility in the timing of employer contributions and offered a
more direct link between employer cost and the mortality or turnover
experience of employees, when compared to the deferred group
annuity contract.     The insurer held contributions to the deposit
administration plan in an unallocated fund. The insurer promised a
minimum return on the fund. When an employee retired, the insurer
would withdraw an amount sufficient to purchase an immediate fixed
annuity for the amount of the retiree’s assured retirement benefit from
the fund account. The insurer did not indemnify the employer against
changes in the price of fixed annuities. The insurer bore all the risk of
mortality and rate-of-return fluctuations for retired employees; the
employer bore the risk for employees who had not yet reached
retirement. Deposit administration plans expanded rapidly in the
1950’s from covering only around 10 percent of all workers in insured
pensions plans in 1950 to covering 31 percent by 1959.

The third type of group annuity contract, first offered in 1950, became
the most popular. It was the immediate participation guarantee
(IPG) contract. This was a variant of the deposit administration
contract, with a fund account maintained by the insurer, but with more
direct links between the mortality experience of covered employees,
returns on investment, and the pension costs of the employer. Under
an IPG, if the employer maintains a fund account balance large enough
to fund the guaranteed annuities for all retirees, the employer’s
account is credited with the actual investment experience of the
insurer, and the actual payments to retirees are withdrawn from this
account.     Therefore, the employer is essentially self-insuring the
mortality experience of retirees and receiving actual rather than
projected investment returns. If the employer’s fund balance drops
below the amount needed to fund the guaranteed annuities, however,
the plan becomes a standard deferred annuity contract. The insurer
uses the account balance to purchase guaranteed individual annuities

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for all participants in the pension plan. As long as the account balance
is high enough, the employer bears the investment and mortality risks
associated with the plan. If the account balance falls below the
necessary levels, then the insurer assumes the risks.

Do Annuities Make Sense?

  There are those who believe in using annuities at all times and those
who would seldom use an annuity. Neither is totally right, nor totally
wrong. The popularity of annuities fluctuates with current financial
climates. When the stock market is performing well, annuities lose
favor but when the stock market is poor, annuities suddenly become a
great financial vehicle. Annuities haven’t changed much over the
years. Annuity products have changed but the way they function
remains basically the same: an individual deposits money and at some
point, begins to withdraw the funds plus the interest earned.

    The way annuities function remains basically the same:
       an individual deposits money and at some point,
         begins to withdraw the funds plus interest.

 There are many reasons why a person considers the use of an
annuity. The security they offer is a widely stated reason, but the tax
status is also considered.    There are two basic tax elements to
annuities:
   1. Tax qualification. The majority of annuities are not tax-
      qualified, although they may be under the right circumstances.
   2. Tax deferred compounding.              Annuities compound tax-
      deferred, which is not the same as tax-free. At some point taxes
      will be paid on the interest earnings.

  If a person has the option of depositing into a tax qualified vehicle it
would certainly make sense to do so, but when no such vehicle is
available, annuities are a good second choice. Since annuities are
designed to be a long-term savings vehicle in most cases (there are
immediate annuities that pay immediately) only top rated insurance
companies should be used. Of course, this is probably true for most
insurance products, but especially when payout will not occur for
twenty or thirty years it is important that the insurer last as long as
the policyowner.


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 Although insurance companies back annuities the annuity itself does
not contain any life insurance benefits. There are products that do
combine the two aspects, but the annuity itself does not contain any
death benefits. An annuity is designed to store principal, and then pay
out benefits at some point.

  Deferred annuities could be considered as having an insurance aspect
in that guaranteed regular monthly income exists for as long as one
lives, if that payout option is selected upon annuitization. However,
this is not really due to life insurance, but rather a structured payout
formula based on such things as age, duration of distribution, and the
amount of money in the annuity.

  In many ways, annuities are like bank loans. A bank deals in credit.
It lends money because the bank expects to be paid back with interest
over a set period of time. When a consumer deposits money into an
insurer’s annuity, he or she expects to receive that money back plus
interest.

       Because insurers must invest in long-term vehicles
             annuities have early withdrawal fees.

  An insurer expects to use the money deposited in long-term
investments that will pay them more than the interest they are paying
the annuitant. It is due to this long-term investing that annuities have
early withdrawal fees. Insurers could not earn adequately if their
investors continually withdrew their funds.

 Annuity deposits are made in either a lump sum, called a single
premium annuity, a series of fixed installments, called a fixed premium
annuity, or by a series of installments of varying sizes, called a
variable premium annuity. These deposits may be either tax qualified
or non-tax qualified, depending upon the vehicle used. If an annuity is
used to fund an Individual Retirement Account (IRA), it will be tax
qualified. If the annuity merely receives deposits as an ordinary
annuity, then it would not be tax qualified. Tax qualified vehicles
receive greater tax benefits than would non-tax qualified.

  Whether the annuity is tax qualified or not, the accumulating interest
is tax-deferred. This means that it is not taxed until withdrawn. The
hope is that the annuitant will withdraw in some method that

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minimizes their taxation on their earnings.        Statistically, most
annuities are never annuitized, so the earnings remain untouched.

  Like most financial products, not all annuities are created equally;
some are better than others.        Since an annuity is designed to
financially protect the policyowner from out-living their assets, due
diligence is essential when choosing an insurer from which to purchase
the annuity. Obviously, a company that is not financially stable would
be a bad choice. Even though most people do not annuitize, the intent
is often to have a lifetime income available. The annuitant does not
have to select a lifetime income, since there are other payout options,
but that is what the annuity was designed for.

           Annuities are designed to financially protect
           the policyowner from out-living their assets.

  Annuities generally have a minimum guaranteed interest rate.
Annuities may pay higher than this guaranteed rate, but never less.
The guaranteed rate prevents the interest earned from ever dropping
below that specified point. With the low interest rates in recent years
those who invested in annuities have come out ahead of many other
types of investments. However, industry professionals believe we will
see current annuities issued with lower guaranteed rates as a result.
While there are multiple types of annuities, most have a 100 percent
guarantee of principal and an ongoing guarantee of all accumulations.

Commission Surrender Periods
  Annuities carry surrender periods. Although annuities vary, it is
common for the surrender period to be nine or ten years. The agent
will also surrender his or her commission if the annuitant terminates
the annuity within a specified time period. In some contracts, agents
will also forfeit their commission if the annuitant dies within a specified
period, often within the first contract year or on a graduated basis for
the first three to five years. Even premature annuitization, which is
allowed under the annuity without penalty, may cause the agent to
lose part or all of their commission.




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An Estate and Retirement Planning Tool

  Annuities are used for many financial goals. They are often used for
retirement and estate planning, although they may also be beneficial
for other reasons. Annuities are often used for corporate partner
buyouts, for example, and deferred compensation.

 Annuities may be constructed as a form of income that cannot be
outlived.    Choosing the lifetime income distribution option often
benefits those who have a family history of long lives. While the
monthly amount may be less, the duration of collection can far exceed
what was deposited or earned. When annuities have been established
that will secure lifetime income, other assets may be freed up for other
goals, such as charitable donations or family gifts. When other assets
would bring taxation, donating them during one’s life may be a tax
benefit for the estate.

Choosing the lifetime income distribution option often benefits
        those who have a family history of long lives.

  During the last twenty years insurance agents are not the only ones
who have sold annuities. Today many others sell annuities, including
banks, savings-and-loan institutions, stockbrokers, accountants, and
even attorneys. Anyone selling annuities must carry an insurance
license and meet all state requirements.

  Annuities have proven a stable investment. While it is true that they
are not going to experience sudden growth, as stocks might, they also
will not experience sudden loss. Annuities are a steady-growth vehicle
with all the guarantees offered by insurance companies, which are
seldom available in other financial vehicles. Since the interest grows
tax-deferred they also allow taxation to be delayed until some point in
the future – when funds are withdrawn.

       Annuities are a steady-growth vehicle with all the
          guarantees offered by the insurer that are
         seldom available in other financial vehicles.

 In the early 1920’s the United States government even began using
annuities to fund government retirement plans. Labor unions followed
their lead funding union retirement plans through annuities. Due to


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the requirements the government mandated, the insurance industry
established two safety features:
   1. A guaranteed minimum interest rate built into the annuity
      contract, and
   2. The reinsurance network to ensure safety.

 At this time insurance company reserves were introduced. From this
point on the legal reserves system has required insurers to keep
enough surpluses on hand to cover all cash values and annuity values
that may come due at any given time. It is the reserves that enable
the minimum interest rate guarantees to exist.

  The reinsurance network was designed to keep the industry solvent
should there be a run on cash values in contracts, including annuities.
No individual insurer would be required to take the brunt of the loss
since the companies spread the risk out among all insurers offering
similar products. In addition, when a state’s insurance commissioner
steps in to prevent an insurer’s financial collapse, he or she freezes the
operations. Those who are already receiving income from annuities
will continue to receive them, but anyone who has not annuitized will
not be able to access their cash values until the state’s insurance
commissioner releases them.          Hardship withdrawals are usually
possible, but the hardship must be proven and approved.

 Although insurance companies can experience financial difficulties the
reasons are not necessarily the same as those affecting banks or
savings-and-loan associations. When the great depression caused
9,000 banks to close their doors, insurers continued to operate. They
did experience vast numbers of policy lapses, as their policyholders
were unable to pay premiums, but insurance companies were able to
continue operating. Insurers also had large numbers of policyholders
withdraw their cash values, but because they had enough cash on
hand they were able to handle it.


Annuity Facts

  Annuities have existed for a long time. Over the years, they have
experienced many changes. From 1973 to 1978 the most popular
type of annuity carried a permanent seven percent surrender charge.
This charge never disappeared. Only annuitization bypassed it.

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  From 1973 to 1978 the most popular type of annuity carried
        a permanent seven percent surrender charge.

  Competition is often the consumer’s best friend. Although there has
been valuable state legislation, some of the most favorable changes in
financial vehicles are due to competition. A few companies began to
add consumer-favorable features, such as bailout options and limited
surrender penalties. Bail-out options allowed policyholders to withdraw
their money without penalty charges if the interest rate on their
annuity fell below the initial rate at application (usually within specific
time periods). This brought about a new generation of consumer
friendly products.

  During the 1980s the New York Stock Exchange member firms began
to aggressively market bailout annuities.      As interest rates hit
unexpectedly high figures, insurance companies quickly had to become
superb asset managers rather than just good risk managers in order to
continue competing in the marketplace. The record high interest rates
fueled uncontrolled growth, which caused the insurance companies
significant financial setbacks. Companies that had been considered
strong, even by most rating companies, suffered severe losses. Some
insurers were forced by financial conditions to sell their blocks of
annuity business to other insurers. Even in these harsh financial
conditions, however, the insurers did not need or seek financial
assistance from the government as the savings and loan institutions
did.

  The 1990s saw the introduction of indices and two-tiered rates. The
index rate annuity is a fixed annuity whose renewal rate fluctuates
during the surrender charge period based upon some independent
market indicators. It might be treasury bills or any variety of bond
indices. This type of indexing is designed to protect the consumer in a
low interest rate environment. These products do not tend to have
bailout options since they are designed to accurately reflect the
changing financial climate as it occurs. It would appear that the
insurers learned from their previous mistakes.

  Two-tiered annuities were designed to reward consumers that did
not surrender their contracts prematurely by offering a higher first tier
interest rate. If the policy were surrendered or transferred to another
carrier, a lower interest rate (the second tier) was retroactively

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applied. Although it is not called a surrender charge, the two-tiered
annuity has effectively activated a second and permanent surrender
charge in the form of the lower second tier interest rate. These
products did not do well. Perhaps the buying public wanted more
freedom to surrender or move their contracts.

   Two-tiered annuities were designed to reward consumers
      that did not surrender their contracts prematurely
          by offering a higher first tier interest rate.

  After insurance companies experienced problems in the 1980’s the
buying public seemed to be wary of purchasing annuities. Sales
dropped dramatically. As a result, insurers looked for new ways of
attracting policyholders. Surrender periods were reduced, bailout
provisions improved and there was a move towards multiple year rate
guarantees, often between three and five years. Many of the new
annuity products were specifically designed to complete with
Certificates of Deposit. At this time banks and savings and loan
institutions also began marketing annuities.


Tax-Deferred Status

  While tax deferral is not the same as tax free, it does still benefit the
investor. Under tax deferral status taxes will be paid when funds are
withdrawn. Even though annuities are not tax-free (unless they are
qualified accounts) delaying taxation benefits the investor. It allows
more of their money to earn interest, with interest earning interest as
time progresses. Financial instruments that are taxed yearly have less
accumulation ability because some portion is withdrawn for payment of
taxes. No, the money is not literally pulled from the account to pay
taxes, but taxes are paid from the income of the individual in some
way.

            Under tax deferral status taxes will be paid
                   when funds are withdrawn.

  When a financial instrument is not tax deferred it is easy to lose sight
of the loss to taxation. Since the money is not specifically withdrawn
for taxes (they are paid at year’s end through federal taxation forms in



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combination with all other pluses and minuses that exist at that time)
it is easy for investors to overlook the impact that yearly taxation has.

 The average annuity buyer is over the age of 60, which is past the
IRS penalty age of 59 ½ for withdrawal purposes. Since growth
requires adequate time, it is likely that these depositors are not
concerned with vehicle duration or even taxation. It could be assumed
that these depositors are moving into annuities for their ability to
distribute funds during their retirement.

“Time Is Money.”
  The average investor is seeking security rather than risk. While
there are those investors who have a high-risk tolerance the majority
of consumers still state that security is a high concern. It is not
possible to have low risk and high return in the same financial vehicle.
Lower risk means lower returns.        Since annuities have minimal
guarantees they are considered a secure safe way to accumulate
funds. When returns are relatively safe, as they are in annuities, time
is necessary for adequate growth.

      While there are those investors who have a high-risk
       tolerance the majority of consumers still state that
                   security is a high concern.

 Compounding power is the ability to create growth over time by
earning interest upon interest. Inflation and interest earnings work
exactly the same way – only in opposite directions. Inflation removes
earning while interest adds earnings.

 In 1990 a study was conducted regarding the priorities Americans
placed on investing.     This study, along with others, consistently
demonstrates that buyers have different priorities than sellers may
believe. It found that investors listed their priorities as follows:
                         Interest earned: 15%
                       Deferred taxation: 20%
                   Total safety of Investment: 76%

 In the same survey, insurance agents felt their client’s chief concern
was the amount of interest they would earn. In reality, interest
earnings were a lesser concern (coming in third), which demonstrates



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how easy it is for agents to misunderstand their client’s investment
priorities.

 Companies have spent thousands of dollars trying to determine what
their clients want. Older Americans often purchase annuities not as a
new way to save, but as a means of repositioning current assets.
Certificates of Deposit are a prime source of annuity investments.
There can be many reasons for moving money from a Certificate of
Deposit to an annuity, but often the goal is monthly income. This is
especially true if the investor is nearing retirement or has retired.

  Safety of investment is a primary goal since we know retirees can
live another thirty years. Annuities should never be placed with an
insurer that is not top-rated. Never is an additional interest point
worth utilizing a lesser-rated insurance company. Certainly a higher
commission is not worth placing annuity business with a lower-rated
insurer. An agent has a professional duty to know the financial rating
of the insurers they place business with.

      The Legal Reserve System consists of two elements:
                the portfolio and the net worth.

 Annuities are backed by the Legal Reserve System. The Legal
Reserve System consists of two avenues: the portfolio that backs the
annuity and the net worth, which is capital and surplus, of the issuing
system.


Periodic Annuity Withdrawals

 Annuities usually allow policyholders to withdraw once or twice each
year without penalty as long as they do so within specified
parameters. Typically, the policyowner can withdraw up to 10 percent
of the account value without insurer penalty. The policyowner will
have to declare the income under the last-in, first-out rule, which says
that all withdrawals are considered interest until no more interest
earnings are left. This is an IRS rule, not an insurer rule. If the
policyowner wishes a larger withdrawal than the 10 percent of the
account value would allow, the additional funds may be subject to
surrender penalties, depending upon the age of the policy. The policy-
owner should refer to his or her contract for exact information. Most


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insurer surrender penalties begin around nine or ten percent and
decline one percent each year. For example, if the first year of the
policy begins with a nine percent surrender penalty, the second year it
drops to eight percent, the third year it drops to seven percent, and so
forth. Eventually there is no insurer penalty applied at all.

  Internal Revenue Service penalties may also apply if the policyowner
is under age 59 ½ when he or she withdraws funds from their annuity.
When IRS penalties apply, it is always ten percent of the amount
withdrawn, regardless of the age of the annuity contract. IRS levies
these penalties because annuity money is considered retirement funds.
The point of the penalty is to discourage individuals from withdrawing
from their annuity prior to retirement, defined for the purpose of the
penalties as age 59 ½.

   The point of the penalty is to discourage individuals from
withdrawing from their annuity prior to retirement, defined for
          the purpose of the penalties as age 59 ½.

  Annuities should not be used for short-term goals. The penalties
involved would remove any financial advantage if funds were routinely
withdrawn. Older people primarily purchase annuities, but annuities
can be a valuable financial tool for younger individuals as well when
utilized for long-range goals ending after age 59 ½ (typically
retirement). Disciplined savers in their mid-30s who seek tax relief for
a long-range goal should consider annuities. In fact, annuities might
actually be one of the best financial vehicles for long-range goals since
annuity penalties will discourage withdrawals.

 Although annuitization is always an option, it is not required. If the
annuity is never annuitized and the insured dies, listed beneficiaries
will receive the funds in the contract, bypassing probate. It is very
important that beneficiary designations be kept current since the
annuity will bypass probate. If no living beneficiary is indicated on the
contract, funds will then go through the probate process. The value of
the annuity may still be included in probate values for taxation
purposes with or without a listed beneficiary.

 Variable annuities are different than fixed annuities in several ways;
one notable difference is how minimum rates are guaranteed. In fixed
annuities, there is a guaranteed minimum interest rate that will always
be paid regardless of how low other interest rates may go. Under a

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variable annuity there is no minimum interest rate guarantee. What
the annuity earns is directly related to the earnings of the assets that
are invested in. The investor selects from an offering of stocks, bonds,
or money-market securities. These annuities are designed to combat
inflation through the possibility of higher earnings. Of course, there is
no guarantee that the investor will actually earn higher earnings.

 When selecting an insurer from which to buy an annuity, little
attention should be paid to first year earnings. Many contracts pay a
higher first-year rate only to dramatically drop the rate offered in
subsequent years. Agents should look at the most recent ten-year
history of the product to determine the average interest rate paid.
While history does not guarantee the future, it will provide an idea of
what may be expected.

   Many annuity contracts pay a higher first-year rate only to
    dramatically drop the rate offered in subsequent years.

  There are several companies that compare annuities. U.S. Annuities
(98 Hoffman Road, Englishtown, NJ 07726) compares different
insurers’ ratings, interest rates and charges.   This company will
provide quotes by telephone and publishes a quarterly brochure called
Annuity & Life Insurance Shopper, which may be purchased for a small
fee. Subscriptions are also available.


Annuitization Options

 Annuities typically have multiple annuitization options available to the
contract owner.      Although the majority of annuities are never
annuitized, they were designed specifically with this feature in mind.
Annuities were considered a retirement fund geared towards providing
a steady income for either a specified time period or until death,
depending upon the payout option selected by the contract owner.

  Since annuities are tax deferred, not tax free, upon withdrawal funds
will be taxed at whatever rate applies, based on the recipient’s entire
financial picture. There was a time when it could be stipulated that
principal (which had already been taxed prior to deposit) was
withdrawn first, so that tax payments were delayed. Of course, today
that is not allowed. As of August 1982, IRS utilizes the last-in, first-


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out rule, which means that interest is withdrawn prior to principal.
The Internal Revenue Service calls the last-in, first-out rule the
“interest first rule” also known as IRS Sec. 72(e)(5).

  The Internal Revenue Service calls the last-in, first-out rule
   the “interest first rule” also known as IRS Sec. 72(e)(5).

  Of course, it is not necessary to annuitize an annuity contract (and
most are not annuitized), since up to ten percent of the account value
may be withdrawn periodically without insurer penalty. Once the
insurer’s surrender period has passed, more than ten percent may be
withdrawn without insurer penalty. At all times, the IRS penalty would
apply if the annuity owner were under age 59 1/2 at the time of
withdrawal.

 At the time of annuitization, the actual amount received on a periodic
basis, usually monthly, is derived from a formula using age, gender,
principal, interest earned, and any other statistics that might be
applicable. In some payout options, estimated length of life would not
apply whereas it would in others.

 Although there can be variations, most payout options are fairly
standard. They include:
  1. Single Life: Payments will be received for a single listed
     annuitant for the remainder of their life. For as long as the
     annuitant lives, he or she will receive a monthly check for a
     specified sum of money. It is possible to use a format other
     than monthly, such as quarterly, but most annuitants receive a
     monthly income. The periodic payment will never change. If it
     happens to be $1,000 per month when first annuitized, it will
     continue to be that amount throughout the duration of payments
     during their lifetime. The insurer is considered the beneficiary
     under this payout option. It is not possible for remaining funds
     to go to any other heir. If the annuitant outlives the funds
     accumulated, he or she will continue to receive the same
     payments even though funds have depleted.
  2. Joint-and-Survivor: Two or more individuals are named
     jointly in the annuity contract. Periodic payments will continue
     until all named surviving annuitants are deceased. Married
     couples primarily use these. Ages of all listed annuitants are
     considered when determining the amount of the continuous

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      payments. Since payments will potentially continue for a longer
      period of time, the monthly amount is usually less than it would
      have been for a single individual under the Single Life option.
   3. Life and Installments Certain: Payout will be for the life of
      the annuitant although installments are guaranteed for a
      certain specified time period – either to the annuitant or their
      named beneficiary. Although the specified time period may
      vary, it is usually ten or twenty years. The amount of the
      installment payments will be less than they would have been
      under the Single Life option since the insurer is not the named
      beneficiary in this payout option. That means that the insurer
      may have to pay out more than the account value if the
      annuitant lives longer than the insurer expected.
   4. Cash Refund: This payout option guarantees that either the
      annuitant or their beneficiaries will receive the full account value
      during annuitization – or receive a cash refund if the annuitant
      dies prematurely. The periodic payment will be less than the
      Single Life option since the insurer is not the listed beneficiary of
      any remaining account values.
  It is important to realize that annuities, once annuitized, are no
longer considered beneficiary-designated money. Once annuitized,
they are purely intended for the annuitant as income.

             Once annuitized, annuities are no longer
            considered beneficiary-designated money.

To recap the payout options:
Single Life means only the annuitant will receive payments after
annuitization, not any beneficiaries (the insurer is the listed beneficiary
in the contract).

Joint-and-Survivor means nothing is paid after the death of two or
more named annuitants, not their beneficiaries (the insurer is the
listed beneficiary in the contract).

Life-and-Installment-Certain means payout will last the annuitant’s
lifetime, or at least the length of the certain time period selected
(usually ten or twenty years). If the annuitant had received payments
for the selected certain time period beneficiaries would receive nothing
more; if the annuitant had not reached the certain time period, then

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the listed beneficiaries would continue receiving payments until the
stated period of time was reached.

Cash Refund means either the annuitant or his or her beneficiaries
are guaranteed to receive the annuity cash values.


Annuity Models

 While annuities may be either immediate or deferred, there are
multiple annuity models within those two categories.

  Accumulation deferred annuities are often the annuity of choice
for younger individuals who need time to accumulate contract values.
The contract owner regularly deposits some amount of money into the
annuity for use at a later time – usually at retirement. Most insurers
require regular installments, so agents prefer to set these annuities up
with a monthly draft deposit from the owner’s bank account.
Accumulation deferred annuities are often used by employers to
automatically deposit a predetermined amount from the employee’s
paycheck.

 Single pay immediate annuities (SPIA) receive a lump sum
deposit with payout beginning immediately (usually within 30 days of
the actual deposit) if desired by the annuitant. If immediate periodic
payments are taken it is likely that the annuitant annuitized the
contract. However, this annuity does not need to be annuitized since
the annuitant may elect to wait until a later date to begin receiving
payments or they may choose to withdraw only interest earnings at
regular intervals (never annuitizing at all).

  Variable annuities are different than fixed-rate annuities. Fixed
annuities have a minimum interest rate guarantee not shared by
variable annuities. In a fixed rate annuity it is the insurance company
that shoulders the investment risk, which is why they may not earn as
highly as other investments, such as stocks. With a variable annuity it
is the investor that takes on the investment risk. The annuity may
perform better than a fixed-rate annuity but there is no guarantee that
this will be the case. Both individual and group annuity contracts have
seen a growing use of variable annuities.



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  Variable annuities, by their design, address the risk of purchasing-
power erosion normally associated with fixed nominal annuities.
Variable annuities, unlike their fixed rate cousins, offer an opportunity
to select a payout that bears a fixed relation to the value of an asset
portfolio. If the assets rise in value with the nominal price level, then
the payout on the variable annuity will adjust to mitigate, at least in
part, the effects of inflation. Because variables are defined in part by
the securities that back them, they are more complex than fixed
annuity contracts are. Despite their complexity, they have become
one of the most rapidly growing annuity products.

               Variable annuities, by their design,
          address the risk of purchasing-power erosion
        normally associated with fixed nominal annuities.

  Like fixed-rate annuities, variable annuities may be annuitized but
the amount the investor receives is formulated differently. In a
variable annuity the insurer guarantees to pay an unchanging
percentage of the value of an unchanging number of investment units.
This means that the periodic payment is not “fixed” as it would be in a
fixed annuity. The payment is “variable” based on the performance of
the selected investments. Therefore, the annuitant (not the insurer) is
taking on the investment risk. This does not necessarily mean that
the variable annuity is a risky investment.      The amount of risk
depends upon the type of investment made. Many variable annuities
invest in mutual funds, which are not generally considered to be high
risk. In fact, since the insurers specify the group of investments
available, any mutual funds offered are usually of high quality, which
lowers the investment risk. Even so, there is risk for the investor
since there are no minimum guarantees as seen in fixed annuities.
The goal, of course, are higher returns than those available in fixed
annuities.


Investment and Insurance Component

  Variable annuities are structured to have both an investment and
insurance component.       During the accumulation phase, premium
payments are used to purchase investment units, with the price
depending upon the value of the variable annuity’s underlying asset
portfolio. The quantity of units bought will depend upon unit pricing at


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the time of purchase. Variable annuities resemble mutual funds during
the accumulation phase (although there are differences between the
two). Mutual fund providers manage the assets in many recent
variable annuity products. The dividends, interest, and capital gains
on the assets that underlie the investment units are reinvested to buy
additional investment units.

 Once the accumulation phase ends, the variable annuity’s
accumulated value of the investment units is transformed into
“annuity units.” This transformation happens as if the accumulation
units were cashed out and used to purchase a hypothetical fixed
annuity. The annuitant does not receive a stream of fixed annuity
payments, but this hypothetical annuity plays an important role in
computing actual payouts. The payout amount for the hypothetical
annuity is used to credit the annuitant with a number of annuity units.
Many variable annuities allow annuitants the option of choosing a fixed
annuity stream, or some combination of a fixed stream of income and
a variable stream of payouts.

              Once the accumulation phase ends,
  the variable annuity’s accumulated value of the investment
           units is transformed into “annuity units.”

  Actual payouts from variable annuities will depend upon the number
of annuity units that the annuitant is credited with and the value of the
assets it contains. If the value of this portfolio rises by more than the
increase implicit in the assumed interest rate, after the annuitant has
converted to annuity units, the payout might rise during the payout
phase. The opposite could also happen. If the values decline, payout
could decrease. The potential payout variability is called an advantage
by some (protecting funds against inflation), and a disadvantage by
others (making retirement income both impossible to determine and
impossible to depend upon).

  The past years have expanded the menu of investment options
available for variable annuities. The range of portfolio investments
available has certainly increased. The first variable annuities focused
exclusively on diversified common stock portfolios. Today’s policies
offer variable annuities tied to more specialized portfolios of equities,
as well as bonds and other securities. Usually policyholders may move
their assets among various policy sub-accounts, offering different
investment objectives, without fees or penalties. Virtually all variable

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annuities now offer lump-sum withdrawal options after the policy has
reached a specified maturity date and there may be the possibility of
withdrawing the principal in a set of periodic lump-sum payments. As
a result of these features, it is possible to use variable annuities as an
asset accumulation vehicle without necessarily purchasing an annuity-
like payout stream once the accumulation phase ends.               That is
because it contains a purchase rate guarantee. Some no-load mutual
fund families now offer variable annuities in conjunction with some
insurance companies. There are fees connected to variable annuities
due to the types of investments and investment features involved.


The Variable Annuity’s Introduction

  The Teachers Insurance and Annuities Association-College Retirement
Equity Fund (TIAA-CREF) first introduced variable annuities in the
United States in 1952. The first variable annuities were qualified
annuities that were used to fund pension arrangements. Their growth
was slow up into the 1980’s because regulatory approval was needed
from many state insurance departments before new variable products
could be introduced.

       The first variable annuities were qualified annuities
         that were used to fund pension arrangements.

  Variable annuities have seen rapid growth over the last ten years. In
fact, the growth of variable annuities during the last ten to fifteen
years has been second only to health insurance premiums. Between
1989 and 1993, individual annuity premiums increased from $58.6 to
$71.8 billion, primarily as a result of growth in variable annuity sales.
Payouts have not affected statistics yet, since the variable annuity
growth has been so recent. Therefore, it is not possible to say
whether a substantial fraction of the assets currently accumulating in
variable annuity contracts will ultimately be used to purchase life
annuity contracts, or whether it will be withdrawn as lump sums or in
other forms.

  Wrap-Around Annuities may also be called Switch-Fund Annuities.
A life insurance company joins a mutual fund organization managing
several mutual funds with different goals and investment policies. The
insurer provides the annuity contract and the mutual fund company


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provides the investments. The annuitant has greater investment
choice since there is the freedom to specify which mutual funds they
invest in. Taxation is different in this type of annuity since the
investor maintains so much investment control. It is important to seek
professional tax advice when considering this annuity. The IRS terms
wrap-around annuities “investment annuities.”

  CD-Like Annuities are a hybrid of the single premium deferred
annuities. These were developed to compete with the Certificates of
Deposit that banks sell. The policyowner receives a greater liquidity
and rate of return similar to Certificates of Deposit. There are typically
very short insurer surrender penalties, although any IRS penalties
would still remain. Even though there is greater liquidity in CD-like
annuities, they still provide the safeguards of other annuities, including
minimum rate guarantees when they are fixed annuities. Commissions
are typically very low since liquidity and other features allow a shorter
time period for the insurer to make a profit. Most of these products
run for periods of one, three, or five years. Availability to add deposits
or withdraw funds generally exists for 30 days at specified time
periods. These time periods are called “windows of opportunity” and
occur after each guaranteed interest period.

         Availability to add deposits or withdraw funds
      generally exists for 30 days at specified time periods.


Retirement Advantages

 Several factors have contributed to the growth of individual annuity
products, especially variable annuities. These factors are likely to
continue to generate annuity sale growth. First is the tax-deferred
status of annuities. While there are other financial vehicles that
provide this, continually fewer opportunities exist as Congress seeks
greater federal income. The Tax Reform Act of 1986 limits the
opportunity for tax-deferred savings through individual retirement
accounts and other tax changes have further eroded the effectiveness
of some financial vehicles.

 Perhaps one of the largest factors in annuity growth has to do with
our retirement funds. As fewer companies offer the types of pension
plans seen in past years, workers are becoming increasingly aware of


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the need to set aside funds. While there are many homes for savings,
few offer the advantages an annuity does. Additionally, the ability to
set up a lifetime income at some point makes retirement sense.

