Stephen King apparently went a little crazy when, after years of just getting by, he found himself wealthy from the paperback sale of his first horror novel, Carrie. Like other newly rich people, King went on a shopping spree. Fortunately for his bank balance, he was living in a small town and the most expensive present he could find for his wife was a hair dryer.

Other people with unexpected windfalls have been more fiscally inventive than King, making enormous ill-advised purchases and ghastly investment errors. Even those who work with a planner from the outset can prove to be unusually difficult and irrational. Planners who choose to work with the suddenly rich have to use special people skills and sometimes even wear a psychologist's hat.

An unexpected inheritance, large divorce settlement, sale of family business, sudden access to retirement savings or even a lottery jackpot can all put millions into the hands of people who never had large sums to manage and never felt the need for advice. For those of modest means, even half a million dollars can radically and permanently change their lives.

"Unfortunately, this is a time when there are more emotion-based decisions than rational ones," says Susan Bradley, CFP, of the Sudden Money Institute in Palm Beach Gardens, Fla. "Helpful" friends and relatives come out of the woodwork with advice on investing the money -- and spending it -- leading to continued confusion. The planner's job is to deal with the emotions while piloting a rational course. Planners seem to agree that although the management of the money may be the same whether it came gradually or all at once, the management of the client differs.

For example, the clients can have certain distinct attitudes based on how they got their money. Heidi Flammang can understand this. She found herself a widow at 27 with a considerable insurance settlement. Her own experiences managing her new wealth, and her frustration dealing with planners she felt were incompetent, led her to create the Maginot Group in Parker, Colo., which specializes in helping clients with sudden wealth issues.

"When a client inherits money, particularly in a tragic situation, they may want to become totally involved in all investing decisions," she says. "They see the money as a special responsibility, a trust." Those who won a lottery, or a professional athlete who just hit the big time, for example, may be more willing to leave the details to the professionals. However, in their giddiness they may lack discipline; Flammang says this sub-group is likely to change planners a lot.

In general, says Ron Selik, CFP, of Selik Financial Services in Troy, Mich., what separates the suddenly rich from those who became rich gradually is the emotional event that led them there. To work through these problems, planners must have a combination of patience and discipline. Experienced advisers even stand ready to refer particularly difficult clients to psychologists.

An initial period of reflection may be the best advice a planner can offer the newly wealthy. Before clients buy a mansion or book a suite on the QE2, Bradley and other planners in her network recommend a decision-free zone for six months to a year. During this period the money, whether it comes from an insurance settlement, relative's estate or IPO windfall, goes into conservative, liquid investments, such as CDs or money market accounts. Based on the amount of money, planners may authorize small expenses, such as a new car to replace the old clunker (but not a Rolls Royce), but no new houses or commitments to long-term investment strategies.

Planners also have to stand firm. Steve Wightman, a planner at Lexington Financial Management in Lexington, Mass., practices financial tough love, saying, "Clients commit with us from the start or we don't work with them." And Selik says, "I act as the scapegoat," particularly during the decision-free zone. When friends and relatives descend on the client with requests for money or dubious investment opportunities, the client can just say, "I'm sorry, but my planner has it all tied up now and won't let me make any commitments at the moment."

The decision-free zone is a deceptively quiet period, because even though no strategies are being implemented, both planner and client are using the time to create a foundation for long-term money management. Bradley sees planning and preparation as the first part of a structured plan, in which implementation (such as buying a house and making investments) and stewardship (i.e., cash flow and estate planning) constitute the second and third, respectively. "If clients know there is an order, they will hold off on major spending and buy into the plan," she says.

Meanwhile, they should compile a "bliss list," a list of what the client wants to do or accomplish with the money. If a couple receives sudden wealth, each one will create his or her own list, which they will eventually merge. Bliss lists are subject to revisions over time, as the planner helps the client assign values and "perform reality checks." What is affordable? Do you want to buy a new house? Retire at 45? Sail around the world? "You can probably do some things on your list, but not everything," Bradley says.

Once there is a game plan that is in line with reality, the planner can move into implementation. Of course, these clients may never have even considered a financial plan before, and never thought actual management of money was going to be an issue in their lives, and so the planner has to keep this in mind. "The plan can be a hard sell," says Kent (Chip) Addis, Jr., of Addis & Hill in King of Prussia, Pa. "About a third of sudden-wealth clients will say a new house is the top priority. Another third will say education is." But, as he grimly relates, only about 2% want to primarily use their money to pay down current debt, and only 1% consider investments as most important.

Problems can crop up no matter where the money comes from. Selik says some of his sudden-wealth clients came into money not from something startling like a lottery but from the very prosaic source of a well-funded 401(k) plan. "For years, they couldn't really touch this; it was Monopoly money. Now they could have $1.5 million in the account." He has to point out that this money has to last for years; it's not something they can quick go out and spend. Maybe the new retirees can afford to set up a college fund for a grandchild? Great, says Wightman, as long as no one is too squeamish to discuss money. "You need intergenerational planning," he says. "Preparation is better than surprise." For example, he knew of one family in which parents and grandparents each started a college fund for a child without the other's knowledge, over-endowing the future scholar.

Shelley Fernstrom, of Raymond James in Naples, Fla., works with lots of divorced women. "It doesn't matter whether they're getting $100,000 or $10 million. They have to develop a budget," something they may not have done before if their husbands handled all the money issues. "Did they get the marital residence or is it being sold? Is there child support?" In addition to a settlement, some women get "rehabilitative alimony" for a few years until they can get back onto a career path. "I have to explain that this money isn't going to last forever."

