SHOULD YOU CONSIDER A HEALTH SAVINGS ACCOUNT? - July 2005 Newsletter

Often described as an individual retirement account for medical expenses, health savings accounts (HSAs) are billed as the elixir to rising health care costs, according to the Journal of Financial Planning.

But what are HSAs? Simply put, a HSA is a special account owned by an individual in which contributions to the account are used to pay for current and future medical expenses. Created in Medicare legislation signed into law by President Bush on Dec. 8, 2003, and modeled after Archer MSAs, HSAs are used in conjunction with a “high deductible health plan (HDHP). With the exception of preventive care, a HDHP is insurance that does not cover “first-dollar” medical expenses. For those who contribute to a HSA in 2005, the annual deductible is at least $1,000 with a $5,100 limit on out-of-pocket expenses. For families the annual deductible is a minimum of $2,000 with a $10,200 limit on out-of-pocket expenses. (These amounts are indexed annually for inflation.) The insurance can be a health maintenance organization (HMO), PPO or indemnity plan, as long as it meets the requirements.

In short, the HSA provides triple tax savings, including tax deductions when you contribute to your account; tax-free earnings through investments, and tax-free withdrawals for qualified medical expenses.

Who is eligible for HSAs? According to the Department of Treasury, any individual who is covered by a HDHP and; 1) is not covered by other health insurance that is not a HDHP, i.e. a low-deductible insurance; 2) is not enrolled in Medicare; and 3) can’t be claimed as a dependent on someone else’s tax return. Children, for instance, cannot establish their own HSAs. Eligibility to contribute to a HSA does not depend on:

1) your income. There is no income phase out as with IRAs, for instance;

2 earned income. You don’t have to be working, for instance.

3) who is the primary policyholder? Spouses, for instance, can establish their own HSAs, if eligible.

4) Insurance coverage of your children.

Those that have the following type of “first dollar” medical benefits would be ineligible to establish a HSA: Medicare, Medicaid, Tricare, Flexible Spending Arrangements (FSAs); Health Reimbursement Arrangements (HRAs); and coverage under a spouse’s plan,

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including a low-deductible insurance plan or a FSA or HRA through the spouse’s employer.

Administered by a financial institution or insurance company, contributions to the HSA are tax deductible and can be made by the employee, employer, or both, according to the Journal of Financial Planning. You may fund up to 100 percent of the policy’s deductible but may not exceed in 2005 $2,650 (individual) or $5,250 (family). As with IRAs, individuals who are age 55 and older can make additional catch-up contributions to a HSA. In 2005, for instance, the catch-up contribution is $500. Contributions must stop once a person is enrolled in Medicare. Money that is contributed to the HSA and not used may be rolled over to next year or future years. Typically, the money in a HSA is invested in instruments that provide safety of principal, such as money market deposit accounts and short-term certificates of deposit. As with an IRA, the money grows tax free and distributions taken to pay for qualified medical expenses are tax free, too. According to the Department of Treasury, qualified medical expenses include

· over-the-counter drugs,

· specific health insurance premiums, including COBRA continuation coverage, health insurance coverage while receiving federal or state unemployment compensation, qualified long-term care insurance; and for individuals enrolled in Medicare: Medicare premiums and out-of-pocket expenses (Part A and Part B, Medicare HMOs, and the new prescription drug coverage). The HSA cannot, however, pay for Medigap insurance premiums.

HSA distributions not used for qualified medical expense (such as cosmetic surgery) are subject to ordinary incomes taxes and a 10 percent penalty unless the individual dies, is disabled, or is 65 years of age. Money left in a HSA account after age 65 withdrawn for a purpose other than health care is taxed at the account holder’s ordinary income tax rate.

Also of note, there is no time limit on distributions. There is not “use it or lose it” rules as there are with FSAs. Distributions from a HSA can even be used to reimburse prior years’ expenses as long as the expenses were incurred on or after the date the HSA was established.

As with IRAs, it’s important that individuals keep good records to prove that the expenses were incurred and they were not paid for or reimbursed by another source or taken as an itemized deduction. The Department of Treasury also notes that mistaken distributions from an HSA can be returned to the HSA. Also noteworthy, rollovers from Archer MSAs and other HSAs are permitted.

