Author: A.T.

Last week we had a kind of dense column on variable universal life insurance, largely written by my friend Less Antman and another, also largely by him, that read like a thriller, on Qualified State Tuition Plans.

In each case, I provided a one- or two-word “executive summary” for those of you who might have been running late for work.

“Your executive summaries,” writes Less, “have inspired me to stop wasting my time with time-consuming posts. So instead of spending weeks writing 10 more such pieces, I thought I’d fit them into a single list of 10 executive summaries. That way, you can spend the other 9 days sharing with the readers your balanced and unprejudiced political views.”

Less is a libertarian (see June 5, 1998, “The Trouble with Libertarians”). Instead of contributing to the Democratic National Committee, he has contributed this nifty holiday package of One-Word Hyperlinked Executive Summaries:

The best tax shelter in America today . . .
Executive summary: Buy-And-Hold.

The surest way to outperform 80% of all stock market investors over the long term . . .
Executive summary: Index.

The surest way to outperform the indexes over the long-term . . .
Executive summary: Miscalculate.

Where to start if you have at least $3,000 to invest . . .
Executive summary: Vanguard.

Where to start if you have only $25 to invest . . .
Executive summary: TIAA-CREF.

The surest way to guarantee you don’t outlive your retirement savings . . .
Executive summary: Smoke.

The cause that deserves a contribution from you every year . . .
Executive summary: Roth.

The people who benefit most from variable annuities . . .
Executive summary: Salesmen.

The quickest way to reduce your tax bill . . .
Executive summary: Daytrade.

Executive summary: Thanks, Less.

You read faster than I do. You need less sleep. You call that fair? As long-time readers know, to try to catch up I occasionally declare an Andy Day.

This is one of those days.

Something tells me you will be able to fill the void just fine. If not, click Archives, at left, and be my guest. But I warn you: as weak as these columns are in real-time, they weaken with age.

We started the week with frozen grapes, and you figured I had slipped into egg nog mode. Pretty hard to write about Variable Universal Life after a glass or two of the nog. The ol’ noggin noddin’ and bobbin’ and wobblin’ — and yet there it was: everything you could possibly want to know about paying for college with a Variable Universal Life insurance policy. (Executive Summary: Don’t.)

So how DO you pay for college?

(Executive Summary: One state has a really good plan anyone can take advantage of.)

One of the little-known provisions of the 1997 Tax Act, I am again indebted to Less Antman for knowing, was the federal government’s improved treatment of Qualified State Tuition Programs (QSTPs), also known as “529 plans.” Almost anybody saving for college would be crazy not at least to consider them. They put the wretched Education IRAs to shame, and are better than Uniform Trust to Minors Act accounts as college savings vehicles because they don’t turn control over to the beneficiary at 18 or 21 or any age, for that matter. The contributor owns and controls the account completely.

The 1997 law allows QSTPs to have many special benefits. Unfortunately, most states are not taking advantage of them all. Then again, you don’t have to choose the plan of your own state!

According to Less, here are some of the benefits Uncle Sam allows:

(1) No “adjusted gross income” limits on participation (in contrast, the Education IRA isn’t available to contributors above a certain AGI).

(2) Up to $100,000 or more can be saved in them (compared to the pathetic $500 per year Education IRA limit).

(3) Tax deferral until withdrawal.

(4) Income taxed at beneficiary’s rate (that often means the student’s 15% rate instead of the high-income parents’ 39.6% rate) if used for qualified higher education costs.

(5) Total control by contributor (unlike UTMA accounts), but still excluded from contributor’s estate in case of death. The owner of the account can even withdraw all the funds personally, subject to a minimum IRA-like 10% penalty on the income from the plan, plus tax. If the beneficiary dies, becomes disabled, or gets a scholarship to college, funds can be withdrawn without penalty (but still subject to ordinary taxation at the contributor’s rate).

(6) Can be deferred until the beneficiary reaches age 45. (Talk about being held back!)

(7) Can be rolled to another family member (which is defined very broadly).

(8) Gift tax can be avoided on contributions up to $50,000 ($100,000 couple) by use of 5-year averaging.

(9) Can draw funds without stopping HOPE and Lifetime Learning Credits (when applicable).

