FEBRUARY 2013
Khaas Baat : A Publication for Indian Americans in Florida
Finance

Children and Money: Lessons in Self-Control

By SEEMA RAMROOP

Providing opportunities for children to practice self-control and to learn about saving will help them mature into adults who understand the value of money.

We all know that money doesn’t grow on trees, but do your children know how to manage it? Making the connection between saving first and spending later makes possible a lifetime of responsible money management. You can emphasize this connection by following a plan of age-appropriate techniques designed to emphasize the importance of controlling impulsive behavior.

Why Starting Early Is Important

Before teaching children about money, it is important to help youngsters control their impulses, potentially as early as age three. According to a study presented to the National Academy of Sciences in January 2011, a child’s self-control, as evidenced by traits such as conscientiousness and persistence in striving for goals, are strong predictors of success, including wealth, later in life.1 Children who scored lower on self-control were more likely to experience problems with saving, home ownership, credit and money management.

Depending on the age of your children, consider whether the following suggestions are compatible with your views about children, self-control and money.

Ages 2 to 8

Ages 9 to 12

Ages 13 to 18

Ages 19 and Older

1Source: Proceedings of the National Academy of Sciences, “A Gradient of Childhood Self-Control Predicts Health, Wealth and Public Safety,” Jan. 24, 2011.

2Source: Jump$tart! Financial Smarts for Students, “How to Raise a MoneySmart Child: A Parent’s Guide,” http://jumpstart.org/assets/files/MoneySmart%20Child.pdf, retrieved on April 9, 2012.

3Source: npr.org, “For Kids, Self-Control Factors into Future Success,” Feb. 24, 2011.

Seema Ramroop, financial advisor, Morgan Stanley Smith Barney, can be reached at Seema.Ramroop@morganstanleysmithbarney.com or call (727) 773-4629.


Accounting

ARE NONDEDUCTIBLE IRAs A SENSIBLE INVESTMENT?

By Kamlesh H. Patel, CPA

If you’re in a company retirement plan and your 2013 adjusted gross income exceeds certain levels ($69,000 for singles and heads of household; $115,000 for married people filing jointly), you can’t deduct contributions to an IRA. You can still make contributions (up to the usual annual limits), but if they’re not deductible, why would you do so?

Here are three possible reasons:

1. Earnings within an IRA are tax-free and thus compound at a higher rate.

2. Only the earnings are taxed when the funds are withdrawn. Since the initial contributions weren’t deductible, their subsequent distribution isn’t taxable. (In IRAs funded by deductible contributions, withdrawals are 100 percent taxable.)

3. Under certain conditions, you can convert a nondeductible IRA to a Roth IRA. This could be useful where you want to fund a Roth but your income level disqualifies you from doing so directly.

Caveat: If you have two or more IRAs, you can’t attribute withdrawals to just one of them, even if that’s the only one you actually withdrew from. A distribution from one IRA will be treated as a pro-rata distribution from all of your IRAs. Thus, if you have one IRA that was funded by nondeductible contributions and another that was funded by deductible contributions (where all withdrawals are taxable), the two will be lumped together to determine a combined taxable withdrawal percentage.

In some situations your funds might be better used elsewhere. You’d generally be wise to liquidate high-interest debt (such as credit card balances) before investing in a nondeductible IRA. You should also compare your potential earnings within the IRA to outside investments offering higher after-tax returns, adjusting, of course, for relative risk. Since funding a nondeductible IRA is only one among many possible investment strategies, always review your options with your financial adviser before proceeding.

CONSIDER AN S CORPORATION ELECTION BEFORE IT’S TOO LATE

S corporations have certain tax advantages that you might consider for your small business in 2013 – before it’s too late.

An S corporation is a regular corporation that has opted to have all income or loss passed down to the personal tax returns of its shareholders rather than taxed at the corporate level. This avoids the dreaded double-taxation scenario – income first taxed at the corporate level and then taxed again as dividend income to the shareholders. Thus, S corporations provide the legal liability protection of a corporation, but have the tax characteristics of a partnership.