  The demographic trends and the nature of the country’s budget
policy also suggest a need to save for our retirement. When the baby
boom generation hit middle age (traditionally the age when retirement
funding seems to loom over us) they looked around for financial
vehicles that would suit their needs. Annuities seemed a perfect fit.
There is some statistical evidence that the baby boom generation is
attracted to variable annuities more than previous generations have
been.    Furthermore, no one is especially confident in the Social
Security system, although it is unlikely that funding will cease, despite
some dire predictions. We certainly question how many dollars will be
available from the program as more and more people crowd into it.

  Variable annuity growth is probably related, at least in part, to the
increase in stock prices and the coincident decline in long-term interest
rates, which has stimulated investor interest in annuities in general.
There is less fear regarding the uncertainty of variable annuity payouts
than there used to be. The generation entering retirement is more
concerned about inflationary factors that would erode their income.


Estate Advantages

  Annuities have estate advantages in most cases. When properly set
up, an annuity will eliminate the delays and costs of probate, though it
will not necessarily prevent taxation on the invested money. An
annuity will give the contract owner control of the assets through
restrictive beneficiary designations. For example, by adding the words
“per stirpes” (Latin for “through the blood”) to the beneficiary listing,
the owner’s annuity assts will never be distributed outside of his or her
own bloodline even if the listed beneficiary dies prior to the
policyowner. This is often used for assets acquired prior to a second
marriage, where the policyowner may want to be certain that his or
her assets stay with their own children in the event that both partners
are killed in the same accident. Per stirpes is often referred to as the
“inlaw-avoidance clause.”

   “Per stirpes” added to the beneficiary listing keep annuity
         funds within the bloodline of the policyowner.

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 Policyowners can restrict the ways in which their beneficiary is able to
receive their annuity funds.     If beneficiaries have had difficulty
managing their money, a monthly income is often preferable to simply
giving a lump sum inheritance.

  Annuities are private contracts. Like the living trust, they are not
open to the public. For those who do not have need of a trust, an
annuity may be able to accomplish the same goal without the expense
and upkeep that a trust would require. Only the insurance company,
the writing agent, and the policyowner have access to the annuity
terms. This enables the owner to provide differently for each of their
beneficiaries without each of them knowing what the other received.

      For Example:
       Jackson has three sons. Jeff went to college, acquired a
      high-paying job and has good earning potential. Jason
      entered a technical school. He has two years remaining,
      but his earning potential is also very good if he graduates
      with good grades. The third son, Joseph, is still in high
      school. Even though Jackson is in good health he initially
      sets up his beneficiary designations in the following way:
            1. Jeff receives 10 percent of the account value;
            2. Jason receives 40 percent of the account value;
               and
            3. Joseph receives the balance (50 percent) of the
               account value.

       Since Jackson may change his beneficiary designations as
      needed, he knows that he can equalize the beneficiary
      percentages once all three sons have completed college or
      vocational training. His sons will not know what the other
      received unless they choose to tell each other.

 Many states consider annuities as “beneficiary-designated money.”
When such definitions apply, annuities are usually safe from creditors.
Add to this the ability to keep the contents private and annuities are
certainly a key part of any estate-planning blueprint.




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 While there are various annuity settlement options available,
          many choose to receive a lifetime income.

  One of the greatest fears of retirees is outliving one’s money. While
no one wants to die sooner than necessary, if funds have been
depleted it is likely that the final years will be marked by poverty.
While there are various settlement options available, many choose to
receive a lifetime income. This is a gamble since the annuitant is
gambling that he or she will live long enough to collect more than their
account value while the insurer is gambling that the annuitant will die
sooner than expected. When a lifetime settlement option is chosen,
no remaining funds will be given to beneficiaries. Even if the annuitant
received only one payment, under a lifetime settlement option, all
remaining funds would stay with the insurer. This is not the insurance
company being greedy; it is how the insurer is able to pay for the
lifetime of all their policyholders. Those that die prematurely are
paying for those who live far longer than expected.

  Most annuities are purchased from insurance companies, although
this is not always the case. Private annuities may also be purchased
from a private individual. While annuities purchased from an insurance
company are required by law to maintain certain reserves, this is not
the case for private annuities. When two parties create their own
annuity contract, there are no reserves required and no state
regulatory oversight.

  The Internal Revenue Service has published tables for valuing private
annuities since there is certainly not the same assurance that funds
will be paid. A loss under a private annuity is disallowed for federal
income tax purposes when the other party is a spouse, brother, sister,
ancestor or lineal descendant. Various fiduciary relationships between
the parties may also result in an automatic disallowance of loss.

         A loss under a private annuity is disallowed for
      federal income tax purposes when the other party is
    a spouse, brother, sister, ancestor or lineal descendant.

 Why would an individual use a private annuity? In most cases they
are used between family members, business associates, or others that
have a personal relationship of some kind. These annuities are often a
contract for special circumstances.


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     For Example:
       Margaret knows her health is deteriorating. She should
     have purchased a long-term nursing care policy, but now
     that she is sick, no insurer will accept her as an insured
     risk. She discusses this with her granddaughter, Melody,
     who is a single person with no dependents.              Her
     granddaughter agrees to quit her job and live with
     Margaret, caring for her until she dies. Melody must
     receive income since she has her own financial obligations.
     To cover the needs of both, Margaret sets up a private
     annuity. She deposits a lump sum into an account that is
     set up to pay Melody a specified amount each month for as
     long as Margaret lives. If Margaret should die prior to
     using the account balance Melody will receive the
     remainder of the funds. Although the private annuity is
     sufficiently funded to provide Melody with ten years
     income, the contract still requires Melody to continue
     Margaret’s care even if the funds deplete. If Melody does
     not fulfill her contract obligations during the ten-year
     funding period, monthly payments will stop.

   There are several problems with private annuities. One of the most
obvious problems is that of performance. There is usually no way to
assess whether or not Melody adequately performs her duties. If she
continues to live with Margaret who will determine the level of care
provided? Who determines if Margaret is getting any care at all? If an
outside agency is contracted who pays those bills? If Margaret has
allotted all the assets she has to Melody she may or may not have
adequate funds for her other health care needs. Additionally, since full
time care is very demanding, what happens if Melody becomes ill?
Does she still have a right to receive her monthly income? If she does
not continue to receive a monthly income that could force her to seek
employment elsewhere once her health resumes.            In that case,
Margaret would have no one to care for her, she still would not qualify
for a long-term care insurance policy and there is no guarantee that
she would qualify for Medicaid (the joint state and federal program for
the poor). Most professionals recommend that each party’s lawyer
review private annuities. This may prevent errors that would render
the contract useless.




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Competition

  Annuities have always competed with other types of investments. In
fact, different types of annuities may even compete against each
other. Since each type of investment has both strengths and
weaknesses the various annuities often work well as one of several
financial vehicles. It is important to note that different annuities are
designed with different goals in mind. There may be a trade-off when
selecting one annuity product over another or even when selecting one
financial vehicle over another.

 When an investor is considering an annuity product, he or she will be
considering such factors as the costs of any insurance involved, the
costs of surrender charges if the annuity is withdrawn prior to the end
of the contract, potential tax advantages, any transaction costs that
might be involved, and the investment options associated with the
various financial vehicles. Sometimes an annuity will be a good sound
choice; other times some other financial vehicle will be the better
choice.

  The insurance feature of annuities distinguishes them from many
other types of financial products. Even though fixed annuities do not
have any actual life insurance involved, they still use an insurance
feature – the guaranteed lifetime income option. Annuities insure
against the risk of living too long (living longer than our money).
Some annuities may offer insurance with respect to the rate of return
on the invested capital as well. Both fixed and variable annuities
insure mortality risk and they are the only products that permit buyers
to contract for a guaranteed lifetime income. Only fixed annuities
guarantee the amount of periodic lifetime income; variable annuities
merely guarantee an income – not an amount of income. Some
specific annuity products may use aspects of insurance besides those
we have mentioned.

     Even though fixed annuities do not have any actual life
    insurance involved, they still use an insurance feature –
            the guaranteed lifetime income option.

 Individual annuities provide insurance features regarding changes in
the insurance market.       For example, deferred annuities must
guarantee the participant the right to purchase an annuity on


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particular terms years ahead in the future. This insures against
changes in aggregate mortality risk that results in changes in the
pricing of annuities, as well as against changes in expected rates of
return that could result in modified terms in newly issued annuity
contracts.

  Providing these insurance features affects the cost of annuities. The
insurance value must be considered when choosing an annuity product
since the costs of these features is built into the performance of the
product. The management cost associated with variable annuities
usually average between 100 and 150 basis points per year. This is
much higher than comparable expenses for many mutual funds.
Considering this, why would an investor choose a variable annuity over
a good mutual fund account? The variable annuity is chosen because
the investor wants the insurance features involved and is willing to pay
for those features. Tax deferred status is likely to have also played a
role in the decision.

 Annuities have surrender penalties (charges) for withdrawing
principal prior to the contract’s end. These penalties would not apply if
the annuity were annuitized nor would they apply if principal were part
of the allowable 10 percent yearly withdrawal features. Most annuities
have a maturity date of at least five years. A few may be as little as
one year.

        Annuities have surrender penalties (charges) for
        withdrawing principal prior to the contract’s end.

  Insurers justify the use of early surrender penalties or fees as a
necessary element in order to recover the commission and other
production costs associated with annuity products. The insurer is able
to recover these costs when the funds remain in the vehicle until the
maturity date.

 The Internal Revenue Service may also charge a 10 percent early
withdrawal penalty on annuity products, but for a different reason.
The IRS is not compensating for commissions and management fees;
they want the funds left in the annuity until age 59 ½ because the
monies are considered retirement funds. The tax-deferred benefit is
granted for this goal, so an individual who withdraws funds
prematurely should not, in their view, escape penalty. This IRS view
of annuities is one of the major reasons annuities are primarily

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marketed to those who are older. While younger investors may also
benefit, they are less likely to be saving for retirement during their
twenties and thirties.

  While there are product variations, most annuities have surrender
charges between 5 and 10 percent lasting for five to ten years. The
typical 10-year contract annuity might look like this:

     First year principle withdrawals:            10 percent fee
     Second year principle withdrawals:           9 percent fee
     Third year principle withdrawals:            8 percent fee
     Fourth year principle withdrawals:           7 percent fee
     Fifth year principle withdrawals:            6 percent fee
     Sixth year principle withdrawals:            5 percent fee
     Seventh year principle withdrawals:          4 percent fee
     Eighth year principle withdrawals:           3 percent fee
     Ninth year principle withdrawals:            2 percent fee
     Tenth year principle withdrawals:            1 percent fee

 There would be no insurer surrender fees in the eleventh year and
thereafter. If the investor were not yet age 59 ½ there could be IRS
penalties for withdrawal.

 Companies were most likely to use surrender penalties in the 1930’s
and 1940’s, although most products still contain them today. It should
be noted, however, that not all annuities include surrender penalties
and they tend to be used for a shorter time period than in the past. In
the 1940’s some annuity products also contained a loading charge.

  Other products may contain surrender charges. Some mutual funds
impose a special charge on investors who withdraw funds prior to a
specified holding period. It may not be called a surrender penalty but
it functions the same way. Most investors understand the purpose of
surrender penalties and similar charges. Since the investment is
intended to be a long-term vehicle, the consumer generally accepts
these fees.

       Most annuities are tax-deferred vehicles, meaning
       the interest earned is not taxed until withdrawn.

  Most annuities are tax-deferred vehicles, meaning the interest earned
is not taxed until withdrawn. Currently, the IRS considers the first

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money out to be interest; it is not possible to specify principle as being
withdrawn first.

                          There are both “tax-qualified” and
                            “non-tax qualified” annuities.

  There are both “tax-qualified” and “non-tax qualified” annuities.
Those that are qualified are part of a qualified retirement plan and
are purchased with pre-tax dollars.        Annuities that are non-tax
qualified are purchased with after-tax dollars. Between the time that
the dollars are deposited and the time they are withdrawn, usually no
taxes are due on the earnings. Once payout begins, whether through
annuitization or lump-sum withdrawal, taxes are due on the difference
between the annuity payouts and the annuitant’s policy basis. The key
tax principle is the derivation of an exclusion ratio, an estimate of the
ratio of the contract owner’s investment in the contract to the total
expected payouts on the contract. The exclusion ratio is multiplied by
the annuity payout in each period to determine the part of the payout
that can be excluded from taxable income.1

 Mutual fund investors pay taxes when their fund receives dividends
or realizes capital gains. Mutual fund investors are liable for both
dividends and capital gains taxes even when no shares are sold. In
contrast, annuity investors do not deal with taxes unless interest is
withdrawn. The liquidity of annuities is limited since a loan, pledge, or
assignment of an annuity is treated as a taxable event.

             The ability to shield financial growth from taxation
                       is a powerful asset-building tool.

  Annuity payouts are typically taxed as ordinary income rather than
capital gains. This often means a lower taxable rate. These taxation
features are not necessarily the reason investors purchase annuities,
but they certainly help persuade them to do so. The ability to shield
financial growth from taxation is a powerful asset-building tool. While
it is possible to show many examples of the mathematical difference
this makes, the equations are often lost on laypersons. However, the
disparities are largest when the investment is allowed to grow over a
long period of time, when the rate of return is high (7% percent or
more), and when the marginal tax rate is high. In some cases, the

1
    History of Annuities in the U.S. researched conducted by James Poterba

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principal at retirement from investing in a tax-deferred account can be
more than double that of investing through a taxable account.


Investment Expenses and Loads

 When considering any type of financial vehicle, it is important to
consider the investment management fees associated with the
product.    Certainly investment staff must be paid and there is
overhead for any business, but the investor does not want to pay more
than practical or necessary.

     Variable annuities may include a contract expense fee,
                 as well as a fund expense fee.

  Annuity fees take the form of an expense charge that the insurer
deducts each year. Variable annuities may include a contract expense
fee, as well as a fund expense fee. Mutual funds charge investors for
management expenses, and possibly up-front loads or redemption
fees. Other investments will have fiduciary fees or other types of
expense fees or loads. It would be unrealistic to think that any type of
investment could function without somehow receiving part of the pie.

 Measuring the effective load on annuity products is not a quick and
easy process. Some types of vehicles, such as variable annuities can
develop loads (costs) from adverse selection (the possibility that the
mortality experience of annuitants is more favorable than that for the
population in general). Statistically, annuitants live longer than do
randomly chosen individuals from the population at large. While no
one can say why this is true, several studies have confirmed it. As a
result, it is likely that calculations that use the average population
mortality experience to compute the expected present discounted
value of annuity payouts will make annuities appear less financially
attractive than they actually are. A person that lives longer than
average will collect more from a lifetime annuity than would a person
who dies early or at the average lifetime age.

  As we know, the insurance industry is one of the most regulated in
the country. The legal and regulatory climate for annuity products,
especially variable annuities, is complex and constantly changing, as
individual states continue to pass legislation. Most insurance regulation


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involves consumer protection. Annuities are long-term commitments.
Consumers make large up-front payments in return for promises of
lifetime income. Obviously, it is important that the insurers making
those promises have the financial ability to fulfill them.        Fixed
annuities are regulated as insurance products, while variable annuities
are regulated both as insurance products and securities. Therefore,
variable annuities are subject to federal security regulation and state
insurance regulation. When other institutions, such as banks, are
eventually allowed to produce their own annuity products, additional
legislation is bound to follow.

  Annuity regulation in closely tied to life insurance regulation. Until
1850 there was little regulation of the insurance industry in the U.S. It
is not surprising that there were several scandals involving invested
funds. As a result of those scandals, in 1850 New Hampshire became
the first state to appoint an insurance commissioner, with other states
soon following. By the early 1870’s virtually all states had insurance
regulatory control. In 1945 the U.S. Congress passed the McCarran-
Ferguson Act confirming the need for insurance regulation. State
insurance regulation is not uniform, so there are variances from state
to state.

              By the early 1870’s virtually all states
                had insurance regulatory control.

  Especially in the early years of annuities, buyers had little knowledge
of the insurance industry. They certainly did not understand annuities.
Insurance regulation came about because this lack of understanding
led to serious consumer issues. Many types of annuities involve
investment decisions and even decisions relating to mortality risk.
Few consumers are educated enough to fully understand the
complexities involved. Regulation often involves restrictions on the
types of policies that can be offered, constraints on how contracts
must be explained to buyers, limits on what constitutes an acceptable
expense, and regulations on the capital that insurance companies
must have and the types of investments insurers may utilize.
Insurance regulation is intended to protect consumers by increasing
the safety and security of the promises they receive from insurers.

  There is no doubt that investment regulations affect insurance
companies. They are regulated in virtually every area of business,
including how they may invest consumer funds. So-called “legal lists”

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describe the set of securities that insurers may invest in and the
fraction of their assets that may be held in different securities. The
rates of return insurers may offer on fixed annuity products are
directly affected by these regulations since they usually restrict the
amount of high-risk securities in insurance portfolios. It is the high-
risk investments that are most likely to offer high return. Of course,
these same investments also have the potential for loss. Group fixed
annuities are subject to additional regulations from the provisions of
ERISA, which mainly affect the structure of contract terms.

  Variable annuities are regulated differently than fixed annuities. The
insurers must maintain separate asset pools as reserves against
variable annuities.    The goal is to prevent poor variable annuity
returns from affecting the capital base of other types of insurance
products. As we said, variable annuities are also regulated under the
federal securities law, under the provisions of the Securities Act of
1933, the Securities Exchange Act of 1934, and the Investment
Company Act of 1940. The first two acts concentrate primarily with
the prevention of fraud in the issuance and trading of securities while
the ICA of 1940 empowers the Securities and Exchange Commission to
regulate the insurance industry’s sales of insurance products
containing a substantial equity component, such as variable annuities.

              Variable annuities are regulated under
                    the federal securities law.

 Annuities are both an investment and an insurance product. As a
result, other financial institutions have long felt that they should be
allowed to develop and market products similar to annuities that would
qualify for the same tax treatment. Why are only insurers currently
allowed to underwrite and sell annuities? The historic rationale was
that annuities relied on such things as risk sharing and indemnification
that insurance companies were already expert at. Annuities have been
viewed as very similar to standard insurance contracts. However, with
the evolving nature of annuity products this may no longer be true.
There is now debate as to whether there is a large enough insurance
component in today’s annuity products to continue restricting who can
develop and market similar contracts.

 There are two issues, one of which has already been settled.
NationsBank v. Variable Annuity Life Insurance Company (VALIC)
concerned the right of national banks to sell annuities as agents of

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insurance companies.      The Supreme Court’s decision upheld the
authority of banks to sell both fixed and variable annuity products.
The second issue concerns who may underwrite (develop) annuity
products. In late 1994 the U.S. Comptroller of the Currency (who
regulates the products that banks my offer) approved the offering of
some annuity-like products by some banks. Most professionals feel
banks and other financial industries will eventually begin to develop
and market similar products in the future. This will especially be true
if the products enjoy similar tax advantages as those currently granted
to annuities.


Similarities

  The IRS defines pensions as a series of definitely determinable
payments made to an individual after he or she retires from work.
Pension payments are made regularly and are based on such factors
as years of service and prior compensation. Annuities are defined by
the IRS as a series of payments under a contract made at regular
intervals over a period of more than one full year. They may be either
fixed or variable. An annuity may be purchased by an individual or
with the help of an employer.2

        Annuities are defined by the IRS as a series of payments
               under a contract made at regular intervals
                over a period of more than one full year.

  Pensions and annuities are similar vehicles, even in the view of the
Internal Revenue Service. Recently many types of retirement vehicles,
including annuities, have come under fire for various reasons: some
feel annuities offer too little growth, some feel they are not fully
understood by those who buy them, and some feel agents sell more on
the basis of commission than value. Of course, many others recognize
the potential of annuities when properly included in the overall
retirement portfolio. According to U.S. News & World Report3 academic
research shows investors can afford to withdraw only 4 to 5 percent of
their savings annually in order to insure their money will last 30 or
more years. Therefore, annuities may be especially valuable when
interest rates fall below this level. When annuitized for a lifetime

2
    IRS Publication 575 (Main Contents)
3
    U.S. News & World Report, 6/13/2005 by Paul J. Lim

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income, retirees can be sure that they will continue to have income no
matter how long they live.

 Fixed annuities are designed to produce stable income during
retirement. Even the IRS defines annuities in comparable terms with
pension plans. In its simplest form, a fixed annuity is a contract that
allows an individual to receive an income for life. Of course, the
amount of income is dependent upon the amount of money placed in
the annuity. As is the case for pension income, there is no guarantee
that the annuity lifetime income will be adequate. Individuals must
plan throughout their working years to set aside enough income in all
their retirement vehicles to add up to enough to live on during their
retirement.

  Annuities have generally been considered to be conservative vehicles
performing stably over time. However, at times annuities may be a
better investment than stocks, depending upon market conditions.
Baylor University investments Professor William Reichenstein studied
various portfolios between 1972 and 2000. He reported that a 65-
year-old retiree with a $1 million portfolio invested in a mix of 40
percent stocks and 60 percent bonds withdrawing $45,000 each year
from his account would have run out of money in 1995, at the age of
88. This was due in part because of the poor performance in the early
years. Had he taken half of this portfolio and bought a fixed annuity,
he would still have had $136,000 left by age 95.

      At times annuities may be a better investment than stocks,
                 depending upon market conditions.

 Reichenstein says fixed annuities function like bonds in a portfolio,
but with the added advantage of the lifetime versions available with
annuitization. Bonds can lose risk, but annuities do not since most of
them come with a minimum interest rate guarantee.

 Rande Spiegelman, vice president of financial planning for the
Schwab Center for Investment Research says: “If you think you need a
million dollars to retire but saved only $750,000, you can annuitize a
portion of the account to spend as much as someone with $1 million.”4



4
    U.S. News & World Report 6/13/2005

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  Despite the advantages of annuities, it may not work well for
everyone.     Some may already have enough guaranteed income
through pensions and Social Security income.         In addition, few
professionals would recommend that anyone place all of their savings
into an annuity. There should always be a portion of the savings in
some vehicle that allows easy and quick access in case of emergencies
or other immediate cash-flow needs. As every agent should know by
now, an annuity locks away cash. This is especially true once the
contract is annuitized.

  The first rule in financial planning is simple: avoid hasty decisions at
all times. This is not a statement for or against any particular choice.
It simply makes sense to consider all financial options before jumping
into any particular financial vehicle. Annuity payments, for example,
are tied to long-term interest rates. If the investor believes they will
soon rise, perhaps waiting to purchase the annuity would be wise.
Annuity payments are also tied to age, just as Social Security income
is. Therefore, waiting to annuitize and begin withdrawing funds will
increase the amount of monthly income received from the annuity.


           The first rule in financial planning is simple:
                avoid hasty decisions at all times.

  Some specialists suggest layering annuities, in the same way
Certificates of Deposit are often layered. They feel this allows access
to a portion of the money that has not yet been annuitized if necessary
due to an emergency or cash flow crisis.

  Many annuities now come with inflation protection, but it is important
to realize that any additional option that is purchased comes at a price
– sometimes a high price. Annuities are intended to be part of, not
the entire, retirement package. While company pension plans can no
longer be relied upon, it would be foolish to think an annuity will
automatically be adequate. Just as pension income may or may not
be adequate for the long haul, annuity income will also depend upon
the amount invested. Even when it seems adequate, as costs soar,
the income may not cover every need that arises. No agent should
ever state or imply any guarantees of that sort.

 Annuities are valuable estate planning tools. Some professionals
consider them an essential part of proper retirement and estate

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planning while others prefer other types of investment vehicles.
Whether or not annuities are used will be a personal choice. However,
there is no denying their importance. Annuities are used by lotteries,
employers for retirement plans, and by government entities.
Obviously annuities will continue to play a role in our financial plans for
some time to come.




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                              Chapter 7


             Retirement Funding


 There was a time when many Americans could rely on a company
pension when they retired. That simply is not true today for many
reasons. A primary reason is the mobility of today’s society. We
change jobs often. Another primary reason is the reducing likelihood
that an employer will offer a pension plan. Many companies, in fierce
competition with foreign companies, are reducing costs. One way of
reducing costs is the elimination of pensions that are funded by the
employer.

  Each of us will eventually retire. Some people will work far past the
normal age of retirement, but that is not the usual course taken. In
fact, the goal of many thirty-somethings is to retire earlier than
normal. It is interesting that at the same time those in their thirties
are saying they want to retire at a younger age, those in retirement
are returning to work in record numbers.

 As of 1986, some type of pension plan covered approximately 50
million people. That’s not to say they were “adequately” covered, but
they did have a pension plan of some sort. Participants represented
about 3.5 trillion dollars in trust assets.

  Pension plan participants have specified legal rights. Many people
worry that their employer can reclaim their pension in some way. Any
money contributed by the employees themselves should be secure. If
it is a qualified pension plan there is even more security.

  The basic U.S. congressional legislation that protects an employee’s
retirement plan is ERISA (Employee Retirement Income Security Act of
1974). ERISA requires that anyone associated with the pension plan,
including those who direct pension investments and contributions, act
with the same care, skill, prudence, and diligence as a “prudent man”
would in the same circumstances. Under the prudent man rule, the
individual must exercise the same thought and care that a person with
similar training or experience would in similar circumstances.

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  ERISA also requires that pension participants receive notification of a
plan adoption, revision, or termination, a summary plan description of
any new or amended plan document, and a summary annual report
after the end of each plan year. This should describe the basic total
financial activity in the plan. ERISA allows the employee the right to
request additional information from the plan sponsor or trustee, which
must be received within 30 days at a reasonable cost. A sponsor or
trustee that does not respond to such a request can be fined.

             Two government agencies were given
           the responsibility to enforce ERISA rules:
  the Internal Revenue Service and the Department of Labor.

 Two government agencies were given the responsibility of enforcing
ERISA rules: the Internal Revenue Service and the Department of
Labor. Either one of these agencies have the authority to ensure the
pension plan is in compliance with the rules established by ERISA and
any other applicable legislation.


Pension Plan Players

  Congress is the legal body of individuals that passes laws affecting
pension plans. Many of these laws have been detrimental to companies
that offer pension plans, which is one of the reasons we are seeing
less and less of them being offered. That does not mean that these
laws were not necessary because most of them were (although not
everyone agrees with this statement).

  The IRS and the DOL (Department of Labor) have the job of
enforcing our pension laws. Congress gave them this authority. It is
the IRS that most frequently seeks compliance with the pension laws,
however. The Department of Labor is more likely to deal with the
rights of the participants. Neither body is actually set up to offer
individual help if the pension participant believes he or she is not
receiving a fair deal from their employer. Their intent is more often
that of pulling more money from the plan sponsors. As a result, the
individual seeking personal help may only cause themselves more
problems by involving either of these government agencies. This is



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unfortunate since it means individuals are often forced to hire
attorneys instead.

  Plan sponsors are business entities that choose to offer a pension
plan to their employees. They take advantage of any tax shelters
available as a result of this offering. The plan sponsor might be a sole
proprietor, a partnership, a regular corporation, or a Sub Chapter S
corporation. It is the responsibility of the plan sponsor to adequately
fund the pension plan, which may come from company funds,
employee funds, or a combination of the two. The plan sponsor and
plan administrator are often the same entity. The administrator is the
person or company that has the responsibility of fulfilling all reporting
and disclosure requirements of the IRS and DOL. The plan sponsor
creates a trust to receive and hold plan assets and executes a plan
document that is submitted in some way to the IRS for qualified tax
status.

    The administrator is the person or company that has the
     responsibility of fulfilling all reporting and disclosure
              requirements of the IRS and DOL.

  The plan trust account is established with a financial institution and
can be funded or nonfunded. If it is funded it was established with a
financial institution whereas a nonfunded account would be established
with an insurance company. It is possible to have a trust that has
both a funded and nonfunded portion. The trust is the legal vehicle
designed to hold plan assets. The trust is tax exempt since it pays no
income tax on its holdings. Only the trustee has control of the trust so
even though the employer might be able to make deposits on the
employee’s behalf, he or she does not have access to the trust funds.

  The plan document is the legal directions for the trustee. It outlines
what the trustee may and may not do with the trust funds. The plan
document will name the plan sponsor, administrator, and trustee. If
the pension plan is tax qualified, the plan document will be submitted
to the IRS. If the plan document is sent to the IRS prior to signing by
the sponsor it is called a prototype plan; if it is sent after the signature
it is called a custom plan.

 Each participant will receive a copy of what is called the Summary
Plan Description (SPD). This is required by the DOL (Department of
Labor). The SPD is supposed to be printed in lay terms so that a

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person of normal ability can read and comprehend it.         Pension
participants also have the right to request a copy of the actual plan
document for a reasonable cost. Many pension professionals feel each
plan member should order a copy and keep it on file.

 The plan trustee or trustees (there can be more than one) is the
person or persons who is legally responsible for safeguarding the trust
assets on behalf of all who participate in it. A trustee (meaning
someone who holds something in trust) is a fiduciary. The trustee is
expected to act as a prudent man would in similar circumstances.
Even if the trustee is the employer, he or she is legally held to the
same fiduciary level as a professional trustee would be. The summary
plan description is required to state who the trustee of the pension
plan is.

  Many pension plans have a person designated as an investment
advisor. The trustee often chooses to delegate the responsibility of
managing the trust funds to a person with higher investment
qualifications than those possessed by the trustee. The investment
advisor is not always a person; sometimes it is an institution such as a
bank or insurance company. Of course, the institution assigns the
account to an actual individual or group of individuals. When the
investment advisor is a person, he or she is often a financial planner,
security broker, or even an insurance agent. An investment advisor
has the same fiduciary responsibility as the trustee, meaning he or she
must follow the prudent man rule and is legally responsible for errors
that might be made through carelessness, failing to properly diversify
plan assets, using highly speculative investments, or unethical actions.
The employees participating in the pension have no input regarding
the choice of the investment advisor unless the pension plan addresses
this in some way.

          Some types of plans, such as 401(k) Plans,
      may require the plan trustee to offer a certain range
           of investment choices to their members.

  Some plans allow “segregated accounts,” meaning the same choices
of financial investments must be offered to all participants. The
sponsor of the tax sheltered plan cannot put all the owner’s money in
an account expected to earn one rate while other participants are put
into a separate account expected to receive less, for example. Some


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types of plans, such as 401(k) Plans, may require the plan trustee to
offer a certain range of investment choices to their members.

  Because managing a pension plan is complex, many employers do
not wish to take on the task themselves. They often hire contract
administrators. These are often outside firms that keep track of
changing laws, IRS and DOL rules, and anything else that would affect
the pension plan. They may be referred to as pension watchdogs. It
is not unusual for contract administrators to even interact with the
pension participants.

  Contract administrators often know more about the pension plan
than the employer does since these firms and individuals deal with
pensions on a daily basis. He or she is a paid professional whose job
is knowing and understanding how pensions work, the laws affecting
them, and the mistakes that can potentially be made. Most companies
would be wise to hire a contract administrator but not all do, since it is
an additional expense to do so.

  The pension plan participant is the employee or any other person
who contributes or has money contributed on their behalf to the plan.
The employer and employee are typically both participants, each
having equal rights and privileges that were given by the plan
document. Qualified retirement plans are not savings plans; they are
retirement plans. This is an important legal distinction. Congress has
passed several laws restricting the use of pension plans for any use
other than retirement. That does not mean that there are not “savings
plan” options available in pension plans. Newer plans are less likely to
offer these, but they often still exist. These include (but are not
limited to) such things as participant loans, hardship withdrawals, after
tax voluntary employee contributions, company stock options, and the
purchase of limited amounts of life insurance.

          The monthly pension amount is reduced when
          payout is based on two lives rather than one.

