Financial Insights for Living Well - April 2014

Transcription

1 George Financial Advisors Ted George, CFP, MSFP Financial Advisor 1414 Soquel Ave, Suite 220 Santa Cruz, CA April 02, 2014 Greetings! This month we take an in-depth look at Master Limited Partnerships(MLP), a tax advantaged income investment that is benefiting from increased oil and gas drilling around the country. We start with a short introduction to the concept of Limited Partnerships, followed by a detailed article on MLP's. Our third and fourth articles continue our mini-series on Insurance with an article and illustration describing Whole Life Insurance. A final reminder to file your tax returns on time. And when that is done get out and enjoy the rest of April! Financial Insights for Living Well - April 2014 Documents in this presentation: How does a limited partnership work? Master Limited Partnership How Traditional Whole Life Insurance Works Whole Life How does a limited partnership work? Question: How does a limited partnership work? Answer: A limited partnership is a form of business ownership that consists of general partners and limited partners. There is no maximum number of either type of partner, but there must be at least one general partner. The general partners manage the partnership and are typically personally liable for all of the partnership's obligations, as well as for the acts of the other partners on behalf of the partnership. Limited partners are generally exposed to such liability only to the extent of their investment in the limited partnership. However, they are not permitted to participate in management of the partnership without the loss of this liability protection. A limited partnership offers some flexibility when allocating profits 3:56:08 PM]

2 and control. This flexibility can provide certain tax and business advantages for individual partners. State law and the partnership agreement govern a limited partnership. Your partnership agreement should spell out the entire arrangement between the partners and state each partner's share of profits and losses. In cases where the partnership agreement fails to address an issue, state law will dictate how the partnership is to operate. In these instances, your state's version of either the Uniform Limited Partnership Act (ULPA) or the Revised Uniform Limited Partnership Act (RULPA) will determine how disputes are resolved. Refer a friend To find out more click here IMPORTANT DISCLOSURES Fee-only financial planning and investment advisory services are offered through George Financial Advisors, a registered investment advisory firm in the state of California. Appointments are available in our offices in Los Gatos, Palo Alto and Scotts Valley. See for more information. The information presented here is not specific to any individual's personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice. The receipt of this document shall in no direct or indirect way be construed or interpreted as a solicitation to sell or offer to sell investment advisory services to any residents of any state other than the state of California or where otherwise legally permitted. We are legally empowered to provide investment advisory services to residents of California and certain other states. Certified Financial Planner Board of Standards Inc. owns the certification marks CFP, CERTIFIED FINANCIAL PLANNER and federally registered CFP (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board s initial and ongoing certification requirements. Copyright 2014 George Financial Advisors LLC All Rights Reserved Prepared by Broadridge Investor Communication Solutions, Inc. Copyright :56:08 PM]

3 George Financial Advisors Ted George, CFP, MSFP Financial Advisor 1414 Soquel Ave, Suite 220 Santa Cruz, CA April 02, 2014 Greetings! This month we take an in-depth look at Master Limited Partnerships(MLP), a tax advantaged income investment that is benefiting from increased oil and gas drilling around the country. We start with a short introduction to the concept of Limited Partnerships, followed by a detailed article on MLP's. Our third and fourth articles continue our mini-series on Insurance with an article and illustration describing Whole Life Insurance. A final reminder to file your tax returns on time. And when that is done get out and enjoy the rest of April! Financial Insights for Living Well - April 2014 Documents in this presentation: How does a limited partnership work? Master Limited Partnership How Traditional Whole Life Insurance Works Whole Life Master Limited Partnership What is it? Developed in the 1980s, a master limited partnership (MLP)--sometimes known as a publicly traded partnership (PTP)--is generally a limited partnership that operates an active business. An MLP offers interests (known as "units") that are traded, much like shares of stock, on an established securities market, or that are readily tradable on a secondary market or its substantial equivalent (for more information, see the technical tip under "How does an MLP work?"). When you purchase an interest in an MLP, you technically become a unitholder rather than a shareholder. In this respect, it is different from a private limited partnership. An MLP typically has a two-tiered structure: (1) a general partner (in some cases, multiple general partners) that manages the day-to-day operation of the business, and (2) limited partners whose investments provide the partnership with capital and who receive income from the operation in return. 3:56:33 PM]