(10) Definition of qualified higher education expenses includes room and board in many cases.

(11) Can be used in- or out-of-state.

(12) No relationship between contributor and beneficiary required (“Rich man adopts elementary school with QSTPs . . . “)

(13) No-fee plans starting with contributions as low as $25 per month.

“After I finished pinching myself over and over again to be sure I wasn’t dreaming,” writes Less, “I started ordering the literature on plans from various states. I discovered that the plan of my home state (California) is one of those not taking advantage of all the potential benefits. Also, these plans don’t let you choose your own investments, and many states have picked some investment companies with miserable track records. Arizona, for example, limits you to an investment company whose equity fund choices have trailed the S&P 500 by more than 5% per year for the past decade.

“Some of the states allocate the investments in absurdly conservative ways, such as 10% stock and 90% money market fund. And once you’ve allocated funds, you often can’t change the allocations. Some states prohibit rollovers to other beneficiaries or other states. Some impose penalties for non-qualified withdrawals massively exceeding those Uncle Sam requires.

“But I quickly discovered that there are some excellent plans. Out of 18 states with plans that are currently open to non-residents, I think there is one state — Indiana — with a plan that stands head-and-shoulders above the others. [NOT ANY MORE — A.T. 1/17/02] I’ll be recommending this plan to all of my financial planning clients. Indiana’s 529 plan:

“(1) Offers a low-cost S&P 500 stock index fund as one option, for those who want to maximize the potential growth of the account and minimize active manager risk.

“(2) Offers another option that diversifies globally, uses a fund-of-funds approach to minimize the impact of any one manager, and moves automatically from reasonably aggressive to reasonably conservative as the beneficiary reaches college age.

“(3) Takes advantage of virtually all of the 13 benefits allowed by the federal government, with maximum allowed contributions far exceeding $100,000 and penalties set at the absolute minimum level required by federal law.

“The plan has a web site, but before you click, be aware that they haven’t yet updated the site for recently added benefits. So if you read it online, you’re not going to find out how good it is.”

Better, Less suggests, to go to Joseph Hurley’s site. Hurley updates his site before the states update their own. He is also the author of The Best Way to Save For College, available for $22.95 at Amazon.com or $17.21 at buy.com.

[See March 13, 2000 update: Hurley has downgraded the Indiana plan for poor customer service, administrative errors.]

Thanks again, Less.

[Great Robert Mankoff New Yorker cartoon caption (guy speaking on the phone in his skyscraper office): “No, Thursday’s out. How about never — is never good for you?”]

“My question is, do you have an opinion about Variable Universal Life Insurance for a young, recent widower dad with a chunk of life insurance proceeds who wants to use VUL in part as a tax-free growth investment to fund college for two young children? I’m getting conflicting opinions which seem mainly to be based on the age of the person giving the advice. Older people say ‘no way,’ and younger people say that it’s a great idea. The tax-free nature of the growth is attractive — very attractive — but the fact that it is a life insurance policy is not attractive at all. My financial planner, who will sell it to me if I want it, is — not surprisingly — in favor of it. (But he hasn’t pushed it on me; he’s mainly responding to my request for a way to grow assets without paying taxes where possible.)” — Frank Isaacs

Over the years, I’ve made life insurers pretty angry. Rather than rub salt in the wounds, I asked my friend and tax expert Less Antman to do it for me. Let the life insurance guys hate him. He is a Taoist, so hate just bounces off him and is returned as love. (Or something like that.) Anyway, he is a very fine soul.

Less writes:

<< Older people say ‘no way,’ and younger people say that it’s a great idea. >>

“I must be a VERY old man! The punch line, of course, is going to be ‘buy term life insurance and invest the difference in index funds,’ but before we arrive there, let’s take a look at the supposed tax advantage of VULs and the many — many — disadvantages.

“(1) Income in a VUL is not tax-free, it is only tax-deferred. Once the income is withdrawn, it is taxed at ordinary income rates, even if the income resulted from long-term capital gains within the policy. If Frank is in the 28% federal tax bracket, having income tax-deferred for 15 years and then withdrawn is equivalent to paying an annual tax rate on the earnings of 18%. [It’s not intuitively obvious; Less has done the math.]