Check with your state’s insurance department to locate a company that offers HDHP plans.

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July 2005— This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by http://www.boldfinancial.com/, a local member of the FPA.

ADD PRENUPTIAL AGREEMENTS TO YOUR WEDDING PLANS - July 2005 Newsletter

True, it may seem unromantic. But couples who plan to exchange marriage vows ought to consider a prenuptial agreement long before saying I do.

Yes, there was a time when only the wealthy executed such agreements. But now more and more couples, especially those who have been married before or who have a blended family structure, need to evaluate the pros and cons of a prenuptial agreement as part of their wedding plans.

In essence, a prenuptial agreement, also known as an antenuptial agreement or premarital agreement, is nothing more than a written contract created by two people before they are married. It can be used to accomplish many legal and financial objectives, but in general couples use it to protect separate property (a family business, for instance), support an estate plan, define what is marital or community property, reduce conflicts and save money in the event of divorce, clarify special arrangements and establish procedures and ground rules for deciding future events.

Typically, the agreement spells out what each person owns (assets) and what they owe (liabilities) prior to a marriage and then it details how those assets and liabilities will be disposed after separation, divorce or death. It might also detail how assets and liabilities acquired during a marriage (say through an inheritance) will be disposed after separation, divorce or death, as well.

In short, a prenuptial agreement can help make sure there is an orderly process if a marriage ends. But that order will turn to chaos if certain conditions are met. Of course, meeting the below conditions doesn’t guarantee that an agreement won’t be challenged by an unhappy spouse or struck down in court. But it can go a long way toward making sure there’s marital bliss in the short-term.

Full disclosure. Each spouse should prepare a detailed financial statement when drawing up a prenuptial agreement, including all assets and liabilities, annual gross income, interests in family trusts, and even potential inheritances. Full disclosure ensures that each spouse understands what he or she is getting and giving up, and failure to do so can result in a prenuptial agreement being set aside.

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Fairness. The agreement should be fair. Courts tend to strike down agreements that favor one spouse over the other. Plus, courts will set aside agreements where there is ink on the wedding dress, those signed under pressure, within 48 hours of the wedding.

In writing. Though states have different laws about prenuptial agreements, they basically follow the same general form. A prenuptial agreement is a written contract signed by the two prospective spouses and witnessed by a notary. These agreements needn't be filed with a court and can be drawn up by the two prospective spouses without assistance.

Hire a lawyer to review the agreement. Each spouse should hire a lawyer to review the contract and make sure their interests are protected and that the agreement follows the letter of that individual state's law. Some agreements get struck down because each spouse didn’t hire a lawyer to review the agreement.

Add clauses. Generally, the agreement should contain a clause stating that if any provision of the agreement is invalidated, the rest of the agreement remains valid. Couples should also add a clause that makes sure the laws of the state in which the couple were married govern should they get divorced in another state. In the absence of such a clause, couples who get divorced may have their assets divided according to the laws of the state in which they reside. Thus, community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin) will generally divide in half the couple's assets acquired during the marriage, while other states (the equitable distribution states) may decide how to split the assets fairly, based on years of marriage, status of children, lifestyle considerations, and any number of other factors. Adding a clause that details how a decedent’s assets (in the absence of a will) will be passed to particular individuals – such as children from a prior marriage – can be helpful as well. And the agreement should contain a clause stating that all arrangements between the prospective spouses are included in the prenuptial agreement.

Specificity and circumstances. Couples might also quantify "maintenance," the amount of alimony a divorced spouse may receive from his or her wealthier counterpart. In addition, an agreement could speak to the preservation of a business, family assets or family fortune held prior to the marriage such that those assets stay with the original owner should the marriage end in divorce. In many cases, a wealthy family will want to ensure that assets gifted to an adult child do not become the property of the non-blood-related spouse in the event of divorce. In still other cases, couples about to exchange marriage vows might also consider protecting separate property through other more sophisticated legal tools such as irrevocable trusts, revocable living trusts, or family limited partnerships.

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July 2005— This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by http://www.boldfinancial.com/, a local member of the FPA.