4 Despite the name, an MLP may be structured as a partnership but taxed as a corporation. Some MLPs are actually publicly traded limited liability companies (LLCs) that have chosen to be taxed as a partnership and do not have a general partner. An MLP may also represent a smaller piece of a corporation that has been spun off as an MLP for which the corporation is the general partner (in some cases, the general partner also may increase its percentage of ownership by holding limited-partner units). Though the differences may seem like technicalities, they are actually important, because partnerships and corporations are taxed differently. Corporate earnings are taxed at the corporate level and again as part of an individual investor's income if paid out to shareholders as dividends. By contrast, MLPs that are considered a partnership are not treated by the tax code as a business entity but simply as an aggregation of all of the individual partners involved. Therefore, an MLP pays no tax at the partnership level; each individual unitholder pays tax on his or her proportionate share of the earnings. As a result, because a partnership is not subject to taxes at the partnership level, it becomes a "flow-through" entity that is able to pass on more of its earnings to individual investors. That can make it attractive to individuals seeking an income stream. Limited partners also receive benefits such as deductions and depreciation allowances, which would normally be applied at the corporate level. As of 1987, the tax code requires a publicly traded MLP to receive 90 percent of its income from specific qualifying passive sources, including natural resources such as oil and natural gas, real estate, or commodities, in order to qualify for tax treatment as a partnership. If it does not, it is taxed as a corporation and therefore owes taxes as a business entity. Because of this restriction, most MLPs now are in energy-related businesses (for example, those involved in exploration, development, production, mining, refining, marketing, and transportation of oil and gas, minerals, geothermal energy, timber, and alternative fuels such as biodiesel); oil and gas limited partnerships and real estate tax credit limited partnerships are particularly common. Some exchange-traded funds (ETFs) also are legally structured as MLPs. Income sources that count toward the 90 percent requirement for qualifying passive income and tax treatment as a partnership include: Interest Dividends Real estate rents Gains from disposition of real property, such as real estate Income or gains from certain mineral or natural resource operations Gains from disposition of capital assets or property, such as commodities, that are held for the production of passive income Tip: Several qualifications and limitations apply. For more information about this exception, consult a tax expert. Technical Note: An MLP that traded prior to 1987 but whose income was not derived from any of the sources that meet the definition of qualifying passive income for treatment as a partnership could choose to continue to be taxed as a partnership if it paid a 3.5 percent annual tax on the partnership's gross income from the active conduct of its trade or business. However, relatively few MLPs still trading fall into this category. For more information about this, consult a tax expert. How does an MLP work? As noted above, an MLP typically has both a general partner and limited partners. Most individual investors who buy units in an MLP become limited partners; however, if the general partner is a publicly held corporation, investors may buy shares of stock in it just as they would any other corporation. MLPs must register with the Securities and Exchange Commission and provide investors with a prospectus and other disclosures. MLPs typically make cash distributions to limited partners quarterly, which are reported to each partner on a K-1 form (rather than the 1099 form used for corporate dividends). These cash distributions represent a proportionate share of the partnership's distributable cash flow, which includes not only income from the MLP's operations but also depreciation, depletion allowances, tax credits, and other tax deductions. The K-1 will specify each partner's share of income gain, loss, deductions, and tax credits for that tax year. Unlike corporate dividends, an MLP's cash distributions are considered a return of capital and used to adjust the individual partner's cost basis when the units are sold. At that point, the portion of the sale proceeds that results from adjusting the cost basis downward by the amount of the accumulated distributions, deductions, and depreciation becomes taxable as 3:56:33 PM]