“This can be bettered easily by leaving the money in index funds, since (a) only the dividends are taxed annually, (b) the capital gains are deferred unless and until the shares are sold, and (c) at that point the tax rate will only be 20%. It is hard to determine the exact effect, but it probably works out to the equivalent of a 15% rate applied annually.

“For someone in the 31% federal bracket or higher, the comparison is even worse for the VUL. And if the index funds are kept in the name of the children, the effective tax rate on ordinary income will be 15%, and the eventual tax on the long-term gains 10%. And the first few hundred dollars each year will be taxed at a rate of 0%!

“(2) The income within the VUL must be distributed and taxed sooner or later, even if the policy owner dies. Capital gains in a mutual fund disappear automatically upon death. All of the assets in the VUL, including the insurance benefit, are included in the assets of the decedent for estate tax purposes. This is also true of mutual fund assets, but many people are deceived into believing that insurance benefits and VUL assets bypass estate taxes. They only bypass the legal process known as probate for settlement of the estate, and mutual fund assets can duplicate this by the use of living trusts, joint tenancy, or transfer-on-death designations. He probably should establish a trust for the protection of his minor children in any event.

“(3) It is often mentioned that the insurance premiums can be paid from the income of the VUL, thereby making some of the income tax-free. What isn’t mentioned is that the insurance charges within a VUL policy are, on average, enough higher than term policy rates that the tax-free status only reduces the net cost to approximately the same amount as the term cost. Furthermore, the policies often require the continuation of insurance well beyond the point that need has ended (for instance, once all children are grown), because a policy that ceases to have a sufficient insurance element may be declared a modified endowment by the IRS, causing all income to be immediately taxed and subject to pre-age 59 1/2 withdrawal penalties. But just try to get an insurance agent to explain simply the maximum funding rules and the seven-pay test (I know I can’t).

“(4) The average VUL has a sales load of 4%, state governments assess a premium tax averaging 2% (raising the effective sales load to 6%), setup costs average $400, and annual fees average $70. It will take close to 10 years for the benefits of deferring taxes on dividends to just recover the initial costs of the policy (the additional cost in the form of higher tax rates on withdrawals cannot be recovered within the expected lifespan of the universe). But that’s okay, because the insurance company and tax penalties that result from terminating most VULs within the first 15 years are so high early termination will be unthinkable anyway.

“(5) Although most VULs allow policy loans, these must be fully collateralized by transferring an equal amount out of the investment accounts of the VUL and into cash accounts that earn interest 1-2% less than the interest rate that will be charged the borrower (not to mention the typical $25 fee to process each loan request). The interest paid to the insurance company is NOT deductible (and is not adding to the value of the policy), but the interest earned on the cash account will be taxed upon withdrawal.

“(6) The cash value available to borrow is substantially less than the sum of the premiums and income. The overpriced insurance premium and expenses obviously reduce that is invested, most policies limit loans to 90% of cash value, and they won’t lend the surrender charge (which takes 10 to 15 years to phase out).

“It is no wonder that the head of the insurance analysis division of the Consumer Federation of America recommends against these policies, and that the SEC is planning to start an investigation into them shortly, due to the enormous number of complaints of policy holders.

“Now, let’s see how the reader can better accomplish his objectives.

“(1) Buy term life insurance for the amount needed, choosing a policy with guaranteed premiums for 20 years to take care of his small children until they are no longer dependent on him. He can reduce the coverage later if he doesn’t need as much, both without penalty and without fear it might trigger terrible tax consequences.

“(2) Invest the rest equally in two stock index funds, one of U.S. stocks, the other international (such as Vanguard’s Total U.S. Stock Market and Total International index funds). Pay the miniscule annual taxes resulting from the dividend distributions, which will undoubtedly be less than the expenses of a VUL.

“(3) To reduce taxes further, consider these strategies: (a) take margin loans against the value of the shares once the kids start college, instead of liquidating shares, (b) keep track of the purchases and reinvestments in the mutual funds so as to sell higher cost shares first, and/or (c) transfer assets into Uniform Transfers to Minors Act (UTMA) accounts for the kids so that the income is taxed at their lower rates. If the last is chosen, these can be transferred in annual amounts that don’t exceed the gift tax return exclusion limit ($10,000 per child per year at the moment, indexed for inflation), or larger sums can be transferred, using part of the available lifetime exclusion now instead of later. There is good reason to believe that the lifetime exclusion will be increased enormously within a few years by the federal government, so this might be a costless transfer. The sums transferred to the UTMA accounts do belong to the children once they reach 18 or 21, depending on the state. A threat to disinherit should help encourage them to spend it on college, though!