 Congress has given the worker’s spouse legal rights regarding
pension plans. One very important right is the legal right to continue
receiving income following the worker’s death. Only if the spouse
waives this right may the worker draw the full monthly amount of their
pension. If the spouse does not waive this right, the pension received
each month will be reduced by approximately 20 percent (depending

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upon factors such as the spouse’s age) so that he or she may continue
to withdraw income following the worker’s death.         The monthly
amount is reduced because the pension is then based on two lives
rather than one.

  The spouse has an equal say in most pension aspects, even in regard
to pension loans taken out prior to retirement. In most plans, the
pension participant cannot make a loan or distribution without the
written consent and agreement of his or her spouse. If another person
is desired as a designated beneficiary the spouse must also agree to
that since the spouse would normally be considered the beneficiary. A
single participant may make any changes without anyone else’s
consent.

  A pension plan is legally safe from any person or creditor –
 except a spouse in a legal proceeding, or the IRS in a tax lien.

  Spousal rights always hinge on being legally married. During a
divorce pension benefits are often a legal issue. A pension plan is
legally safe from any person or creditor – except a spouse in a legal
proceeding, or the IRS in a tax lien. In a divorce, the participants
pension balance is considered as part of the common property of the
marriage and could be divided between the two parties. A legal order
signed by a judge is called a Qualified Domestic Relations Order
(QDRO). The Federal ERISA law covers this.

  When the IRS confiscates pension funds to satisfy a tax lien it is
technically against ERISA law, but despite this the action has been
upheld in tax courts. It is likely that the IRS will continue to be able to
attach pension funds to settle a tax lien.


How Much Money Will You Need?

 It may sound good to tell your friends that you plan to retire at age
50. It is an entirely different matter to actually be able to do so.
Assuming that an individual lives until the age 80 (many live longer)
retirement at age 50 means there must be enough assets to pay for
thirty years of life. How much money will be needed each month? Will
your dollars at age 50 go as far as they do today if you are currently
30 or 40 years old?


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  The Wall Street Journal (July 3, 2005) ran an article, How Much We’ll
Need in Retirement, written by Jeff Opdyke regarding that exact topic.
It points out that the majority of people have not calculated how much
their retirement will cost. “Cost” is an appropriate word. We seldom
consider our monthly living expenses in terms of “cost.”           When
considering retirement, the cost of funding it is the basis of how much
money should be accumulated for that purpose. As Jeff Opdyke
pointed out, while it’s important to know what you are saving for, it’s
equally important to know what the cost will be. For example, it would
be very difficult to save for a new car if the buyer had no idea what
the cost would be. Goals need an ending point (at what point does the
buyer have enough to pay for the car?).

         The majority of people have not calculated how
                much their retirement will cost.

  Too many Americans reach retirement only to discover they don’t
have enough to fund the cost of it. There are many reasons for this
but the fundamental reason is simple: we don’t save enough. Most
people get sidetracked with the desire for a new car, new furniture,
new anything. While we may believe that the day-to-day costs of
living take everything we earn, how will we deal with retirement when
there is not enough funds for even the basic needs of rent, utilities,
medical care, and food?

 By calculating the cost of retirement, the time left until retirement,
and the amount of savings currently in place for that goal, a person
can determine how much should be saved on a monthly basis.

  Step 1: What will basic costs of retirement be? It is true that
we cannot say exactly what costs will be in the future, but we can use
the starting point of what it currently costs each month to pay for rent
or a mortgage, property tax, utilities, insurance for auto, home, and
health, and food. Extras, like traveling, could be included but usually
the starting point does not include non-essential items. One extra that
probably should be included is the cost of long-term care. That could
be handled with an insurance policy in order to keep the cost lower.
For our example we will use $4,000, but each person should use a
figure based on his or her current expenses with at least 6 percent
inflation added in.


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  Step 2: What is one’s current age? This determines the length of
time that exists to save for the cost of retirement.

  Step 3: How many years does the individual expect to live in
retirement? That will depend upon the age at which he or she
expects to retire. Family history of longevity must also be considered
(the age the individual anticipates living to).

 Step 4: What is the current income and expenses? While it
makes sense to save whatever is necessary for retirement it may not
be possible if current spending levels are too high. This is probably
why so many people fail to save adequately for retirement – they
never want to face the possibility of having to spend less today.

 Let’s take this through the mathematics:

  $4,000 current monthly expenses X 12 = $48,000 yearly X 30 years
= $1,440,000. This does not factor in what it will cost to live in the
future. As we know, it costs more to live each year as our dollar has
less spending power due to inflation and increased costs of living.

  The often heard “I will have Social Security income to help out” is
just a way to avoid cutting back on spending in order to save more.
Even factoring in the highest amount available from Social Security, it
will not be adequate. Mr. Opdyke figures that an individual should
factor in 3.3% per year until retirement to cover increases in costs of
living above the increases given in Social Security. Health care costs
will grow faster than Social Security income so any increases in Social
Security will not be adequate. If a person only had Social Security to
live on, there would be a retirement shortfall of approximately $1.3
million just to cover the basic-needs gap for thirty years of retirement.
Therefore, it is that $1.3 million that must be saved during one’s
working years.

  Not everyone will be alive for thirty retirement years. The length of
time will depend upon health factors, family longevity, and the age of
retirement, but many people will need to cover thirty retirement years.
If a person has 28 years in which to save for retirement, he or she
would need to save nearly $800 per month, assuming an annual
interest earning of 7%, which we know is often not the interest being
earned. In recent years, investors have had a hard time finding 5% in
a safe vehicle.

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 Many people begin saving for retirement far later than they should so
there is no way to save adequately for retirement. The longer one
waits, the more he or she must save each month.

        If an individual is not saving at least 10 percent,
                 he or she is spending too much
      and there will be inadequate funding for retirement.

  Paul Farrell said in Market Watch (April 2005) that anyone who is
saving less than 10 percent of their income is not saving adequately.
It doesn’t matter what income level exists, 10 percent must be saved.
If each individual is not saving at least 10 percent, he or she is
spending too much and there will be inadequate funds for retirement.

 Where funds are held can also impact the bottom line. No load funds
should always be sought. Commissioned funds can rob the account of
all earnings, especially in low interest rate markets.


Inflation

  Inflation is the largest thief of a retiree’s dollars. Inflation affects
virtually every type of investment in one way or another. There is no
type of investment that escapes inflation. Inflation is also affected by
other elements, such as political climates and programs, tax laws, and
even investment fads.

  Once an individual retires, safety of accumulated assets becomes a
big concern since there is no easy way to make up financial losses.
Therefore, the retiree is likely to seek out safer investment vehicles,
which are likely to pay a lower rate of return. As a result, even if an
individual is playing the stock market today (and possibly doing well) it
is unlikely that he or she will want to do so in retirement. Risk takes
on a different meaning when there is no longer any earned income to
offset losses in stocks.

 Since inflation and interest have much in common (although one is
negative while the other is positive) looking at how interest earnings
work will help to understand the negative effects of inflation.



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      For Example:
       An investment of $10,000 earning an interest rate of 5
      percent will accumulate an additional $500 now equaling
      $10,500. Along comes inflation. For this example, we are
      using an inflation rate of 4 percent. Therefore, the same
      $10,000 will experience an inflationary loss of $400. The
      end result? Instead of earning $500 the investment earns
      only $100.

  When inflation is higher than the interest being earned the investor
experiences a loss. If inflation were 5 percent while the investment
was only 4 percent, the end result would be a loss of $100 so that the
investor ends up with $9,900 rather than the $10,000 he or she began
with.

  It isn’t just inflation that robs an account; taxation also takes its cut.
If the investor had his or her $10,000 in a Certificate of Deposit, for
example, at year’s end the investor must also pay taxes on any
interest earned. The Internal Revenue Service does not consider the
effects of inflation, so even if the investor lost money in real spending
power, IRS will still tax any interest earnings. Therefore, not only did
inflation remove the interest earned, IRS then takes an additional bite.
If the investor has his or her funds in an annuity or other tax-deferred
account, taxation will be deferred until funds are withdrawn. The
investor would try to withdraw funds at a time when taxes would be
lowest.

 Obviously it is not an easy task to determine how much one must set
aside to cover thirty years of living. It is also obvious that it would be
better to save too much than not enough since an individual cannot
determine future rates of inflation.

     If an individual is currently living on $3,000 per month,
         it is conceivable that the same standard of living
         during retirement will require $5,000 per month.

 If an individual is currently living on $3,000 per month, it is
conceivable that the same standard of living during retirement will
require $5,000 per month. Thirty years at $3,000 per month equals
$1,080,000. Thirty years at $5,000 per month equals $1,800,000.
That is one million, eight hundred thousand dollars! Few people


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realize the amount of money it takes to live on for thirty years so it is
little wonder that few Americans save adequately for retirement.

  When setting aside money for retirement, most people will combine a
permanent portfolio with a variable portfolio. The permanent portfolio
will include investments that are intended to be “permanent” or long-
term. The variable portfolio will include those investments that are
short-term (Certificates of Deposit are often the preferred short-term
investments). These are usually flexible, allowing for changes as
needed or desired by the investor.


Company Sponsored Pension Plans

  When a company-sponsored pension plan exists it will be one of two
types: defined benefit plan or a defined contribution plan. A pension
plan defines either the benefits to be paid the employee at retirement
or the annual contributions employers must pay to buy retirement
benefits for the worker.

  Pension plans in the United States have seen better times. The
Pension Benefit Guaranty Corp (PBGC), the federal agency that insures
private pension plans has a deficit of about $24 billion. This is
expected to triple within the next ten years as more pension plans
default.1 There is urgency for Congress to act, but no one should
expect to totally count on a defined benefit pension plan. While
Congress could require an extreme pension boost to cover the deficit,
it is thought that such a move would force more pension plans into
bankruptcy. Even so it is likely that companies sponsoring defined
benefit plans will be required to pay higher rates to the PBGC in order
to keep it solvent.

    It is likely that companies sponsoring defined benefit plans
               will be required to pay higher rates to the
                  PBGC in order to keep them solvent.

  Most of the PBGC’s money comes from investment returns on
corporate assets assumed from companies that turn over their pension
liabilities to the government. The agency also collects premiums from

1
 June 9, 2005 Pension Agency’s Gap is Expected to Balloon to $71 billion in Decade by Michael
Schroeder

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employers whose plans it guarantees. When a pension plan shuts
down without enough funds in it to meet the obligations, the PBCG
guarantees up to a set amount per retired employee per year. The
exact amount will vary based on several factors, including retirement
age. In 2004 there was a $23.3 billion shortfall (double the previous
year’s gap).

  While it is comforting to know that our pensions have a guaranty
fund it is not comforting to know that there are caps placed on the
maximum that will be insured. If you are a pilot expecting much more
income than the amount the PBGC will deliver, for example, receiving
only half of what you worked for doesn’t seem fair. The PBGC is
subject to the limits imposed by Congress each year. The limit mostly
affects higher salaried employees.

 When a pension plan bankrupts those most affected are the people
nearest retirement and those already in retirement. If those already in
retirement receive more than the amount covered by the PBGC they
would experience a monthly reduction in their pension. Those nearing
retirement may find themselves receiving much less each month than
they had been promised. If their lifestyle cannot continue at the
reduced amount the worker may have to work longer than planned in
order to make up the shortage. Defined benefit plans use a formula
reflecting years of work and final average pay. The longer one works
the more they have at retirement. Therefore, someone at the verge of
retirement has few options to make up what they will potentially lose
by a pension crash. The PBGC will determine the benefit based on
salary and years of service as of the plan termination. If an employee
has worked for a company 30 years when its pension plan is assumed
by the PBGC, but retires five years later, his payout is based on 30
years rather than the 35 he actually worked. This is also true for the
salary figure used. The worker’s final and most lucrative earning years
are ignored by the PBGC.

      The PBGC will determine the benefit based on salary
        and years of service as of the plan termination.

 Many question whether the Pension Benefit Guaranty Corporation can
continue to keep up with the number of defined benefit pension plans
that are likely to end. In the airline industry alone, they have taken
over the pensions for Eastern, Pan Am, TWA, US Airways, and United.
Others are operating with court protection from creditors under

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Chapter 11 of the bankruptcy law. The metal manufacturing industry
is also likely to see defined benefit pension assumptions by the PBGC.

  Workers who have defined benefit pension plans should save as
though they do not have such a plan. Utilize 401(k) plans if they are
available as well as personal savings of at least 20% of gross income
even if current lifestyles are affected, says Eileen Dorsey, a certified
financial planner at Money Consultants in St. Louis, MO. She saw
many of her clients lose great portions of their retirement when TWA
terminated its pension plan in 2001. Of course, we know that few
Americans will save at the cost of current lifestyles. Americans are the
great procrastinators when it comes to setting money aside for
retirement.


Defined Benefit Plans

A defined benefit plan promises the employee a fixed dollar benefit
at retirement. The pension is related to the employee’s salary and
length of employment. The more money paid in and the more time
allowed for accumulation, the larger the pension will be. These plans
are often associated with large manufacturing, mining, and finance
industries. They are also associated with the growth of the labor
industry (labor unions).

       The more money paid in and the more time allowed
        for accumulation, the larger the pension will be.

  Defined benefit plans promise a lifelong string of payments,
beginning at retirement. They are based on a pre-set formula that
considers such things as gender, age, length of service, and other
relevant factors. The employer assumes all the investment risk,
promising to pay the retired worker a regular income even when
investments perform poorly. The accrued benefits cannot be reduced.

  Defined benefit plans account for just 7 percent of traditional
pensions, according to the Department of Labor. Another 29% have
defined contribution plans, such as 401(k) accounts. Fourteen percent
of workers have both kinds of pensions. Most financial experts feel
defined benefit plans will cease to exist as current plans end in favor of
less costly employer pension plans. Defined benefit plans are costly to


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employers because workers are living far longer today than when this
type of plan was first conceived.2 Employers compete globally today
rather than nationally which also affects their ability to offer this type
of pension plan.

  Where defined benefit plans are involved with unions, such as the
auto manufacturing industry, it will be harder to dissolve defined
benefit plans because they are part of collective bargaining. Even
though it may make the company unprofitable or in a difficult position
to compete globally, it is likely that the unions will refuse to give up
these lucrative benefits.

  It is not just the airlines and auto-manufacturing companies that
have used defined benefit pension plans. Many states have as well.
State and local governments often provided their workers with defined
benefit retirement plans. These are funded with tax dollars. Since
they are so expensive to maintain some states have been looking at
offering defined contribution plans instead. Lawmakers nationwide
face problems of funding pension plans for current retired public
workers, so obviously they cannot continue to offer these plans.

  We read about the financial problems Social Security funding is
having, but we are less likely to hear about the same issues faced by
defined benefit plans. More than 5.1 million retired teachers, judges,
law enforcement, and other public employees now rely on public
pensions with an additional 15 million workers expecting benefits when
they retire. All of this requires tax dollar funding.

 Periods of poor investment returns, rising benefits, longer life, and
states’ failures to properly fund their plans have created a gap
between assets and benefits in 45 states.3             In 13 states, the
unfounded liabilities exceed their annual general revenue budgets. In
half of our states pension fund shortfalls top $3 billion.

          Baby boomers are expected to double the 65 and older
                 segment of the nation’s population to
                    more than 67 million by 2030.




2
    Patrick Purcell, pension expert at Congressional Research Service in Washington DC
3
    National Association of State Retirement Administrators 2005

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  State and local government pension plans will be strained even worse
as the baby boomers begin to reach retirement age. That generation
is expected to double the 65 and older segment of the nation’s
population to more than 67 million by 2030. By that time and for
many years afterward, one in five Americans will be in that age group.

  Many states are acting now by proposing a variety of retirement
restrictions and changing how they offer pension plans. Most states
are trying to move to a defined contribution pension plan and away
from defined benefit pension plans. Many of the changes will include
later retirement requirements, working generally two years more than
previously required.    Some states, such as New Mexico, have
increased employer and employee contributions to their plans. Many
states will be selling bonds for state pension and social service
programs.

         Nine out of ten state retirement plans currently
      provide a defined benefit retirement plan, but thanks
      to the popularity of the 401(k) plan that is changing.

 Defined benefit plans are changing, even at the government level,
over to defined contribution plans. Nine out of ten state retirement
plans currently provide a defined benefit retirement plan, but thanks to
the popularity of the 401(k) plan that is changing. It will not be an
easy changeover, but the change is necessary as funding defined
benefit plans becomes increasingly difficult.

  There are disadvantages in defined benefit plans. These plans are
very expensive for the employer, which has contributed to the decline
in pension plan offerings. Administration is complicated and difficult
for employees to understand. Defined benefit plans require an actuary
to operate. Considering this, it is not surprising that defined benefit
plans are disappearing. Some have actually gone bankrupt, placing a
strain on the PBGC (Pension Benefit Guarantee Corporation).

 For those working employees who are currently part of a defined
benefit plan he or she can probably assume:
  1. The company they work for is doing well financially; and
  2. The company has decided to keep this plan rather than change
     to a defined contribution plan as many companies have done.


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  Defined benefit plans reward long periods of service with the same
company or same group of companies. Older employees who have at
least ten years of employment with the same company or group of
companies before they retire are likely to be the most satisfied with
their pension plan. Those with less than ten years of service will not
benefit as greatly as those who have ten or more years.

 Once the worker retires and begins collecting from his or her defined
benefit plan the sponsor may never take away the benefits that have
accrued. This is true even if the plan sponsor is no longer doing well
as a business or has been taken over by another firm. Even if the
defined benefit plan becomes insolvent there is a measure of
protection from the PBGC.

 Workers should realize that a company experiencing financial
problems probably couldn’t afford to continue their defined benefit
plan. In fact, if the firm does not change the plan, they might even be
considering reducing the work force if they do not freeze the pension
plan benefits at current levels. Many companies, even when not
experiencing financial difficulties have changed their pension plans to
Profit Sharing Plans or 401(k) Plans as a means of reducing the costs
associated with defined benefit plans.

          Professionals using defined benefit plans can
       accrue large amounts later in their career, retire,
     and terminate the plan taking their pension with them.

  Many professionals, such as doctors and lawyers, actually prefer
defined benefit plans for personal use. They can accrue large amounts
later in their career, retire, and terminate the plan taking their pension
with them. Professionals usually run the plan for ten to fifteen years
in order to accumulate enough assets within the pension plan.


Defined Contribution Plans

 A defined contribution plan permits the employee, the employer, or
both to invest a certain sum each year (before taxation) on behalf of
the employee. The employee is entitled to the accumulated funds
upon retirement. Company thrift and profit sharing plans are defined
contribution plans. Employers may choose to match funds deposited


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by their employees, or set aside a percentage of profits. Employee
contributions and all their earnings are tax-deferred. Taxes will be
assessed upon withdrawal. If the defined contribution plan performs
poorly, the losses eventually come out of the employee’s pocket.

 Defined contribution plans became popular at the end of World War II
and have grown as more companies move over to them. As Americans
have become very job-mobile, these plans are more likely to work for
those who change jobs often over the span of their working years.
They offer a year-by-year benefit, which accumulates along with the
growth of dollars previously contributed.

 Defined contribution plans may be based on a set formula, called a
money purchase plan or be based on yearly company profits, called a
profit sharing plan. Between the two, profit sharing plans are more
widely used.

            A defined contribution plan is not insured
                by the PBGC or any other agency.

 The employee will assume the investment risk under a defined
contribution plan. The amount received each month in retirement will
be directly related to how well the investments performed during the
pre-retirement years. A defined contribution plan is not insured by the
PBGC or any other agency.

  The defined contribution plans are popular with small and medium
sized companies since they are more flexible and certainly less costly
to fund. They are also easier to administer so that companies with few
extra dollars could do the task themselves.

 Despite the fact that the employee takes on the investment risk
rather than the company, they have tended to perform well as long as
the workers are young enough to weather investment losses and they
work sufficient years to build up the account.

 Of course, not all pension plans are equal. Some are better managed
than others; some receive more funding than others, and so forth. If
the company (employer) becomes insolvent it will certainly affect the
continuance of the pension plan. Although employees do have rights
regarding their pension plan, few people actually pay attention to how


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it is performing. Most individuals are likely to assume their employer
knows what they are doing – whether or not that is actually true.

  Even when a pension fund is well managed and adequately funded,
the employee may expect more at retirement than he or she actually
receives.    The monthly payments could be much less than was
expected from reading pension statements. The monthly payment is
usually derived from a formula that takes into account how long the
retiree is expected to live. Additionally, according to a company
survey by Hewitt Associates, only 3 percent of companies give cost-of-
living raises to pensioners.

 Many companies have a minimum employment period before the
employee becomes “vested.” Becoming vested means the individual is
entitled to keep the benefits built up even if he or she leaves the
company prior to retirement age. Of course, the longer the employee
works for the company the more time there is to build up funds and
accumulate interest earnings. Individuals who change jobs frequently
cut their odds of lasting at any firm long enough to become vested.
Additionally, employees who work for small companies often get less
generous pension plans that their counterparts at major corporations
that have more dollars to work with.

 There is more to vesting than one might realize. If an employee
does not see a vesting statement on their plan summary, he or she
should ask their employer for specific facts regarding it. Vesting
percentages and vesting balances should be in writing in the
employee’s plan summary. Vesting should be at least at 20 percent
after 3 years of creditable working history. No more than 1,000 work
hours per year may be required for vesting, although it can be less.
That means that those who work at least 20 hours per week would
qualify for vesting. By seven years, the employee should be 100
percent vested. Many companies vest earlier than that.

            Some use what is called “cliff vesting.”
   There is no vesting interest for a set number of years at
  which time the employee is instantly vested at 100 percent.

 Not all companies vest by percentages. Some use what is called
“cliff vesting.” There is no vesting interest for a set number of years
at which time the employee is instantly vested at 100 percent. Usually


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the time period is between three to five years, depending upon the
company size and company policy.

 When a new pension plan is begun the employee will not always
receive credit for previous time with the company. The employee may
have to begin the vesting period from the time the pension plan was
born. Service with the company prior to the age of eighteen may also
be excluded.


401(k) Plans

  401(k) Plans are now offered through many employers. 401(k) Plans
are defined contribution plans. Created by Congress in 1978, IRS
Code Section 401(k), these plans shift the burden of providing
retirement benefits from the employer over to the employee. That
simply means the employee must take on the responsibility for funding
their own retirement rather than counting on their employer to do it
for them.     Many employers are willing to cover the expensive
administrative fees associated with this type of pension plan, which
makes it that much more attractive for the employee.            Many
employers will also match all or a portion of what the employee
contributes, up to specified limitations or percentages. When that is
the case, the employee should contribute as much as allowed by the
401(k) Plan in order to receive full employer matching status.

          401(k) Plans are defined contribution plans.

  401(k) Plans may be offered by employers in addition to another type
of pension plan or it may be the only type of pension plan available
through the company. Some employers will offer matching funds for
401(k) contributions. When this is the case, the employee should
always make the maximum contributions allowed. Some 401(k) Plans
will include a hardship withdrawal feature or the participant loan
feature. Even if this is offered, however, funds should be considered
retirement funds – not money available for other purposes.

 We know that Americans are not statistically good savers in general
and this includes for retirement. 401(k) Plans do place the entire
responsibility for retirement saving directly on the employee. If he or
she fails to contribute to the 401(k) Plan there will be no funds for


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them at retirement. Employers may offer matching funds, but if the
employee deposits nothing, the employer deposits nothing. If the
worker is at least 21 years old and works at least 1,000 hours per
year, within one year of employment the employer must give the
worker the chance to participate in the company’s 401(k) Plan. In
order to participate the employee must authorize the payroll
department to have a certain percentage amount (usually up to 15%)
deducted from their paycheck before state or local income taxes are
deducted. The income taxes that were saved will be due when funds
are withdrawn from the 401(k) Plan. Social Security taxes will still be
levied on the amount deposited into the 401(k) Plan. Therefore, only
state and federal taxes are saved on the 401(k) contribution – not
social security payroll taxes.

  The employee makes investment decisions for his or her 401(k) Plan
but the plan sponsor will have narrowed the choices. The IRS only
requires the sponsor to offer a specific number of diversified groups of
investments (at least 3). Employees have the right to move their
funds at least quarterly. Some companies may offer a “daily pricing”
or “daily transfer” option.

  Upon retirement the tax deferred 401(k) funds may be rolled into the
employee’s personal IRA, although there are IRA contribution
limitations. It is often wise to seek professional tax advice prior to
making such decisions.       Employee contributions are always 100
percent vested, as legally required.


Collecting Pension Funds

 Employees should assume their pension would replace no more than
60 percent of their pre-retirement income. Seldom is a pension
generous enough to equal their working income. The theory is that
there will be fewer costs once retirement arrives. Unfortunately that is
seldom true unless the retiree plans to give up many activities
previously enjoyed. While some expenses will be less, such as gas to
commute back and forth to work or work-related clothing, there will be
other expenses that take their place, such as health and long-term
care insurance. At one time, many corporations continued health care
coverage into retirement, but that is less likely to happen today. In
the future it is likely that few companies will be able to afford the


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expense of providing health care for their retirees, even though they
may do so during employment.

     Many employers cut pension benefits by a third or half
           for those who depart at age 55 or earlier.

  If a worker meets their goal of an early retirement, pension income is
likely to be reduced. Many employers cut benefits by a third or half for
those who depart at age 55 or earlier.

  Marriage may also affect the amount of monthly retirement income.
In most cases, the pension is reduced by 20 percent in order to
provide income to the legally married spouse after the worker has
died. Employers pay insurance companies more for an annuity for a
couple than for a single person. The cost is passed on to the employee
in the form of a smaller pension.

  When an employee is vested, the law requires companies to give the
spouse at least one-half of the pension benefits after the death of the
worker, unless the spouse waived that right. Why would a spouse
waive this right? Because he or she wanted to receive a higher
monthly income while the worker was alive. There may be another
choice: the pop-up option. If the spouse dies first, the pension reverts
to the higher monthly income for the single worker.

 Companies may reduce their pension contribution if the worker will
also receive Social Security. This is not illegal since the company must
pay into Social Security on behalf of the employee. The pension
summary that is provided to workers will note this. When this is the
case, the employee will have their pension reduced by the amount of
Social Security they are expected to receive, which could be as much
as 83 percent on benefits accrued through the company plan’s fiscal
year that ended on or after 1988. Subsequent benefits fall under a
newer tax rule that guarantees the employee at least half of the
company benefit.

          The pension assets are committed irrevocably
              to a pension annuity or other vehicle.

 A pension plan is funded when assets are accumulated in advance to
pay benefits at the time of retirement. A trustee or an insurer usually


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administers these assets. Pension assets are committed irrevocably to
a pension annuity or other vehicle. A funded pension guarantees that
participants will receive their full pension benefits only if the plan is
fully funded. In order to be funded, a sufficient amount must have
been paid in to cover the past service liability and sufficient
contributions must be made each year to cover current service
benefits as they accrue.

 Pension liabilities are divided into two parts:
   1. Accumulated past service, and
   2. Current service when earned.
 Liability for accumulated past service includes not only liability for
benefits earned prior to the plan being initiated, but also for any
improved benefits for past service if the plan happens to be altered in
some way.

 Discharging all past service liabilities in one payment would usually
be prohibitive so the technical requirements for a fully funded plan are
seldom met. A less stringent definition of a fully funded plan would
allow past service liabilities to be covered by installments spread over
the time until each employee retires.

 Actuaries must make reasonable assumptions about interest
 rates, mortality rates, employee turnover, retirement ages,
         salary scales, and administrative expenses.

 In a defined benefit plan the employer’s contributions must be
determined actuarially. Actuaries must make reasonable assumptions
about interest rates, mortality rates, employee turnover, retirement
ages, salary scales, and administrative expenses. Although this is not
an exact science, those who work with pension plans become very
good at estimating. These assumptions and benefit levels determine
estimated costs of the plan; the final cost will depend on how reality
meets estimations.

  When judging the actuarial soundness of a pension fund, not only its
liabilities must be viewed, but also its assets. Valuation of assets
requires that realistic values be placed on the fund assets. Some
types of assets are difficult to value, such as real estate holdings or
unsecured notes.

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  Defined benefit plans require some specific elements for adequate
funding:
  1. Reasonable funding standards,
  2. Realistic actuarial assumptions for measuring liabilities, and
  3. Sound procedures for valuation of assets.

  Defined contribution plans do not need actuarial estimates since
contributions determine what the worker will receive at retirement.
Contributions are determined by the plan agreement, usually being a
percentage of the employee’s earnings. Even though there is no
actuarially computed employer contribution that does not cause the
plan to be unsound. As long as the employer makes the required
contributions, the plan is fully funded and the employee has the
security the plan promises. Once the employee retires the amount he
or she receives from their pension plan will be determined by the
amount that has accumulated in the account and the mortality,
interest, and expense assumptions used to determine the benefit per
$1,000 of accumulations.

  Under a defined contribution plan, contributions are segregated and
used to finance the employees’ retirement benefits through immediate
payment either to a life insurer or a trust (a trust is usually situated
with a bank). If an insurer is used, funds are typically deposited in
one of two ways: (a) in a series of single premium deferred annuities
for each employee’s retirement or (b) they are invested in various
ways until the employee retires. If an annuity was used, retiring
employees will receive a pension amount equal to the sum of the singe
premium annuities purchased on his or her behalf during their
employment.

 If pension contributions were paid to a trustee, funds may
accumulate, with the trustee purchasing immediate lifetime annuities
at the time of the employee’s retirement or the trustee can accumulate
pension funds, bypass the insurer, and pay lifetime annuities from
these funds directly to the retired employee. The amount paid by the
annuity, whether through an insurer or privately held by the trustee,
will depend upon the amount accumulated, current interest rates,
mortality, and expense assumptions made by the trustee’s consulting
actuary.


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 It is important that employers use assumptions to determine
   retirement benefits rather than rely solely on predictions
             determined by employer contributions.

  Since the employer must meet certain requirements under ERISA, it
is important that they use assumptions to determine retirement
benefits rather than rely solely on predictions determined by employer
contributions. Using statistic assumptions reduces the employer’s risk
of failing to meet ERISA’s funding standards. Since ERISA, 80 percent
of new plans have been defined contribution plans rather than defined
benefit plans. Many existing defined benefit plans shifted to defined
contribution plans as well.

  Why are companies shifting over to defined contribution plans? It
would seem simple enough to meet minimum funding standards for
defined benefit plans (which state in specific dollar terms how much
will be received in retirement) but that is not necessarily the case.
Minimum funding calls for full funding of current service costs when
incurred and full funding of any supplemental liability over a
designated period, usually ten to thirty years. A pension is a long-
term financial commitment, subject to changes in the law and outside
influences beyond the company’s control. There may be mandated
changes in the pension plan benefits, costing the employer more than
anticipated. There may be actuarial experience that deviates from the
original assumptions, which affect the pension. Revaluation might
occur that affect the actuarial assumptions that were originally made.
Current changes could also affect future assumptions making the cost
higher than anticipated or planned for. Because a pension is a long-
term commitment, today’s costs affect the plan’s effectiveness for
years.

          Pensions usually include two cost elements:
             normal costs and supplemental costs.

  Techniques for spreading pension costs are called actuarial cost
methods. While it is more complicated than we will go into, in simple
terms they are the accrued benefit cost method and the projected
benefit cost method. Pensions usually include two cost elements:
normal costs and supplemental costs.



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 Normal costs are the annual costs of funding current service
benefits.  Supplemental costs are those of discharging the
accumulated liability for service performed in the past.

 There are several cost methods used. One of these is the accrued
benefit cost method, which assumes that an employee earns a
precise unit of benefit for each year of eligible service. Ineligible
periods would not affect the equation. The current or normal service
cost for each year is the benefit earned times the cost of that benefit.
This does not necessarily produce a level annual pension charge
because as employees age, the cost of providing employee service
benefits typically increases. Only when employee turnover produces a
constant age distribution and the supplemental liability remains
constant would the employer’s pension costs be a level annual charge.
Both conditions are unlikely to exist.