5 ordinary income, while the remaining portion is taxed at the capital gains rate. Since depreciation and deductions can offset or even eliminate current tax liability on the cash distributions--and many MLPs attempt to make sure that their quarterly distributions exceed any tax owed--an MLP can in effect provide taxdeferred income. Some MLPs focus on rapid growth; others offer slower growth but more reliable cash distributions. Also, an MLP may have an anticipated duration, which will be detailed in its prospectus. Although the lifespan will typically run anywhere from 5 to 15 years, the general partner can decide when to liquidate. Although MLP units are certainly more liquid than private limited partnership shares, you should be prepared to hold on to them for a number of years, or risk selling at a loss. The MLP's organization, business strategy and objectives, potential risks, fees, and anticipated duration, as well as other important information, can be found in the prospectus available from the partnership, which you should read and consider carefully before investing. State law and the partnership agreement will govern the limited partnership. The partnership agreement should contain, among other things, the amount of each partner's distributive share of partnership profits and losses. In cases where the partnership agreement fails to address an issue, state law will dictate how the partnership is to operate. Technical Note: A partnership will be treated as readily tradable on a secondary market or the substantial equivalent thereof if the partners are readily able to buy, sell, or exchange their partnership interests in a manner that is comparable, economically, to trading on an established securities market. This occurs in several cases, including if (1) partnership interests are regularly quoted by any person making a market in the interests (i.e., a broker/dealer), or (2) an investor has a readily available, regular, and ongoing opportunity to sell or exchange the partnership interest through a public means of obtaining or providing information of offers to buy, sell, or exchange interests in the partnership. However, interests in a partnership will not be treated as readily tradable on a secondary market or the substantial equivalent thereof unless (1) the partnership participates in the establishment of the market or the inclusion of its interests thereon, or (2) the partnership recognizes transfers made on that market. For more information, see Internal Revenue Code Reg (d) and consult a tax expert. Why invest in an MLP? To provide an income stream: Cash distributions can provide periodic payments that can help pay for living expenses. To take advantage of certain tax benefits: As noted above, MLPs that meet the requirements for qualified passive income do not pay taxes at the partnership level; that lack of a tax burden can potentially increase the amount available to be distributed to the individual partners. Also, because the tax liability on cash distributions that exceed the partnership's income is deferred until holdings of an MLP are sold, MLPs can essentially provide an investor with the equivalent of a tax-advantaged income stream as long as the cost basis for the investment remains above zero (see "Tax considerations" below). To diversify a portfolio: An MLP focused on a commodity such as oil may be able to provide an investor with an asset that is not necessarily well-correlated to the rest of a stock-heavy portfolio. Strengths Potentially higher yield An MLP that qualifies for taxation as a partnership does not owe taxes at the partnership level. As a result, it may pass on a greater share of its earnings to the limited partners (i.e., individual investors). Also, the tax advantages of distributions being treated as return of capital can mean a higher immediate net yield, particularly for higher-income investors, than if those distributions were taxed as ordinary income in the year received. Relatively inexpensive and liquid compared to private limited partnerships Private limited partnership shares often require a steep initial investment. By contrast, units of widely traded MLPs may be much more affordable for the average investor. Also, because MLP units are traded on an established securities market or are readily tradable on a secondary market (or its equivalent), they are more liquid than private limited partnership shares. This is an advantage if you no longer wish to be a partner (for whatever reason), or if you have an immediate need for cash. Reduced cost of capital for the partnership 3:56:33 PM]