“For details on saving this way, he should read chapter 6 of The Only Investment Guide You’ll Ever Need, keeping in mind that he should fund his own retirement accounts to the maximum degree possible since he can withdraw that money without penalty for college tuition as well if necessary. Furthermore, many of the arguments against variable annuities in the book apply to variable universal life.

“I think there is a very important general lesson that people need to learn sooner or later. Complicated strategies ALWAYS have a catch, but the complications make them hard to catch, and by the time the catch is caught, the investor is caught. And there must be some rule worth inventing that any investment which penalizes you for changing your mind in the next 10 years must have a reason for not wanting to let you change your mind for the next 10 years.

“Now, time for the punch line: BUY TERM LIFE INSURANCE AND INVEST THE DIFFERENCE IN INDEX FUNDS. “Okay, I need to get back to work. Love, Less.”

Is your tax advisor a Taoist? Should be.

Happy birthday to all you guys turning 87 today.

My editorial compass told me it would be self-indulgent to wish a friend happy birthday. But this way, I’m wishing ALL such people happy birthday.

Kind of like those tax loopholes Senators insert that apply to ALL corporations with hydro-powered paper mills placed in service between March 10 and March 15, 1922.

Happy birthday, y’all.

I certainly panicked when the portfolio-update function of DOS Version 12 of Managing Your Money failed. CompuServe had made a change as of December 1, possibly coincident to their Y2K readiness, that put me out of business. (If only not being able to watch AMZN zoom kept shortsellers from losing money! Then again, as God’s way of keeping me from going bankrupt with AMZN, 400 shares of ICGE mysteriously appeared in my account from some kind of spin-off this summer. At 12. Yesterday, I noticed it was 238, and sold it. Is this normal? Is this scary? Will the hangover be pleasant? Does it matter that I know nothing at all about ICGE yet just made $80,000 on it? But I digress.)

MYM 12 users: If your QuoteLink went kaput December 1, there is hope. For me, at least, Mike Starkey has saved the day. Bless his huge heart and playful mind. If QuoteLink still works for you, ignore this. Otherwise, try this:

1. Go to FILE, PROGRAM SETUP, COMMUNICATIONS.

2. Highlight “CompuServe” and select “Service Setup.”

3. That screen has a hidden F9 function key to edit the setup and scripts. Press F9 and you’ll see.

4. Very carefully, replace the old login script (which begins ^D^D^C^WID: ) with this login script (beginning with an asterisk and ending with a colon, and all on one line, even though it takes more than one line here): *^U^M^WPASSWORD: ^P^M^WOK^W!^SGO CIS:MYMQUO^M^WINTERFACE: ^S100^M^W:

5. Make the new logout script simply a single asterisk: *

Now, for everyone else, yesterday’s promised “more about Y2K.”

Greg Johns: “I’ve heard talk of food shortages, planes crashing, etc at Y2K, but I’ve heard surprisingly little about what I’m worried about most: Will the stock market plummet horribly between now and Jan. 1, because people will sell out of a panic that they’ll lose their money when computers MIGHT go haywire?

“I asked someone about this, and she said, ‘Oh, those computers have been put in good order.’ I believe this is true. And I have my stocks held by big New York monolith investment companies, that should be in good shape come 2,000. (I just heard an investment talk this morning at a country-club breakfast by a Senior Vice President at Salomon Smith Barney, who said his company has spent $400 million Y2K-proofing themselves). So I think, technically, where my stocks are held are safe (although I’m keeping my monthly statements just in case!).

“But what if there is an Orson Welles/H.G. Welles WAR OF THE WORLDS radio broadcast type of situation, where people IMAGINING something bad happening, that in fact is not, will result in panic. And the Dow itself goes down to 2,000, giving new meaning to the term Y2K.

“Sell now to avoid Y2K plummeting, and get bargains come January 3, when Y2K might have proven itself to be a bugaboo? That is the question.