This was a concept Wightman had to hammer home in a case involving a $12 million estate. "The divorced woman's new boyfriend was already talking about a yacht and mansion, without giving any consideration to taxes she still had to pay." Also working with many divorced women is Michelle Maton, CFP, of Aequus Wealth Management Resources in Chicago. "Some of these women now have $4 million and up. They have to ask themselves what they want to accomplish." Maton teaches them about managing their own money and cash flow with the aid of Quicken, the simple off-the-shelf budgeting software.

Fernstrom also has to explain that unlike salaries, income from investments can vary from year to year. George Strickland, CFP, of Financial Synergies Advisory in Houston, finds even a good investment year causes problems for clients just getting used to the idea of living partly or entirely from investment income. "If we're assuming a steady 10% a year from certain investments and one year we get 20%, I tell clients to give the extra back." That is, he tells them to reinvest it and not assume there will be another 20% next year.

Many clients also want to use their new wealth for charitable purposes. Again, this is a sudden ability, not a gradual development as with clients who slowly increased their money, and charitable giving, accordingly. Philanthropy should be subject to the same rational plan as other uses of the money. And clients don't have to have tens or hundreds of millions of dollars to engage in charitable giving in a meaningful way. Harvey Rowen, of Starmont Asset Management in San Francisco, says even clients with a few million can set up a charitable foundation. "The planner needs to assemble a team, with a lawyer, CPA and a charitable-giving consultant, if necessary."

As with all your clients, the investment specifics will vary with the amount of income, age of clients and their goals. Nevertheless, Fernstrom has found that many of her clients can do well with a mix of mutual funds and bonds for income. In a more general way, Strickland says he ascribes to the "three-bucket theory." For many of his clients, he puts two years of what the client will need to live on into CDs. The client then lives off that. Three additional years of income is in bonds. The rest is in long-term investments. He finds this a suitable balance between the desire for high interest and the need for some liquidity.

Of course, investment plans and matching goals with money is nothing new for planners. But with a suddenly wealthy client, it isn't the "wealthy," it's the "suddenly" that's the problem. Instead of getting to prepare for wealth over many years as a business grows over the decades, or as a client rises from junior manager to CEO, these challenges hit recipients all at once. Sober analyses of fund performance sometimes come up hard against irrational human emotion. Bradley sums it up: "The client will follow your lead, but the adviser has to be strong. Clients with new money may suddenly feel too empowered and thus not acquiesce. They think of themselves as too rich, too beautiful, too popular, to follow your advice."

Financial advisor Patrick Christensen was watching the news on television, like virtually everyone else in the nation, when his phone rang.

It was John, a client who is about three years away from retirement.

As the world watched rescue workers dig through the smoking wreckage of the World Trade Center and Pentagon, John told Christensen this is a major crisis, and he wasn’t going to be left holding the bag.

"Sell," he told Christensen.

"It was less about the investments and more that he wanted to do something," says Christensen, president of Independent Financial Solutions LLC in Salt Lake City. "He wanted to feel that he was somehow taking action. The way I handled it is, I listened to him for a while."

Then Christensen started to reason with him.

If he sold now, Christensen told John, he’d be doing the worst possible thing by probably selling low. To make matters worse, history shows the market again and again plummets and then bounces back after a national or international crisis.

Appealing to John’s sense of patriotism, Christensen told him he’d be playing into the hands of the terrorists if he sold off his equity holdings. Hang in there, he told him, and go about your business as usual. In the end, John, a Vietnam veteran, calmed down and agreed to stay the course.

It was, it turns out, the only call of panic Christensen received after the tragedies of September 11. But he was busy the following days calling clients, checking on their feelings and reassuring them that over the long run, things would be OK.

Financial advisors across the nation, in fact, were engaged in similar activities—making telephone calls, sending out e-mails and rushing out letters, urging their clients to remain calm.

Reflecting on John’s call, Christensen shook his head at the irony of it all. During the high-flying days of the bull market, he spent much time instilling caution in his clients. As clients relished in a stock market that seemed so incredibly strong, Christensen constantly was harping on how things could someday go so incredibly wrong.

Now, Christensen says, he has taken on the role of an eternal optimist—constantly reminding clients that things will get better. "I think you could call us romantic depressives," he says wryly.

Christensen certainly is not alone. Following possibly the most traumatizing tragedy in the nation’s history, financial advisors found themselves among the nation’s crisis workers. While rescuers were digging through rubble, advisors were working the phones to provide support, calm nerves and solidify hope among a shaken clientele.

Few advisors interviewed for this article reported a rush of calls from panicky clients. In fact, many advisors say they were surprised how calm their clients remained through the crisis and the subsequent fall of the stock market the week after.

"I think it could have been worse," says Dottie Koontz of Financial Dimensions in Longview, Wash. "I’m really surprised, because for the most part, my clients aren’t panicking. I think we’re all just waiting."

Linda Leitz, co-owner of Pinnacle Financial Concepts in Colorado Springs, Colo., was on her way to the airport to attend the annual conference of the Financial Planning Association in San Diego. Those flight plans were dashed and the conference canceled as a result of the terrorist attacks.

She returned to her office expecting a flood of frenzied telephone calls. But they never came. "I was expecting a bunker mentality," she says, "but most clients have done just the opposite … A lot of them are saying they really need to get their financial act together now."