6 The absence of taxes at the partnership level makes it easier to use relatively inexpensive capital to pursue business opportunities. Partnership may be commercially rated Standard & Poor's Corporation rates a number of limited partnerships. In addition, several firms analyze limited partnerships and rate such factors as the offering terms. This information permits comparison of limited partnerships and can lead to a more informed investment decision. Limited liability for limited partners In general, limited partners are liable for partnership liabilities only to the extent of their capital contributions to the partnership, including any contributions you may have agreed to make in the future. Tradeoffs Possibility of losing principal The safety of your principal depends on the type of limited partnership and quality of its holdings. Programs aimed at high capital gains involve commensurate risk. For instance, with oil and gas MLPs, there may be risk as to whether oil or gas will be found at all, and, if found, whether the source will dry up sooner than expected. High fees may apply Brokerage commissions and other front-end costs can reduce the amount available to be invested, and there also may be additional management fees. The general partner's share of cash distributions may increase over time With many MLPs, if cash distributions increase over the years to certain specified levels, the general partner's share of the cash distributions also grows. That means the limited partners may not participate as fully in the growth of the business as the general partner does. The general partner has an incentive to increase the distribution, but such growth can also gradually reduce the incremental benefit for the limited partners. Example(s): ABC Energy Corp. is the general partner of the XYZ Master Limited Partnership, which owns pipelines used to transport natural gas. According to the partnership agreement, ABC receives 2 percent of the MLP's cash distribution, while the remaining 98 percent is distributed proportionately among the limited partners. However, once the MLP's distribution reaches 30 cents per unit, ABC's share of that distribution is increased to 25 percent. And according to the agreement, if the distribution reaches 50 cents per unit, ABC is entitled to 50 percent of the distribution. That can cut into the return for the limited partners. By the same token, if the distribution were to decrease from 50 cents per unit to 25 cents, the general partner would feel the impact more dramatically than the limited partners. In some cases, MLP general partners have been accused of making acquisitions simply to reach the threshold at which the general partner's percentage of the cash distribution increases, rather than because the acquisition truly benefits the limited partners' return. Limited partners have no participation in management and aren't fully shielded from liability Because limited partners generally have no voting rights and cannot play an active role in the management of the partnership, much depends on the integrity and management ability of the general partner. And though there are limits on a limited partner's liability for the obligations of the MLP, they are not fully protected against the MLP's creditors in the way that corporate shareholders are. Potential tax complexity Because each unitholder is responsible for paying a proportionate share of the MLP's taxes, tax issues can become complex, especially for larger unitholders who could be required to file returns in the various states in which the partnership operates. 3:56:33 PM]

7 Potential liquidity issues In the past, individual investors have been the primary market for MLPs; many institutional investors (such as pension funds) cannot hold MLPs without running into tax complications and have either avoided or been prohibited from investing in them. Because institutions represent such a large percentage of the investing universe, that lack of institutional demand reduces the total potential demand for MLP units and could possibly affect liquidity. May not be suitable for all types of accounts Investing in an MLP through a tax-advantaged retirement account can negate the tax benefits of owning an MLP--for example, the tax deferral provided by cash distributions--because a retirement account is already tax deferred. Also, if an MLP's pass-through income is high enough--over $1,000--it can potentially subject the retirement account to the "unrelated business income tax" (UBIT) on that income (see "Tax considerations" below). Can be sensitive to interest rate changes and commodity prices Higher interest rates can affect the value of an MLP's units, much as they do bonds. Bond prices tend to sink if higher interest rates make a bond's fixed interest payments less attractive; the value of an MLP can experience a similar reaction. Also, an energy-related MLP can be sensitive to changes in commodity prices. How to invest in an MLP Investors purchase shares in an MLP through a securities broker-dealer or a financial planner. Offerings frequently involve suitability rules requiring that individuals meet minimum net worth, income, and tax bracket criteria. As an investor, you should be aware that many limited partnerships intend to dispose of their holdings within a specified period (often 7 to 10 years) and distribute the proceeds as capital gains to investors. Tax considerations MLPs may be taxed as corporations If an MLP is characterized as a corporation for federal income tax purposes, its income is taxed at the business entity level, and taxed again at the individual partner level when the earnings are distributed as dividends. In such a case, individual MLP investors are unable to take certain tax benefits, such as depreciation, deductions, and tax credits, on their own tax returns. Losses are not passed through to the partners, but are used as net operating loss carryovers by the partnership. Investors in an MLP should be sure they understand the tax implications of their choice. MLPs may be subject to the passive loss limitation rules and the at-risk rules An MLP that is taxed as a partnership is treated by the tax code in much the same way as a private limited partnership. Both private limited partnerships and MLPs that are not taxed as a corporation are subject to the passive activity loss limitation rules. That means that on their personal income tax returns, the limited partners are able to deduct their share of partnership losses only if they have passive gains from another investment to match against them. Investment income, such as interest or dividends from stocks or bonds, is not considered passive income, and losses from an MLP cannot be used to offset them. Example(s): Assume Hal invests $20,000 in a newly organized private limited partnership. This is Hal's only passive investment. At the end of the year, the limited partnership suffers an operating loss, $2,000 of which flows through to Hal as a limited partner. Because Hal does not possess passive income from another source, he cannot utilize the loss on his federal tax return this year. Nevertheless, Hal may carry forward the unused loss to offset passive income in future years. Assume, now, that the above partnership was an MLP taxed as a corporation. Hal would not be subject to the passive loss limitation rules. Nevertheless, he would not be allowed to take a $2,000 loss on his personal income tax return, because the net operating loss would not flow through to the limited partners. MLPs are also subject to the at-risk rules, which limit a partner's share of losses in a partnership to his or her financial risk therein. (MLPs that are taxed as corporations are not subject to the at-risk rules.) 3:56:33 PM]