  Under the accrued benefit cost method each benefit is fully funded as
it accrues. When this method is used, a precisely determinable benefit
must be allocated to each year of service. Usually the basis for
allocation is specified in the plan’s benefit formula.

 The accrued benefit cost method can be used even when the formula
does not precisely allocate benefits to each year of eligible
employment. In this case, the employer would make the allocation by
dividing the projected benefit by the number of years of remaining
service and a projected benefit. The employer’s allocation is not
scientific, so a better approach is to use the projected benefit cost
method. This method may be used either on an attained age or an
entry age normal basis. “Normal” means the typical age standard
used.

  When a projected benefit cost method is used, the pension is
funded with equal annual contributions. Normal and supplemental
costs are combined. The full cost is spread over the period elapsing
from the employee’s age when first eligible (attained age) for the
pension plan until retirement actually occurs. Contributions are level
and calculated to be sufficient to fully fund the supplemental liability
by the time the employee retires. Unless the plan is fully funded by
insurance or annuity contracts, the attained age basis will not meet
ERISA’s minimum funding standards because the plan is likely to
include employees with more than thirty years of remaining service.


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This extends the supplemental liability funding period beyond the
maximum years allowed.

     Contributions are level and calculated to be sufficient
            to fully fund the supplemental liability
               by the time the employee retires.

  Usually supplemental costs and normal costs are handled separately
using the entry age normal basis. In computing current service
(normal) costs, this basis assumes that costs accrue before the plan is
installed and that the employer has funded past service benefits for
each employee from the time he or she first became eligible to
participate in the pension plan. Of course, this begins the plan with an
initial past service supplemental liability. The current service cost
would be lower because it is computed at the employee’s lower entry
age rather than the higher attained age. The initial supplemental
liability offsets the lower current service cost. The employer’s annual
pension cost is a level contribution sufficient to cover current or
normal service cost and at least the amount required to fund the initial
supplemental cost in equal payments over thirty years.

  So far, it has been assumed that the cost for each participant’s
projected benefit has been separately calculated with the employer’s
total cost being the sum of these calculations. This method is called
the individual projected benefit cost basis.           An aggregate
projected benefit cost basis can be used to compute the employer’s
annual pension cost without identifying particular employees. The
aggregate level projected benefit cost basis requires fewer
computations than the individual basis. Employees are divided into
age groups, usually banded by five-year increments. Computations
are made from the midpoints of each group.

 When a bank or individual trustee is the funding agency, the plan is
called a trust fund plan. When a life insurer is the funding agency,
the plan is called an insured plan. When both agencies are used, the
plan is called a split-funded plan.

  In trust fund plans, employers give the contributions to a trustee who
invests them and pays the benefits according to the plan’s
specifications.    The plan is suitable for employers with sufficient
employees to predict mortality within an acceptable range and who are
financially able to handle losses that could occur if mortality

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experience goes beyond the anticipated range. The trust fund plan is
popular with multi-employer and union pension plans.

   Guarantees made by the insurer depend on the insurance
     contract selected, often called a funding instrument.

  With an insured plan, employers transmit the contributions to an
insurer who invests them and pays the scheduled benefits.
Guarantees made by the insurer depend on the insurance contract
selected. This contract is often called a funding instrument.

  When insurers are the pension funding agencies, two types of
funding instruments are used:
  1. Allocated Funding Instruments, where cash value life
     insurance or deferred annuities are immediately purchased for
     each participating employee, and
  2. Unallocated Funding Instruments, where the funds
     accumulate and are used later to purchase immediate annuities
     for employees upon their retirement and pay any contractual
     benefits due to terminated employees.

  Allocated funding instruments have three forms: individual life or
annuity contracts, group permanent life, and group deferred annuities.
Unallocated funding instruments include group deposit administration
contracts, immediate participation guarantee plans, and guaranteed
investment accounts. Unallocated funding instruments grew from the
efforts of insurers to improve their competitive position among banks
and other pension funding agencies.

     Unallocated funding instruments grew from the efforts
        of insurers to improve their competitive position
       among banks and other pension funding agencies.


At Retirement

 Even though today’s society typically has two working partners, it is
not typical for both to have earned a pension. In many families, the
wife does not have continuous employment because she worked
between pregnancies, took time off to care for an ill parent, or left to


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follow her husband’s career as he moved around the country pursuing
better pay or opportunities. Many women do not begin a vesting
period until later in life when children are independent and the
husband has settled into a permanent job. Because she no longer has
the time to invest in a long-term job, if she earns a pension it will be
small compared to her husband’s – if he is lucky enough to have one.

 Most professional financial planners no longer factor in a company-
sponsored pension. It is simply wiser to save as though none will
exist. If a pension is present at retirement it is always better to have
more than expected rather than less.

  When a couple retires with a pension some decisions must be made.
The first will be whether to receive the pension for the life of both
spouses (receiving a lesser monthly amount) or to waive the pension
for the spouse following the worker’s death and receive a higher
monthly income. The amount of the reduction for covering both lives
will depend upon some elements involved – especially the age of the
worker’s spouse. If the spouse is considerably younger than the
worker it can have a dramatic impact on the monthly income
reduction. Usually it is possible to expect a 20 percent monthly
reduction in pension payment, but a much younger spouse will make
the reduction greater.

 Insurance agents often suggest that the higher pension be taken,
waiving the pension on the spouse. Then purchase a life insurance
policy on the life of the worker paying the premiums from the extra
monthly income received. When the worker dies, his or her spouse
receives the insurance proceeds. If the spouse dies before the worker
he or she can surrender the policy, taking any cash value, and
continue to receive the higher monthly income.

  While the insurance policy sounds like a sensible avenue the future
cannot be predicted. The pension income is a sure thing while
continuing the life insurance policy premiums may not be. If premium
rates are not guaranteed to stay at a specified dollar amount,
increasing age may cause the premium level to become unaffordable.
Inflation may cause even a level premium policy to become
unaffordable. As the value of the dollar declines, the worker may find
that he or she is no longer able to pay the premium, even though they
took the higher monthly pension income. A lapsed premium means no
protection for the non-pension spouse. If the choice comes down to

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purchasing food or healthcare or continuing the policy, the policy will
lapse.

  If the retiree is not able to maintain the policy, it may lapse,
    losing any protection offered to the non-pension spouse.

  When a life insurance policy is kept active, the surviving spouse will
collect the proceeds once the insured dies. Many spouses, however,
find that the proceeds are not adequate to last for her remaining
lifetime. Additionally, receiving a lump sum, as is usually the case,
may not be invested wisely providing a continuing monthly income.
Statistically, when a lump sum is received from any source (life
insurance, court settlement, or lottery winnings) a great deal of the
money is initially wasted. It may be a child that needs the down
payment on a house; it may be a dream vacation that becomes very
extravagant, or a luxury item that would not otherwise have been
purchased. Whatever the reason, if the life insurance settlement is not
invested into an annuity or other vehicle that will continue providing
adequate monthly income, the spouse may find herself without the
amount of income the pension would have provided.

  While many of today’s workers want to retire early, some companies
are hoping workers will do so. They may even tempt higher paid
employees with early retirement incentives.         Companies have a
financial reason for doing so.      Even though they may give the
employee a cash incentive, the cash will be far less than it would have
cost the company to keep the employee, paying not only wages, but
also health benefits, and various payroll taxes on their behalf. In most
cases, these early retirement incentives are offered to employees
between the ages of 50 and 60 but it will vary depending upon the
situation and the company.

  Almost every company pension plan provides for early retirement.
Most of them cut early retirees’ pension income by less than the
actuarial tables would mandate. Even so, the difference in payments
can be substantial.

  What many workers also fail to realize is that their pensions would be
higher had they continued working, continuing to build up their
pension accruals. When the cut in benefits for early retirement is
combined with the loss in pension accruals (which contribute to the
final valuation of monthly pension income) the actual loss could be as

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high as 75 percent. In other words, the retiree receives only 25
percent of what they would have received had he or she had waited to
retire until age 65.

    Most people will need between 70% and 80% of their
pre-retirement income to maintain a similar standard of living.

  Money managers believe most people will need between 70 percent
and 80 percent of their pre-retirement income to maintain a similar
standard of living. Inflation will certainly play a role. While it is not
possible to know exactly where inflation will be, most managers use a
rate of 4 to 6 percent when evaluating future needs. An individual
who has not yet retired may not realize some future expenses, such as
paying for health care over a long period of time. In fact, one of the
most overlooked expenses is for long-term nursing home care. A
healthy 50 year old may not consider his health at age 70 or 75 when
this type of care is often needed. The longer one expects to live, the
more likely that some form of long-term nursing care will be needed.
Many people end up in the nursing home not due to illness, but due to
frailty, resulting from simple old age.

  We often hear working individuals say their retirement is the home
they will have acquired and paid for. While there are programs geared
towards providing income from home equity, all of us must live
somewhere. Therefore, even if a home is sold, another must be
purchased or monthly rent must be paid. It is better not to consider
one’s home when formulating retirement income. Again, if it turns out
that the home does provide a bulk sum of money or monthly income,
it will simply be additional to what already exists. More is always
better than less.

  Any time the combination of company pensions added to Social
Security falls below what will be needed to live in retirement, the
difference must be made up. Without personal savings to make up
this difference, retirees may find themselves returning to work. Some
retirees discover they prefer working, but no individual wants to be
forced back to work in order to have adequate income.

 Social Security penalizes those who retire early. At age 62, the
earliest age that Social Security benefits may be received, the monthly
payment is about 20 percent less than benefits that begin at age 65.


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As more and more people approach retirement, we may see the “full”
retirement age continue to be pushed farther back.

      We may see the “full” Social Security retirement age
             continue to be pushed farther back.

 Around 70 percent of pension plans allow the worker to take their
retirement funds in a lump sum settlement. Some individuals believe
they can do more with their money than the pension plan will.
Additionally, many people no longer have confidence that their pension
will remain solvent and available. Even if the pension does remain
strong and well managed, we can understand why Americans may feel
this way. We have seen multiple examples of unethical company
behavior.

  When a lump sum seems advisable, it is very important that the
money be moved in its entirety into a vehicle that will provide
continuous income. If even a portion is used for any other purpose, it
may defeat the purpose of the pension – to provide retirement income.
It is also best to move directly into another vehicle to prevent taxation
of the withdrawn income. Having the money moved to an Individual
Retirement Account may be the best choice so that the funds never
touch the worker’s hands.




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                              Chapter 8


         Other Financial Options


  Since many Americans will not have a pension at retirement from a
former employer they must accumulate their own retirement. The
only way to do this is by putting away money and assets for use
during retirement.


Individual Retirement Accounts (IRA)

 An Individual Retirement Account is a type of personal pension
created by the individual for their own use once they no longer work.
Congress first sanctioned IRAs in the early 1970’s. Until 1982 IRAs
were for people who did not participate in a company’s pension plan,
but now they are available to everyone within specific financial
guidelines. Those who wish may open an account through a bank,
savings-and-loan, brokerage house, or insurer for the express purpose
of setting aside funds for retirement. The institution must comply with
IRS regulations for IRAs. When the traditional IRA is used, the income
placed in the vehicle is deductible from the individual’s yearly
earnings. Taxes will be paid upon withdrawal. That is not the case for
a Roth IRA but the proceeds are tax free upon withdrawal. IRAs are
immediately vested because the funds belong to the depositor – not to
any employer or pension fund.

  The Economic Growth and Tax Relief Reconciliation Act of 2001
changed the contribution limits on the Traditional, Roth, and Education
IRAs. In 2005, an individual could contribute up to $4,000 to their
Traditional or Roth IRA. That figure rises to $5,000 in 2008. From
that point on the amount will be adjusted annually for inflation in
increments of $500. It is the desire of the government to encourage
Americans to save for their retirement. American taxpayers cannot
continue to support those who did not adequately plan for their needs
in retirement (including not only income, but also health care such as
long term care needs).


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 For those who are 50 years old or more there is also the ability to
catch up by contributing larger amounts. These larger contributions
are called “catch-up contributions.” As of 2006 those who were 50 or
more could contribute up to $5,000. This rises to $6,000 in 2008.

  The wider the spread between a person’s tax bracket while working
and the tax bracket in retirement the more valuable an IRA is. The
IRA is tax-deferred so the money grows without the negative effects of
taxation. The traditional IRA will have taxes owing when the funds are
withdrawn.

  The wider the spread between the working tax bracket and
     retirement tax bracket the more valuable an IRA is.

 Individual Retirement Accounts should not experience withdrawals
until age 59 ½ or later. IRS penalties exist on withdrawals prior to
that age. The holding institution might also levy early withdrawal
penalties.

  The earlier one begins to use an IRA the more it will pay at
retirement. This might seem obvious since time is an important
element in any long-term savings plan, but a surprising number of
people do not use an IRA until later in life. The earlier one begins to
save for retirement, the less he or she actually has to deposit since
time, compounding power, and tax deferral will do most of the
accumulation work.

  Not all Individual Retirement Accounts are created equally. Some
institutions may impose management fees, accounting fees, or other
costs. Any fees rob the IRA of accumulation so all fees should be
investigated.    If an institution seems to impose more fees than
necessary it should be avoided.


Keogh Plans

 Not everyone can utilize a Keogh plan. Only self-employed persons
may use a Keogh plan. Keogh plans have lids on the maximum
amounts that may be deposited but those lids are much higher than
those imposed on IRAs.


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  Like many other retirement plans, Keogh plans need a trustee. Often
the trustee selected is a mutual fund, bank, brokerage firm, or an
insurer. It makes sense to use a flexible trustee in order to allow
more flexibility in the investments made. It must be understood that
more investment flexibility also means higher management fees.

 When a self-employed person sets up a Keogh plan, he or she must
also set one up for eligible employees and make minimum
contributions on their behalf. If a partnership exists, it would be the
partnership that sets up the Keogh plan, not an individual partner.

 IRAs, Keogh plans, pensions, and annuities all use the same
principle. Money is set aside during the investor’s working years into
some type of growth fund. The gains are not immediately taxed,
which allows for more rapid growth of assets. Upon retirement the
money is withdrawn by selecting some payout option. Part or all of
the money will be taxed as it is withdrawn.


Simplified Employees Pension Plans

 A simplified employees pension plan (SEP) requires that one be the
company owner. Any type of business may use a SEP. It may be a
corporation (whereas a Keogh plan may not be used by a corporation),
a sole proprietorship, a partnership, or a tax-exempt nonprofit
organization. The primary point in a SEP plan really is its simplicity.
Unlike a Keogh plan, there are no forms to file with the IRS and no
annual reports required. There is no trust agreement involved. The
business owner must issue each employee a notice provided by the
IRS telling them what the basis is for the contributions (usually a
percentage of earnings). The owner must be fair to all. Whatever he
or she does for his or her own SEP account must also be done for all
employees. In other words, if the owner deposits 5 percent of his or
her earnings into the SEP account, that same percentage amount must
also be deposited into the accounts of all eligible employees.

     A primary reason for using a SEP plan is its simplicity.




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 It is not necessary to make contributions every year. Failing to
deposit in any year or series of years will not affect the standing of
each SEP account. Nor will it affect the tax shelter.

  An employee that is 25 years of age or more and who has been
working for the business owner for three or more years is eligible for a
SEP account. Each eligible person must establish an IRA in his or her
name. There are contribution maximums, but these are higher than
that for an IRA. Although the business owner must contribute as
much to his or her employees as is contributed to their own account, it
is possible to offset that contribution by the amount paid into Social
Security on behalf of the employee. This can mean a dramatic
reduction in the SEP contribution.

An employee that is 25 years old who has been working for the
     business owner for three years is eligible for a SEP.


Incorporation

  When a person is self-employed a business typically exists that must
be considered for the purpose of estate planning. When the individual
is a one-person operation the business relies on him or her to stay
intact. If the individual becomes ill and is unable to work this will also
affect their financial standing. Small business owners should always
consider purchasing disability insurance on him or herself for financial
protection.

 Many self-employed people choose to incorporate. While people can
obtain the paperwork and complete the incorporation process
themselves we recommend that either an attorney or accountant be
consulted.

  Use of a corporate pension plan is often a reason for incorporating a
business. An individual is not allowed to borrow from a Keogh plan or
an IRA, but may borrow from a corporate pension plan (depending
upon plan documents). There are three primary reasons why an
individual might wish to borrow money from a corporate pension plan:
   1. The personal need for cash is so great that the individual cannot
      afford to take the smaller salary that would be left after the
      corporation made the maximum contribution. In this case, the

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     corporation could still make the maximum contribution and the
     individual could borrow the amount of cash needed back from
     the plan. The business retains the tax advantage and the
     business owner gets the cash through a pension loan.
  2. In the following years the individual pays interest on the loan,
     which can be deducted from his or her personal taxes, while the
     pension plan pays no tax on the interest it receives. The result
     is a tax deduction for the individual without an offsetting tax
     increase elsewhere.
  3. If the loan carries a higher interest rate than the plan could earn
     elsewhere, the extra interest paid is simply a way of getting
     additional money into the tax shelter. This may mean it would
     be beneficial to pay the maximum plausible interest rate that is
     defined in the contribution plan.

 There are other reasons for incorporating a business. A corporation
may be taxed at a lower rate than an individual. A tax accountant can
advise on this.

           A corporation may be taxed at a lower rate
                   than would an individual.

  Some double taxation can result from incorporating. In the case of
an insurance agent, the corporation will be taxed as it receives income
from commissions paid to it. If the agent is an employee of the
corporation, he or she will again pay taxes on the money the
corporation pays them in the form of wages.

  There are    many   reasons    why    an    individual   may   choose   to
incorporate:
  1. It is a small business needing the tax advantages and protection
     a corporation offers.
  2. It is a professional practice.       Doctors and dentists routinely
     incorporate.
  3. It is an independent contractor providing any type of consulting,
     sales, or services to other companies.
  4. It is currently a partnership and the partners want the protection
     a corporation would give them. Partnerships carry great risk


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     when one partner suffers personal financial problems that may
     be brought on by divorce, bankruptcy, or lawsuit. Creditors and
     even divorcing spouses can reach into the partnership affecting
     everyone.
  5. It is primarily a business of lending.  This might include
     mortgage lending, buying contracts, or any type of lending
     business.
  6. The business contains income properties. Rental properties work
     well under a corporation. However, most professionals do not
     recommend that the corporation actually own the properties, but
     rather merely act as a managing company for them.

  The business owner could be the sole stockholder. When only one or
a few closely tied people own the corporation’s stock it is called a
closely held corporation. The stockholders could also be employees
if they wished, with the corporation paying them a salary.

     A corporation whose stock is held by only a few people
              is called a closely held corporation.

  If a corporation’s shares will be part of an estate, it must be noted
that closely held corporation shares are very hard to value and could
delay estate settlement. There is likely to be disagreement on values
between the IRS and beneficiaries, with the IRS wanting to tax at a
higher rate and beneficiaries wanting a lower rate established. Since
closely held corporations are not likely to have had shares previously
sold or traded, no market value has been established.

 While there are ways of valuing closely held corporation shares that
does not mean that the dispute between heirs and the IRS will be
solved. Many estate professionals feel the corporation should be
valued prior to a major stockholder’s illness or death by someone who
has credentials in such matters. While the IRS is not required to
accept the valuation, it may help prevent a lengthy fight over value.

  There is no single way of valuing closely held stocks, but most use
similar methods when doing so:
  1. Balance sheet and earning statement ratios will be
     considered by nearly everyone valuing closely held stock. While



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   averages may be misleading (since current business climates
   can greatly affect values), they will be a good starting point.
2. Future earning capacities may be difficult to predict precisely
   although professionals will make a determination regarding the
   capitalization rate of return at which an investor is willing to
   invest, assuming the corporation is capitalized at the going rate
   for its type of company. There could be a great deal of risk that
   should be factored in, especially if the deceased was a major
   player in the corporation. An agent-owner who dies may have
   been the major reason capital came into the corporation. IRS
   will assume that if a comparable company is returning 7 percent
   to its investors and most elements are approximately equal, this
   corporation should also have the ability to return 7 percent.
   The heirs may realize that they must bring in a salesperson at
   least as good as the family member that died. The heirs will
   also realize how difficult this might be to achieve whereas IRS
   will either not be aware or choose to ignore this fact during
   valuation of the corporation.
3. Corporation assets will partially determine its worth.
   Obviously a company that owns assets has some measure of
   security and worth. In some cases, the corporation has a better
   value if it is liquidated than it would have by valuing stock. For
   example, if the company has a large block of business on the
   books, but the death of the owner makes maintaining that
   business difficult, it might be better to sell the block of business
   to another company and terminate the corporation. In other
   cases, there are no actual financial assets, but the good name of
   the corporation carries value.
4. Comparison to other like companies is a common way of
   establishing a corporation’s stock value. When stock has never
   been sold this may be the only realistic way of establishing a
   value. There should be caution taken however, since all types
   of business experience ups and downs. If the corporation is
   currently up, it may not give a reliable value if a down time is
   coming soon. These ups and downs may be tied to many things
   such as time of year, current political climates, or even popular
   trends. If the IRS is doing the value comparison, the estate
   executor should follow their comparisons. There have been
   many cases where the comparisons made by the IRS were
   grossly unfair to the estate beneficiaries.


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  5. The importance of the deceased business member has a
     great deal to do with the value of the corporation. If the
     founder of the business is no longer part of it, will this affect the
     company’s future?
  6. The extensiveness or narrowness of the product sold will
     affect the value of the corporation. Some companies exist
     solely due to the existence of another company. For example,
     around Boeing Corporation huddle a number of smaller
     companies that exist purely because Boeing exists. If Boeing
     were to close their doors or relocate, many of those small
     businesses would also close or be forced to relocate.
  7. Debt or other financial commitments affect the corporation’s
     value. A company that is heavy with debt may struggle for
     years before the debt or other commitment is satisfied.
     Anytime a corporation has financial obligations or tax liabilities it
     affects the stock’s value.
  8. Shareholder disagreements will affect a corporation’s value.
     There have been cases where divorce has nearly bankrupted
     companies as the two major shareholders (husband and wife)
     tried to maintain control during their divorce. If legal litigation
     is involved it is always worse than personal disagreement
     among stockholders, although both will bring down a stock’s
     value.
  9. Dividend records, if they apply to the corporation, will be
     attractive to investors. Therefore, if the corporation issues
     dividends it may raise the value of the corporation’s stock.
  10. Quantity of customers is always an indication of value.
      Whether the company is an insurance agency, a manufacturing
      company, or a grocery store, the more customers it has the
      greater the company’s value will be.

 Many things affect stock values, but if the IRS is the one performing
the evaluation, beneficiaries will want to know precisely how the
numbers were arrived at.

              When a corporation issues dividends
        it may raise the value of the corporation’s stock.




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  Many companies have minority interests. Minority interests in a
closely held corporation are those who hold shares, but not enough to
be able to affect company policy.

      For example:
       John and Joan are the majority shareholders, each having
      40 percent of the stock. Their two children were given 10
      percent each.      When John and Joan begin divorce
      proceedings, their two children had no ability to affect
      what happened to the company because their minority
      holdings totaled only 20 percent of the total stock.

  If the children wanted to sell their stock in order to get out from
under the turmoil, there would be little value in their stock because the
amount they hold has little effect on company policy. This is especially
true when the founding shareholders hold the majority of the stock
and have a personal relationship.


S-Corporations

 S-Corporations have elected to have its income, deductions, capital
gains and losses, charitable contributions, and credits pass through to
the shareholders. It is treated somewhat like a partnership for tax
purposes.

                 An S-Corporation is treated
          somewhat like a partnership for tax purposes.

 An S-Corporation might be appropriate for several reasons:
   1. An S-corporation can provide legal protection from creditors
      while allowing business losses to be personally deducted by the
      shareholders.     Corporate losses are passed through the
      corporation and deducted on the individual shareholder’s tax
      returns, but only to the extent of the adjusted basis of their
      stock in the corporation and any loans made to the corporation.
   2. If a business has a period of loss during the first five years of
      starting up, the S-Corporation can help absorb them. Once the
      business begins making a profit, the S-Corporation status
      would probably be terminated. Future profits would then be


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       taxed to the corporation, since it would be likely to have a
       lower tax rate than the individual stockholders.
   3. S-Corporations do not have the double taxation problems that a
      C-Corporation has. Under an S-Corporation stockholders take
      out all corporate income so avoid the double taxation that
      would otherwise occur under the C-Corporation. Of course,
      stockholders must still justify their withdrawals as reasonable
      compensation.     S-Corporations usually have no tax at the
      corporate level. A tax consultant should always be involved in
      these decisions. This course is not intended to offer personal
      tax or legal advise.
   4. An S-Corporation is often used when the benefits of
      incorporation are desirable but the shareholders are in a lower
      tax bracket than the corporation.


Estate Planning Tools

  Financial planning must always include the legal instruments that
follow our deaths or affect how we will be treated just prior to death.
There are several types of legal tools that this could include:
   1. A living will;
   2. A durable power of attorney;
   3. A competency clause;
   4. Appointment of a conservator;
   5. A catastrophic illness provision;
   6. An assignment of personal effects or special items;
   7. Appointment of guardians, if applicable (this might even include
      a guardian of a beloved pet);
   8. Anatomical gifts; and
   9. A separate property agreement.

 There may be additional items that are useful. Each state may also
have laws that make one financial tool or another especially important
which is why it is necessary to draft wills and trusts according to the
state where probate will be performed.

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   The living will may also be called the “right-to-die” clause.

  Living wills are often used, especially when an individual fears living
life as an invalid. The living will may also be called the “right-to-die”
clause. There was a time when these were easily challenged but, due
to those challenges, they are now drafted following state and federal
laws, making a challenge much more difficult. The living will has
become so widely accepted that those entering a hospital or nursing
home may now be requested to produce it for the institution’s files.
Having it on file prevents resuscitation measures when they are not
legally appropriate.

  The durable power of attorney is specifically designed to allow an
individual to name another person to act on their behalf if they
become incapacitated or incompetent. It must be drafted while the
individual is neither incapacitated nor incompetent. There is also a
power of attorney that is viable only while the individual is
competent.

                  A durable power of attorney
          Begins when a person becomes incompetent.
                      A power of attorney
          Ends when the person becomes incompetent.

 A durable power of attorney can vary, depending upon state laws. If
an individual changes residence his or her durable power of attorney
should be rewritten.

  A competency clause allows a specified person, usually a family
member, to continue to handle the daily activities that are necessary
to life. This would include such things as buying, selling, or moving
assets and paying monthly bills. Without such a clause, a family
member would have to go to court to establish this ability. Many
people add a child on to their checking account to allow this without
having to go to court or filing a competency clause.

 When a competency clause is used, it requires two doctors to agree
that the person has become incompetent before the clause would
become effective. The competency clause may even name the two
doctors that must be used.



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  The appointment of a conservator document names the person
who would be responsible physically for the creator of the trust or will
if incompetency develops. This is not the same as a competency
clause that names an administrator for the assets. The conservator
document is designed to assign a person who will control the physical
safety and well being of the document creator. It is likely that the one
who is assigned to handle the assets would not be the same person
assigned to handle the physical well being of the person. Having two
separate people avoids potential conflicts of interest. The person
appointed to care for the person is usually a family member having a
close bond with the document creator.

 The catastrophic illness provision applies specifically to married
couples with an A-B living trust. This provision is used to preserve a
couple’s assts should one of the two need prolonged medical care. At
the onset of illness the couple’s assets are divided in half so that only
one half of all assets would be depleted.

  Some types of assets do not have a legal title, as a car or home
would. Personal effects may or may not have a monetary value, but
they are often important to the owner and to potential beneficiaries.
Whether it happens to be Grandma’s special set of china or just a
picture painted by Uncle Charlie, anything of importance should be
specifically mentioned in a trust or will so that the appropriate
beneficiary will receive it. Many professionals recommend that such
items be given away prior to death. This eliminates any doubt that it
will go to the desired person and prevents any disagreements following
one’s death.

  Many professionals recommend that personal items having
  sentimental value be given away prior to death if possible.

 Guardianship appointments are typically used when minor
children or persons who are considered incompetent are involved.
There are two types of guardians: those who care for a person and
those who handle assets. Nominating guardians in a will or trust does
not automatically guarantee that they will accept the appointment. It
also does not automatically guarantee that the courts will approve the
person named although courts do try to carry out the decedent’s
wishes if possible and practical. Individuals that were named may not
be able to accept the position for many reasons or they may simply
not wish to take on the responsibility.

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  The person named as a guardian for a person may not be a good
choice to also guard the assets. Most estate professionals recommend
that two separate people be named: one to make decisions for the
good of the child or handicapped individual and a different person to
make decisions for the good of the assets. Aunt Sarah, who loves the
child, may not have the background or instincts necessary to also care
for the assets that will provide for the child. Therefore, while Aunt
Sarah is an excellent choice for providing the love and security that
the child will need, a trustee at the local bank may be the best choice
to perform the financial guardianship.

 Anatomical gifts allow vital organs to be used to save the lives of
others. It is possible to donate one’s entire body if that is their wish,
but especially organs such as the heart or kidney are important to the
continuance of life for others.

 Separate property agreements are often used when either or both
spouses have been previously married.      This agreement requires
specified assets to go only to the children rather than the current
spouse.

     Separate property agreements require specified assets
       go only to children rather than the current spouse.


When Death Occurs

  When a person dies, the estate goes through whatever course of
action is required by the domicile state. Assets located outside of the
domicile state will proceed by the laws of the state where they are
located.

 While there will be some variances among the states, the general
steps are consistent:
   1. The executor must collect all assets.
   2. A value must be placed on each asset, including those placed in
      a revocable living trust.
   3. Enough assets must be converted to cash to pay debts, cash
      bequests made in the will, taxes, legal fees, executor’s

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      commissions and other legal expenses. Advertisements must be
      placed regarding the death and several months must pass
      allowing any person or company to file debts against the estate.
      If the estate is large, taxes will likely be the major cost. In small
      estates, expenses are more likely to be the major cost.
   4. The remaining property must be distributed to the beneficiaries.
      Property held in joint ownership, property held in trust, life
      insurance proceeds, and employee benefits that were not
      included in the distributed property due to beneficiary
      designations would pass outside of the probate proceedings.

  Property that passes to beneficiaries outside of the will (because they
listed a beneficiary) may incur expenses in connection with the estate,
but they are not necessarily available to pay taxes and expenses
incurred during probate. When an asset does not list a beneficiary it
will go through the probate process. Some types of assets could have
bypassed this process had a beneficiary been listed so it is important
to list them whenever possible. These assets would include (but may
not be limited to):
   1. Items held in joint names;
   2. Items that offer a specific beneficiary listing such as an annuity;
   3. Death benefits in pensions and profit sharing plans that have
      beneficiary listings available;
   4. Deferred compensation to be continued by an employer to a
      spouse; and
   5. Life insurance payable under optional modes of settlement.

 Even estates that seem large to many people can go bankrupt when
the majority of the assets pass outside of the estate. This happens
when the tax liability exceeds the available assets or when taxes
coupled with outstanding debts exceed available cash.

            A well thought out estate plan will provide
          some means of supplying the estate with cash
             to settle final bills, taxes, and bequests.

 Most estate settlements require cash for debts, taxes, and other
death expenditures. Even the funeral must be paid for somehow if it


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was not prepaid. Any bequests made in the will must also be covered
even if it means liquidating assets. A well thought out estate plan will
provide some means of supplying the estate with some amount of cash
to settle final bills, taxes, and bequests. Some types of assets will
incur taxation even if a beneficiary designation allows it to pass
outside of the will.