S corporations also have unique flexibility on how shareholder-employees are compensated. For example, if more income is distributed as dividends and less as salaries, the corporation can potentially save on social security, Medicare, and unemployment taxes. However, certain rules govern how far you can go with this strategy, so understand the requirements to avoid problems.

Another S corporation advantage is that charitable deductions are not limited to 10 percent of income as they are with regular corporations. And S corporation shareholders can potentially deduct the company’s losses against other personal income.

So what’s the downside? S corporations can have only one class of stock and are limited to 100 shareholders. Shareholders cannot be partnerships, corporations, or nonresident foreigners. S corporations have a narrower range of tax-deductible fringe benefits available to their employees.

If you are considering an S corporation election for this year, you better hurry. Corporations with a calendar year-end have until March 15 to file their intentions with the IRS for the current tax year. New corporations have until the 15th day of the third month after incorporation to make the election.

WHAT WILL TRIGGER AN IRS AUDIT?

What are your chances of being audited by the IRS? Not surprisingly, the nation’s tax collector tends to go after the big money.

According to figures recently released by the IRS, approximately 1.11 percent of all 2010 individual tax returns were audited in 2011, the same as the prior year. This rate has hovered around the 1 percent mark for several years.

In comparison, the audit rate of 1.02 percent for taxpayers with income of less than $100,000 almost quadrupled to 3.93% for those with an income of $200,000 or more. That means the IRS audited roughly one out of every 25 of these returns. And the odds of being audited jumped to about one out of eight for those with income above $1 million.

Besides chasing high-income taxpayers, the IRS often flags returns for the following reasons:


Kamlesh H. Patel, CPA, can be reached at (813) 949-8889 or e-mail kpaccounting@verizon.net or kpinsurance@verizon.net


FINANCE

Questions and Answers about Social Security

By HAREN MEHTA

Whether you're close to retirement or years away from receiving Social Security benefits, you may not know much about the intricacies of this important program. Here are some questions and answers that can help you learn more.

Will Social Security be around when you need it?

You've probably heard media reports about the worrisome financial condition of Social Security, but how heavily should you weigh this information? While it's likely that some changes will be made to Social Security (e.g., payroll taxes may increase, benefits may be reduced by a certain percentage, or cost-of-living adjustments may be calculated differently), there's been no proposal to eliminate Social Security. Although no one knows what will happen, if you're approaching retirement, it's probable that you'll receive the benefits you've been expecting.

How does the Social Security Administration know how much you've earned?

If you work for an employer, your employer will deduct Social Security taxes from your paycheck and report your wages to the Social Security Administration (SSA). If you're self-employed, you pay your self-employment Social Security taxes and report your earnings to the SSA by filing your federal income tax return. To view your lifetime earnings record, sign up to access your Social Security Statement at www.socialsecurity.gov

Will a retirement pension affect your Social Security benefit?

If your pension is from a job where you paid Social Security taxes, it won't affect your Social Security benefit. However, if your pension is from a job where you did not pay Social Security taxes (such as certain government jobs) two special provisions may apply.

The first provision, called the government pension offset (GPO), may apply if you're entitled to receive a government pension as well as Social Security spousal retirement or survivor's benefits based on your spouse's (or former spouse's) earnings. Under this provision, your spousal or survivor's benefit may be reduced by two-thirds of your government pension (some exceptions apply).

The second provision, called the windfall elimination provision (WEP), affects how your Social Security retirement or disability benefit is figured if you receive a pension from work not covered by Social Security. The formula used to figure your benefit is modified, resulting in a lower Social Security benefit.

If someone else receives benefits based on your earnings record, will your benefit be reduced as a result?

Your benefit will not be affected if other people, such as your spouse, former spouse, or dependent children, receive Social Security benefits based on your earnings record.

If you delay receiving benefits until after full retirement age, should you still sign up for Medicare at age 65?

Even if you plan on waiting until full retirement age or later to take your Social Security retirement benefits, make sure to sign up for Medicare three months before you reach age 65. If you enroll late for Medicare Part B (medical insurance) your coverage may be delayed or cost more later. Visit www.medicare.gov

Do IRA withdrawals count toward the Social Security earnings limit?