Some silence could have been due to disbelief and shock. Moreover, it seemed that many clients realized there were some things a lot more important than their portfolios. Around the nation for several days, few people were thinking of finances first as they were transfixed by the news.

But advisors still reached out—and not necessarily to talk about finances. "You just cease to be a financial planner, and you just become a human being, first and foremost," says Richard Hearn, president of STARCARE Inc. of Newport Beach, Calif. "You couldn’t find a time when caring about people and their feelings is more important. This is so much bigger than people’s money. This is about our way of life."

Because STARCARE has 300 clients, Hearn couldn’t call everyone. So he wrote a newsletter that contained condolences, confidence in the nation and the warning that financial markets would be unsettled for a while. He sent it the day of the attacks.

"Doomsayers and financial news people will spread misinformation and gloom for instant consumer anxiety," he wrote. But he concluded by reminding clients of the reasons to expect the nation to get through the crisis. "Thugs have hijacked planes and brought down buildings. They have not hijacked our markets or brought down our dreams. They can never do that."

The day after the Twin Towers collapsed, Weil Capital Management LLC of Palo Alto, Calif., called its 95 clients. "Two of the clients literally reduced me to tears, saying, ‘You know, it never dawned on us to be worried,’" says Curt Weil, the firm’s principal.

Few clients, meanwhile, called the firm, he says. Weil insists the only panic he’s seen in the financial markets has been in the media. "The ones who have to fill the air every minute," he says. "I think it’s silly to get my knickers in a twist over the remainder of a correction that’s been going on since March of last year."

If anything, advisors say, the market’s reaction to the terrorist attacks have served to educate investors further about the risks of equity investing.

The overoptimism that was a hallmark of the 1990s bull market seems finally to be a thing of the past, says Dan Moisand, president of Optimum Financial Group in Melbourne, Fla. "Even a few weeks ago, we were fighting that battle with people," he says. "There has been a profound attitude adjustment on a lot of levels with regards to investments. You don’t have to convince people of the risks."

Advisors repeatedly pulled out historical references to convince clients that the financial impact would be short-term. Several firms, in fact, constructed charts showing a list of historical crises and the subsequent stock market reaction. The charts quickly made the rounds among advisors nationwide, becoming a commonly used tool for crisis intervention. "Part of our job is to be there and give perspective," says Bill Carter, president of Carter Financial Management in Dallas.

He notes that Operation Desert Storm was marked, at first, by a declining market. Following the invasion and retaking of Kuwait, there was an upturn. The recovery led to a bull market that didn’t let up for nine years. "When things are really, really bad, when emotions are at their highest, that’s typically, historically, one of the best times to buy," he says.

But part of the uncertainty arises from the fact that the events of September 11 are unprecedented historically, say some advisors. "I didn’t really know what to do," Stanley Ehrlich, of S.F. Ehrlich Associates in Clinton, N.J., says of his reaction to the attacks, which took more than 6,000 lives. "Who’s been through this before? What’s the history on this one?"

Ehrlich eventually sent e-mails to clients, strongly advising them not to take any drastic financial actions. He expected to be fielding a lot of calls during the day, but he received only two. "And the two I got were positive," he says.

But Ehrlich doesn’t know what that really means. He points out that financial advisors probably don’t top the list of people to call during a time of such crisis. "I’m not so naÔve as to think that people aren’t concerned," he says. "Nor am I so presumptuous to think they feel there’s never a need to worry because Stan’s on the case."

Existing clients may have been quiet, but prospective clients seemed visibly distracted. Steve Wightman, a principal of Lexington Financial Management in Lexington, Mass., says several potential clients canceled meetings after the attack. "Financial planning is low on people’s list of priorities," he says. "They, understandably, would rather be with their families now more than anything. Outside of that, their minds are preoccupied by bigger and greater things."

Many advisors specifically warned their clients that they expected a precipitous drop in the market when Wall Street went back to business the Monday after the tragedies. The prediction came true, of course, but nobody seemed to sense the drop would be as prolonged and deep as it turned out to be.

Continuing to extract hope out of such a bleak situation, advisors kept prodding their clients to look past the immediate events. Randall Kratz, an independent advisor in Richmond, Va., says he’s been stressing to clients the factors that point to an economic recovery, including the prospect of massive government spending and the Fed’s continued reduction of interest rates. "The worst-case scenario is if people listen to the wrong people, and that would be just listening to the doomsday preachers," he says.

Backing up the silver-lining perspective, some advisors were doing limited buying the week of September 17. David L. Berman, of the Berman Financial Group in Baltimore, says his office did $1 million net investing that week. "Philosophically, we haven’t changed a thing," he says. The firm sent out a five-page letter to clients that "reinforced our philosophy as being one of building all-weather portfolios and letting them endure through all types of weather. You don’t build an all-weather portfolio and change it once you hit a storm."

Despite a dark view of the short-term economic picture, Thomas Grzymala, president and CEO of Alexandria Financial Associates in Alexandria, Va., has been doing limited buying for some clients. Among the shares the firm bought were General Electric, Nokia and Cisco—all of which fell below the firm’s buy price the week after the terrorist attack.

For the most part, however, the firm is sitting tight, he says. "We’re not jumping in with both feet at all because I think the market volatility will continue at least until that time when we have had a demonstrable effect on the terrorists," he says.