 There are several ways to transfer property:
  1. If the decedent is married, keep all assts until death, at which
     time they would be transferred to the legally married spouse
     using a community property agreement.           The spouse will
     eventually transfer the assets to beneficiaries, probably
     children. There is no obligation to do so, however.
  2. Using a will, move assets into a trust with the income going to
     the spouse during their lifetime and, upon his or her death,
     giving the assets to children or other beneficiaries.
  3. Will half of the assets outright to the spouse with the remainder
     going to children or other beneficiaries after taxes, costs, and
     other debts have been paid.
  4. Will half of the assets to a marital deduction trust with the
     income payable to the spouse for life. Give the spouse an
     appointment over the principal, which means he or she has the
     right to say who receives them upon their death. The other
     half, or remainder, would go to a trust after all taxes, debts,
     and costs have been paid. The income from this trust would
     also go to the spouse for life and the principal would go to the
     children upon his or her death.
  5. The same as number 4 except that income of the second trust
     would go to the children, either being accumulated for them
     while they are minors or used for their support while they are
     minors, depending upon the specific circumstances. The spouse
     may have the ability to use part or all of the principal from the
     second trust if circumstances warrant it.
  6. Set up a revocable trust, which may be used to achieve any of
     the objectives of the previous distribution methods.
  7. Use a combination of both a revocable and an irrevocable trust
     to achieve virtually any distribution goal desired.



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   8. Use only an irrevocable trust which may be able to escape some
      or all taxation of the estate, but will likely result in gift taxes.
   9. Make use of gifts to children. Depending upon the asset value,
      some gift taxes could be levied.
   10. Depending upon the individual’s age, the shifting of capital into
       an insurance contract will increase the size of the estate. In
       addition, if the insurance contract is properly handled, the
       capital transferred and its increase in value may be shifted so
       that the impact of any federal estate taxes is lessened. In all
       cases, a tax specialist should be sought for specific advice.
   11. All or part of one’s assets may be placed in joint ownership.
       These assets would pass to the survivor outside of the probate
       process. The asset value would be subject to estate taxes
       unless the legal representative can show that the survivor put
       up all or part of the investment.
   12. An individual may escape both gift and estate taxes on any
       property or asset that is transferred to a member of the family
       in return for their promise to pay that person an annual amount
       for as long as the expected accumulated payments are basically
       the same value as the property transferred to the family
       member. There are some tax dangers if the family member
       fails to meet their obligation.

 No matter what type of strategy is used for estate settlement it is
very important to get current state specific advise from an estate
professional and a tax professional. This may be a single person or it
may involve more than one person.

  Since taxes are part of our estate (whether we like it or not) many
people advise the purchase of a life insurance policy to provide funds
specifically for the costs of probate and end-of-life expenditures, such
as medical bills and funeral costs. For this purpose, the beneficiary
listed in the life contract would be the estate. It will also provide cash
assets for bequests that may be desired in the will.

    Wills often pass assets directly on to listed beneficiaries.

 Wills often pass assets directly on to the listed beneficiaries but that
does not necessarily have to be the case. The will could:


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  1. Give beneficiaries the assets outright (the typical method);
  2. Use a “strict trust” that directs all or part of the assets to a trust
     at the time of death. The trust would then direct the assets as
     instructed in the trust document.
  3. Use a “marital deduction trust.” This would direct the assets
     into two equal trusts upon the decedent’s death, with income
     often going to the spouse from both trusts. The spouse would
     direct how the assets from one trust pass on after his or her
     death. This would be necessary to qualify the trust for the
     marital estate tax deduction.

 Each use of a will could produce different estate settlement costs.
Most professionals feel the outright transfer method produces the
greatest amount of taxes, however. Even so, each method has its
uses depending upon specific circumstances.

 The primary function of a will or trust is to fulfill the wishes of its
creator. The person who draws up the will or trust must be aware of
the desires of the creator. This means he or she must completely
relay their desires to the attorney or other professional who will draft
the document. Some attorneys and paralegals use a questionnaire in
order to cover every possible detail.            Some may utilize a
preprogrammed software program.           When this is the case, it is
important to fully discuss one’s desires since such programmed wills
and trusts often fall short of accomplishing the desired results.

              The primary function of a will or trust
               is to fulfill the wishes of its creator.

  When an appointment is made with a professional to draft a will or
trust the creator can prevent misunderstandings, omissions, and lack
of communication by writing down important information and desires
prior to the appointment. Bring this information to the appointment so
that nothing is forgotten. In addition, attorneys and paralegals often
charge by the minute so having this information already organized and
in a written form will save time, resulting in saved money.

  Specific items should be included in the list taken to the attorney,
including:
  1. The creator’s full name and Social Security number.

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2. The creator’s current address and telephone number.
3. A list of all living immediate family members, including spouse,
   children, siblings, and parents.
4. The full names of all beneficiaries and charitable organizations.
   It is very important that all names be accurate, especially if
   there could be any misunderstandings regarding the person or
   entity intended.
5. If available,   current     beneficiary     addresses   and   telephone
   numbers.
6. Funeral instructions. Many consider a prepaid funeral the best
   course to take. This allows all wishes to be adequately handled,
   including cost, prior to the actual death when price may be
   higher due to emotional decisions.
7. Directions for personal items, such as family heirlooms,
   antiques, jewelry, clothing, and anything else of importance.
8. Cash bequests.     Make sure there is adequate funding for
   bequests since they can affect other directives in the will.
9. Lists of real estate holdings, including complete addresses. If
   they are located in multiple states it may be necessary to check
   with multiple attorneys. It may be best to sell real estate
   located outside of the domicile state, putting the proceeds into
   an annuity or other easily transferred vehicle.
10. A statement of desired lifetime incomes for specific
    beneficiaries. This is often done when the creator does not feel
    a specific person is capable of handling a lump sum settlement.
11. Directions for the care of minor beneficiaries, including desired
    guardians of persons and the assets they will inherit.
12. Estate remainder divisions.
13. Trust property in the decedent’s possession.
14. Recommendations for selection of executors or trustees. Unless
    it is an institution or professional executor or trustee that will be
    paid to hold the position, any recommendations are just that –
    recommendations. The persons named are not required to
    accept the position.



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  Following the creator’s death, the will becomes their spokesperson.
A confusing or badly written will does not speak clearly so the creator
may not accomplish what he or she wished to. Even a well written will
can become obsolete, however, so it is important that the document
be updated periodically to comply with changes in the law or changes
in the person’s circumstances.

  What kinds of changes could change a person’s circumstances? Such
things as deaths in the family, marriage, divorce, births, adoptions,
changes in family finances or wealth, or any change that would affect
the wishes of the individual would apply. Once death has occurred it is
obviously too late to update an outdated will or trust. A will can be
changed as often as necessary, but constant changes reflecting family
turmoil should be avoided. Some feel their will should be a statement
of current family strife. Constant changes are made as they become
mad at Uncle Joe or when Aunt Connie suddenly becomes their best
friend.   A will is a legal document that needs to reflect logical
judgments based not on who is the current favorite but rather on
financial wisdom.

         A will is a legal document that needs to reflect
   logical judgments based not on who is the current favorite
                  but rather on financial wisdom.

  The will’s executor will take appropriate steps to continue a business
if one exists or to terminate it and distribute the proceeds if that is the
directive given. If the will directs that the business be sold, any
information relating to a sale should be provided.

  When a husband and wife die simultaneously, such as in an auto
accident, the executors will make a determination, based on available
information, as to which person died first.                The first-to-die
determination impacts asset distribution. If the wife died first, then
her will would be probated first, distributing as she saw fit, with the
husband’s will then distributing as he wished. If both were giving all
assets to their children it would not matter, but if their wills were
significantly different, it could impact asset distribution.

      For example:
       This is the second marriage for both Wilbur and Mary
      Thompson. Both have children by their previous marriage
      but no children from this union. Both Wilbur and Mary

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     have left their assets first to each other and secondly to
     their own children.

      An automobile accident takes the lives of both Wilbur and
     Mary. It is determined by the medical examiner that
     Wilbur died instantly with Mary dying three hours later in
     the hospital.

       Wilbur’s will gave everything to Mary first and his children
     second. Since Wilbur died prior to Mary his assets flowed
     to her estate. Mary’s will names Wilbur as the primary
     beneficiary but since he is deceased all assets then flow to
     Mary’s children including the assets Wilbur would have
     wanted his children to receive.       As a result, Wilbur’s
     children receive nothing.

  Some wills require that the spouse live a specific length of time
following their death, such as three days. Of course, even this could
fail to prevent fair distribution. For example, Mary could have lived a
week following the accident and then died. An estate professional
should be able to word a will to prevent such circumstances, but all
estate professionals are not created equal. Some are simply better
than others at drafting legal documents. The more knowledgeable the
creator, the more likely it is that his wishes will be carried out.

 American humorist, John Billings, has been quoted as saying: “It ain’t
what a man don’t know that makes him a fool, but what he does know
that ain’t so.”

 How does one find a competent attorney?             Unlike doctors who
generally specialize, attorneys often do all things legal. This does not
mean they are proficient at all things legal. There are thousands of
estate planners and attorneys to choose from. Any person can write a
will, including the creator (called holographic wills), so how does one
know a competent attorney or paralegal from an incompetent one?

  Surprisingly few attorneys are actually experts when it comes to
estate planning.       Certainly, he or she should have extensive
experience at doing so, but how does the layperson find out whom this
would include? The Bar Register, published annually, will list those
lawyers who are considered to be outstanding in their specialties, so
this is a good starting point.

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 The Martindale-Hubbell Law Directory lists every attorney in the
United States, rating him or her according to time in practice. The
assumption is that experience will bring about competence. Whether
or not this is true must be an individual decision. Their rating system
gives:
   1. An “A” rating for very high based on 10 years admission as the
      minimum required for receiving this designation.
   2. Five years is required for a “B” rating.
   3. Three years in practice is required for a “C” rating.

  Contacting a law school may offer some recommendations from the
faculty but this is not always satisfactory either. Faculty may have
favorites or may simply give a name they remember.

  Professional trust officers often know the top-rated attorneys in the
estate-planning field. They are also likely to know which lawyers
should be avoided although they are not likely to share that
information.

        If the executor was inadequate or not properly
    authorized by the will to carry out the creator’s wishes,
         it may fail to achieve that which was desired.

 It is common for costly wills and trusts to fail to do that which the
creator desired. Not because the creator didn’t try but because the
document drafter failed to properly state the creator’s wishes. In
addition, if the executor was inadequate or not properly authorized by
the will to carry out the creator’s wishes, it may fail to achieve that
which was desired.

  Every person of legal age needs to draft a will. Having said that, it is
equally important that the will be drafted logically, correctly, and as
simply as possible. Long documents solve nothing if the same could
be said in fewer pages with greater understanding.

  A will is each person’s opportunity to speak after his or her death. It
is their final statement regarding their family, friends, and causes that
were important to them. Asset distribution is their way of speaking to



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those people and causes they loved in life.            As such it should be
properly carried out.




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                               Chapter 9


          Ethics and Other Myths


 We hear a lot of talk about ethics these days. Everyone wants to
have ethical repairmen, ethical doctors, ethical lawyers, and ethical
politicians.  There was a time when a person’s handshake was
adequate to bind an agreement. Today we want to see the signature
on the dotted line. We no longer trust our fellow man’s word.

  It wasn’t always necessary to consider a person’s ethics.       An
individual that failed to keep his word was not respected and it was
unlikely that another would do business with him. A man’s word was
considered a valuable asset – perhaps as valuable as money in the
bank. People guarded their reputation. A handshake was just as good
as a signature. Proof of repayment method or service delivery simply
wasn’t necessary.

  But times change. Banks no longer loan on the basis of a man’s
promise. Service is no longer guaranteed, so agreements must be
printed. There is no longer social status linked to solid reputations. In
fact, our society openly accepts dishonesty. We know our children will
cheat in school; we accept a store’s error as our good fortune; we
reelect our politician despite proof of dishonesty. We complain about
the unethical attitude of today’s society, yet as individuals, we seem
unwilling to do anything about it.

  How have we digressed from accepting a man’s word to the trust-no-
one mentality? It could be said that we lost our innocence through
bad experiences. People were too often taken advantage off, or at
least often enough to spoil their trust.

 Is there any industry today that is considered consistently ethical?
Probably not; even scientists may be shaky, according to a poll of U.S.
researchers. They found that unethical practices are more common
and widespread in science than anyone might have believed, with
15.5% saying they changed the design or results of a study in


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response to pressure from their funding source.1 We no longer look up
to those who are honest. Instead we worship rock stars, billionaires,
and athletes. Admirable qualities in those we admire do not seem
necessary (wealth is more likely to be admired than honesty).

  Many industries seem to be trying to return to the days of honesty –
at least in the public’s perception of them. Some industries need to
from a financial standpoint. For example, some law enforcement
agencies have lost such vast sums in lawsuits that they must begin to
change their public image in an attempt to stop the financial losses.
The medical field has been so frequently targeted by lawsuits that they
now use stacks of legal forms for everything, including surgeries and
procedures (a handshake won’t hold up in court).

  Lawsuits have been the primary reason we have become a society of
mistrust and preventative measures. Somewhere along the line we
decided that no one was to blame for anything – it was always some
one else’s fault. From this attitude came a multitude of lawsuits. One
might believe that only valid claims would be rewarded but that has
not been the case. Juries are increasingly awarding vast sums to just
about anyone for any reason. As a result, many professions have had
to legally protect themselves through an endless stream of paperwork.

 As people have won lawsuits, others have decided to join in the
parade by suing anyone and everyone available. As lawsuits became
more prevalent, some of our ethical standards have dissolved. We can
no longer afford to base a business relationship on a handshake. Each
of us must protect ourselves so we now require signatures on a
contract that outlines everything from schedules to payments to faulty
workmanship.

 This does not necessarily mean we no longer have good ethical
standards, but it does mean that we cannot consider our fellow man
ethical. There is lack of trust and (let’s be honest) most people will
accept something more than they deserve without a guilty conscience.
We put up a good front for honesty and ethics, but few of us actually
expect to live up to what we ask of others. We may demand an ethical
repairman, but that does not stop us from cheating on our taxes.



1
    National Institutes of Health, lead author Brian C. Martinson

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  We put up a good front for honesty and ethics, but few of us
      actually expect to live up to what we ask of others.

  State insurance departments want ethical behavior too. They want
their insurance agents to care more about the state’s citizens than
about their own commissions. That’s a big order. Just like other
industries, it can be very difficult to monitor a large group of people
working independently among our consumers.

  As it relates to the insurance industry (and many other professional
groups), ethics is defined as “the formal or professional rules of right
and wrong; a system of conduct and behavior.” Much of this conduct
and behavior is mandated by the individual states. While we refer to it
as ethical conduct, much of what an agent may and may not do is
actually based on state and federal laws. What does this mean to an
agent? Agents who do not follow all legal requirements could be fined
for misbehavior or even jailed if the action was considered fraudulent.

      Ethics is defined as “the formal or professional rules
     of right and wrong; a system of conduct and behavior.”

 Ethics are a means of creating standards within our profession that
give it honor and respect. Many community leaders are doubtful that
a commission based industry, whether it is insurance or something
else, can ever be ethical. Since income is directly tied to performance
there is always going to be those who do not follow the rules.

  Additionally, we tend to have layered values. For example, we value
life but not evenly. People are the most valued with the various
animal species falling into different layers of importance below us.
Some philosophers say we can determine our level of compassion and
ethics by studying how we treat our animals, including those we plan
to consume.

 Another example of our varying codes of ethics has to do with telling
the truth. Most people would say they always speak the truth even
though statistically people lie all the time. Most of us do not tell lies to
hurt others. In fact, some lies are told to spare the feelings of others.
We have all probably told someone their new hairstyle is attractive or
they don’t look heavier when we actually think otherwise. Did we
actually spare their feelings or do damage by not being honest?


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                From a purely ethical standpoint,
    a lie is always wrong regardless of the reason it is told.

 Obviously, a hairstyle is not of great importance, but it demonstrates
how we layer our values. From a purely ethical standpoint, a lie is
always wrong regardless of the reason it is told. Perhaps that is why
our grandmothers said: “If you can’t say something nice don’t say
anything at all.” Of course, ethics are never totally black-or-white.
Some may feel hurting another is wrong even if a lie must be told to
prevent doing so. Ethics are about perceptions of right and wrong.

 Each of us determines what is ethically right for ourselves. There are
no hard facts that define ethical behavior. Ethical behavior is not
uniform from country to country or even between family members
(note the civil war). While the pure ethicist allows no shading of gray,
most of us know that there will be differences of opinion, and we
mostly accept those differences.       When a difference of opinion
adversely affects another, such as hate crimes, we have even put legal
consequences in place. It may not change a person’s view but we
hope it will change their behavior.

  The study of ethics is typically based on varying philosophies. In this
chapter we will attempt to primarily focus on the rules and regulations
that affect the insurance industry. From a practical standpoint, doing
so is very restrictive since even current laws evolved from past
incidents or practices.       Most industry laws develop to protect
consumers. Some felt it would be easier to banish the unethical agent
from the profession; others hoped establishing rules of conduct would
correct the problems. Many feel agents will be forced to conduct
themselves ethically due to the standards required of insurers (who
often have the task of enforcing insurance laws). Of course, for every
problem we think is solved, another one pops up to take its place.


Industry Knowledge

  Many industries require knowledge that would not be possessed by
the average person.      Professionals in these industries, such as
insurance, have knowledge that other individuals must rely upon.
Laypeople seek out these professionals in order to obtain products that


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benefit them and the goals they wish to reach. The consumer must
rely upon the professional’s honesty and integrity since the consumer
would not know if the professional was lying to them. A feeling of
ethical standards must exist.      It is the potential for abuse of
knowledge that provides a set of rules for ethical behavior in our
industry. Most agents are ethical people; it is the few who are not that
cause all of us to jump through the same hoops. Unfortunately, the
few who are not can cause lots of problems for lots of consumers.

  Codes of ethics may be either formal or informal. Formal codes are
the laws that govern us while informal codes of ethics are those
actions we know to be right, though not governed by law. Informal
codes of conduct often end up becoming formal as individuals fail to
follow them. There was not always a law against jaywalking. It was
assumed that individuals would use crosswalks.        When sufficient
numbers of people failed to do so, causing automobile accidents, it
became necessary to make a law forbidding the practice so that those
who failed to follow the rules could be punished. An informal code
then became a formal code in order to enforce the restriction.

    Formal codes are the laws that govern us while informal
     codes of ethics are those actions we know to be right.
              If we fail to follow the informal code
            it is likely to become law at some point.

 How can a state’s insurance department enforce codes for selling and
maintaining insurance contracts? Certainly the states can mandate
how contracts must be written.     Insurance is, in fact, the most
regulated of all industries. Why was all the regulation necessary?
Much of it came about because the public voiced its unhappiness at
some event or circumstance concerning their policy, their insurer, or
their agent.

  Some insurance regulation comes about not because agents are
unethical, but because our products might be used in unethical
circumstances. An excellent example of this is the results of a two-
year sting operation of money-laundering schemes involving
Colombian drug money (approximately $80 million). It was realized
that most insurance agents had no knowledge of money laundering
procedures, so they were often the unknowing accomplices of such
acts. In an effort to correct this situation, laws were passed requiring
agents and others in financial fields to acquire such education.

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  It is important to understand how strongly insurance products affect
a person’s financial standing. There would be no reason to purchase a
life insurance policy, for example, if there was no financial need for the
settlement possibilities it provides. When a consumer buys a life
insurance policy they anticipate it paying their beneficiary a benefit if
the insured should die prematurely. Upon death, if the benefit is not
paid, they potentially suffer a financial hardship. Therefore, the law
must make sure that the contract pays as promised.

  Parties do not always read a contract the same way. The buyer may
think he or she will receive something that the seller does not believe
is deserved. Contract language is a very important part of any
agreement and insurance is no exception. As a result, contracts must
be written in legal language, which can lend itself to misinterpretation.
That is why the insurance industry has traditionally relied upon the
agent to bridge the gap of policy interpretation. It is the role of the
agent to explain in lay terms the conditions upon which a policy will
pay a benefit. The agent must also explain in lay terms when a policy
will not pay. Therein lies the ethical problem.

  Agents want to sell the insurance contract’s best points. What are the
best points? They are always the conditions under which the policy
will pay the insured some money. It does not matter whether that
involves a health care policy, an automobile policy, or a life policy: the
buyer only cares about what triggers payment. Anything that prevents
payment is considered “small print.” Actually, law dictates that both
conditions of payment and conditions of denial are in the same size
font in the contract but consumers seldom believe this. If consumers
would read their contracts they might understand what will and will
not be paid, but policies are not always simple to comprehend even if
read (few people actually do read their policies).

    It does not matter whether that involves a health policy,
              an automobile policy, or a life policy:
       the buyer only cares about what triggers payment.

  Agents generally do a good job of describing what the buyer is
purchasing, but we must be realistic. The new car salesman does not
tell his potential buyer: “Yeah, it looks great on the lot, but as soon as
you drive off it loses several thousand dollars in value. You’d be better
off buying a car with a couple of years on it.” His job is to sell new

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cars. If the salesman were to tell a few customers that he would not
keep his job. No one would fault the dealership for firing him. It
would be understood that he was causing the company to lose
customers and the resulting income.

  Americans understand that a salesperson’s job is to sell an item,
whether than happens to be a car, a dress, or an insurance policy. So
why are insurance salespeople so mistrusted? The answer is simple.
If a saleswoman pushes her customer into buying a new dress, even if
it is not right for her, the sale is not likely to cause future financial
hardship (despite what her husband might claim). When a wrong
insurance policy is sold there may well be future financial hardship.

      For example:
        Jose buys a life insurance policy with his wife, Maria, as
      the beneficiary. Jose believes he has bought a $100,000
      life insurance benefit.    When he dies suddenly Maria
      discovers that the policy is only worth $50,000. She
      knows he believed he had purchased a larger death benefit
      so she is confused about the lower payout and complains
      to the Department of Insurance in her state.

  Since no one other than Jose and his agent was present at the time
of sale it is impossible to know how the misunderstanding happened.
Perhaps they talked about a higher benefit but settled on something
less expensive. Perhaps the agent needed the commission and led
Jose to believe he was purchasing something higher. It is impossible
to know. However, if enough consumers complain the state will look
at possible remedies. It may mean that agents must add a form to
their stack of existing forms or it may mean a disclaimer will be used.
Whatever remedy is selected, when multiple complaints come in,
insurance departments will respond.

  Agents do not have an easy job. People often believe that insurers
are large uncaring institutions and their agents are out to get their last
dollar. People feel pressured by the many types of products pushed at
them. Some insurance, such as auto liability, may even be mandated
by the state. As an added pressure, many agencies have a warfare
mentality that they push on their agents (“clients say “no” because
they need more information”). Many agents say they are made to feel
like a failure if they produce less business than another peer produces.


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Brokerages say they are expected to manage the ethics of agents who
work independently.

  Most people are well aware of what it means to be honest.

  Many states now mandate the topic of ethics as part of the overall
continuing education requirement. It is hoped that agents will come to
understand their ethical obligation. Most people are well aware of
what it means to be honest. As with the jaywalkers, however, states
must have the ability to enforce ethical behavior. By mandating ethics
as part of their continuing education requirements, agents can no
longer claim they did not realize they were behaving unethically. Of
course, the honest agents must jump through the same hoops, but
that is part of being an agent.


Due Diligence

  Professionals of all types must practice due diligence. Diligence
involves doing whatever is professionally required in a reasonably
prompt manner. That can include everything from returning a client’s
telephone call to researching an insurer prior to recommending it.

  Diligence involves doing whatever is professionally required
                in a reasonably prompt manner.


Competency
  Competency may be one of the most difficult areas for state
insurance commissioners to deal with. Even when the agent is honest
and has good intentions, an incompetent agent can be more damaging
to the client than a dishonest one.        A dishonest agent may be
recognized in some cases by his display of greed. An incompetent
agent thinks he or she is doing a good job; as a result he or she may
not be easily recognized by a layperson. Of course, the agent that
follows him into the house recognizes it immediately by the incomplete
or wrong policies that have been placed. The real danger is not
another agent finding his shortcomings but rather the failure to find
out in enough time to correct the situation. By the time the policy is
needed it is too late to fix.



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 Usually the first to recognize the incompetence are other agents.
This brings up another problem in the insurance industry. Seldom will
one agent report another. Not because he or she is protecting the
problem agent but because it will appear to be industry squabbling.
The competent agent is afraid that the state insurance department will
think it has more to do with commissions than competency. To some
degree this is probably true. Generally the complaint must come from
the consumer who often feels he is being put in the middle of two
agents who disagree over products. Only when the incompetency is
quite obvious will the state become involved. It usually becomes
obvious only when consumers have been financially harmed.

 It is probably not possible for agents to police themselves since
action must come from the state’s insurance department. While
agencies can release those they feel are incompetent that does not
prevent the agent from continuing to sell insurance as an independent
or for another unsuspecting agency.

Understanding the Products
  Agents are typically self-employed even if they work under an
agency. Most agencies do give some type of training on the products
they market, however.        Independent agents must acquire their
product knowledge on their own. Some agencies merely hand out
product brochures expecting their agents to gather what is necessary
from that and on their own. When errors are made, unless an agent is
wise enough to carry errors and omissions liability insurance, he or she
is also fully responsible for the mistake. There are times when an
agency might also be held responsible, but agents are primarily on
their own.

  All insurers will send, upon request, a sample policy to their agents.
The wise agent always requests one on any product he or she is not
fully familiar with. While this may be a selling tool that can be used in
the consumer’s home, it also allows the agent to fully read the policy
prior to presenting it to their client. An agent who has not read the
contract in its entirety may as well post a sign on their forehead that
says: “sue me.”

           Agents should always read a sample policy
        of any new product he or she will be presenting.




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  Today’s consumers are well aware of their legal rights. They will not
hesitate to sue an incompetent or uneducated agent that does not
perform their job appropriately. Even good agents that do their best
could be sued. Doctors and lawyers would not think of practicing
without liability insurance, yet agents routinely “go bare,” working
without such a policy to protect them. Some do so because they are
foolish enough to believe that they will not be sued. Some go without
liability insurance because they do not want to pay the cost to obtain
it. Some agents simply never consider the possibility at all, working
with blind faith instead.

 While all agents face the threat of lawsuit some are more likely than
others to be sued. Those that advertise themselves as financial
planners have a greater threat of lawsuit since that title implies
greater knowledge. Cheryl Toman-Cubbage reported in her book,
Professional Liability Pitfalls for Financial Planners, that she saw
numerous complaints filed against financial planners during her years
working for the International Board of Standards and Practices for
Certified Financial Planners. Some of the complaints were valid and
others were not, but either way the planner was required to spend his
or her time responding – sometimes in court.

  When life does not go as we anticipated we now live in a society that
accepts placing the blame elsewhere. You didn’t save enough for
retirement? It must be the financial planner’s fault. Your mother
ended up in a nursing home that consumed all her life’s savings? It
must be the fault of her agent for not covering that cost. There was
too little life insurance on your husband when he died? It must be the
fault of someone else – someone that can be sued.

  Attorneys look for new clients every day. In the 1970’s and 1980’s it
became fashionable and acceptable to sue professionals for
malpractice. Agents can be sued for malpractice just as a doctor can.
While we felt lawsuits gave the so-called “little man” power that was
equal to the powerful corporations (and this had many beneficial
effects) it also allowed individuals to seek compensation for anything
they found wrong in their lives. We have become a nation dedicated
to suing anyone and everyone.

 The scope of who was a professional broadened about thirty years
ago to include agents, as well as architects, engineers, accountants,
real estate agents, financial planners, and stockbrokers.      Other

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occupations can also be sued of course, but these groups were hardest
hit by lawsuits following their indoctrination as professionals.

  While agents may have always considered themselves professionals
having that legal definition means they are held to a higher standard
of conduct. Agents know they must follow all laws, of course, but it
also means that they are expected to perform in the client’s best
interest. Financial planners are especially burdened by the expected
standard of performance since clients who lose money are bound to
blame someone, whether it is their fault or not.

        It is not enough to understand just the basics anymore.
        Agents must completely understand how products work,
                  what they can and cannot accomplish
               and who is most likely to benefit from them.

  While no one can positively avoid lawsuits, one way to minimize the
possibility is through knowledge of products. When an agent knows
the products being sold he or she is less likely to make an error in
judgment. It is not enough to understand just the basics anymore;
agents must completely understand how products work, what they can
and cannot accomplish and who is most likely to benefit from them.

Catastrophic Loss on a Large Scale
  Life and health insurers face different issues than do property and
casualty insurers. This is due to the impact that both natural and
man-made losses can have. Hurricane Katrina demonstrated that
large massive losses could occur beyond what any insurer is prepared
for. While many types of losses can financially impact an insurer, no
single event affects policyholder and debt-holder security quicker than
catastrophes. Additionally, immediately following a significant event
like Katrina, the company retains its exposure base and subsequent
events can occur prior to implementation of risk mitigation strategies.2

  There is concern regarding the rapid escalation in insured exposures
taking place over the past ten or fifteen years. There are many factors
that can affect the concentration of risk in specific areas that are at
risk from natural disasters such as Hurricane Katrina. Rising property
values are just one of the elements that are causing financial concern
for insurers in some demographic areas where catastrophes are

2
    Methodology, April 2006 by A.M. Best.

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increasingly affecting risk for insurers. Another factor is the growing
concentration of people and industries in some high-risk areas of the
United States. People go where the jobs are; they live near their jobs.
This can result in higher risk for insurers since natural and man-made
catastrophic losses affect greater numbers of people and industries.

  Greater concentrations of workers and business also impact such
things as workers compensation, loss of business, and other related
types of policies. If the United States were to experience another
terrorist attack, for example, losses would be greater in areas of highly
concentrated people and companies. While we certainly see this in our
country, it is not isolated to the US. The same rising risk factors for
property and casualty insurers are happening worldwide.

 The combined frequency and severity of losses is on the rise.

  The combined frequency and severity of losses is on the rise. These
trends require insurers to find ways to improve their financial
effectiveness in catastrophe risk management systems and controls
and provide stronger capitalization to support the risk. Those in the
fields of climatology and meteorology feel that global warming, a trend
that earth has periodically experienced from the beginning of time, is
contributing to the rising numbers of severe natural events we have
seen. When we combine the increasing natural events and the rising
likelihood of terrorist attacks it is easy to see why insurers and state
insurance departments are concerned. In the past natural events and
political events did not heavily impact insurers. Today those events
tend to be insured.

  Insurers utilize all the technology available in an attempt to
      provide loss estimates and insure risk accordingly.

  Insurers utilize all the technology available in an attempt to provide
loss estimates and insure risk accordingly. Rating firms must take into
account the ability of insurers to utilize all the information that is
available. Of course, rating companies must also determine if the
information insurers use is reliable.




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Insurer Rating Companies

 Part of due diligence involves using insurers that are financially
stable. As a professional an agent is responsible for correctly stating
the strength or weakness of any company being recommended or
replaced. Of course, this is also an ethical duty.

 There are firms that provide financial ratings for insurance companies
that allow agents to recognize a financially strong company without
having to do the investigative work personally. Most professionals
recommend that an agent consult with more than one rating company.
There are multiple companies to choose from, including:
      1. A.M. Best Company
         Ambest Road, Oldwick, NJ 08858
         (908) 439-2200
      2. Standard and Poor’s
         (212) 208-1199
      3. Moody’s Investors Service
         99 Church Street, New York, NY 10007
      4. Fitch Ratings
         (312) 368-3198
      5. Weiss Ratings, Inc.
         (800) 289-9222

 Each company will use their specific parameters for measuring the
strengths and weaknesses of insurers. Best’s financial strength rating
uses “an independent opinion, based on a comprehensive quantitative
evaluation, of a company’s balance sheet strength, operating
performance and business profile.”3

  Evaluations from any company are not a warranty of a company’s
strength and no guarantees are made on the basis of their evaluation.
It is still possible for an apparently strong company to fail to meet its
obligations to their policyholders if circumstances suddenly changed.
Agents should view the ratings of more than one rating company.