NEW BANKRUPTCY LAW PROTECTS IRAS - July 2005 Newsletter

On April 20, 2005, President Bush signed into law the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPA). The new law generally makes it tougher for people to protect their assets, but there are some exceptions. For instance, IRAs, fast becoming the biggest asset people have, actually receive more protection under the new law, which takes effect on October 17, 2005

Under the new law, up to $1 million of assets held in a traditional IRA and Roth IRA, or a larger amount determined by the bankruptcy court “in the interests of justice,” will be exempt from the IRA owner's bankruptcy estate.

What’s more, IRA assets that came from an employer retirement plan rollover (such as a 401(k), 403(b), or profit-sharing plan) will not be subject to the claims of the IRA owner’s creditors, regardless of the state in which the IRA owner resides or the value of rollover assets and their subsequent growth.

BAPA has other details to digest as well. For instance, the new law also reinforces the unlimited protection for 401(k) plans, 457 plans, 403(b) plans, governmental plans, and tax-exempt organization retirement plans, and adds to the list exemptions from the bankruptcy estate for SEP-IRAs, SIMPLE IRAs, Keogh plans and solo 401(k) plans. And given unlimited bankruptcy creditor protection, such retirement accounts are likely to become even more attractive retirement-savings vehicles in years to come.

Also, retirement funds in transit from one IRA or retirement account to another are also protected under the new bankruptcy law. The law even provides protection if funds are withdrawn from an IRA and rolled over within 60 days back into an IRA or retirement account.

But not all facets of IRAs are protected. For instance, required minimum distributions, 72(t) distributions, and hardship distributions are not protected under BAPA. Once money is withdrawn from a plan it is no longer protected.

What’s more, the new law provides greater creditor protection for IRA assets, but only in bankruptcy. They do not apply to judgments awarded in other courts where state creditor protection laws will apply. And BAPA will not stop a divorcing spouse from taking a share of the pension.

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So what’s the significance of the new law? First, the new law creates clarity where there had been confusion. Prior to BAPA, it was difficult to determine how a person’s IRA would be exempt from claims of his or her creditors if they filed for personal bankruptcy. There was such a confusing mix of federal and state laws and court cases that a person did not know whether or how much of his/her “rollover” IRA would be subject to claims of creditors. That is no longer the case. Of note: IRA owners who live in states that have poor IRA creditor protection benefit most from the new law.

One implication of the new law: Investors may want to keep IRAs that are funded with rollover contributions separate from IRAs funded with annual contributions. The Economic Growth and Tax Relief Reconciliation Act (EGTRRA) of 2001 made obsolete the need to create a conduit IRA, but the new law provides an incentive to have separate IRAs – an IRA funded with rollovers and one funded with contributions. To commingle rollover and contributory IRA assets would make it difficult to identify which portion of the IRA represented assets that are “unlimited protection” rollovers (plus earnings) and which portion represented IRA contributions and earnings (subject to the $1 million limitation).

The new law also encourages investors to rollover their 401(k) to an IRA after they leave an employer. Prior to BAPA, investors often left their funds in their former employer’s 401(k) plan since such plans were fully protected from bankruptcy. But now 401(k) plans and IRAs have near equal protection from creditor claims, so there’s less reason to leave such funds behind.

Of note, there are some good reasons to transfer funds from a 401(k) to an IRA. For instance, transferring a 401(k) to an IRA not only broadens investment options, but also may open the door to create what some refer to as a “stretch IRA”, an IRA that continues to grow tax-deferred over the life of its beneficiaries. The downside to leaving money in a 401(k) plan is that oftentimes money in such plans must be immediately distributed to beneficiaries after the plan participant dies, eliminating any chance of the plan participant creating a stretch IRA.

But there are some good reasons to leave the money in a 401(k). For instance, qualified retirement plans are protected under ERISA, which extends to judgments other than bankruptcy, regardless of your state law.

Like all new laws, BAPA will likely be challenged at some point by creditors in the courts. So it would be considered prudent to seek the advice of your financial planner and a bankruptcy attorney, and frequently review any legal challenges and clarifications issued by federal authorities including the Internal Revenue Service (IRS) or Department of Treasury.

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July 2005— This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by http://www.boldfinancial.com/, a local member of the FPA.