During the first week of trading after the attack, cash was moved in only a few thousand of the 110,000 advisor accounts at SEI Investments, says Carmen Romeo, the company’s executive vice president. Starting on September 12, SEI held four nationwide conference calls, involving from 600 to 1,000 affiliated advisors with each call.

SEI advised callers to separate their client bases into three groups: those who are comfortable with the market volatility, those who need a little reassurance and those who can’t sleep at night.

For the latter two groups, Romeo says, SEI suggested advisors reprofile clients, including a reassessment of risk tolerance and planning goals.

"Fundamentally, we believe in asset allocation and diversification and staying the course," Romeo says. "But this is also an opportunity for advisors to revalidate their clients’ starting positions."

With the stock markets shut down for four days, there eventually was time for people to opine in self-serving fashion that it was investors’ patriotic duty to buy stocks or that it was in poor taste to even think about the subject. Ultimately, however, more level-headed commentators noted that the United States is blessed with free markets than can express whatever they want.

When the markets finally opened, there was a lot of pent-up selling pressure and bargain-hunting. At LPL Financial Services, the nation’s largest independent brokerage, the firm experienced its biggest day ever on September 17. The firm processed 20,000 transactions, but they were split almost 50-50 between buy and sell orders. "It was pretty clear people were selling something to buy something else," says Jim Putnam, managing director at the San Diego-based firm.

Keeping one’s cool has been important, says Michael Kresh of M.D. Kresh Financial Services Inc. in Hauppauge, N.Y. He says he received "absolutely no calls of panic" from any of his 100 clients, some of whom added to their equity holdings the week after the terrorist attack.

But he adds that it is wrong to be too optimistic in light of what happened. He says the events of September 11 amount to a "defining moment" on the scale of Pearl Harbor and the assassination of President John F. Kennedy.

"I don’t think it could not change anybody in a permanent way," he says. "We cannot ignore the fact that the basic fundamentals of this country have changed. We will never be the same."

Guest Speaker: Gideon Rothschild, estate planning attorney with Moses and Singer in New York.

Moderator: Melissa Phipps, community manager of Financial Planning Interactive.

Phipps: Hello everyone, welcome to our Live Forum with Gideon Rothschild, an estate planning attorney with Moses and Singer in New York who will discuss using trusts to lessen estate tax bills for high-net-worth clients. I am your moderator, Melissa Phipps.

Welcome, Gideon. Why don't you begin by telling us a little bit about yourself and your practice?

Rothschild: I'm an attorney and partner with the law firm of Moses and Singer in New York City, co-chairing the wealth preservation practice group. Our firm is a general practice firm of approximately 70 lawyers with various specialties, including new media, health care, corporate securities, banking and real estate. To find more information about our firm, you can visit www.mosessinger.com.

Joe Weiner CLU ChFC: Do you think estate taxes will be reduced or eliminated?

Rothschild: As you know, Congress had a bill that President Clinton vetoed. This bill proposed to repeal the estate and gift tax in 10 years. However, due to budgetary constraints, the year following its repeal it would be re-instituted. So, in essence, there was only a one-year window for clients to die and avoid estate taxes. It is unlikely that the minority of wealthy voters will succeed in convincing Congress to eliminate the tax entirely, which would be viewed by most Americans as pandering to the wealthy. Even if the tax is repealed some day, clients should continue to plan their estates in ways that require minimal outlay in the form of gift taxes. Many possibilities exist to accomplish these goals, including sales to grantor trusts, the use of unified credit exemptions and annual exclusion gifts.

Evan Simonoff (editor in chief and associate publisher of Financial Planning magazine): Gideon, I hate to be a party pooper but will folks like you do if we get a Republican president and Congress and the estate tax is abolished? Will you turn your attention more to charitable work and issues like estate equalization?

Rothschild: If the estate tax gets abolished there will still be individuals who need to address the transfer of wealth to the next generation, which requires drafting wills and trusts to accomplish those goals in addition to the charitable objectives that one may have. Query whether there will be as much philanthropy if there is no estate tax.

Nick N: Please comment on "Pure Trusts." My clients are hearing about these wonderful trust to transfer assets, get stepped-up basis, no gift problems, asset protection, no estate taxes, etc, etc. Please give an information source to protect clients from making mistakes.

Rothschild: Recently, the tax court held against a firm by the name of Estate Preservation Services, who were promoting trusts which they represented, would avoid estate taxes, income taxes and creditors. These trusts have been given various names, including "Pure Trusts," constitutional trusts, common-law trusts, etc. The bottom line should be: If it sounds too good to be true, it probably is. The IRS has announced a full-fledged attack against these structures and their promoters, and clients will face substantial adverse consequences, including possible criminal penalties, if they engage in these structures. That is not to say that asset protection trusts, which are tax-neutral, are in the same category as the foregoing.

Frank: What estate tax strategies are effective for S Corps. that hold highly appreciated marketable securities?

Rothschild: S Corporations that hold appreciated securities, as you know, are flow-through entities. Therefore, any gains on the sale of the securities would be reported by the shareholders. When a shareholder dies, there would be no step-up in basis on the underlying securities. However, the deceased shareholder's estate will obtain a step up in basis for the S Corp. stock. When the S Corp. is subsequently liquidated, the loss recognized by the estate will be offset by the gain recognized by the corporation if the transaction occurs in the same year. If the objective is to freeze the value in the shareholder's estate, then the strategy to recommend would be a sale to a grantor trust. A grantor trust is an eligible shareholder of an S Corp.