“Incidentally, this Salomon Smith Barney vice president said at the breakfast-talk that he does think the U.S. and Europe are safe come Y2K, but that he thinks the third-world countries might be in trouble. He said a friend of his was just in Spain, and told him that the Spanish don’t even have a word for Y2K, which he and his friend interpreted as the Spanish being oblivious to Y2K. (And Spain is in Europe, and not a Third World country, right? So this vice president sort of contradicted himself.) Anyway, global economy and all, Third World countries going bad may mean USA going bad, too. So maybe a possible panic would be in response to something real.

“I’m bracing myself. And, believe it or not, my mom is planning to get a boatload of food at Costco to store in her garage, out of Y2K fear.”

My guess is that the ‘panic’ occurred several months ago, when people got scared about this. By now, it’s old news. Most people who would panic have already thought about this — and panicked.

This is not to say the market may not sooner or later be in for really rough times. And/or that Y2K could not turn out to be worse than the market expects. Surprises do move the market, and my sense is that few people expect much Y2K disruption. So if it occurred, the market could plunge. But it might also quickly bounce back, when people realized the problems were likely to be surmountable.

Look at the earthquake in Taiwan and what that did to Apple’s supply chain . . . yet investors pretty quickly decided that Apple would get past that problem and it has since nearly doubled.

So the Y2K dip may have happened a year ago. The next dip will come from something else. But, yes, Y2K could contribute to it. Or maybe if/when nothing much happens there will be a huge BUYING surge that drives the market up . . . and, anticipating that possibility, there will be some good year-end BUYING just before the ball drops (or fails to drop).

I guess I’m more worried about the casino stock market and today’s valuations than I am about Y2K. We’ll know shortly whether this is foolish complacency.

PS – It’s always a good idea to have a couple months’ supply of emergency food and other essentials, bought in bulk on sale. It’s convenient, saves money, you never run out of anything, and it makes society stronger to have this buffer against floods, quakes, twisters . . . whatever.

Monday, at Last: Cooking Like a Guy™

RETROBOX.COM

Looking for a cheap used laptop? Check out retrobox.com. They buy used machines by the hundreds from big companies that are upgrading, then wipe the hard drives clean (including the operating system) and sell them to you. You install Windows ’98 or whatever and, with luck, have a machine that would have thrilled the pants off you three years ago when it was new, and can still handle most routine chores. My friend Stampp Corbin came up with this idea.

DRYER LINT

I put on one of those Saks Fifth Avenue T-Shirts I know all you guys are now wearing (see Ode to an Undershirt), and it felt great, as usual. Thick strong cotton. But it felt so great I suddenly realized the contrast — that the ones I had been wearing lately actually hadn’t been feeling this great. A little skimpy, even. Did Saks’ quality vary? Did they have one shirt for summer and another for winter?

“Dryer lint,” said Charles.

I squinted at him, uncomprehending.

“Dryer lint. The one you have on must be new. Each time you wash them, they get a little thinner. Where do you think dryer lint comes from?”

Oh. My. God. In 52 years I had never realized this. I had always assumed dryer lint was like condensation; it just formed out of thin air. But of course! It’s your sheets and towels and clothes! From now on, I’m hanging it all out the window.

VITAMIN F (as in flunk)

Sara Wolfson: “I would just like to relate my own experience with Vitamins.com and their $25 off special. I placed my order on 11/19 and got a confirmation notice telling me it would take 2-4 days to come. By11/29, no order had arrived. I called the 800 number to complain and was told they were backed up a week due to overwhelming response to this great offer. They had sent an incorrect confirmation notice, but told me my order had actually been shipped 11/24. A supervisor tells me I will get my stuff on 12/2. And lo and behold! It’s not here! I have sent 2 e-mails to the supposed headquarters which I was told is in Virginia and have received no response. Meanwhile my supply of a supplement which my son, who has a rare disorder, takes is completely gone. I ordered it way in advance so I wouldn’t have this problem and I started ordering off the Internet because my son takes high doses and it costs a fortune. Oh well, some lovely vitamin company here in town will be glad because now I will have to give them my business. Hey, it will be that much better of a tax deduction for me, right?”