3
    Best’s Rating Center, www.ambest.com

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  As consumers become aware of the importance of insurer ratings,
agents must be prepared to share that information. The company’s
financial rating can impact whether or not a consumer purchases the
policy the agent is recommending.          An agent should never
misrepresent a company’s financial standing. It is both unethical, and
also illegal to do so.

  The company’s financial rating can impact whether or not a
  consumer purchases the policy the agent is recommending.

  Reports on insurers allow an individual to evaluate income
statements, balance sheets and underwriting experience of primary
companies and reinsurers. Since those who do not have a stake in the
insurer gather the information, it is likely that it will be unbiased.


A.M. Best’s Ratings

  A.M. Best was founded in 1899 with the stated purpose of performing
a constructive and objective role in the insurance industry toward the
prevention and detection of insurer insolvency.       A.M. Best is an
independent third-party evaluation that subjects all insurers to the
same rigorous criteria, providing a valuable benchmark for comparing
insurers, even outside of the United States.       While some rating
companies rate multiple industries, Best rates only insurers, placing
their full attention on that industry.

 Ratings are independent opinions, with the operative word being
“opinion.” No rating company can make guarantees. However, they
do use information they feel is reliable to formulate those opinions.
They use comprehensive quantitative and qualitative evaluations of
the company’s balance sheet strength, operating performance, and
business profile.

 Best assigns three types of ratings:
  1. Strength ratings provide an opinion of an insurer’s financial
     strength and ability to meet ongoing obligations to policyholders.
  2. Credit ratings provide an opinion of the insurer’s ability to meet
     its senior obligations.



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  3. Debt ratings provide an opinion for the credit marketplace as to
     the insurer’s ability to meet its financial obligations to security
     holders as they become due.

 Best will use many quantitative and qualitative means, including
comparisons to other insurers and industry standards. Also used will
be assessments of an insurer’s operating plans, philosophy and
management. Best, like other reporting companies, will send the
current data to agents who purchase these reports. Many agents and
agencies subscribe to various reporting companies, receiving reports
and updates on a regular basis.

 When Best decides to rate an insurer, they will use analytical
components involving both quantitative and qualitative factors
grouped into three categories of evaluation:
        •   Balance Sheet Strength
        •   Operating Performance, and
        •   Business Profile

 Expert members of their staff, such as Certified Public Accountants
and actuaries, perform the analysis.

 Analysis of property/casualty insurers may require different
  information than would a rating for a life or health insurer.

 Each rating company has a specific rating structure. The information
used will pertain to the type of policies the company issues.
Property/casualty companies may require different information than
would a rating for a life or health insurer.


Financial Strength Ratings (FSR):

   Secure:                                Vulnerable:
   A++, A+ (Superior)                     B, B- (Fair)
   A, A- (Excellent)                      C++, C+ (Marginal)
   B++, B+ (Very Good)                    C, C- (Weak
                                          D (Poor)
                                          E (Under Regulatory Supervision)
                                          F (In Liquidation)
                                          S (Rating Suspended)

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 Not Rated categories (NR) are assigned to companies reported on
by A.M. Best, but they are not assigned a Best’s rating:
      NR-1: Insufficient data
      NR-2: Insufficient size and/or operating experience
      NR-3: Rating procedure inapplicable
      NR-4: Company request
      NR-5: Not formally followed

  Rating modifiers and affiliation codes are also used. A rating
modifier can be assigned to indicate that a Best’s rating may be
subject to near term change or are under review, that the company
did not subscribe to Best’s interactive rating process, or that the rating
is assigned to a syndicate operating at Lloyd’s. Affiliation codes (g, p,
and r) are added to Best’s ratings to identify companies whose
assigned ratings are based on group, pooling, or reinsurance affiliation
with other insurers.

     Rating Modifiers                   Affiliation Codes
     u: Under Review                    g: Group
     s: Syndicate                       p: Pooled
     pd: Public Data                    r: reinsured

  Best’s interactive ratings (A++ to D) are assigned a Rating Outlook
that indicates the potential direction of a company’s rating for an
intermediate period, generally defined as the next 12 to 36 months.
Rating Outlooks include Positive, Negative, and Stable.


Financial Size Categories (FSC)

 To enhance the usefulness of the Best ratings, A.M. Best assigns
each letter rated (A++ to D) insurance company a Financial Size
Category. The FSC is designed to provide a convenient indicator of the
company size in terms of its statutory surplus and related accounts.

 Many consumers today are concerned with the ratings insurers
receive. Buyers want to feel secure that the company they select will
have sufficient financial capacity to provide the necessary policy limits
they require. Although insurers utilize reinsurance to reduce their net

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retention on the policy limits they underwrite, many buyers still feel
more comfortable buying from companies having greater financial
capacity.

     Adjusted                      Adjusted
     FSC   Policyholders Surplus FSC        Policyholders Surplus
     I     Less than 1             IX       250 to 500
     II    1 to 2                  X        500 to 750
     III   2 to 5                  XI       750 to 1,000
     IV    5 to 10                 XII      1,000 to 1,250
     V     10 to 25                XIII     1,250 to 1,500
     VI    25 to 50                XIV      1,500 to 2,000
     VII   50 to 100               XV       Greater than 2,000
     VIII  100 to 250
                             Note: Ranges are in millions of U.S. dollars

 Best’s ratings are proprietary. They may be used only in a manner
consistent with normal insurer purposes.

  A.M. Best also provides Debt Ratings. Again, these ratings are not a
warranty of a company’s financial strength or ability to meet its
financial obligations. They are the opinion of Best based on data it has
received.

 Ratings are not a warranty of a company’s financial strength
          or ability to meet its financial obligations.

 Ratings from “aa” to “ccc” may be enhanced with a plus or minus (+
or -) to indicate whether credit quality is near the top or bottom of the
category. A company’s long-term credit rating may also be assigned
an “Under Review” modifier, using “u”. This is usually event-driven
and indicates that the company’s Best’s Rating opinion is under
review, meaning it may be subject to change in the near future.

   Long-Term Debt Ratings
   Investment Grade:                  Non-Investment Grade:
   aaa (exceptional)                  bb (Speculative)
   aa (Very strong)                   b (Very Speculative)
   a (Strong)                         ccc, cc, c (Extremely Speculative)
   bbb (Adequate)                     d (In default)
                Note: Debt Ratings displayed with an (i) denote indicative ratings.



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   Short Term Debt Ratings
   Investment Grade:                   Non-Investment Grade:
   AMB-1+ (Strongest)                  AMB-4 (Speculative)
   AMB-1 (Outstanding)                 d (in default)
   AMB-2 (Satisfactory)
   AMB-3 (Adequate)

  Best’s long-term credit ratings (aaa to c) are assigned a Rating
Outlook that indicates the potential direction of an insurers rating for
an intermediate period, usually 12 to 36 months. Rating outlooks
include Positive, Negative, and Stable.


Issuer Credit Ratings (ICR)

  Long-term Credit Rating by Best is their opinion as to the ability of
the insurer to meet its senior obligations. These ratings are assigned
to insurers, holding companies, or other legal entities authorized to
issue financial obligations.

       Ratings from “aa” to “ccc” may be enhanced with
    either a plus or minus to indicate whether credit quality
           is near the top or bottom of each category.

 Ratings from “aa” to “ccc” may be enhanced with either a plus or
minus to indicate whether credit quality is near the top or bottom of
each category. A company’s Long-Term Issuer Credit Rating may also
be assigned an Under Review modifier (“u”) that is often event-driven
(positive, negative, or developing) and indicates that the insurer’s
Best’s Rating opinion is under review, so it may be subject to change.

 It must again be noted that the ratings given are the opinions of
those who perform the ratings. Of course, those who are issuing these
opinions are well qualified to do so.

 A.M. Best uses their Long-Term Credit Rating scale when assigning
an Issuer Credit Rating.




                        Issuer Credit Ratings

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Non-Insurance Company:                    Insurance Company:
                    Non-Investment                            Non-Investment
Investment Grade:                         Investment Grade:
                         Grade:                                   Grade:
aaa (Exceptional  bb (Speculative)        aaa (Exceptional) bb (Fair)
aa (Very Strong)  b (Very Speculative)    aa (Superior)     b (Marginal)
                  ccc, cc, c (Extremely
a (Strong)                                a (Excellent)     ccc, cc (Weak)
                  Speculative)
bbb (Adequate)    d (In Default)          bbb (Very Good)   c (Poor)
                                                            d (In Default)


      Short-Term Issuer Credit Ratings are also issued:
Investment Grade:              Non-Investment Grade:
AMB-1+ (Strongest)             AMB-4 (Speculative)
AMB-1 (Outstanding)            d (In Default)
AMB-2 (Satisfactory)
AMB-3 (Adequate)


Fitch Ratings

 Fitch publishes a variety of rating opinions. The most common of
these are credit ratings, but Fitch also publishes ratings, scores, and
other relative measures of financial or operational strength.

 Even though companies may receive the same rating symbol it is
important to realize that differences still exist. Ratings are relative
measures of risk. Ratings may not fully reflect other types of company
differences, including small differences in the degrees of risk.

  Fitch’s credit ratings provide an opinion on the relative ability of a
company to meet financial commitments, such as interest, preferred
dividends, repayment of principal, insurance claims or counter-party
obligations. Credit ratings are important to consumers since it is an
indication of whether or not the insurer will be able to meet their
financial obligations to their policyholders. Fitch’s credit ratings cover
the global spectrum of corporate, sovereign, financial, bank,
insurance, municipal, and other public finance entities and the
securities or other obligations they issue, including structured finance
securities backed by receivables or other financial assets.




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  The different types of credit ratings vary based on their function:
“investment grade” ratings indicate relatively low to moderate credit
risk, while those in the “speculative” or “non investment grade”
categories either signal a higher level of credit risk or that a default
has already occurred. Credit ratings express risk in relative rank
order. They reflect the opinion of the evaluator, who uses sets of
criteria designed to give the most accurate ratings available. They do
not predict specific frequency of default or loss. Ratings could be
compared to weather prediction in that scientific methods are used to
predict the financial strength of a company, but it is not a guarantee of
performance (it could still rain on your parade).

       Short-term credit ratings give primary consideration
      to the likelihood that obligations will be paid on time.

  Although there are multiple reasons to use a credit rating, in the
insurance industry they are generally used to predict companies that
are or may become financially unstable. Obviously an individual would
want to avoid companies in danger of bankruptcy. Short-term credit
ratings give primary consideration to the likelihood that obligations will
be paid on time. Securities ratings, on the other hand, take into
consideration probability of default and any losses that would result
from default. Therefore, corporations and similar entities are given
security ratings that may be higher, lower, or the same as the issuer
rating to reflect expectations of the security’s relative recovery
prospects and differences in ability and willingness to pay. Recovery
analysis is always important throughout the ratings scale, but it is
especially critical for below investment-grade securities and
obligations, especially at the lower end of the non-investment-grade
ratings scale (where Fitch often publishes actual Recovery Ratings)
that are complementary to the credit ratings.

  Structured finance ratings typically are assigned to each security or
tranche in a transaction – not to the issuer. Each tranche is rated on
the basis of various stress scenarios in combination with its relative
seniority, prioritization of cash flows, and other structural mechanisms.

 International Credit Ratings assess the capacity to meet foreign
currency or local currency commitments.        Both foreign and local
currency ratings are internationally comparable assessments. Local
currency is rated by measuring the likelihood of repayment in the
currency of the insurer’s domicile jurisdiction, which would not take

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into account any difficulty that might exist converting local currency
into foreign currency or in making transfers between sovereign
jurisdictions.

   National Credit Ratings are made in certain markets by Fitch. They
are an assessment of credit quality relative to the rating of the “best”
credit risk in a country. It will usually (not always) be assigned to all
financial commitments issued or guaranteed by the sovereign state.
In particular countries Fitch Ratings assigns National Insurance
Financial Strength Ratings, using a scale unique to such ratings. It is
not possible to use National Ratings to make international
comparisons.      A special identifier denotes the country they are
intended for.

             It is not possible to use National Ratings
                to make international comparisons.

  Country ceiling ratings are assigned internationally and reflect Fitch’s
judgment regarding the risk of capital and exchange controls levied by
sovereign authorities that could prevent or materially impede the
private sector’s ability to convert local currency into foreign currency
and transfer to non-resident creditors. This is called transfer and
convertibility risk (T&C). Ratings at the country ceiling could cause a
greater degree of volatility than would normally be associated with
ratings at that level.

  Fitch ratings are based upon information obtained directly from
issuers, other obligors, underwriters, their experts, and other sources
believed to be reliable. No audits are made to verify the truth or
accuracy of the information obtained. Fitch does not state or imply
any obligation or due diligence responsibility to verify information or
perform any other kind of investigative responsibility into the accuracy
or completeness of information provided to them or acquired by them.

 At no time should anyone assume that Fitch ratings, or ratings by
any company, is a recommendation to buy, sell, or hold any security.
Fitch assesses only credit risk and there are certainly other elements
that one may want to consider in addition to the ratings. Ratings do
not deal with the risk of a market value loss due to changes in interest
rates and other market considerations. Ratings from all companies are
opinions based on available information. As a result, the ratings can
only be as good as the information provided. A rating score is not

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described as being either accurate or inaccurate, but rather an opinion
based on available data. No rating company would want to take on a
due diligence or fiduciary responsibility.

                    Ratings from all companies
           are opinions based on available information.

 Rating companies may change their rating at any time. A Fitch rating
may be changed, qualified, suspended, placed on Watch or withdrawn
of changes in, additions to, accuracy of, unavailability of or inadequacy
of information or for any reason they deem sufficient.

Fitch Ratings Actions
Affirmed: the rating has been reviewed and no change was deemed
necessary.

Change: The rating has been changed or modified due to a revision in
methodology. This value would only be used for Bank Support Rating
codes.

Confirmed: Due to an external request or change in terms, the rating
has been reviewed and no change was deemed necessary.

Downgrade: The rating has been lowered in the scale.

Expected Rating: A preliminary rating, usually contingent upon the
receipt of final documents, has been assigned.

New Rating: A new rating has been assigned.

Paid In Full: This tranche has reached maturity, regardless of
whether it was amortized or called early. As the issue no longer
exists, it is therefore no longer rated.

Rating Watch On: The issue or issuer has been placed on active
Rating Watch status.

Rating Watch Review: The rating has been reviewed and the Rating
Watch status has been extended for up to six additional months. This
value is only used for Structured Finance transactions.



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Revision IDR: The issuer Long- or Short-Term Credit Rating has been
changed to an Issuer Default Rating type. This does not necessarily
denote an upgrade or downgrade.

Revision Outlook: The Rating Outlook status has been changed.

Revision Rating: The rating has been modified. This is usually the
result of the introduction of a new scale, rather than a change in terms
of credit quality.

Upgrade: The rating has been raised in the scale.

Withdrawn: The rating has been removed and is no longer
maintained by Fitch.

  Insurer financial strength ratings (IFS Ratings) provide an
assessment of the financial strength of an insurance company. The
IFS is assigned to the company’s policyholder obligations, including
assumed reinsurance obligations and contract holder obligations.
These might include such things as guaranteed investment contracts.
It reflects the insurer’s ability to meet their obligations (and meet
them on time) and the expected recovery received by claimants in the
event the insurer stops making payments as a result of either insurer
failure or some type of regulatory intervention, usually by the state.
The timeliness of payments is considered relative to both issued
contracts and to policy terms. Delays due to circumstances beyond
the insurer’s control, or circumstances affecting the entire insurance
industry, would not necessarily impact the insurer rating.

       Delays due to circumstances beyond the insurer’s control,
       or circumstances affecting the entire insurance industry,
            would not necessarily impact the insurer rating.

  Expected recoveries are based on Fitch’s assessments of the
sufficiency of an insurer’s assets to fund policyholder obligations, when
payments have been stopped or interrupted.4              Expected insurer
recoveries exclude the impact of recoveries obtained from a
government sponsored guaranty fund and also exclude the impact of
collateralization or security, including letters of credit or assets placed
in trust.

4
    Fitch Ratings Resource Library 2006

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 Financial ratings can be assigned to both insurance companies and
reinsurance companies in any insurance sector. Even managed health
care companies may receive a rating.          Insurer financial strength
ratings do not address the quality of an insurer’s claims handling
services or the relative value of their products.

  Both International and National rating scales are used. International
IFS Ratings can be assigned using the Long-term and Short-term
rating scales, but National IFS ratings use only the Long-term scale.
Although the ratings use the same symbols used by Fitch Ratings for
its International and National credit ratings of long-term and short-
term debt issues, the definitions associated with the ratings reflect the
unique aspect of the IFS Ratings within the insurance industry.


International Long-Term IFS Rating Scale

  The following applies to foreign currency and local currency ratings.
Ratings of “BBB-“ and higher are considered to be “secure,” and those
lower than “BB+” are considered to be financially vulnerable.

AAA: Exceptionally Strong
  The “AAA” IFS ratings reflect a financially strong company. There is
the least expectation of ceased or interrupted payments when this
rating is received. Only companies with exceptionally strong capacity
to meet policyholder and contract obligations on time receive this
rating. It is unlikely that foreseeable events would adversely affect
the financial stability of an AAA rated company.

AA: Very Strong
 Companies receiving an “AA” IFS rating have a very low expectation
of ceased or interrupted payments. There is a strong capacity to meet
policyholder and contract obligations on time. This capacity is should
not be significantly affected by foreseeable events.

A: Strong
 Companies receiving an “A” rating have a low expectation of ceased
or interrupted payments.       There is a strong capacity to meet
policyholder and contract obligations on time. This capacity could,
however, be affected by changes in circumstances or by economic
conditions that would not affect a company with an AAA or AA rating.

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BBB: Good
  Companies receiving a “BBB” rating have a low expectation of ceased
or interrupted payments. The capacity to meet these obligations on
time is considered adequate, but this could change if circumstances
changed. Such companies are financially at risk when economic
conditions change.   IFS rating BBB is the lowest “secure” rating
category.

BB: Moderately Weak
 When a company is assigned a “BB” IFS rating there is the possibility
that ceased or interrupted payments could happen, especially when
adverse economic or market circumstances develop.            Even so,
business or financial alternatives may be available to allow for
policyholder and contract obligations to be met on time. Obligations
rated in “BB” categories and lower are considered to be “vulnerable.”

B: Weak
 Companies assigned a “B” IFS rating indicate two possible conditions:
       • If obligations are currently being met on a timely basis,
          there is significant risk that ceased or interrupted
          payments could still happen in the future, although a
          limited margin of safety remains.
       • The ability for continued timely payments is contingent
          upon a sustained, favorable business and economic
          environment, as well as favorable market conditions.

 When a “B” IFS rating is assigned to obligations that have already
experienced ceased or interrupted payments, but with the potential for
extremely high recovers, the obligations would have a recovery
assessment of “RR1” (Outstanding).

CCC: Very Weak
 A company receiving a “CCC” IFS rating indicates two possible
conditions:
         • Like the “B” rating, if obligations are currently being met
            on a timely basis, there is significant risk that ceased or
            interrupted payments could still happen in the future.
            Unlike the “B” rating, however, there is not a limited
            margin of safety remaining.




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         •   Continued timely payments are reliant upon favorable
             market conditions, with a sustained favorable business and
             economic environment.

 When a “CCC” IFS rating is assigned to obligations that have
experienced ceased or interrupted payments, there is the potential for
only average to superior recoveries. These recoveries would have a
recovery assessment of “RR2” (Superior), “RR3 (Good), or “RR4”
(Average).

CC
  This rating indicates that, if obligations are still being met on time, it
is probable that this will not continue. Obligations are likely to cease or
be interrupted at some time in the future. If obligations have already
experienced ceased or interrupted payments there is the potential for
average to below-average recoveries. These obligations would have a
recovery assessment of “RR4” (Average) or “RR5” (Below Average).

C
  The “C” rating indicates that obligations either will not be met at
some point or they already have ceased. If they are currently being
met on time, ceased or interrupted payments are imminent. A “C” IFS
rating assigned to obligations that have already experienced ceased or
interrupted payments has the potential for below average to poor
recoveries. It would be assigned an “RR5” (Below Average) or “RR6”
(Poor) rating.

 A “+” or “-“ (plus or minus) may be appended to a rating to indicate
the relative position of a credit with the rating category. These are not
added to ratings in the “AAA” category or to ratings below the “CCC”
category.


National Long-Term IFS Rating Scale

 National IFS Ratings are applied to local insurance markets. National
IFS Ratings are assigned to an insurer’s policyholder obligations and
are an assessment of relative financial strength. Like other forms of
National Ratings assigned by Fitch, National IFS Ratings assess the
ability of an insurer to meet their policyholder and related obligations.
The ratings are relative to the best credit risk in a specified country
across all industries and obligation types.       Comparisons between

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different countries’ National IFS rating scales or between an individual
country’s National IFS rating scale and the International IFS rating
scale would not be appropriate since different criteria is typically used.

AAA (xxx)
 This rating indicates the highest rating assigned within the national
scale for that specified country.     The rating is assigned to the
policyholder obligations of the “best” insurance entities relative to all
other issues or issuers in the same country, across all industries and
obligation types.

AA (xxx)
 This national IFS rating denotes a very strong capacity to meet
policyholder obligations relative to all other issues and issuers in the
same country, across all industries and obligation types. The risk of
ceased or interrupted payments differs only slightly from the country’s
highest rated issues or issuers.

A (xxx)
 The “A” national IFS rating denotes a strong capacity to meet their
policyholder obligations relative to all other issues or issuers in the
same country, across all industries and obligation types. However, the
company could be affected by changes in circumstances or economic
conditions that would affect their ability to make timely payment of
policyholder obligations to a greater degree than for financial
commitments denoted by a higher rated category.

BBB (xxx)
  This national IFS rating denotes an adequate capacity to meet
policyholder obligations relative to all other issues or issuers in the
same country, across all industries and obligation types. Changes in
circumstances or economic conditions are more likely to affect the
capacity for timely payment of policyholder obligations than for
financial commitments denoted by a higher rated category.

BB (xxx)
  The “BB” denotes a fairly weak capacity to meet policyholder
obligations relative to all other issues or issuers in the same country,
across all industries and obligation types. Within the context of the
specified country, payment of these policyholder obligations is not
certain in. The capacity for timely payment remains more vulnerable
to adverse economic change over time.

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B (xxx)
 The national IFS rating of “B” denotes two possible outcomes:
        • If policyholder obligations are still being met on time, the
           rating implies a significantly weak capacity to continue
           doing so relative to all other issues or issuers in the same
           country, across all industries and obligation types.
        • A limited margin of safety remains and capacity for
           continued payments is contingent upon a sustained,
           favorable business and economic environment.

 A “B” national IFS rating is assigned to obligations that have
experienced ceased or interrupted payments, but with the potential for
extremely high recoveries.

CCC (xxx)
 A “CCC” national IFS rating offers two possible outcomes:
       • If policyholder obligations are still being met on time, the
          rating implies ceased or interrupted payments are very
          possible.
       • Capacity for continued payments is contingent upon a
          sustained favorable business and economic environment.

  A “CCC” national IFS rating is assigned to obligations that have
experienced ceased or interrupted payments, but having the potential
for very high recoveries.

CC (xxx)
 If policyholder obligations are still being met on time, the “CC” rating
suggests ceased or interrupted payments appear probable. A “CC”
national IFS rating is assigned to obligations that have experienced
ceased or interrupted payments, but with the potential for average to
below-average recoveries.

C (xxx)
 A “C” national IFS rating for policyholder obligations implies that
ceased or interrupted payments are imminent, if that has not yet
happened. Obligations that have experienced ceased or interrupted
payments have the potential for below-average to poor recoveries.

  When a plus or minus symbol is used with the rating symbol it
indicates the relative position of a credit within the rating category.

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They are not used for the “AAA” category or for ratings below the
“CCC” category.

  What does the (xxx) indicate? The ISO International Code Suffix
is placed in parentheses immediately following the rating letters to
indicate the identity of the National market within which the rating
applies. Therefore, since we are not indicating which National market
is used, (xxx) is inserted in place of them.

  The ISO International Code Suffix is placed in parentheses
immediately following the rating letters to indicate the identity
    of the National market within which the rating applies.


International Short-Term IFS Rating Scale (ST-IFS Rating)

  An ST-IFS Rating provides an assessment of the intrinsic liquidity
profile of an insurer’s short-term policyholder obligations that are
contractually due for payment within one year from the date of
issuance. Fitch will only assign such a rating to insurers that have also
been assigned a Long-term IFS Rating.

 Ratings of “F1”, F2”, and “F3” are rated “secure”. Those of “B” and
below are considered “vulnerable.” The following applies to foreign
and local currency ratings.

F1: Strong
  An F1 rating indicates the strongest intrinsic liquidity and capacity for
timely payment of short-term policyholder obligations. There may be
a “+” added to indicate any exceptionally strong credit features.

F2: Moderately Strong
  An F2 indicates a satisfactory level of intrinsic liquidity and capacity
for timely payment of short-term policyholder obligations, but the
margin of safety is not as great as an F1 rating.

F3: Moderate
 While capacity for timely payment of short-term policyholder
obligations is adequate, the near-term adverse changes could result in
a reduction to “vulnerable”, which is indicated by the F3 rating.



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B: Weak
 A “B” rating indicates a minimal capacity to meet short-term
policyholder obligations, as well as vulnerability to near term adverse
changes in financial and economic conditions.

C: Very Weak
  There is a real danger of ceased or interrupted payment of short-
term policyholder obligations.   The capacity to meet short-term
policyholder obligations is completely reliant upon a sustained,
favorable business and economic environment.

RD
  An RD rating indicates the insurer has ceased or interrupted
payments on a portion of its policyholder obligations, although the
insurance company continues to meet other obligations.

D
 A “D” rating indicates the insurer has ceased or interrupted payments
on all of its obligations. This includes insurance companies that have
continued to make payments, but at less than full contractual
amounts.


Standard & Poor’s

  Standard & Poor’s rates many types of entities, with insurer financial
strength being one of them. We will look at several of their ratings
since they impact investments as well as insurers.

Insurer Financial Strength Rating Definitions
 A Standard & Poor’s insurer financial strength rating is a current
opinion of the financial security characteristics of an insurance
organization concerning its ability to pay under its insurance policies
and contracts in accordance with their terms. Health Maintenance
Organizations and other managed care companies receive ratings
along with insurers.


                  Insurer ratings are not specific
                to any particular policy or contract.



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  Insurer ratings are not specific to any particular policy or contract.
Ratings also do not address whether or not the policy is suitable to the
person considering it. Insurer rating opinions do not take into account
deductibles, surrender or cancellation penalties, timeliness of
payment, nor whether payment of claims will occur smoothly. For
organizations with cross-border or multinational operations, including
subsidiaries or branch offices, the ratings do not take into account
potential that may exist for foreign exchange restrictions that prevent
financial obligations from being met.

  Insurer financial strength ratings are based on information furnished
by rated organizations or obtained by Standard & Poor’s from other
sources considered to be reliable.        No audits are performed in
connection with the insurer ratings and may partially rely on unaudited
financial information, meaning the information could prove to be
wrong. Ratings may be changed, suspended, or withdrawn as a result
of changes in, or unavailability of such information or based on some
other circumstance.

  Insurer ratings do not refer to an organization’s ability to meet non-
policy obligations, such as debt. Assignment of ratings to debt issued
by insurers or to debt issues that are fully or partially supported by
insurance contracts, or guarantees is a separate process from
determination of insurer financial strength ratings.           It follows
procedures consistent with issue credit rating definitions and practices,
which will also be included in this text.

 Like all rating companies, Standard & Poor’s issues financial strength
rating opinions and are not recommending an individual purchase or
not purchase any specific policy. Nor are they recommending that
anyone buy, hold, or sell any security issued by an insurer. A rating is
not a guaranty of an insurer’s financial strength or security.

             A rating is an opinion - not a guaranty of
            an insurer’s financial strength or security.


Long-Term Insurer Financial Strength Ratings

 An insurer rated ‘BBB’ or higher is regarded as having financial
security characteristics that outweigh any vulnerabilities that might


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exist. The insurer is highly likely to have the ability to meet financial
commitments as they come due.

AAA
 The insurer has extremely strong financial security characteristics.
This is the highest insurer financial strength rating assigned by
Standard & Poor’s.

AA
 Under this rating, the insurer has very strong financial security
characteristics, differing only slightly from the ‘AAA’ rating.

A
 Under this insurer rating, the company has strong financial security
characteristics but is a bit more likely to be affected by adverse
business conditions than those insurers given a higher rating.

BBB
 This rated insurer has good financial security characteristics but is
more likely than higher rated companies to be affected by adverse
business conditions.

BB
 An insurer with the ‘BB’ rating has marginal financial security
characteristics. Positive attributes exist, but adverse business
conditions could lead to insufficient ability to meet financial
commitments.

B
 The insurer has weak financial security characteristics. Adverse
business conditions will likely impair its ability to meet financial
commitments.

CCC
 The insurer has very weak financial security characteristic, and is
dependent on favorable business conditions to have the ability to meet
their financial commitments.

CC
 The insurer with this rating has extremely weak financial security
characteristics and is likely not to meet some of its financial
commitments.

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R
 The insurer is under regulatory supervision due to its financial
condition. During the pendency of the regulatory supervision, the
regulators may have the power to favor one class of obligations over
others or pay some obligations and not others. The rating does not
apply to insurers subject only to non-financial actions such as market
conduct violations.

NR
 The insurer is not rated, so Standard & Poor’s has no opinion about
the insurer’s financial security.

 Ratings from ‘AA’ through ‘CCC’ may be modified by the addition of a
plus (+) or minus (-) sign to show relative standing within the major
rating categories.

CreditWatch
  CreditWatch highlights the potential direction of a rating, focusing on
identifiable events and short-term trends that cause ratings to be
placed under special surveillance by Standard & Poor’s. These events
could include mergers, recapitalizations, voter referenda, regulatory
actions, or anticipated operating developments.            Placement on
Standard & Poor’s CreditWatch list does not necessarily mean the
company will experience a change in their rating, just that it is a
possibility due to an event or a deviation from an expected trend. A
“positive” designation means that the rating could be raised.           A
“negative” designation means that the rating could be lowered. A
“developing” designation means that the rating could be raised,
lowered, or affirmed.

       Placement on Standard & Poor’s CreditWatch list
   does not necessarily mean the company will experience a
     change in their rating, just that the possibility exists
    due to an event or a deviation from an expected trend.


Short-Term Insurer Financial Strength Ratings

 Many of the following ratings are similar or the same as those for
credit ratings on issues and issuers that will follow insurer ratings in
this chapter. We have still chosen to list them individually since small

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details may differ that would change the meanings. However, the
reader may feel as though they are reading the same ratings more
than once.

A-1
  This insurer has a strong ability to meet its financial commitments
on short-term policy obligations. This is the highest rating available by
Standard & Poor’s. Within this category, some insurers are designated
with a plus sign (+), which indicates that the insurer’s ability to meet
its financial commitments on short-term policy obligations is extremely
strong.

A-2
  The insurer has a good ability to meet its financial commitments on
short-term policy obligations. This insurer a slightly more susceptible
to adverse effects of changes in circumstances and economic
conditions than those rated ‘A-1’.

A-3
 The insurer has an adequate ability to meet its financial
commitments on short-term policy obligations, but adverse economic
conditions or changing circumstances are more likely to lead to a
weakened ability of the insurer to meet its financial obligations.

B
  The insurer is vulnerable and has significant speculative
characteristics. The insurer has the ability to meet its current financial
commitments on short-term policy obligations, but it faces major
ongoing uncertainties that could lead to an inadequate ability to meet
its financial obligations.