Phipps: What are dynasty trusts and how are they used within a financial plan?

Rothschild: Dynasty trusts are generally irrevocable trusts established in states which have repealed the rule against perpetuities (currently 12 states), and therefore allow these trusts to last in perpetuity for the benefit of future generations. They take advantage of the available generation-skipping tax exemption and therefore allow the grantor to transfer a substantial amount of wealth, either during lifetime or upon his death.

Milt Colegrove: Have you ever used trusts to protect your clients from tort liabilities by putting apartment buildings, commercial property, etc., in the trust? The trustee of the trust would be a professional trustee and the beneficiary would be another trust, so you have two layers of trusts before you get to the individual?

Rothschild: A better approach would be to transfer the real property to a LLC, which insulates the owner from personal liability, and the LLC interest can then be transferred to a trust with a professional trustee.

Phipps: A lot of financial planners will recommend life insurance to cover an estate tax, is this necessary? If so, when?

Rothschild: Life insurance is a useful tool, particularly where there may not be sufficient liquidity in the estate to pay the estate taxes which are due nine months after death. Life insurance can also be utilized to achieve other objectives, such as equalizing an estate between children who receive a family business and those who are not involved in the business. However, when recommending life insurance, it should always be owned by an irrevocable trust to avoid including the proceeds in the insured’s estate.

(Question received in advance): What do you see as the downside to the QPRT? My clients who are considering one on their second home have a net worth of $10 million, the majority of which are traded securities.

Rothschild: The downside that concerns most people is the fear of losing control of their home to the children or, perish the thought, their daughter-in-law or son-in-law. The other potential drawback is that the grantor is giving up the use of the equity in the home should he need it at a later date for his own retirement. The first concern can be addressed fairly easily by providing in the trust that at the end of the term the property remains in trust for the benefit of the children, with a reliable trustee controlling the property. This avoids the possibility of the home falling into the hands of an in-law, or conflicts between parents and children.

The other concern can be accomplished by transferring only a fractional interest in the home. So, for example, if the grantor retains 50% and transfers the other half to the trust, upon the sale of the home half the proceeds will go to the grantor for his or her own personal use, while the other half will continue to remain outside the grantor's estate, provided he outlives the term.

By the way, planners should note that the current AFR rate is at a high point (8.2%), and gifts to QPRTs are more advantageous at higher rates.

Jordan: I attended an [International Association for Financial Planning] meeting last fall and a speaker, Alan Eber, JD, was teaching on using life insurance wrappers in offshore trusts that used private annuities and variable life policies. Have you studied this and do you like this approach?

Rothschild: The use of life insurance wrappers is not new and does not accomplish anything that cannot be achieved by using more traditional variable life insurance. However, these life insurance products, which are sold by offshore insurance companies, are basically variable life insurance which allow the insured to select investment advisers to manage the investment portion of the policy. The investment adviser selected can include the insured's exsisting investment adviser. As in all insurance products, the increase in cash value remains tax-free and can be borrowed (provided the policy is not an MEC) tax-free, converting at death to an income-tax-free death benefit.

(Question received in advance): A client is questioning if family limited partnerships are as safe as irrevocable life insurance trusts from the standpoint of the IRS, any chance they may disqualify FLPs?

Rothschild: First, we have to clarify that if life insurance is owned by an FLP, the death benefit can be included in the insured's estate to the extent the insured owns an interest in the FLP. If we are assuming the insured will be gifting the entire FLP interest to his children, then only perhaps 1% of the proceeds will be included in his estate. Since a contribution to an FLP does not require CRUMMEY notices to qualify for the annual exclusion and can be amended easier than a trust, some people have suggested using an FLP to hold insurance. I believe the IRS might take a contrary position if the FLP does not have an independent business purpose. One method I've used is to fund the FLP with income-producing property. An insurance trust can be the owner of the LP interests and thereby receive income distributions from the FLP sufficient to pay the insurance premiums.

M. Nommensen (question received in advance): Last year I missed the opportunity to convert to a Roth IRA, which would enable me to pay the resulting taxes over five years. Would a smaller Roth (funded with $2,500 for example) set-up for an infant be a good way to pay for their college costs 18 years from now?

Rothschild: A Roth IRA can only be used where there is earned income and where the tax payer's AGI is not greater than the allowable limits. Therefore, if the objective is to fund for college education, the only options besides a minor's trust or a UGMA account is an education IRA (maximum $500 per year) or a Section 529 plan. These Section 529 plans have become very popular, and many states provide for these. For example under New York's plan, an individual (who does not have to be a New York resident) can contribute up to $50,000 per child ($100,000 if married). The beneficiary can be changed by the grantor at any time, and should the grantor wish to take the money back he can, subject to a 10% penalty. If the child uses the funds for education-related expenses, the child pays income tax on the income distributed from the account.

Jordan: I understand and agree with your evaluation of the VUL wrapper. However what [Eber] is doing is even more. He would transfer appreciated assets into an offshore private annuity arrangement with an offshore trust. The VUL is then connected with the annuity in a business arrangement.

Rothschild: Frankly, I have participated in seminars with Alan Eber, and am familiar with his structure. However, I have some reservations as to the tax consequences.

Steve Wightman: Pertaining to your Roth IRA answer: If the owner will be at least 59 1/2 when college tuition hits, then a Roth is an excellent choice. Especially for aggressive portfolios because all distributions are tax free to the owner and not included in the financial aid calculation for a non-child student.

