The usual caveats apply. Everyone’s financial situation differs. Consult your own advisor or do your own research. We have been wrong before.

[Formatting problems at the bottom are known issue. Webmaster on the case.]

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The financial sector had taken over our economy. Over 40% of all profits in the US were made by financial firms, a statistic more befitting a small Caribbean tax haven. Financial regulation in this country was inconsistent and ineffective.

Your messengers,

Elizabeth and Jessica

The usual caveats apply. Everyone’s financial situation differs. Consult your own advisor or do your own research. We have been wrong before.

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Shocking VP picks, Russian invasions and now a government takeover of Fannie Mae (FNMA) and Freddie Mac (FHLMC)… the news just won’t stop coming.

Our overall view has not changed. The US will have to suffer through a few unpleasant years before the housing market normalizes, financial institutions can get back to business and our economy can get moving again. It will get worse before it gets better. At the end of the day, the financial sector should be smaller and more efficient which would be a positive thing. People will start saving money and that will be a positive thing.

Asset classes around the world have taken a beating lately. The rumors are that many hedge funds have had to liquidate large positions. While this is ugly for current holdings, most of you hold a lot of cash and we have identified a number of compelling investments.

Items of note from the government takeover of FNMA and FHLMC:

Mortgage rates will probably go down. The government is doing a lot of things to get rates down, many of which will eventually cost us all as taxpayers and mean much higher mortgage rates in the future. But in the meantime… there should be some deals available.

Future tax rates will be even higher than we have been assuming. This bailout will cost a lot. If you can contribute to a Roth IRA, you should seriously consider doing so.

This is not the final restructuring. The current specifics of the FNMA / FHLMC deal have the mortgage giants being responsible for something like 90% of all new mortgages over next year or two and then virtually ceasing issuance after that. The concept is that offering really, really low rates on mortgages over the next 18 months will stabilize the situation enough that the government can just leave. Methinks this is not very realistic. Who on earth will step up to fill the void? Homeowners and banks will be dependent on the US taxpayer for years to come. There are some eerie parallels to the Iraq war…

Debt issued by FNMA and FHLMC is money good. Many of you hold shares in your 401(k)s in the Pimco Total Return fund, which had gone “all in” on a bet that the government would do a bail out. It turned out to be a good bet.

In other news:

Washington Mutual (WaMu) got officially placed on super secret probation by its regulators. This is not a good sign. They are offering desperation-level high rates on CDs. This is not a good sign. We have sent out previous warnings about this bank. You should not have more than the FDIC minimum at WaMu. Your family and friends should not either.

Don’t shoot the messengers-

Elizabeth and Jessica

Things I learned:

1) These decisions have a huge impact over how much money people and their heirs end up with and are important to think about.

2) The calculations required to make these decisions are really hard, even for the country’s top financial professionals, and not always intuitive.

3) There were people of all political persuasions in the room and EVERYONE thinks tax rates are going up, way up. As someone said, if taxes were a stock, they would be rated a long term “buy”.

4) The Roth IRA / 401(k) can be great for people of even very high incomes.

5) Congress will allow unlimited conversions to Roth IRAs from regular IRAs in 2010. Currently, you can only do this if you earn less than $100,000. This is a fabulous opportunity for our clients but will be very costly for our nation’s finances without any obvious public benefit.

When you convert to a Roth, you have to pay the taxes on all the income that was sheltered in an IRA, but you and even your grandchildren who inherit that money never pay tax again on any investment or dividend income. You pay $1 today to avoid $2-$30 of tax in the future.

Even though Congress gives up a huge amount of revenues in the future, it still loves this idea because all its budget calculations are done on a 10 year basis. They get all of the benefit from people writing checks to the IRS today without having to account for the taxes people will avoid paying 10-100 years from now. When they passed the provision, they were able to count it as a revenue raising measure.

According to this New York Times article, this one little obscure tax law could cost over $50 billion when all is said and done. I guess we can just add unlimited Roth conversions as reason #932 that tax rates will be headed north.

Anyway, if you are our client, and you got a notice from the HR department about a new Roth 401(k) option and shoved it into a desk drawer, pull it out and give us a call.

If you happen to be a member of Congress, you need to consider revisiting the Roth conversion idea.

As always, everyone’s financial situation differs and you need to consult your own advisor.

For further reading:

An explanation of why it is a problem if the bond insurers blow up

Barron’s article by Vitaliy Katsenelson that explains why we should value stocks assuming profit margins are lower in future

New York Times article on American’s consumption habits

The husband in his family left his old job October 31 and health coverage through his new job doesn’t start until January 1. They just got a huge bill for COBRA coverage and they were wondering if they have to pay it. The answer turns out to be no, not unless they have some major health expense between now and the start of their new coverage.

With COBRA, you get 60 days to decide to use it and another 45 days after that to actually pay. If you don’t pay, they don’t have to cover any expenses you had.

The 60 day clock starts running when you get your Cobra notice (which can be up to 6 weeks after you leave your job, depending on how on the ball administrators are) but the coverage will be retroactive to the day you actually quit.

So for people who have their next health insurance lined up, the clear strategy is to wait until the day the new coverage starts to decide whether or not you wanted health insurance. If your expenses were more than the insurance premium, pay the premium. If not, skip it.  You can even cherry pick which family members you wanted covered. The wife breaks her arm – she gets covered. The kids manage to stay healthy – they don’t get covered.

The only really downside I’ve come across is that your insurance card, while theoretically valid, may not be “live”,which could be a hassle. On a practical basis, most of the health providers in this area do not actually do anything with your card except make a photocopy of it until they are ready to send out a bill. This is not true of pharmacies, however, and you will have to pay the retail price and later get reimbursed if you decide you wanted insurance.