C
  The insurer is regarded as currently vulnerable to nonpayment and is
depended upon favorable business, financial, and economic conditions
for it to meet its financial commitments on short-term policy
obligations.

R
 See the definition of “R” under long-term ratings.




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 Ratings from ‘AA’ through ‘CCC’ may be modified by the addition of
either a plus or minus sign to show relative standing within the major
rating categories.

  As always, a rating on an insurer is not a recommendation to
purchase or discontinue any policy or contract issued by an insurer.
Nor is it a recommendation to buy, hold, or sell any security issued by
an insurer. No rating or assessment is a guaranty of an insurer’s
financial strength.

Financial Enhancement Rating Definitions
 Standard & Poor’s insurer financial enhancement rating is a current
opinion of the creditworthiness of an insurer with respect to insurance
policies or other financial obligations that are predominantly used as
credit enhancement and/or financial guarantees. Standard & Poor’s
analysis focuses on capital, liquidity, and company commitment
necessary to support a credit enhancement or financial guaranty
business when assigning the rating. It does not consider every aspect
such as market price or policy suitability.

  Standard & Poor’s ratings are based on information furnished by the
insurers or obtained from sources considered reliable. No audit is
performed to assure that the information received is accurate. Insurer
financial enhancement ratings are based, in varying degrees, on the
following:
     •   The likelihood of payment.          This is the capacity and
         willingness of the insurer to meet its financial commitment on
         an obligation in accordance with the terms of the obligation.
     •   The Nature and provisions of the obligations.
     •   The protection afforded by, and relative position of, the
         obligation in the event of bankruptcy, reorganization, or other
         arrangement under the laws of bankruptcy and other laws
         affecting creditors’ rights.

AAA
 The insurer has extremely strong capacity to meet its financial
commitments. This is the highest insurer financial enhancement rating
assigned by Standard & Poor’s.




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AA
 The insurer has a very strong capacity to meet its financial
commitments and differs only slightly from those rated ‘AAA’.

A
  The insurer has strong capacity to meet its financial commitments. It
is slightly more susceptible to the adverse effects of changes in
circumstances and economic conditions than insurers rated ‘AAA’ or
‘AA’.

BBB
  The insurer has adequate capacity to meet its financial commitments,
but adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity of the insurer to meet its
financial commitments.

BB, B, CCC, and CC
 Insurers rated with one of these are regarded as having significant
speculative characteristics. Insurers listed under ‘BB’ have the least
degree of speculation and ‘CC’ has the highest.

 Ratings from ‘AA’ through ‘CCC’ may be modified by the addition of a
plus or minus sign to show relative standing within the major rating
categories.

R
 The insurer is under regulatory supervision due to its financial
condition. During the pendency of the regulatory supervision the
regulators may have the power to favor one class of obligations over
others or pay some obligations and not others.

NR
 The insurer is not rated.


Credit Ratings
 Like other rating companies, a Standard & Poor’s issue credit rating is
a current opinion of the creditworthiness of an obligor with respect to a
specific financial obligation, a specific class of financial obligations, or a
specific financial program, including ratings on medium-term note




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programs and commercial paper programs.5 Standard & Poor’s ratings
consider the creditworthiness of guarantors, insurers, or other forms of
credit enhancement on the obligation. They also consider the currency
in which the obligation is denominated since that can affect aspects of
credit. As with other rating companies, the issuance of a credit rating
is not a recommendation to purchase, sell, or hold a financial
obligation, since ratings do not comment on the suitability of a product
or other factors that should be considered.

    Credit ratings consider the currency in which the obligation is
         denominated since that can affect aspects of credit.

  Issue credit ratings are based on current information furnished by the
obligors or obtained by Standard & Poor’s from other sources they
consider reliable. No audit is performed in connection with the credit
rating for accuracy of information, meaning there is no certainty that it
is correct. However most rating companies are careful to use only
sources that are considered reliable. Credit ratings may be changed,
suspended, or withdrawn due to changes in, or unavailability of,
information or based on other circumstances.

  Issue credit ratings may be either long term or short term. Short-
term ratings are generally assigned to those obligations considered
short-term in the relevant market. In the United States that means
obligations with an original maturity of no more than 365 days,
including commercial paper. Short-term ratings are also used to
indicate the creditworthiness of an obligor that incorporates features of
long-term obligations. The result is a dual rating, addressing short-
term and long-term issues. Medium-term notes are assigned long-
term ratings.

            Medium-term notes are assigned long-term ratings.

  The reader will note that both Issue and Issuer credit ratings are
included in this text. One is the rating of the investment and the other
is the rating of the entity providing the investment.



Long-Term Issue Credit Ratings

5
    Ratings Direct May 2006

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 In varying degrees, issue credit ratings are based on:
  1. The likelihood of payment. The capacity and willingness of
     the obligor to meet its financial commitment on an obligation,
     meeting the terms of the obligation.
  2. The nature and provisions of the obligation.
  3. The protection afforded by, and the relative position of, the
     obligation in the event of bankruptcy, reorganization, or other
     arrangements under the laws of bankruptcy and any other laws
     that could affect the creditors’ rights.

 The issue rating definitions are expressed in terms of default risk.
Therefore, they pertain to senior obligations of the entity. Junior
obligations are generally rated lower than senior obligations to reflect
the lower priority in bankruptcy. Differentiation would exist when an
entity has both senior and subordinated obligations, secured and
unsecured obligations, or operating company and holding company
obligations. When applied to junior debt, the rating may not conform
exactly with the category definition.

 The issue rating definitions are stated in terms of default risk.
   Therefore, they pertain to senior obligations of the entity.

AAA
 An obligation rated “AAA” has the highest rating assigned by
Standard & Poor’s.    The obligor’s capacity to meet its financial
commitment on the obligation is considered extremely strong.

AA
 This rating is very similar to the “AAA” rating, with only a small
degree of difference. The obligor’s capacity to meet its financial
commitment on the obligation is very strong.

A
 An “A” rated obligation is somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than
obligations in higher rated categories (“AAA” or “AA”). However, the
obligor’s capacity to meet its financial commitment on the obligation is
still strong.



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BBB
  An obligation rated “BBB” exhibits adequate protection parameters
but adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity of the obligor to meet its financial
commitment on the obligation.

BB, B, CCC, CC, and C
  Obligations with one of these ratings are regarded as having
significant speculative characteristics. “BB” indicates the least degree
of speculation with “C” having the highest. While such obligations will
probably have some quality and protective characteristics, those may
be outweighed by large uncertainties or major exposures to adverse
conditions.

BB
  While a “BB” rating is less vulnerable to nonpayment than other
speculative issues, it faces major ongoing uncertainties or exposure to
adverse business, financial, or economic conditions. These could lead
to the obligor’s inadequate capacity to meet its financial commitment
on the obligation.

B
 A “B” rating is more vulnerable to nonpayment than obligations rated
“BB” but the obligor currently has the capacity to meet its financial
commitment on the obligation.         Adverse business, financial, or
economic conditions are likely to impair the obligor’s capacity or
willingness to meet its financial commitment on those obligations.

CCC
  This rating on an obligation means it is currently vulnerable to
nonpayment, and is dependent upon continued favorable business,
financial, and economic conditions in order to meet its financial
commitment on the obligation. If adverse business, financial, or
economic conditions developed, the obligator is not likely to have the
capacity to meet their financial commitment on the obligation.

CC
 An obligation     rated   “CC”    is   currently     highly   vulnerable   to
nonpayment.


C

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 A subordinated debt or preferred stock obligation rated “C” is
currently highly vulnerable to nonpayment. The rating may be used to
cover a situation where a bankruptcy petition has been filed or similar
action was taken, but payments on this obligation are being continued.
A “C” rating will also be assigned to a preferred stock issue in arrears
on dividends or sinking fund payments, but that is currently paying.

D
  A “D” rating means payment is in default. The rating category is
used when payments on an obligation are not made on the date due
even if the applicable grace period has not yet expired. If Standard &
Poor’s believes that payment will be made during the grace period, a
different rating may be used. The “D” rating will also be used upon
the filing of a bankruptcy petition or the taking of a similar legal action
if payments on the obligation are jeopardized.

Plus or minus (+ or -)
 The ratings from “AA” to “CCC” may be modified by the addition of a
plus or minus sign to show relative standing within the major rating
categories.

NR
This indicates that no rating has been requested, that there is
insufficient information on which to base a rating, or that Standard &
Poor’s does not rate a particular obligation as a matter of company
policy.


Short Term Issue Credit Ratings

A-1
  A short-term obligation rated “A-1” is rated in the highest category
available by Standard & Poor. The obligor’s capacity to meet its
financial commitment on the obligation is strong. Within this category,
certain obligations are designated with a plus sign, which indicates the
obligor’s capacity to meet its financial commitment is extremely
strong.

A-2
  This rating is more susceptible to the adverse effects of changes in
circumstances and economic conditions than obligations I higher rated


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categories, but the obligor’s capacity to meet its financial commitment
on the obligation is satisfactory.

A-3
  A short-term obligation rated “A-3” shows adequate protection
parameters.    However, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity of the
obligor to meet its financial commitment on the obligation.

B
  This rating is regarded as having significant speculative
characteristics. Finer distinctions within the ‘B’ category will be
indicated by the use of ‘B-1’, ‘B-2’, and ‘B-3’. The obligor currently
has the capacity to meet its financial commitment on the obligation,
but it faces major ongoing uncertainties that could lead to their
inadequate capacity to meet its financial commitment on the
obligation.

 B-1 is regarded as having significant speculative characteristics, but
the obligor has a relatively stronger capacity to meet its financial
commitments over the short-term compared to other speculative
grade obligors.

 B-2 is regarded as having significant speculative characteristics, with
an average speculative-grade capacity to meet its financial
commitments over the short-term compared to other speculative-
grade obligors.

  B-3 is a short-term obligation with significant speculative
characteristics. The obligor has a relatively weaker capacity to meet
its financial commitments over the short-term compared to other
speculative-grade obligors.

C
  A short-term obligated rated ‘C’ by Standard & Poor is considered to
be currently vulnerable to nonpayment and is depended upon
favorable business, financial, and economic conditions for the obligor
to meet its financial commitment on the obligation.

D
 An obligation rated ‘D’ is in payment default. This rating category is
used when payments on the obligation are not made on the due date

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even if the applicable grace period has not expired. If Standard & Poor
believes the obligator will make the payments during the grace period
they will not use this rating. The ‘D’ rating will also be used upon the
filing of a bankruptcy petition or the taking of a similar action if
payments on the obligation are jeopardized.


Active Qualifiers (Currently applied and/or outstanding)

i
  The lower case i is a subscript used for issues in which the credit
factors, terms, or both that determine the likelihood of receipt of
payment of interest are different from the credit factors, terms, or
both that determine the likelihood of receipt of principal on the
obligation.

L
  Ratings qualified with the upper case L apply only to amounts
invested up to the federal deposit insurance limits.

p
  The lower case p is a subscript used for issues in which the credit
factors, terms, or both that determine the likelihood of receipt of
payment of principal are different from the credit factors, terms, or
both that determine the likelihood of receipt of interest on the
obligation. The ‘p’ subscript indicates that the rating addresses the
principal portion of the obligation only. It will always be used in
conjunction with the ‘i’ subscript that addresses likelihood of receipt of
interest. For example, a rated obligation could be assigned ratings of
“AAAp NRi” indicating that the principal portion is rated “AAA” and the
interest portion of the obligation is not rated.

pi
  This rating subscript is based on an analysis of an insurer’s published
financial information, along with additional information in the public
domain. They do not reflect in-depth meetings with the issuer’s
management, however, and are therefore based on less
comprehensive information than ratings without a ‘pi’ subscript.
Ratings with a ‘pi’ subscript are reviewed annually based on a new
year’s financial statements, but may be reviewed on an interim basis if
a major event occurs that could affect the issuer’s credit quality.


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pr
  The letters ‘pr’ indicate that the rating is provisional, which assumes
the successful completion of the project financed by the debt being
rated and indicates that payment of debt service requirements is
largely or entirely dependent upon the successful, timely completion of
the project. It is important to note that this addresses credit quality
subsequent to completion of the project, but makes no comment on
the likelihood of or the risk of default upon failure of the completion.
An investor must exercise his own judgment with respect to such
likelihood and risk.

Preliminary
 Preliminary ratings are assigned to issues,              including   financial
programs, in the following circumstances:
      •   Ratings may be assigned to obligations, most commonly
          structured and project finance issues, pending receipt of final
          documentation and legal opinions. Assignment of a final
          rating is conditional on the receipt and approval by Standard
          & Poor’s of appropriate documentation.        Changes in the
          information provided to Standard & Poor’s could result in the
          assignment of a different rating. They reserve the right not
          to issue a final rating.
      •   Preliminary ratings are assigned to Rule 415 Shelf
          Registrations. As specific issues, with defined terms, are
          offered from the master registration, a final rating may be
          assigned to them in accordance with Standard & Poor’s
          policies. The final rating could differ from the preliminary
          rating.

t
  The lower case ‘t’ indicates termination structures that are designed
to honor their contracts to full maturity or, if certain events occur, to
terminate and cash settle all their contracts before their final maturity
date.


Inactive Qualifiers (No longer applied or outstanding)

*
 This symbol indicated continuance of the ratings was contingent upon
Standard & Poor’s receipt of an executed copy of the escrow


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agreement or closing documentation confirming investments and cash
flows. Use of this qualifier was discontinued in August 1998.

c
  Discontinued in January 2001, it was used to provide additional
information to investors that the bank might terminate its obligation to
purchase tendered bonds if the long-term credit rating of the issuer
was below an investment-grade level and/or the issuer’s bonds were
deemed taxable.

q
  Discontinued in April 2001, the ‘q’ subscript indicated that the rating
was based solely on quantitative analysis of publicly available
information.

r
  The ‘r’ modifier was assigned to securities containing extraordinary
risks, particularly market risks, which were not covered in the credit
rating. The absence of the ‘r’ modifier should not be taken as an
indication that an obligation will not exhibit extraordinary non-credit
related risks. Standard & Poor’s discontinued the use of the ‘r’
modifier for most obligations in June 2000, with the balance (mainly
structured finance transactions) ending in November 2002.

Local Currency and Foreign Currency Risks
  Country risk considerations are a standard part of Standard & Poor’s
analysis for credit ratings on any issuer or issue, with currency of
repayment being a key factor in the analysis. An obligator’s capacity
to repay foreign currency obligations may be lower than its capacity to
repay obligations in local currency. This is due to the sovereign
government’s own relatively lower capacity to repay external versus
domestic debt. These elements are incorporated in the debt ratings
assigned to specific issues. Foreign currency issuer ratings are also
distinguished from local currency issuer ratings to identify those
instances where sovereign risks make them different for the same
issuer.

                  An obligator’s capacity to repay
          foreign currency obligations may be lower than
        its capacity to repay obligations in local currency.




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Issuer Credit Rating Definitions
  The Standard & Poor’s issuer credit rating is a current opinion of an
obligor’s overall financial capacity, which is its creditworthiness, to pay
its financial obligations. Standard & Poor’s opinion focuses on the
obligor’s capacity and willingness to meet its financial commitments as
they come due. This does not apply to any specific financial obligation
since it does not consider the nature or provisions of any particular
obligation, its standing in bankruptcy or liquidation, statutory
preferences, or the legality and enforceability. Nor does it take into
account the creditworthiness of the guarantors, insurers, or other
forms of credit enhancement on the obligation. The issuer credit
rating is not a recommendation to purchase, sell, or hold a financial
obligation issued by an obligor, as it does not comment on market
price or suitability for any particular investor.

       The issuer credit rating is not a recommendation to
           purchase, sell, or hold a financial obligation
      issued by an obligor, since market price or suitability
          for any particular investor is not considered.

 Counterparty credit ratings, ratings assigned under the Corporate
Credit Rating Service, previously called the Credit Assessment Service,
and sovereign credit ratings are al forms of issuer credit ratings.

 Issuer credit ratings are based on current information furnished by
obligors or obtained by Standard & Poor’s from other sources
considered reliable. Rating companies, such as Standard & Poor’s, do
not conduct audits in connection with any issuer credit rating, so it is
possible that unaudited financial information may be used. Issuer
credit ratings may be changed, suspended, or withdrawn as a result in
changes in or availability of information. Issuer credit ratings may be
either long term or short term. Short-term issuer credit ratings reflect
the obligor’s creditworthiness over a short-term time period.


Long-Term Issuer Credit Ratings

AAA
  The ‘AAA’ rating indicates an extremely strong capacity to meet
financial commitments. It is the highest issuer credit rating assigned
by Standard & Poor’s.


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AA
 An obligor has a very strong capacity to meet its financial
commitments. It differs from the ‘AAA’ rating only slightly.

A
  An obligor has a strong capacity to meet its financial commitments
but it is somewhat more susceptible to any adverse effects in
circumstances and economic conditions than those with ‘AAA’ or ‘AA’
ratings.

BBB
  An obligor has adequate capacity to meet its financial commitments,
but adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity of the obligor to meet its financial
commitments.

BB, B, CCC, and CC
  Obligors rated with one of these four ratings are regarded as having
significant speculative characteristics. ‘BB’ has the least degree of
speculation and ‘CC’ has the highest. While such obligors will likely
have some quality and protective characteristics, these may be
outweighed by large uncertainties or major exposures to adverse
conditions.

Plus or Minus
  Plus or minus signs may be assigned to ratings from ‘AA’ to ‘CCC’ to
indicate relative standing within the major rating categories.

R
 An obligor rated ‘R’ is under regulatory supervision due to its financial
condition. During the pendency of the regulatory supervision the
regulators may have the power to favor one class of obligations over
others or pay some obligations and not others.

SD and D
  An obligor rated ‘SD’ (selective default) or ‘D’ has failed to pay one or
more of its financial obligations (rated or unrated) as it came due. A
‘D’ rating is assigned when Standard & Poor’s believes that the default
will be a general default and that the obligator will fail to pay all or
substantially all of its obligations on time. An ‘SD’ rating is assigned
when they believe the obligor has selectively defaulted on a specific


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issue or class of obligations on other issues or classes of obligations in
a timely manner.

NR
 An issuer designed NR is not rated.


Short-Term Issuer Credit Ratings

A-1
  An obligator rated ‘A-1’ has a strong capacity to meet its financial
commitments. This is the highest rating given to issuers by Standard
& Poor’s. Within this category, some obligators may receive a plus
sign (+), which indicates that the obligor’s capacity to meet its
financial commitments is extremely strong.

A-2
 This rating shows satisfactory capacity to meet its financial
commitments, but the obligator is somewhat more susceptible to the
adverse effects of changes in circumstances and economic conditions
than those in the ‘A-1” rating category.

A-3
  This obligator has adequate capacity to meet its financial obligations,
but adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity of the obligor to meet its financial
commitments.

B
  This rating is regarded as vulnerable and has significant speculative
characteristics. Like the issue credit ratings, there are subcategories
of ‘B-1’, ‘B-2’, and ‘B-3’ to indicate finder distinctions within the ‘B’
category. The obligator currently has the ability to meet its financial
commitments but it faces major ongoing uncertainties that could lead
to inadequate capacity to meet the financial commitments.

C
 A ‘C’ rating indicates the obligor is currently vulnerable to
nonpayment and is dependent upon favorable business, financial, and
economic conditions for it to meet its financial commitments.




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R
 The obligator is under regulatory supervision due to its financial
condition. During the pendency of the regulatory supervision the
regulators may have the power to favor one class of obligations over
others or pay some obligations and not others.

SD and D
  An ‘SD’ (selective default) or ‘D’ has failed to pay one or more of its
financial obligations (rated or unrated) when it came due. A ‘D’ rating
is assigned by Standard & Poor’s when it is believed that the default
will be a general one and that the obligor will fail to pay all or
substantially all of its obligations as they come due. An ‘SD’ rating is
assigned with it is believed that the obligor has selectively defaulted
on a specific issue or class of obligations but the obligor will continue
to meet its payment obligations on other issues or classes of
obligations as they come due.

NR
 An issuer designated NR is not rated.

Rating Outlook Definitions
 The Standard & Poor’s rating outlook assesses the potential direction
of a long-term credit rating over the intermediate term, usually six
months to two years. Consideration is given to any changes in the
economic or fundamental business conditions that may exist. An
outlook is not necessarily a precursor of a rating change or future
CreditWatch action.
      •   Positive means that a rating may be raised.
      •   Negative means that a rating could be lowered.
      •   Stable means that a rating is not likely to change.
      •   Developing means a rating may be raised or lowered.

CreditWatch
  CreditWatch highlights the potential direction of a short- or long-term
rating. It focuses on identifiable events and short-term trends, such
as mergers, recapitalizations, voter referendums, regulatory action, or
anticipated operating developments, that could cause ratings to be
placed under special surveillance by Standard & Poor’s staff. It could
mean that more information is needed or that an event or deviation
from an expected trend has occurred. Being put on a CreditWatch


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does not necessarily mean a rating change is inevitable. Usually
Standard & Poor’s shows a range of alternative ratings that are
possible. It should also be noted that ratings could change without
ever having been listed on CreditWatch.


Weiss Ratings

  Weiss Ratings offers a line of products designed to direct consumers
and business professionals toward safe investment and insurance
options while avoiding unnecessary risks that could lead to financial
losses.6

  Weiss issues ratings on more than 15,000 financial institutions,
including banks, brokerage firms, HMOs, life and health insurers, Blue
Cross Blue Shield plans, and property and casualty insurers. Two
rating scales are used: Weiss Investment Ratings and Weiss Safety
Ratings.    The Weiss Safety Ratings assess the future financial
stability of an insurer, bank, or broker. These ratings are derived
without regard to the performance of the specific investment offered
by the insurer or other entity. Weiss Investment Ratings evaluate
the risk/reward trade-off of an investment in the specific stock or
mutual fund. In stock ratings, the company’s stability is an important
component in the evaluation, but the focus is on the investment, not
the company itself.

  Like the other rating companies, a rating by Weiss is not a
recommendation to buy or sell any product issued by an insurer or
other entity. It is the opinion of the Weiss analysis as to the stability
of the company relative to other similar type companies or
investments.

    Weiss uses:
        • A = Excellent
        • B = Good
        • C = Fair
        • D = weak
        • E = Very Weak
        • F = Failed
        • U = Unrated

6
    About Weiss Ratings 2006

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 “Excellent” and “Good” correspond to Weiss’ A and B ratings.
“Excellent” corresponds to Best’s A++ and A+ (superior) ratings.
“Good” relates to Best’s A and A- (excellent) ratings.


Continuing Education Requirements

 Nearly all states require agents to complete continuing education
credits each license renewal period.       Some states have stricter
requirements than others, but that is rapidly changing. In March 1998
the Midwest Zone Insurance Commissioners signed a reciprocity
agreement on course approval practices for CE.         The agreement
provided that each zone state would accept the credits awarded by
another zone state without re-reviewing the course. The majority of
states have joined the Midwest Zone Agreement and agreed to
participate in what is now referred to as the Continuing Education
Reciprocity (CER) process.

         The Midwest Zone agreement provided that
      each zone state would accept the credits awarded
    by another zone state without re-reviewing the course.

  In our case, United Insurance Educators submits a course for
approval in our domicile state, which is Washington. Washington’s
insurance department reviews our submission and assigns continuing
education hours based on the formula they normally use. While other
states (even those who participate in the Midwest Zone agreement)
are not required to accept Washington’s determination, most states
will do so. Recently a universal formula has also been enacted which
will even out how each state approves courses. This will level the
playing field, so to speak.

     For example:
      State A uses a continuing education home study formula
     of 15 full pages of text (discounting pages that contain
     pictures or other non-text fill) per one hour of CE credit. A
     course that contains 45 full pages of text would, therefore,
     receive three hours of continuing education.




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       State B has no home study education formula.
      Whatever the education provider requests is given.

 Obviously, education providers from State B have an advantage over
those whose domicile is in State A. By mandating a specific formula
that all states use education providers are fairly represented and
agents know they can base their preference in companies based on the
quality and presentation of the courses offered rather than the length
of the course (since length will be equal to credit hours provided for all
companies).

  States can deviate from the recommendations of the Midwest Zone
requirement for home study courses, but if all states are following the
same formula this is less likely to happen. Even so, each state has the
option of adopting only those portions of the Agreement that they
concur with. Classroom continuing education will not have these
issues since they are based directly on time spent in the classroom –
not course quality or content (although the content must meet the
state’s requirements).

 Some home study and internet courses are considered the equivalent
of being in a classroom. These are called “classroom equivalent” (CE)
courses.

    Internet courses considered the equivalent of seminars
        are called “classroom equivalent” (CE) courses.

  For classroom courses, all states have agreed to issue one credit hour
for each 50 minutes of contact instruction. The minimum number of
credits is one (1), meaning no partial credits for less than one will be
issued. There is no maximum amount of credits allowed.

  Each state will use its own criteria to determine if an instructor or a
continuing education company is qualified to offer instruction. States
will not review an instructor’s qualifications, but they may disapprove
an instructor or company if that person or company fails to comply
with state laws or regulations. No state is required to accept an
otherwise unacceptable topic for credit. For example, most states do
not approve credit for any course based on product marketing. In all
cases, each state will continue to follow their own regulations and
laws.


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 Many states have changed the quantity of continuing education hours
required as a result of the Midwest Zone agreement. Some agents
must now complete a greater quantity of credit hours, while agents in
other states have a reduced requirement.          The Midwest Zone
agreement states a continuing education requirement of 24 CE credits
(each credit is equal to one hour of education) per two-year license
renewal period. Of the required 24 CE hours, some portion of those
must be in ethics. So far, states are required between one and four
hours of ethics, but this may eventually become standardized.

  Many states have other requirements, such as a long-term care
requirement for those who sell long-term care products. At least one
state has an annuity education requirement in order to sell annuity
products. Many types of professions require specialized education so it
is not surprising to see this for insurance agents.

An Agent’s Personal Responsibility
 Many types of careers have specific requirements. When education is
one of them it is always the individual’s responsibility to meet those
requirements on time. It is not the job of their boss, secretary, or
spouse to remind, monitor, or meet those needs on their behalf. It is
certainly not the responsibility of the education company to provide
special services for those who have failed to fulfill the responsibility in
a timely manner. Following state laws is the legal obligation of each
agent, including meeting their educational requirements.

  Each education course will have a specific course number
assigned to it. This course number allows agents to keep track of
what they have completed. Most states forbid repeating a course
within a specified time period so it is important to keep a record of
courses previously completed and turned in to the state for education
credit. It is not possible to track education by the course title alone
since titles are often duplicated. For example, “Health Insurance” is
probably the title of multiple CE courses, yet the course numbers are
not necessarily the same. As long as the course numbers are different
the agent may take more than one course titled “Health Insurance.”
Multiple companies may offer the same continuing education course so
again, it is always important to track by course number rather than by
course provider.

            It is not possible to track education by
     the course title alone since titles are often duplicated.

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  Some states have requirements as to the subject type that a given
license line may take. For example, it is common to require life agents
to take only life context courses. Some states also mandate the level
of difficulty that must be taken. For example, an agent who has been
a producer for ten years or more may have to take a more difficult
course than would a new agent. When this is the case, courses will be
labeled according to their difficulty, using such terms as basic or
intermediate.

  Education providers will issue a Certificate of Completion each time
an education course is completed. The Certificate may be issued by
mail or online. Some states require the certificate, or a copy of it, be
turned in with the license renewal fee. Other states merely require a
listing of the course number on the renewal form. In either case, the
agent must keep a copy (or the original if a copy is turned in) on file in
case he or she is audited by the state. It is not the responsibility of
the education provider to provide a certificate more than once. Most
schools will charge the agent to provide an additional copy. Where
Certificates may be downloaded from a website it is likely that no fee
would be levied to download multiple copies.

 We are seeing a greater quantity of career agents obtaining more
education than actually mandated by the states. There are many
schools that provide a higher level of learning, with some awarding
specific designations.    Agents may become a Certified Financial
Planner (CFP), a Registered Health Underwriter (RHU), or similar
designations of higher learning.

       There are many schools that provide a higher level
     of learning, with some awarding specific designations.

  Additional education is always beneficial, if only to improve one’s own
professional standing. Agents often complain that it is difficult to find
something to take on a new topic. This can especially be true when
states mandate education based on license type. Additionally, there is
only so much that can be said about automobile insurance. As long as
it is a professional responsibility, however, it is the agent’s duty to
complete the requirements of the state (and to do so in a timely
manner).



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Professional Representation

 Agents have a duty to be professional at all times – whether
presenting a policy or buying groceries at the local market. The
woman checking out your groceries this morning may end up being
your appointment tonight.

 Professionalism means many things from dressing appropriately for
appointments to returning telephone calls and answering emails.

Appointments
  The hardest part of commissioned sales is finding a place to be. It is
especially hard to find a “place” that is qualified to buy. If we want to
fine-tune it even more, if that “place” is not only qualified but also
willing to buy it becomes very valuable. What a shame it would be to
show up at a qualified, willing appointment only to be turned away
because the agent was not presentable.

 Since agents are primarily self-employed there is no one to enforce a
dress code or cleanliness standard. One would hope that an agent
would simply understand the importance of it. Additionally, agents
must avoid doing anything that might prevent a sale. For example,
wearing perfume or cologne can be an error when the client has
allergies. It is hard to commit to a policy once sneezing and swollen
eyes develop.

  Obviously, being on time for appointments is very important. Some
agents also feel there should be a limit to how long the agent stays at
the home. Most sales presentations can be accomplished within an
hour. Overstaying the agent’s welcome could irritate a busy consumer.
When a sales presentation goes longer than an hour it should be due
to multiple questions from the client rather than wordiness on the part
of the agent. Never should an agent spend his or her time boasting
about personal accomplishments or embellishing.

When setting appointments most states have specific requirements.
The agent must immediately identify who he is, which company he
represents, and the purpose for his visit.

      For example:
       “Good morning Mrs. Phillips. My name is Bill Maxwell. I
      am calling you regarding your automobile insurance policy.

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     I represent XYZ Company and I am hoping to be able to
     save you some money on your policy. May I stop by next
     Tuesday or Wednesday to review the policy you currently
     have?”

  It is illegal to falsely state the purpose of the appointment or the
company involved. We have all experienced the annoying telephone
calls that tell us they are not selling anything – just conducting an
interview by telephone. Most of us are smart enough to know that is
seldom the case. While there may be some callers that actually are
conducting some type of interview, most such calls are for the purpose
of marketing some product or service, despite what the caller claims.

 Insurance is a highly regulated industry. Even the initial client
contact is regulated.       Most states are determined to minimize
consumer deception. The Medicare policy market had many problems
a few years ago with deceptive practices. The results were many
additional hoops for all to jump through in an attempt to remove those
agents who were purposely misleading consumers. It is illegal to say
or imply that you represent any government entity, such as Medicare.
You must clearly state, if you sell Medicare or long-term care products
that you represent an insurer – not Medicare or the government.

 It is illegal to say or imply that you represent any government
entity, such as Medicare, when in fact you represent an insurer.

Getting In the Door
  Even when a pre-set appointment exists, consumers may change
their mind when an agent shows up on their front porch. That is their
right. Agents should never bully a consumer in order to gain entrance
to their home. Even when an appointment has been pre-set, it is still
necessary to identify yourself upon arriving at their home. Again, the
agent must state within the first minutes of conversation who they
are, the insurer they represent, and the purpose of their arrival.

     For example:
      Good evening Mrs. Phillips. As you remember, I called
     you a week ago and arranged to review your automobile
     policy this evening. My name is Bill Maxwell and I hope to
     save you some money through the company I represent,
     XYZ Company. May I come in?”