Rothschild: Steve, you're right. I was under the impression that the question was referring to a Roth IRA established by the child.

Frank: Are there any planning strategies available for underperforming GRATs that are projected to transfer all FLP units back to the grantor?

Rothschild: The recommendation I would consider is to continue to roll over the FLP units into new GRATs and hope that the future will be brighter.

Barry Kaplan (question received in advance): I am trying to find information about a technique using a limited partnership combined with a sale to a defective trust, but have been unable to. From what I’ve heard, let’s say the grandparents move some (rapidly appreciating) assets into a limited partnership in which they control all the general and limited shares. Then a trust is set up for the kids and grandkids. Grandparents sell the limited partnership shares (at a discount?) to the trust. The grandparents pay the income tax on any gains, because it is defective for income tax, but since its not defective for estate tax reasons, you get an estate freeze.

How can this be funded? A loan for the discounted sales amount funded by assets in the trust? Second-to-die insurance funded by annual gift exclusion money? Will it fly, or is this suspect? Is this done much? Do you do this kind of thing? Where can I find any literature on it?

Thanks for considering my long-winded question.

Rothschild: Barry, the technique you describe is being used extensively by us and many other estate planners. It is perfectly within the confines of the Code, and is not much different from a normal installment sale to a family member. The difference here, of course, is that by selling the partnership to a grantor trust, no gain is recognized and transactions between the trust and the grantor are ignored for income tax purposes. Provided the client expects the appreciation rate to exceed the Section 1274 rate (currently approximately 7%), the excess will remain outside the grandparents' estate. The other advantage of using this technique now is to lock in the discounts available on the valuation of the LP interests in the event Congress were to eliminate such discounts. The Wall Street Journal had an article describing this technique on February 28. If you would like a copy, e-mail me at This e-mail address is being protected from spambots. You need JavaScript enabled to view it .

The one caution I would make is to ensure the trust has the available cash flow to pay the interest on the note. If the trust does not have such cash flow available, it can pay the interest by using the LP interests in kind, but this would reduce some of the freeze benefits. The trust should also be funded initially with a gift transfer, which some commentators believe should equal 10% of the amount of the sale.

Phipps: Is there any particular estate planning software that you recommend?

Rothschild: There are many software products on the market, including USTrust's E-Plan, ProBate Software, Number Cruncher, among others. The American Bar Association has published a book on software for estate planning, including document drafting software as well as number-crunching software. I generally use a pencil to push my numbers.

Steve Wightman: What five top strategies would you use in estate planning with Roth IRAs? Also, I've lately heard attorneys tout using a trust as beneficiary for IRA assets. Do you think this is a good idea? Why?

Rothschild: I'm not sure I'll have five strategies for you, but we'll give it a try. The key to planning with Roth IRAs is to stretch out the deferral as long as possible. One limitation is, of course, the qualification for using a Roth IRA. Since a taxpayer can not have more than the threshold amount in AGI, it limits the client's ability to use these accounts. Most wealthy clients who have estate tax concerns do not qualify. Where the client does qualify, the key planning strategy would be to spend down all the other assets and allow the Roth IRA to grow. However, if left with a large Roth IRA account at death, there needs to be some consideration on how the beneficiaries will pay the estate tax, and the solution I've found to work best is to have life insurance available for that purpose.

As for using a trust as a beneficiary for IRA accounts, there are numerous types of trusts one might consider using. If a client doesn't have sufficient asset to use their exemption, we might suggest naming the credit shelter trust as a beneficiary. Another example would be where the client wishes to ensure that the IRA would be available for children from a prior marriage, in which event a QTIP trust would be advisable. Other trusts might include GST-exempt trusts and trusts for minors. As long as the trust meets the requirements to be considered a designated beneficiary, it will qualify the deferral over the life expectancy of the eldest beneficiary of the trust.

Phipps: Gideon, thank you very much. And thank you all for participating in our discussion.

Join us next week when our guest will be famed money manager Mario Gabelli, March 16, 5 p.m. to 6 p.m. EST.

Too much Credit card debt can be bad, but what are a few smart ways to use credit?

The best loan rate can be had with a brokerage margin loan, but that's for folks with investments at least 2 times the loan amount. Next to that, it's the old fashioned car loan. Here are some tips.

First, get copies of your credit score and FULL CREDIT REPORT from all 3 reporting bureaus. By federal law, you're entitled to one free copy per year. Getting it in 2005 may save you a few bucks if you were to do it again in 2006. Review it for errors. Each error costs you money - and lots of it - in terms of higher interest rates on your loans. Write to the agency explaining each error and asking them to fix it IAW the provisions of the Federal FAIR CREDIT ACT, FCA, that they are obliged to provide you free of charge.

All entries over 7 years old are non reportable under FCA, so it is easy to get errors this old removed. There are many provisions of the FCA that protect and preserve your rights, so I strongly encourage you to read it before you write your letters, because good credit means good rates and the best loans to you.

DECIDE HOW MUCH YOU CAN AFFORD TO SPEND MONTHLY without straining your budget. Remember to include insurance payments and sales and excise taxes too. Get this figured out before your proceed further. A good budget of your total monthly expense breakdown may look like this: 15% savings and investments, 25% housing; 10% food; 20% income taxes; 10-15% travel, entertainment and personal care; 10% utilities; and the rest for auto. Of course you budget may vary, but you get the picture.

