Financial Crisis Answer Center, Part 2

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November 26, 2008

QUESTION: I have a child in the fourth grade in Maryland and one in kindergarten. Is this a good time to be starting a 529 or is it better to wait for the markets to recover?

—Simon Winter

ANSWER: The short and sweet answer is: Don't wait. When investing — and starting a 529 savings plan is precisely that — it's always best to buy low. "Waiting for the market to rebound is the equivalent to waiting for the price of a gallon of milk to go from $2 to $2.50 before buying. You simply wouldn't do that," says Ted Toal, certified financial planner at Triton Wealth Management in Gaithersburg, Md. You want to get in when the market is going through a temporary downturn like it is now. No one knows when stocks will recover. And besides, by the time they do, you'll be too late and will have missed out on some gains.

Toal suggests investing in a target-date portfolio like the one offered by Maryland's college savings plan and managed by T. Rowe Price (TROW). Target portfolios work by investing according to the child's age: more aggressive investments when the child is young shift to more conservative holdings (like cash and fixed income) as he nears college age. This plan also offers a nice tax deduction: For each beneficiary, you can deduct up to $2,500 of contributions each year from state taxes.

QUESTION: My wife and I have an annuity with AIG (AIG). I am over 65 and she is over 62. I am concerned about AIG given all the bad publicity. Is our money safe there or would you recommend taking it out?

—Norm Allen

ANSWER: The principal on your annuity with AIG is safe. It's protected by a strict financial requirement that insurance companies must maintain cash reserves equal to the withdrawal value of every annuity account. And if AIG suffers a complete meltdown, policyholders will have plenty of time to come up with a backup plan. "An insurance company wouldn't go out of business tomorrow," says Scott Simmonds, an independent insurance consultant based in Saco, Maine. "Regulators wouldn't allow that to happen. There would be a gray period."

November 25, 2008

QUESTION: Is now the best time to buy TIPS? Is it too late to sell TIPS, or should I just hold on to them for a couple of years?

—Paul Freedman

ANSWER: The primary goal of Treasury Inflation-Protected Securities, known as TIPS, is to hedge against the corrosive effects of rising prices. The static interest paid out by typical fixed-income investments loses its buying power over time as the cost of goods increases.

That's why TIPS make sense in an inflationary environment. As inflation, as measured by the Consumer Price Index, rises, the principal of your TIPS is adjusted upward, as are the interest payments. The opposite occurs during periods of deflation, or falling prices. Some economists fear the U.S. could be facing a protracted bout of deflation.

Whether to buy or sell TIPS depends on what your aim is and where you think the economy is headed. If you're looking for near-term outperformance and think we're in for a prolonged slowdown, then it's not a great time to buy since inflation isn't a big factor when the economy stalls. As for selling, if you own TIPS that are near maturity it's probably best to hold on. A nice feature of TIPS is that you'll get back your original principal even if a declining CPI has pushed the adjusted principal below that level. With deflation a looming threat, that's a nice guarantee to have.

QUESTION: When I retire, is it possible to roll over my 403(b) into a Traditional IRA account. When I roll over the 403(b) into the Traditional IRA, would it be possible to invest everything in municipal bonds so I don't have to pay taxes when I withdraw the funds for retirement?

—Angela Tulshi

ANSWER: Similar to a 401(k), a 403(b) is a retirement savings plan primarily used by teachers. It is possible once you retire to roll over your 403(b) into a Traditional IRA account and invest all those assets in muni bonds. But that isn't the best use of either muni bonds or your IRA for two reasons.

First, once you start taking the money from your Traditional IRA it'll get taxed as ordinary income, says Michael Gibney, president of the Financial Planning Association of New Jersey. So, even if you have all of your IRA invested in muni bonds you will still have to pay taxes when you withdraw the money.

Second, IRAs already allow you to grow assets tax deferred. Therefore the tax advantages of muni bonds are wasted in an IRA. Instead, put muni bonds in taxable accounts. For recommendations of muni bond mutual funds, a good alternative to individual muni bonds, read our story.

November 24, 2008

QUESTION: If a company files for bankruptcy, what happens to the stockholders?

—Richard

ANSWER: It depends on whether the company files for Chapter 11 or Chapter 7 bankruptcy protection, but in either case shareholders see their equity stakes severely depleted or destroyed. Chapter 11 generally refers to the reorganization of a business while operating under bankruptcy-court protection; Chapter 7 generally refers to the liquidation of any assets.

In the case of Chapter 11 the company's stock may continue to trade while the firm reorganizes, but it won't be worth much, if anything. In the case of Chapter 7 the company goes out of business, usually wiping out common shareholders, who are last in line (behind secured creditors, bondholders and preferred shareholders) to collect anything that's left from selling off the business in pieces. Companies that declare bankruptcy also stop paying dividends.

QUESTION: Is it legal for a business to charge a customer a restocking fee when returning merchandise in the state of Delaware?

—Lindsey Buckingham

ANSWER: Restocking fees are perfectly legal — and, unfortunately, common. Laws governing them vary by state. (Delaware doesn't have a law in place, so retailers essentially have free reign.) To find out the details of your state's law, or if you think you've been charged unfairly, talk to your state attorney general or the department of consumer affairs. Bottom line: It pays to ask before you buy, no matter what state you're shopping in, especially if you think there's the slightest chance you might need to adjust, return or cancel an order.

November 20, 2008

QUESTION: I'm 71, retired and don't need the money yet, but should I keep Dodge & Cox (DODGX)? Can it come back from the big hit it's taken this year?

—Joe Dion

ANSWER: Dodge & Cox has had a bad year. Its flagship stock fund is down 47% after making bad bets on financial companies like Wachovia (WB) and American International Group (AIG). But, since you don't need to take your money out yet, it's worth considering the fund's past performance. As Morningstar recently pointed out, the fund has done well in years following bad markets, such as in the early 2000s. Its 10-year annualized returns put it in the top 1% of its category. Past performance doesn't guarantee future performance, but bear in mind that several of the fund's managers have had more than $1 million of their own money invested in the fund. That shows internal conviction in their strategy. The fund is also cheap with a 0.52% expense ratio. If you have a five-year time horizon, why sell now with the market down? It may be worth giving managers a chance to recoup some losses before moving on.

QUESTION: I am 64 and my wife is 62. We currently have high medical expenses, enough that we will be able to claim a deduction on our income tax return. If we open and fund health savings accounts, or HSAs, this year will we be able to take income tax deductions on our 2008 return for both the health savings account and the medical expenses?

—Robert Martin

ANSWER: Yes, but there's no double-dipping. You'll need to separate expenses into pre- and post-HSA, says CPA Lisa Featherngill, director for financial and estate planning at wealth-management firm Calibre in Winston-Salem, N.C. Medical expenses are deductible only if you itemize, and then only the portion that exceeds 7.5% of your adjusted gross income. Until you use funds from a health savings account, any qualifying out-of-pocket medical expenses incurred count toward that deduction threshold.

Contributions to a health savings account — which itself requires a high-deductible health plan through an employer — are so-called above-the-line deductions, meaning you can claim them without itemizing, says Featherngill. (For more on using these accounts, click here and here.) For 2008, contributions max out at $2,900 for health plans with single coverage and $5,800 for family coverage. While you can deduct the full amount you contribute, any funds withdrawn this year to cover medical expenses shouldn't be included when calculating your pre-HSA medical expenses deduction.

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