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 Agents may “cold call.” This means they show up at a person’s door
without an appointment. In all cases, the agent must clearly identify
themselves, the company they represent, and the purpose of their
visit. If more than one company is represented, state the company
you feel is most likely to be sold. It should be clear to the consumer
that you do not represent the government or some organization other
than an insurer.

      For example:
        “Good morning. My name is Bill Maxwell. I am in your
      neighborhood today representing XYZ Company as their
      agent. If you own an automobile you probably have auto
      insurance. I am hoping to save you some money by
      reviewing your current policy, making some comparisons,
      and offering some personal advice. May I come in?”

  Please note how short the introduction is. It would be hard for a
consumer to confuse the purpose of his visit. Bill identified himself as
an agent, the company he worked for, and he said he wanted to
compare their auto policy. The consumer has two simple choices: to
allow Bill in to review their policy or to refuse Bill entry. Either way,
Bill has used little of his time (a precious commodity in the
commissioned sales world) and the consumer can say he is either
interested or not interested. Bill should also present his business card
at some point, even if he is not allowed entry.

  If the consumer declines the offer, Bill should make a professional
exit, never showing any hostility at the declination. He might hand the
person his business card, saying: “Okay, I understand how busy
everyone is these days, myself included. Please take my card and feel
free to call me if I can ever be of service.”

  It is important to be honest, even in small talk. Agents have heard
that we must appear to be “just like the consumer.” If the consumer
has a boat, we should love boating. If the consumer has a dog, we
should also say we have a dog.         If honesty is not part of the
conversation it has no business being said at all. We do not have to
share every quality with the consumer. Each person is different and
each person brings his or her own qualities to the conversation. That
is what makes it so exciting to be a salesperson. We meet new and
different people every day. Why would we think we have to be like


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each of our clients in order for them to purchase a policy?         Do not
listen to those who advocate dishonesty in any form.

 It is necessary that the consumer have a feeling of safety. If there is
any indication at all that the agent presents a danger, he or she will
not be allowed entry into the consumer’s home.            Why would a
consumer think he or she could be harmed? Usually it has to do with
how agents present themselves. If the agent is too brisk or too pushy
the consumer (especially older consumers) may feel threatened. It is
best to stand back from the doorway, keeping space between the
consumer and agent. Certainly we would not want to do any of the
stereotyped things we’ve seen on television, like putting a foot in their
door so it can’t be closed. If the agent has a naturally loud forceful
voice, he or she may want to modify it if possible. It should be no
different meeting a consumer for the first time or meeting the next-
door neighbor for the first time. Both are potential friends.

     When an agent is too brisk or too pushy the consumer
      (especially older consumers) may feel threatened.

  Many years ago, when television was still fairly new, there was a
television series named “Father Knows Best” staring Robert Young. He
played the staring role as the father everyone wished they had. He
was also an insurance agent. Today’s heroes are never insurance
agents because somewhere along the line we became known as
untrustworthy, pushy, or greedy. Of course, many industries have
suffered this along with agents. Lawyers are commonly portrayed as
unethical, yet we know the vast majority are good people. Law
enforcement has had multiple incidents leaving people wondering if
they should be trusted. Yes, agents have a lot of company in their
declining public image.

  Why has this happened? What has caused the image of the insurance
agent to be so downgraded from the days of “Father Knows Best”? It
would be impossible to single out a single reason, but much of it has to
do with stereotyping. It only takes a couple of well-publicized problems
to paint all of us with the same brush. The only way to combat this
public image is by displaying professionalism at all times, even in our
nonworking lives.




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Making the Sale (Or Not)

  It would be wonderful if every presentation of insurance resulted in a
sale, but that is certainly a dream rather than a reality. We realize
there will be many disappointments. Even so, it is possible to make a
good living selling sound insurance products. People need multiple
types of insurance and they buy from someone every day.

      If the consumer does not see a need for the product,
     there will be no reason to spend money to purchase it.

  After agent professionalism, the product is probably the primary
reason a consumer will either buy or not buy. If the consumer does
not see a need for the product, obviously there will be no reason to
spend money to purchase it.          An insurance product (called an
intangible item) brings no immediate pleasure. It would be unlikely to
impress your friends if you waived the policy in front of their face.
Even if the consumer realizes the usefulness of a policy, it brings him
or her no particular tangible feeling of pride in owning it. There may
be personal satisfaction but it is never the same as putting on a new
coat, running your hands over the fabric, and standing in front of a
mirror to admire how it looks. Nor can you drive an insurance policy
to your friend’s house to enjoy his look of envy. Reading an insurance
contract will never deliver the same pleasure driving a new car will.

  Knowing this, agents must express the need for insurance in terms a
layperson understands. While it is certainly necessary to cover all the
key components of a policy, including what will not be covered, it is
equally important to do so in a manner that is understandable to a
person with no insurance knowledge. The explanation should also be
as concise as possible. No one wants to spend his or her Saturday
with an insurance agent that drones on and on. In fact, an agent who
can’t stop talking will miss many sales. How do we see agents on the
comedy shows? The insurance agent is often portrayed as a person
who bores everyone around him with constant insurance talk. It would
seem that society in general considers anything insurance related as
boring, and they are largely correct. That doesn’t mean a policy
cannot be concisely explained in clear language.




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  Consumers know they must insure their, home, auto (often required
by state statute), perhaps their lives, and certainly their health. They
will consider any policy they perceive to be of value. It is the agent’s
job to show the value of that invisible product – insurance.

Product Over Commission
  Have you heard the expression: “He wore dollars on his sleeve”? It
means the individual was clearly thinking of his own financial gain.
When an agent needs income, he or she may display this urgency
conspicuously so that clients become uneasy about the agent’s
trustworthiness. Few of us want to buy an intangible service oriented
item from someone who seems overly anxious to make the sale. We
may like seeing that on the face of the salesman who is offering us a
new car (it may mean a better price), but when it comes to a product
that will be used in the future we want to be sure we receive quality.

 The sales presentation must always focus on the benefits of the
product; commission should never be on the agent’s mind – never.
Yes, an agent must pay his or her bills just like everyone else, but
when the agent is overly concerned with the commission that will be
made it may cloud judgment or cause the seller to make mistakes that
could lead to errors and omissions claims. Consumers today are well
aware of their ability to sue when the agent makes a mistake. A
mistake is more likely to happen when an agent is focusing on the
wrong element of the sales process (commission).

              At no time should a financial planner
           consider commissions rather than products.

  Those in the financial planning field are especially vulnerable to
lawsuits. Merely claiming to be a financial planner puts the individual
in a higher level of fiduciary responsibility. At no time should a
financial planner consider commissions rather than products.          Of
course, this is true for all salespeople, but those who have the highest
threat of lawsuit must especially be aware of it.

 When products are the primary focus of an agent, it is likely that this
will show in their presentation. The client will have confidence that he
or she is receiving what they want to buy rather than what the agent
wants to sell.



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Organization
  A disorganized agent rarely looks professional. Organization is a
primary part of professionalism. Briefcases should be organized and
never appear messy to the client. Application packets should be
complete, with all forms included, even those that are not routinely
required. Some agents go through the packet forms and highlight in
yellow or some light color each signature line. This prevents missed
signatures that could result in a subsequent appointment to have the
forms signed. This would delay policy issue which would clearly
demonstrate to the client that the agent was either inexperienced or
disorganized. Either way, the agent looks bad.

            Many professionals like to use preprinted
       sales presentation forms. This allows the agent to
        check off necessary points as they are covered.

 Sales presentations must be organized. While client questions may
disrupt the presentation, it should never make it appear disorganized.
Agents must know their presentation well enough to pick up at any
point and move on. Many professionals like to use preprinted sales
presentation forms. This allows the agent to check off necessary
points as they are covered. This form should be kept and filed with
the client’s paperwork. If a lawsuit is ever initiated, the agent can
then prove the points were covered. In financial planning fields, the
agent often has the client initial each point as well.

Full Disclosure
  It should not be necessary to say that honesty is required at all times
but unfortunately this must be said. Most agents are very honest in
their work and personal lives, but those that are not affect all of us.
Many states now mandate that ethics be part of the agent’s required
continuing education. The insurance departments realize that this
education will not make a dishonest person suddenly become honest,
but such education does prevent the dishonest agent from claiming he
or she was not aware of their ethical requirements. It allows the state
insurance departments to effectively and legally enforce an agent’s
ethical requirements.

 Insurance contracts are legal documents requiring legal language. As
such, they can be intimidating to the layperson. Our clients’ may only
want to know what claims will be paid, ignoring that which is not
covered. It is the agent’s professional duty to fully cover all aspects of

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the policy, including policy limitations and exclusions. It is easy to
bypass these, especially if the agent fears it will prevent a sale. This is
unwise. Not only will the client not fully understand their purchase,
but also the agent may find himself or herself in a costly lawsuit later
on as the result of the omission. When a claim is not paid, but the
purchaser knew it would not be, there is no problem. A problem will
develop when a claim is not paid and the client expected it to be.

Product Replacement
 Many types of insurance lines are a replacement business. While the
states have been working to change this, it will never completely go
away.

  Some policies should be replaced because they are limiting or so old
that they do not contain current language or coverage. However, even
very old policies may be better than those currently available in some
circumstances. For example, many old nursing home policies should
not be replaced because:
      •   The insured’s age would cause a dramatic increase in
          premium cost.
      •   There are health conditions that did not exist when the
          original policy was purchased.
      •   Replacement would cause loss of tax benefits.
      •   A new pre-existing time period has the potential of resulting
          in claims not being covered or only partially covered.

  There may be other reasons not to replace an existing policy. If the
existing policy offers more benefits than currently available, obviously
it would not make sense to replace it. Just because a policy is old
never automatically means replacement is advisable.

          Specific policy replacement forms must be used
                     and signed by the insured.

  States have laws regarding policy replacement. These laws have
become necessary because too many policies were needlessly or
harmfully replaced. Specific replacement forms must be used and
signed by the insured stating that they realize replacement of an
existing policy is taking place. These forms actually protect the agent



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as much as the consumer since consumer acknowledgement is part of
the replacement process.

Policy Application
  Each new policy requires an application. Some types of insurance
allow the writing agent to “bind” the policy, while other types of
insurance must go through underwriting before issuance is possible.
Even when an agent has the authority to bind the coverage, generally
an application is still filled out.

  If policy replacement is taking place, it is extremely important that
full attention be given to underwriting requirements. An existing
policy should not be allowed to lapse until the new policy has been
underwritten, issued, and reviewed for errors that could rescind the
policy issuance.

  Underwriters will use health and lifestyle questions to determine
whether or not the insurer wishes to take on the risk of insuring the
applicant. The writing agent should review any question that may not
be fully understood or fully answered. The health questions must
never be minimized or handled in a manner that leads the applicant to
believe they are not relevant to policy issuance or payment of claims.
If the agent notices indications of existing health issues that have not
been acknowledged by the applicant, the agent must state so on the
application or in an attachment to it. There is no point issuing a policy
that will not pay claims when they are filed due to false information or
information that was not disclosed.

  When an agent knowingly presents an application that does
 not disclose existing information it is called “clean-sheeting.”

 In a desire to earn a commission it is not unusual for an agent to
“overlook” existing health conditions.     When an agent knowingly
presents an application that does not disclose existing information it is
called “clean-sheeting” since the agent is attempting to produce a
“clean” application. Once an insurer realizes that an agent has a
pattern of omitting or ignoring existing information they will red tag
him or her. From that point on (if they accept applications at all) they
will be thoroughly examined for omissions or falsehoods.             The
underwriters might even contact the applicant and go over each
application question again. This will delay issuance of contracts and


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could also be embarrassing as consumers realize the company does
not trust its own agent.

Product Delivery
 Depending upon the product, the issued policy will either be mailed
directly to the insured or it will be sent to the agent for delivery. If the
agent receives the policy it is very important to deliver it as soon as
possible. Delay of policy delivery could jeopardize the sale.

  Upon policy delivery the agent would be wise to go over each page of
the policy, stressing important points. Anything that is not covered by
the policy should be pointed out. Many professionals carry a check
sheet with them that mirrors the policy. As each section is reviewed
the agent has the insured initial either the actual policy or their check
sheet. From an errors and omissions standpoint, it would be best to
have the client initial the check sheet. This form should be filed with
the client’s other paperwork and kept indefinitely. Relatives of the
insured can file lawsuits, so even if the insured should die, the agent
will want to keep the paperwork for a year or two longer. If someone
should file a lawsuit, the agent will be able to better defend him or
herself, based on the paperwork in the file.

 This is also the time to review the copy of the application, which will
be part of the issued policy. Any errors should immediately be
corrected. Even the spelling of the name should be reviewed for
accuracy. In some policies, age can be critical to issuance, so even
the date of birth should be reviewed. Of course, any errors must be
reported immediately to the insurer. If there is any chance at all that
existing errors could affect the issuance of the policy, existing policies
should not be allowed to lapse.

         If there is any chance at all that existing errors
              could affect the issuance of the policy,
         existing policies should not be allowed to lapse.

 Many professionals consider policy delivery just as important as the
actual sales presentation. It is an opportunity to review what has
been purchased and the importance of the protection. It is also an
opportunity to cement the relationship between agent and insured.
We all want to trust the people we do business with. When the agent
returns with the policy in hand it allows the newly insured to breathe a


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sigh of relief since what the agent promised has been delivered (in
person!).

 The hour spent delivering the policy often leads to referrals. If that is
the case, it is important that each referral be contacted within a few
days. Otherwise, the importance of the contact may seem minimized,
potentially embarrassing your new client. He or she may have called
the referral, promising them the agent will call soon.


Yearly Reviews

  Many types of products need to be reviewed periodically, especially if
circumstances have changed. All insurance contracts will not need to
be reviewed, but some that may include life insurance policies, auto or
fire coverage, and many types of financial products. Why would a
review be necessary? Divorce, marriage, adoption, births, or other
changes within the family may affect policy performance or how
beneficiaries would be protected. Changes in financial standing could
leave assets unprotected as well.

Revisiting the Sale (Homework)
  Generally agents maintain files on each of their clients. This allows
them to refresh their memory on why certain products were selected,
customer goals, and family circumstances. While some clients become
friends as well as clients, the majority will only be seen annually so it
would be unlikely that the agent would remember personal details
about them.

  Some type of system must be initiated to bring up clients prior to
their policy anniversaries. In this age of computers that is fairly easy
to do. Even a calendar system may be used, however. Renewals
listed in a calendar format (month by month) can serve as a reminder
of which clients are renewing each month. Of course, it must be
constantly updated as new clients are added.

  Each month clients would be contacted for the purpose of reviewing
their current coverage. This provides an opportunity for the client to
offer new concerns, new or changed goals, and changes in family
circumstances. Yearly visits also allow your clients to feel connected
to you as their agent, renewing business relationships.


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Does the Product Still Meet Their Goals?
 One of the primary purposes of yearly reviews is to address the
needs of the client, including their goals, and assessing whether or not
the product is meeting those needs. This will require enough time to
assess past goals, which should be maintained in the client’s file,
consider new goals, and review how changes in family circumstances
may have affected them.

 Is there a new driver in the home?

 Has the value of their home increased considerably?

  Is a family member entering a new profession that might impact their
financial situation?

 Any type of change that affects the ability of their insurance to
perform adequately should be addressed.


Errors & Omissions Insurance

 Doctors and attorneys carry malpractice insurance.          Securities
dealers carry blanket bond policies. Insurance agents purchase Errors
and Omissions insurance. In each case, the type of liability insurance
purchased mirrors the risk it covers.

  Some in the insurance profession feel it is an ethical duty to carry
errors and omissions insurance (and they are probably right). Many
insurers now require their agents to have such liability protection. It is
not an unreasonable requirement. Consumers are increasingly aware
of their ability to sue any time they are unhappy with the outcome of a
financial situation. As agents, we know that our clients are not always
happy about how their claims are handled or how an annuity pays.

        Consumers are increasingly aware of their ability
       to sue any time they are unhappy with the outcome
                     of a financial situation.

Agent Liability Risk
 When an insurance agent is also a financial planner, a serious conflict
of interest automatically presents itself. This conflict is particular to


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the insurance industry. An accountant who also advertises himself as
a financial planner, for example, does not usually sell insurance
products. Therefore, there is no question that he will be promoting
products for their use rather than any earned commission. Of course
it is possible that the accountant may also be a licensed insurance
agent. If that were the case, he or she could also have a conflict of
interest if insurance products were sold as the result of financial
advice.

  An agent and financial planner must be very cautious. While conflict
of interest can exist for an insurance agent, the degree is greatly
increased when an agent is also an active financial planner. The
agent/planner must always place their attention on the advice given –
not the products sold. Furthermore, he or she must fully document
any advice given and any products sold. It must be clearly evident
that the focus was on appropriate products rather than any earned
commission. If it is appropriate, the agent/planner must forgo their
commission and recommend a product outside of their ability to supply
it. It is not advisable to recommend their clients go to any person that
might be perceived as being a partner of the planner since a conflict
could then still exist.

  Insurance agents face similar professional liability problems as those
faced by other professionals, such as accounts, lawyers, or others in
the service fields. Statistically, negligence is the number one reason
an agent is sued.7 Negligence covers many areas, but it often relates
to placing too much coverage, not enough coverage, or advising a
client to invest in something with high risk. Furthermore, an agent
can be sued for giving unauthorized instruction to insureds or
unauthorized interpretations of coverage. While this sounds confusing
it often relates to giving information they are not qualified to provide.
For example, an agent who recommends a living trust may be sued for
providing legal advice that he or she was not qualified by either
training or experience to give.

                           Statistically, negligence is the
                        number one reason an agent is sued.

 Each type of agent has liability specific to the type of products they
market. For example, a property and casualty agent is expected to

7
    Professional Liability Pitfalls for Financial Planners by Cheryl Toman-Cubbage

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mention umbrella liability insurance when selling an auto or
homeowners policy. Umbrella coverage does not pay particularly good
commissions, so it is not a matter of agent income. Rather it is done
to protect the agent in the event the insured suffers a loss greater
than the amount of liability protection provided under the auto or
homeowners policy.      By having covered the potential need for
umbrella coverage (and fully documenting it), the agent is protected
from lawsuit. That doesn’t mean that he or she can’t be sued; it
means the agent has the ability to defend him or herself in court.

  Anything involving a financial investment brings about a higher
potential of lawsuit, but all insurance activity presents risk. Was
adequate life insurance recommended?         Was appropriate health
insurance put in place? Were application forms correctly filled out to
insure the policy would not be rescinded?

  Agents are liable not only to their clients, but also to the insurers
they represent.      Agents are considered representatives of the
insurance company. Brokers are considered representatives of the
insured. Both can be sued, however. Even so, the distinction is
important if an insured decides to sue both the agent and the insurer.
When a broker is sued, the insurer may be able to escape liability. It
is more likely that the insurer will continue to also be held liable when
an agent is sued.        Even if the agent failed to follow insurer
requirements the insurer may still be held equally responsible by a
court of law. Considering this, it is easy to see why insurers require
their agents to carry Errors & Omissions liability insurance.

Even when the agent failed to follow insurer requirements the
insurer may still be held equally responsible by a court of law.

  Express authority refers to the powers agents do have because the
insurer has given it in the agency agreement or agency contract.
Ostensible authority refers to those powers the public might
reasonably expect an agent to have, even though they may not. It is
ostensible authority that the courts often use when determining legal
awards.



      For example:


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       Marge buys a homeowner’s policy. Her house is 65 years
     old. The company her agent places her with does not
     insure any home that is older than 60 years, but he fails to
     realize the age of Marge’s home. Before the insurer can
     respond, her house burns down. Since it would not be
     possible for Marge to know that the insurer would not
     insure her home, she has a logical reason to believe her
     claim will be covered.

  The insurer would be liable for Marge’s fire claim, even though they
clearly state they do not insure houses that are more than 60 years
old. The courts will base their decision on whether or not it was
reasonable to believe coverage existed. This is based on ostensible
authority – not express authority. It does not matter whether or not
the agent actually had such authority in the agency agreement. It
only matters whether or not the insured might logically believe such
authority existed. In other words, Marge could logically believe that
her agent had the authority to issue a policy through the insurer he
selected.

 Insurance companies have specific forms for legal reasons. It is
necessary for agents to follow the insured’s requirements to prevent
misunderstandings. While the situation with Marge did not involve an
agent overstepping his bounds, but rather an agent who did not
consider the age of her home, insurers often end up responsible for
agents who clearly know they are outside of the insurer requirements.

  Insurers can demand payment from their agents when they clearly
overstep their authority. It has become increasingly common for
insurers to sue their agents for negligence. It has also become
common to include a statement of consequences for errors or
misconduct in the agency agreement.

             It has become increasingly common for
           insurers to sue their agents for negligence.

  We know agents, financial planners, and brokers are required to act
with reasonable care and diligence when representing a policyholder.
Agents, financial planners, and brokers are also required to act with
the same reasonable care and diligence when representing their
insurance companies. They are legally required to follow the agency
agreement and all insurer regulations regarding their policy procedures

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and requirements. There is an implied-in-law duty of good faith and
fair dealing imposed on agents and insurers alike. When an insurer is
sued for bad faith, the agent is likely to be named in the lawsuit as
well. This is understandable since the error often originates with the
agent in the selling field.

 While many insurance agents manage to escape the consequences of
their actions, it would be foolish to think this is always the case.
Agents can be liable for both civil and criminal violations. Criminal
violations may require a fine, imprisonment, or both. In recent years
states have began to take a harder stand than they have in the past.
Legislators have supplied the necessary funding to pursue criminal
violations that may have previously been ignored. Some states allow
a hearing before the state insurance commissioner rather than
appearing in court. Depending upon the offense, the state may allow
the agent to merely surrender their insurance license.

  While negligence is statistically the most common reason for lawsuits
fraud is the most common crime committed by insurance agents.
Fraud can include many types of actions, including failure to turn in
premiums, commingling premium dollars, turning in fraudulent
continuing education certificates, or selling products the agent is not
licensed to sell. These are not the only examples of fraud, but they
are some of the most common.


Giving Our Clients What Is Due Them

 Agents and their clients both have a business responsibility when
purchasing and using insurance. While the agent has more legal
responsibility than the client does, there are ethical responsibilities on
both sides.

 An agent owes his or her clients:
   1. Professionalism and courtesy. At no time should an agent
      ever become rude even if his or her client is. A professional is
      held to a higher standard than a layperson.
   2. A fiduciary duty. This is the most basic obligation owed by
      any professional to his or her client.   Professionals have
      knowledge and experience not held by the general public.


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   Therefore, the agent must act first and foremost for the client’s
   benefit over his or her own interests.
3. Honest and full disclosure. Every client deserves to receive
   the full truth, not just partial truths. Each product should be
   fully explained, including negative aspects. If the agent makes
   a mistake, this should be stated and then corrected to the best
   of the agent’s ability.
4. Honest contract comparisons. Not only is it unethical to
   misrepresent an existing current policy, it is also illegal to do so.
   Policy replacement is not always beneficial for the client. This
   overlaps honest and full disclosure, but it deserves specific
   mention.
5. Due diligence on every product sold.          While no one can
   correctly estimate every industry change, if proper due diligence
   is performed clients will probably be dealing with financially
   strong insurers.
6. Errors & Omissions insurance.           When an agent carries
   liability insurance, serious errors or omissions may be covered
   even if the agent does not have the financial ability to do so
   personally.
7. An understanding of personal limitations. Few of us are
   able to be an expert in all things. Most agents have a few areas
   where we are especially trained or experienced. When a client
   needs information outside of our expertise, it is seldom wise to
   offer advice, even if requested. It is far wiser to refer them to a
   person who specializes in that area of services.
8. Appropriate customer service. No agent can do everything
   immediately for every client, but service should be given in a
   timely manner. It is not acceptable to wait a week before
   returning a telephone call, for example, unless the agent is ill or
   on vacation. Even then, an office staff member should call the
   client and explain the situation, offering the insurer’s customer
   service number if the policyholder is not able to wait for the
   agent’s return.
9. Current information. Nothing stays the same forever. Laws
   change, customs change, client goals change. Agents owe their
   clients current information.   This is accomplished through
   insurer newsletters and brochures, attending seminars on new

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      products, or acquiring continuing education through other
      means.
  10. Periodic reviews. While it may not be necessary to review all
      types of policies, many do require periodic reviews in order to
      preserve the type of financial protection desired.

  The insured also has a responsibility any time a contract is
purchased. Unfortunately, few people consider an insurance policy a
legal contract, even though it is. The insured has the following
responsibilities:
   1. Courtesy. Even though the insured may not be legally defined
      a professional, each of us owes others courtesy.
   2. Honesty on the application. We realize that consumers often
      realize their need for some types of policies too late. Perhaps
      health conditions have developed, or a bad driving record
      exists. Whatever, the situation, honesty is not only expected,
      but also required by law.
   3. Attention to the details. The consumer owes his or her entire
      attention during the policy presentation. It is their responsibility
      to pay attention. The agent is spending his time going over the
      aspects of the contract; the least the consumer can do is pay
      attention.
   4. Notification if the policy explanation is not understood.
      Agents are not always accomplished communicators. We would
      hope they are sufficiently trained to deliver a clear picture of
      the product being presented. However, if the consumer finds
      he or she does not understand it, they have a responsibility to
      communicate this to the agent.
   5. Realistic expectations. No policy covers everything. Some
      goals cannot be met through an insurance policy. Certainly, it
      is not possible to provide a secure retirement income if there is
      not adequate time or savings available. It would be unrealistic
      to expect the agent to deliver this without adequate funding or
      time.
   6. Timely premium payments. When policyholders constantly
      allow a policy to lapse, the agent must spend his or her time
      getting it reinstated. There is generally no fee to do this



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       service but it does take time away from activity that would
       produce income.

Criteria
  Before an insurer will issue a liability product, such as errors and
omissions insurance, there must be specific criteria for the risk. There
must be enough people interested in purchasing the coverage to make
the policy affordable. With insurers mandating E&O insurance, it is
likely that enough people will buy the coverage. The number of
exposure units must be sufficiently large to make the loss reasonably
predictable for the insurer’s analysts.

  The insurance company insuring the risk must be able to determine
when a loss has taken place. In the case of homeowner’s insurance, it
is the fire or theft that is insured. In the case of E&O liability insurance
it is the loss in court. The loss must be definite and measurable. This
means the insurer must be able to tell when a loss has happened and
be able to determine the exact amount of the loss in dollars. The loss
must also be accidental. No company would want to insure an
intentional loss. Finally, it cannot be certain that a loss will take place;
it must be an occurrence that may or may not happen. Usually, the
loss cannot be catastrophic since most types of policies could not be
profitable if that were the case. In fact, known severe catastrophic
losses would probably be deemed uninsurable.

 There are two types of liability insurance available: claims made and
occurrence policies.

Claims-Made Policies
 Claims-Made liability policies are the most common type available.
In fact occurrence policies may be difficult to find and purchase.
Under a claims-made policy, the insured is covered for E&O claims
only while the policy is in force.

Occurrence Policies
  Occurrence policies are the more liberal of the two types of liability
policies. The insured, under this type of contract, is covered for any
loss that occurs during the policy period, even if the policy is no longer
in force. It does not matter when the claim itself is actually filed –
only when the loss occurred. Since this type of liability policy is
obviously best, it is not surprising that it is also more expensive to


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buy. Unfortunately, it is also difficult to find for purchase.         Most
companies now offer only claims-made policies.

  Few insurers want to be liable forever, which would be the case with
an occurrence policy. Those who insured employers under the claims-
made policies found themselves paying thirty and forty years later for
claims. A good example of this is the companies who insured the
asbestos industry. Injuries from the 1950’s were being paid in the
1970’s and 1980’s. Occurrence policies make it very difficult for
insurers to determine amounts of future claims. There are many
examples of claims that occurred years after policies had expired.

 There is not always agreement on when a claim occurred. This can
cause serious problems for insurers if the time of loss cannot be
readily determined. For some financial vehicles it may be relatively
easy to determine, but in many cases it could hinge on either the date
of sale or the date of the actual financial loss, if that did not happen
until after the sale.

  Errors and omissions insurance pays on behalf of the insured legally
owed sums on any claim made against the insured and caused by any
negligent act, error or omission of the insured or their employees in
the conduct of their business as general agents, insurance agents, or
insurance brokers. It is important to note that only “legally owed”
sums are covered. Feeling morally responsible will not obligate the
policy to cover losses; they must be legally owed.

  E&O liability policies typically exclude coverage for dishonest,
fraudulent, criminal, or malicious acts of the agent, as well as libel and
slander. This type of insurance does not apply to bodily injury,
sickness, disease, or death of any person. Nor does it cover injury to
or destruction of any tangible property, including the loss of its use.
That means that other insurance should be in place to cover such
things as running over the client’s dog, or covering the client’s knee
injury when she fell over the box of files you left by the door of the
office.

 Policies vary in size. Just as your client can choose to cover one year
of long term care in a nursing home or five years of care, agents can
choose policies that cover only $25,000 in damages per claim with
$75,000 single limit or as much as several million dollars in coverage.
With the awards we are seeing today in court cases, agents should

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consider higher coverages. It is likely the policies available to buy will
be claims-made rather than occurrence policies. An agent can be
covered for liability to clients, to third parties, and to the insurance
company he or she contracts with.

  According to an analysis by Shand, Morahan, administrators of the
National PIA Errors and Omissions Insurance, errors and omissions
claims against agents fell into three categories: 44 percent resulted
from failure to place proper coverage; 22 percent resulted from the
agent’s failure to place any coverage at all; and 9 percent resulted
from the agent’s failure to forward or process a policy renewal. Other
claims were filed for the agent’s failure to advise the insured of a
policy cancellation (7%), an insurer’s claim against their agent (2%),
and dishonesty or fraud of employees (1%).

  As we have mentioned, financial planners have more liability than
would an agent, especially if the financial planner acts as both an
agent and a planner. Any person wishing to bill themselves as
financial planners should be sure to have the training and experience
necessary to perform the service. Not all states have requirements
limiting who may call themselves financial planners. As a result, many
agents do so believing it will increase their image, and therefore, their
sales. In fact, it increases their liability and their ability to be sued.

  We give a lot of surface talk to ethical conduct. Each of us wants to
be perceived as an ethical person, especially to our clients. We would
like to believe that integrity and high performance goes hand-in-hand,
but there is no evidence of this. A highly ethical person does not
always earn the most sales or make the best financial decisions. In
fact, some of the best con artists appear highly moral, which is why
they are so successful at bilking others out of their money. Of course,
we do have examples of highly moral people that do well financially,
but it is likely they have the ability needed in their profession. These
high achievers have sought the necessary education and
communication skills and then merged it with their moral values.
When an individual has ethical intelligence and the competency
required to do a good job, they will always benefit the company they
work for or the company they own.

  Your state is mandating courses in ethical conduct for two primary
reasons beyond the obvious one: seeking ethical performance in the
insurance industry. By mandating courses in ethical behavior the state

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then has the ability to punish those who fail to act appropriately. The
“I-didn’t-know” defense does not hold up. Secondly, it is the hope of
the state insurance departments that those who are pushed into
conforming to state law and moral standards will eventually form the
habit of doing so. Just as we develop many of our personality traits by
repetitive actions, perhaps that will develop in our business lives as
well.

  Unfortunately, most societies value earning ability more than
morality so we miss many of the daily examples of moral behavior all
around us.      Knowing right from wrong does not guarantee an
individual will perform ethically. Most of us know right from wrong.
The knowledge of morality is not the problem; the problem is acting
morally even when there will be no visible reward for doing so.




                     This completes your course.

                         Thank you for using

              United Insurance Educators
                 for your continuing education needs.

                     Telephone: (800) 846-1155
                        FAX: (253) 846-7536
                       Email: mail@uiece.com




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