DECIDE WHETHER YOU WANT NEW OR USED. The loan rates and terms are different.

Factor in the cost of maintenance. With a used car the onus is all on you. Also, figure at least $2.50/gallon on the mid grade fuel that Westphalia requires and at 15 MPG, figure out your annual estimated driving cost and factor that into the monthly cost of ownership.

GO SHOPPING: Start with the AAA to get a benchmark rate, and then call credit unions. Pick your best deal. Go for a loan term of 4-5 years. Make sure there is no early pay off penalty in case you get a windfall or a higher income stream. Good internet resources are Kiplingers.com and Consumer Union. The library has indexed periodicals on every subject of interest, also Google.

Person with the best credit score and best income will get the best loan deal. Keep the loan in just one name so the division of assets and the credit responsibility are very clear.

Then shop for that car. Whatever your time is worth to your employer, you are likely to save yourself at least ten times that amount annually by implementing these tips and doing your research. Figure out how much credit you can bite so that it doesn't bite you. You're less likely to fall victim to a bad credit rating under, not overestimate how much debt to carry and that's a good thing.

Older Americans, enticed by bargain-basement interest rates, soaring real estate values and easy credit, have been withdrawing the equity in their homes as though they were ATM machines. But now that rates are edging upward, are the good times coming to an end?

In the past, homeowners 65 and over were typically mortgage-free by retirement. But in recent years they have led the rush by cash-hungry homeowners of all ages to refinance their mortgages and get home equity loans.

"The growth of senior household mortgage debt," says Zhu Xiao Di, an analyst at Harvard’s Joint Center for Housing Studies, "is really quite remarkable, because compared with younger groups, their increase is the largest."

Zhu’s analysis of the Federal Reserve Board’s Survey of Consumer Finances shows that the mortgage balance of typical homeowners ages 65 to 74 was $44,000 in 2001, up from $12,000 in 1989. During the same period, bankruptcies rose as well: About 450,000 people over 50 filed for bankruptcy in 2002, up from 180,000 in 1991.

Still, borrowing against home equity—the value of a home minus outstanding mortgages and other debt on it—remains, at least for now, a reasonable way for many homeowners to reduce monthly mortgage payments, change the terms of their loan, pay off debt or raise cash.

Home equity now represents at least half the net wealth of most American households, about $121,000 on average for a 49-year-old and more than $144,332 for a 59-year-old. Most borrowers in the last dozen years came out as big winners, Zhu says, because home prices increased much more than mortgage debt.

But now, with rising interest rates [see Adjusting to Rising Interest Rates] and a cooling housing market, some borrowers could get in over their heads, draining the equity in their home—and with it, their financial security—and even risking the loss of their house if they can’t make their payments.

Experts say that before you borrow or refinance—especially if you’re ready to retire and will have less income—have a hard look at your financial situation and be sure you can pay off the debt. It may be easy these days to get large loans, but just because you can get more money, Zhu says, doesn’t mean you should. "You better think twice before you jump."

HOME EQUITY STATS
Average home equity
Per household in 2004	$130,000
Median mortage debt
In 2001
Among people 65+	$34,148
For all ages	$69,277
In 1989
Among people 65+	$17,783
For all ages	$39,802
Average size new HELOC
In 2002	$55,307
In 2003	$69,513
Average new home equity loan
In 2002	$40,253
In 2003	$58,054
Sources: Federal Reserve Board Survey of Consumer Finances; Consumer Bank Association 2003 Home Equity Study; Freddie Mac

 

And beware of predatory lenders, he says, who charge excessively high interest rates and fees. They typically target people in financial need and the least able to afford costly loans.

Experts recommend that you don’t spend the money on things like starting a business, stocks and other investments, retiring your children’s debts or on fast-depreciating items like SUVs. Use it instead to solidify or improve your financial situation—create an emergency fund, pay off high-interest credit cards, fix up your home or make a down payment on a new one.

Mary Caughey, 57, recently paid off the remaining $102,000 on her mortgage with some savings. Doing so freed Caughey, digital access coordinator for the Oregon State University Libraries in Corvallis, of an $879 monthly payment on her 1,200-square-foot ranch home.

More important, Caughey says, owning her home free and clear boosts her sense of security. If she needs money for home improvements and "occasional indulgences," she will tap the equity in her home rather than touch the principal in her retirement accounts.

She says she will open a home equity line of credit, or HELOC, which is granted by a bank, credit union or other financial services company and functions like a checking account.

HELOCs provide a specific amount of credit—on average 75 percent of a home’s value minus remaining mortgage debt—sometimes for a specific period of time. The borrower does not pay interest until money is withdrawn. HELOCs still offer relatively low interest rates—now around 3 percent. They often have no or low closing costs and flexible payback options. The interest paid on loans is usually deductible from federal income tax.

Shop around before signing up for a HELOC, says Steve Wightman, a financial planner in Lexington, Mass., because interest rates and other terms vary widely.

If rates go up, the interest on unpaid balances will go up—and so will the amount you owe.

While low rates have boosted the popularity of credit lines, there are other ways to tap home equity as rates rise:

Home Equity Loans

These are sometimes called second mortgage loans. The homeowner receives the money in a lump sum and repays it, usually in 10 to 15 years. Unlike a line of credit, this approach lets the borrower lock in a fixed interest rate, with regular, predictable payments. The rates are generally higher than those on first mortgages but lower on unsecured debt, such as credit card debt. Interest is generally tax-deductible.