Prior to full retirement age, an earnings limit applies if you receive Social Security benefits. If you earn more than this amount, your benefit will be reduced. However, only wages from a job or net earnings from self-employment count toward this limit. Unearned income, such as IRA withdrawals, investment earnings, or capital gains, does not count.

DISCLAIMER: Securities and Investment Advisory services offered through SagePoint Financial, Inc., member FINRA/SIPC and a registered investment advisor.Fixed and/or Traditional Insurance Services may be offered through Capital Insurance & Asset Protection LLC, which is not affiliated with SagePoint Financial or registered as a broker-dealer or investment advisor.

Haren Mehta, manager partner of Capital Insurance & Asset Protection LLC, can be reached at (813) 679-5204, e-mail haren@mycapitalinsurance.com or visit www.mycapitalinsurance.com


GUEST COLUMN

CAP Rates and Commercial Real Estate

By NILESH PATEL, CFA

Commercial Real Estate (CRE) properties are often valued based on CAP Rate. So, what is a CAP Rate?

CAP Rate is a short form of “CAP-italization Rate.” In other terms, it is a rate of return desired from investment in that property. It is widely used as a yardstick to measure one property value against the other. It is also used by real estate brokers, banks, appraisers and sellers in evaluating the “deal.”

Let’s start with an example:

You are approached by a RE broker to purchase a 20-unit apartment complex. The asking CAP rate for this property is 8 percent. This means that if you invest in this property without borrowing any money (meaning you pay all cash), you can expect 8 percent return on your investment.

How does she come up with that? Well, she has financial data on the apartment to prove her claim. This 20-unit apartment is 90 percent rented at $500 per month rent collected per unit, which is $108,000 rental income per year (90 percent x 500 x 20 x 12). The yearly expenses to run this place are $ 60,000. The expenses cover maintenance, real estate taxes, insurance, utilities, security, management, marketing, etc. So, the Net Operating Income of this property is $48,000 ($ 108,000 - $ 60,000). Since she is quoting it at 8 percent CAP, the price to be paid for this apartment building is $ 600,000 (NOI of $ 48,000 divided by 0.08). If you buy this place for $600,000, you can expect to make $48,000 per year, which is 8 percent return on your money.

CAP Rate = Net Operating Income / Price of the Property

What happens if you purchase this property by putting 20 percent down payment and borrow from the bank 80 percent of the purchase price?

Down Payment is $ 120,000 (20 percent of $ 600,000)

Loan $480,000 at 4.5 percent interest rate fixed for 5 years with 20-year amortization.

Your $480,000 loan will cost you $36,400 per year. In this case, your take home income is $11,600 ($48,000 in Net Income minus the $36,400 of debt service). That’s bad, isn’t it! But wait, your return on investment is now 9.67 percent ($11,600 Net Income divided by $120,000 down payment). This is also called “Cash-on-Cash” return. The lesson is: Any time when CAP Rate is higher than the loan rate, it is good to borrow money to buy that property than paying cash as it increases your investment return. In simple terms, you earn 8 percent return on $ 120,000 you put as down (as per the stated CAP rate). On rest of the $480,000 (which is borrowed from the bank) your return is 3.5 percent (the difference between your CAP Rate of 8 percent and Loan Rate of 4.5 percent.

Depending on how you end up structuring your purchase, the rate of return from the investment will change. CAP Rates vary based on the risk involved in the particular property type, supply and demand of that property type, as well as what kind of financing is available. There are many variations of CAP Rates that are in use. Convenience stores are often quoted as multiples of 3 or 4. This multiple is number of years it will take to recoup the money you invested in purchasing that C-Store. If you buy a running convenience store business for $ 200,000 and the pricing has 4 multiple that means the store produces $50,000 a year in income to you and it will take four years to recoup your $200,000 investment. (You can also say the CAP Rate is 25 percent).

Nilesh Patel, CFA, a Vice Chairman of Central Bank, Tampa, can be reached at (813) 789 2776 or e-mail NileshPatel@CentralBankFL.com

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