8 Distributions cannot create a negative cost basis Your cash distributions are treated as a return of capital and therefore can lower your cost basis when you sell your units. However, they cannot reduce your cost basis below zero. Once your cost basis for the MLP reaches zero, any future distributions will be taxed as capital gains for the year in which they are received. In a retirement account, income could be taxed as unrelated business taxable income The Internal Revenue Service requires a tax-exempt institution or account to pay tax on income that is not directly related to the purpose for which it is considered tax exempt. This provision of the tax code is known as the "unrelated business income tax" (UBIT). When an MLP passes through its income directly to the limited partners without being taxed at the partnership level, that income is considered to be earned directly by each individual partner. When a retirement account includes units of an MLP, the tax code treats the account as the unitholder. That makes it subject to the UBIT on the retirement account's share of the MLP's taxable business income (minus any deductions or depreciation reported on the K-1). A $1,000 deduction can be taken for the first $1,000 of the account's net income from the MLP, but the remainder will be subject to the UBIT. (However, the UBIT does not apply to any capital gains realized when units are sold.) The decision about where to hold an MLP should be reviewed carefully for its tax implications. Refer a friend To find out more click here IMPORTANT DISCLOSURES Fee-only financial planning and investment advisory services are offered through George Financial Advisors, a registered investment advisory firm in the state of California. Appointments are available in our offices in Los Gatos, Palo Alto and Scotts Valley. See for more information. The information presented here is not specific to any individual's personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice. The receipt of this document shall in no direct or indirect way be construed or interpreted as a solicitation to sell or offer to sell investment advisory services to any residents of any state other than the state of California or where otherwise legally permitted. We are legally empowered to provide investment advisory services to residents of California and certain other states. Certified Financial Planner Board of Standards Inc. owns the certification marks CFP, CERTIFIED FINANCIAL PLANNER and federally registered CFP (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board s initial and ongoing certification requirements. Copyright 2014 George Financial Advisors LLC All Rights Reserved Prepared by Broadridge Investor Communication Solutions, Inc. Copyright :56:33 PM]

9 George Financial Advisors Ted George, CFP, MSFP Financial Advisor 1414 Soquel Ave, Suite 220 Santa Cruz, CA April 02, 2014 Greetings! This month we take an in-depth look at Master Limited Partnerships(MLP), a tax advantaged income investment that is benefiting from increased oil and gas drilling around the country. We start with a short introduction to the concept of Limited Partnerships, followed by a detailed article on MLP's. Our third and fourth articles continue our mini-series on Insurance with an article and illustration describing Whole Life Insurance. A final reminder to file your tax returns on time. And when that is done get out and enjoy the rest of April! Financial Insights for Living Well - April 2014 Documents in this presentation: How does a limited partnership work? Master Limited Partnership How Traditional Whole Life Insurance Works Whole Life How Traditional Whole Life Insurance Works 3:56:56 PM]