Mortgage Refinancing

When interest rates are low, many homeowners refinance their mortgage to reduce their monthly payments. Many also get cash. According to the Federal Reserve, in 2001-2002 about half of homeowners who refinanced "cashed out" an average of $26,700. Fifty-one percent of them used the money to pay off debts, 43 percent used it on home improvements, and 25 percent on travel, education, health care or living expenses.

But the costs (for, say, title searches and appraisals) of refinancing can add up to thousands of dollars. So if your main goal is to get cash, this is probably not the best option.

Reverse Mortgages

People 62 or older who need money may want to consider a reverse mortgage. This type of mortgage allows you to trade your home equity for cash in one of three forms—a lump sum, a line of credit or a series of regular payments.

It’s best suited for those who plan to stay in their home throughout their lives—the mortgage is due when they move out—but need extra emergency funds or dependable income.

Joan F. Beach of Alexandria, Va., was receiving monthly Social Security payments of $800. "I couldn’t make ends meet," says the 74-year-old widow. Beach got a reverse mortgage on her house, which was appraised at $390,000 and owned free and clear. "Now I am getting a monthly check of $1,000," she says, "and I am living high on the hog."

Reverse mortgages are guided by complex rules and, like refinancing, can have high closing costs. Experts suggest borrowers seek professional advice in determining if withdrawing equity is a sound financial move.

Selling a Home

Many homeowners get a big infusion of cash when they sell the home they raised the kids in and downsize to smaller quarters with lower or no payments.

One retired couple in California, who did not want to be identified, lost 70 percent of their retirement accounts in high-tech stocks. So they decided to sell their $410,000 house and buy a new one, mortgage-free, for about $270,000. The profit is helping pay their bills.

"This was a tragic case," says the couple’s financial planner, George Middleton of Vancouver, Wash. But without the equity in their home to fall back on, their story could have been a lot worse.

Savings tips for living well - debt free.     By Steve Wightman, CFP

How do millionaires manage their debt? How to make it from paycheck to paycheck and amass a fortune? Tips told from Dr. Tightwad.

• For low balances, pay off all credit cards monthly. For higher balances, move debt to cards with lower interest rates, cut your spending to basic necessities and pay off the debt. Unless you are in business, select one credit card per adult for all your consumer purchases. I recommend the Quicken card. Apply at www.Quicken.com. It lets you download and categorize each expense monthly. Quicken 2002 now does this automatically for you! Now you know where ever penny goes AND tax filing’s a breeze at year-end because all your expenses are right there – all accounted for!
• Limit the use of credit cards to basic necessities. If you want new furniture, clothing you can do without, or entertainment equipment, wait until you have the money to pay hard cash. Use the credit card for ordinary monthly expenses as you would your checkbook. Never use it to borrow money that you can’t pay back that month. If you’re sympathetic and are in the mood for giving a bank 20% of your hard-earned money, just write them a check and forget about your credit card. I’m sure the bank will be happy to take it. Just what kind of future would you have if you took that same 20% and invested it? The answer for the average person is that they would be very rich! For example, if your household income were $100,000 per year, you’d stash $20,000 at the end of each year. Assuming you did this in a tax-deferred account like a variable annuity (no income limits) at an average 10% rate of return, you’d have one million dollars saved in just 19 years and twice that amount seven years thereafter! That’s plenty to pay any college expenses. With this strategy alone, in only 30 years you would have amassed 4 million cool dollars that you would have otherwise given away to a bank. By the way, when was the last time your bank sent you a “thank you” note for signing away your future?
• “Pay yourself first” is the axiom of a financial planner and prudent parent. Jump start your emergency fund. With the money you’re not spending now on superfluous luxury items and dining out, funnel that to a money market account. Set a minimum goal of how much you will save monthly and just do it! That way you won't have to pay credit card interest should you need crisis cash. I recommend six months expenses in a money market account yielding at least the inflation rate. For those who are in a higher than 24% tax bracket, consider a tax-free money market. You may benefit more. For both, avoid banks. Unlike mutual fund companies, they pay the lowest rates.
• When you get a raise, put 50 to 100 percent aside for investing or paying off consumer and then mortgage debt.
• Shop around for the best deals and the best prices. Use the Internet to do this and you'll cover a lot of territory in a short amount of time. A great place to start is wightmanfinancial.com, packed with articles, ideas, newsletters, links to ways you can save and live a better quality of life.
• Don't tie up too much money in your mortgage -- not more than 25 percent of your gross monthly income. All debts -- mortgage, car payments, credit cards, etc. -- shouldn't take more than 30 percent of your gross monthly income. Reduce those percentages if you can. Just because the bank will give you a mortgage that's 28 percent of your monthly gross doesn't mean you can't take out a smaller mortgage that will let you keep a little more cash each month.
•  
• Still stuck? Find a competent financial planner who loves to work on this basic and common issue of personal finance. You’ll find thousands of professionals through a search engine at www.NAPFA.org, called planner search. This site is the National Association of Personal Financial Advisors, NAPFA, who maintain high standards for members, most of whom are licensed as Certified Financial Planners ®. A planner can guide you and coach you, just like you would want those whom you love most to be coached to be their best.

Moral of the story? You too can move from debt to riches if you just avoid these credit card glitches say Steve Wightman, AKA Dr. Tightwad.