If your new insurance will start more than 2 months after you left your old job (this time period is for California residents), you need to think carefully about whether you will have problems getting pre-existing conditions covered because of a lapse in coverage and have a nice chat with the new benefits person at your work.

If not, you’ve got a free option.

Some further reading:

The California Patient’s Guide

FAQs About COBRA Continuation Health Coverage

The usual disclaimers about everyone’s situation being unique apply.

We sent the following note to our clients and those we have put on our “Friends of Alexis and Palmer” email list. If you would like to be added to this list, please send a request to info@alexis-palmer.com with your name and affiliation.

We are getting inquiries about E*TRADE, their financial future, and the safety of accounts held at E*TRADE.

General takeaway:

• E*TRADE is definitely over its head but has value as a going concern.
• Even if people try and take a lot of cash out of E*TRADE, it has numerous ways to borrow a lot of money.
• Cash deposits/CDs up to $100,000 are usually FDIC insured and safe. (Use the FDIC calculator to know exactly how much coverage you have)
• Securities in brokerage accounts up to $500,000 are covered by SIPC insurance and are safe.
• Accounts over $500,000 are covered by excess SIPC insurance – we have not done the math to see if it will cover all holdings.
• An easy way to increase the security of large cash deposits is to buy a money market fund or short term bond fund – this then becomes covered under SIPC.

More on E*TRADE
I worked for a brief period for E*TRADE five years ago and I still know people who work there. I became VERY concerned about their mortgage holdings several months ago after they publicly released certain portfolio information about their mortgage holdings. Since that time, the stock price declined over 70%. That said, E*TRADE has a number of strategic options which I think could keep it afloat. I actually published an “article” on SeekingAlpha.com (http://seekingalpha.com/article/54013-e-trade-a-bargain-at-these-levels) about E*TRADE last night that you can read for more background information on their woes.

Please remember that everyone’s financial situation is different and the information provided may not apply to your situation in particular.

The question we have is: if she had a financial advisor who understands the risks of employee stock options, why didn’t he convince her to exercise them before they fell off a cliff?

Financial planning is more than just telling a client the “right thing to do.” With our clients, most of whom are very capable professionals, the lore and lure of stock options have to be be dismantled before we can get them in the framework to make good decisions about their holdings.

Options are economically similar to buying stock on margin, equivalent to buying a house with very little money down. The first thing we do with clients is translate their option holdings into a share equivalent for them (downpayment -> house price, exercise value-> share position). The market value of these shares is usually dwarfs their other investments.

After the shock of that revelation wears off, we talk about the likelihood of them getting fabulously wealthy from their holdings, just like their neighbor John did.

Everyone in Silicon Valley has a neighbor John. John worked for XYZ Corp. and didn’t exercise any of his options and his company’s stock went to a zillion dollars and now he has enough money to buy a decent house in the Bay area.

Then we show them how much money they would have if they had exercised all their options in ABC Inc., paid the taxes and bought  options on Apple XYZ Corp. stock.

Then we do an analysis of their actual company and start looking at how different scenarios impact their overall net worth.

Then after all that sinks in, we can start talking about strategies for exercising stock options.

Update 2: Fidelity has published a lengthy research report [Fidelity Gifting Appreciated Securities -pdf] on gifting appreciated securities in lieu of cash.

Charitable gift funds offer a really easy and IRS subsidized way for people with appreciated assets to give money away. They make giving money away cheap and easy. What’s not to love?

Here’s the concept:

1) You donate your appreciated asset to XYZ Charitable Gift Fund.

2) You get an immediate tax deduction for the current market value of what you gave.

3) The Fund sells the asset and puts the proceeds into a gift account in your name. The IRS will not make you pay any tax on the gain.

4) You decide how you want the money in the account invested.

5) At your leisure, you can “suggest” that they donate money to whoever you want. They mail out a check to the charity.

Most large financial institutions now offer have some kind of gift fund. Our clients generally use the Fidelity Charitable Gift Fund. It has been around since 1991 and is the largest one in existence. We have found it straightforward to use.

Some benefits our clients have gotten from participation:

1) All the tax savings of gifting appreciated assets with minimal hassle.** Many organizations are not set up to receive stock and may not even know what to do with it. You can transfer stock once and send cash to multiple organizations.

2) Easier recordkeeping. You only have to keep track of one donation for your taxes, instead of each individual gift.

3) Online giving. Some charities cannot take online donations or get clipped 5-10% by a processing company for online donations. You can go online in the middle of the night and Fidelity will take care of sending the cash without any fees.

4) Putting their money where their mouth is. We all have the best of intention to give x% of our income to charity but we can get busy. If you actually put the money in the fund, you have made an irrevocable decision to give.

5) Timing a gift. You can get a deduction today, even though you may intend to give the money to the end recipients over the next several years.

There are, as always, caveats that apply.

The one that most often trips people up is that you cannot fulfill a pledge you personally have made with money from a gift fund. Instead of pledging money, you want to state that you will suggest a gift from your charitable fund. This will makes the IRS happy as well as the director of development.

There are some other issues to be aware of. Based on your particular tax situation, you may not get the full writeoff. You only want to give securities you have owned for more than a year. There are some restrictions on the gifts that can be made. Your employer may not match gifts to funds. Etc etc.

If you are a client and are reading this because we told you that a charitable gift fund might make sense for you and you agree, give us a call.

If you are not a client, do your own homework or talk to your financial planner.

**The tax savings can be huge. Some of our California AMT payers with zero basis stock are able to give $10,000 worth of stock, get a $4,430 deduction and avoid $3,130 in capital gains taxes.