10 1. The premium you "pour in" is fixed for the life of the policy. As you age, the cost of insuring your life increases. However, your premium stays the same, because the company projects this expense in advance and factors it into the premium at the onset. 2. As you pay your premium, the insurance company deducts all of its expenses, premium taxes, and the cost of pure insurance (net amount of risk coverage), or mortality charge. 3. The remainder of your premium represents a portion of the insurance company's investment portfolio. Your cash value account is credited with a fixed amount (predetermined by your contract) at the end of each premium period. 4. Like water in a tank, the level of your cash value rises over time. 5. As the cash value increases, the amount of risk coverage (or pure insurance) in the policy decreases. 6. When you die, your beneficiary receives the "full tank" of the policy amount, which is the sum of the cash value and the pure insurance. 7. You may take a policy loan in an amount not to exceed the policy's cash surrender value less the annual loan interest. Repayment replenishes your cash value; any loan balance outstanding (plus interest due) at the time of your death would be deducted from the policy amount. Refer a friend To find out more click here IMPORTANT DISCLOSURES Fee-only financial planning and investment advisory services are offered through George Financial Advisors, a registered investment advisory firm in the state of California. Appointments are available in our offices in Los Gatos, Palo Alto and Scotts Valley. See for more information. The information presented here is not specific to any individual's personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice. The receipt of this document shall in no direct or indirect way be construed or interpreted as a solicitation to sell or offer to sell investment advisory services to any residents of any state other than the state of California or where otherwise legally permitted. We are legally empowered to provide investment advisory services to residents of California and certain other states. Certified Financial Planner Board of Standards Inc. owns the certification marks CFP, CERTIFIED FINANCIAL PLANNER 3:56:56 PM]

11 and federally registered CFP (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board s initial and ongoing certification requirements. Copyright 2014 George Financial Advisors LLC All Rights Reserved Prepared by Broadridge Investor Communication Solutions, Inc. Copyright :56:56 PM]

12 George Financial Advisors Ted George, CFP, MSFP Financial Advisor 1414 Soquel Ave, Suite 220 Santa Cruz, CA April 02, 2014 Greetings! This month we take an in-depth look at Master Limited Partnerships(MLP), a tax advantaged income investment that is benefiting from increased oil and gas drilling around the country. We start with a short introduction to the concept of Limited Partnerships, followed by a detailed article on MLP's. Our third and fourth articles continue our mini-series on Insurance with an article and illustration describing Whole Life Insurance. A final reminder to file your tax returns on time. And when that is done get out and enjoy the rest of April! Financial Insights for Living Well - April 2014 Documents in this presentation: How does a limited partnership work? Master Limited Partnership How Traditional Whole Life Insurance Works Whole Life Whole Life What is it? Permanent (cash value) life insurance Whole life insurance is called permanent protection, meaning the coverage (and possibly the premiums) lasts for your entire (whole) life, as long as the premiums are paid. The death benefit is a guaranteed amount, and your premium is fixed. When you pay the premiums on a whole life policy, part of the money accumulates in a cash value account. When can it be used? You have a long-range insurance need The purpose of whole life insurance is to protect against long-range or permanent needs. The coverage extends over your entire lifetime (generally up to age 95 or 100), protecting you even after you stop working. You can lock in a premium 3:57:16 PM]

13 schedule, so you won't have to worry about the rising cost of insurance as you get older or your health deteriorates. Strengths Provides benefits common to all cash value insurance Like all other permanent (cash value) policies, a whole life policy contains the following features: Cash value grows tax deferred Cash value can be borrowed against (however, unpaid policy loans will reduce the death benefit available to your survivors) Caution: With a whole life insurance policy, you may be allowed to access your cash value by surrendering (canceling) the policy (you may be subject to surrender charges). However, once you cancel the policy, you will no longer have insurance protection. See Tradeoffs for more information. Policy provides guaranteed minimum death benefit Your whole life policy provides a minimum death benefit, which is usually equal to the face amount of the policy. This death benefit is guaranteed as long as you pay your premiums when due and your policy remains in force. See Tax Considerations for more information. Caution: Unpaid policy loans will reduce your death benefit below the guaranteed minimum. See Tradeoffs. Policy cash value receives guaranteed rate and predictable growth With a whole life insurance policy, the insurance company manages your cash value and guarantees the return you will receive. The cash value that is part of your whole life policy is held in the general account of the insurance company. Even if the insurance company's investments perform poorly, you still receive the same rate of interest on your cash value. However, you should keep in mind that if the insurer faces insolvency, funds in the general account could be subject to claims by creditors of the insurer, including all other policyholders. Your premiums are a fixed amount When you buy a whole life policy, your premium payments are a set, level amount, making budgeting for your payments easy because the premium can't be increased. Even if the insurance company's general account (through which death benefits are paid) performs poorly or your health declines, you can never be required to pay a higher premium to maintain the guaranteed minimum death benefit. Tip: If your policy pays dividends, you may choose to have the dividends applied toward your premium payment, reducing your out-of-pocket expense. Choice of premium payment periods available While whole life insurance coverage lasts your entire lifetime, your premium payments don't necessarily have to. Whole life insurance may offer a variety of premium payment options. For instance, if you want to pay a smaller premium over your lifetime, you may want to consider ordinary level premium whole life. Or, if you want to pay larger premiums for a shorter amount of time, you may want to consider limited pay whole life. Can be cost-effective form of permanent insurance protection If you expect your insurance need to last your entire life without diminishing, a whole life policy can be a cost-effective way to buy insurance protection. In the short term, whole life (or any type of permanent (cash value) life insurance, for that matter) is more expensive than term insurance. In the long term, however, whole life may be less expensive. With term insurance, you can count on your premiums increasing with each renewal. When you buy a whole life policy, however, your premiums are level and will not increase over time, an advantage if you keep the policy for many years. Tradeoffs Policy surrender in early years of policy can be costly 3:57:16 PM]

14 If you want all your cash value from a whole life policy but don't want to take a policy loan, you must surrender (cancel) your policy, and you may be subject to surrender charges. In addition, policy fees and expenses are usually charged against the policy in the first few years. As a result, policy surrenders during the first few years of the policy may provide little cash value. Cash value could be subject to insurer's creditor claims The cash value that is part of your whole life policy is held in the general account of the insurance company. This means that if the insurer faces insolvency, funds in the general account could be subject to claims by creditors of the insurer, including all other policyholders. Whole life not best option if seeking competitive returns If you are seeking competitive investment returns in addition to insurance protection, a whole life insurance policy may not be your best option. With this type of policy, the insurance company controls your cash values, which are usually invested conservatively. You do receive a guaranteed return on your cash values, but you don't get the potential for higher returns that may accompany other investments. Tip: If you want to be able to control your cash value investments and participate in other types of investments such as stocks, consider a variable life or a variable universal life insurance policy. Caution: Variable life insurance and variable universal life insurance policies are offered by prospectus, which you can obtain from your financial professional or the insurance company issuing the policy. The prospectus contains detailed information about investment objectives, risks, charges, and expenses. You should read the prospectus and consider this information carefully before purchasing a variable life insurance policy. Guarantees are subject to the claims-paying ability of the issuer Guarantees relating to the policy are subject to the claims-paying ability of the issuing insurance company. How to do it Determine your life insurance need and overall financial goals Before you buy life insurance, you need to know how much insurance you need. Insurance need is based on numerous factors, including your current age and income, marital status, number of incomes in the household, number of dependents, long-term financial goals, level of outstanding debt, and existing insurance and other assets. Your overall financial, estate, and tax planning goals and your planning time horizon should be considered as part of your insurance need evaluation. Tip: Consult your financial advisor concerning your need for insurance. Some of the analysis can be complicated. Complete the insurance application and name your beneficiary Before the insurance company can issue your policy, it must receive a completed application form. The application includes general health questions, and the process may include a physical examination, which is usually paid for by the insurance company. A critical part of the application is the beneficiary designation--the naming of the person or persons to receive the policy proceeds when you die. You must name a primary beneficiary (this can be your estate) to receive the proceeds of your insurance policy. Your beneficiary may be a person, corporation, or other legal entity. You may name multiple beneficiaries and specify what percentage of the net death benefit each is to receive. If you name your minor child as beneficiary, be sure to designate an adult as the child's guardian in your will. Generally, you can change your beneficiary at any time. Changing your beneficiary usually requires nothing more than signing a new designation form and sending it to your insurance company. If you have named someone as an irrevocable (permanent) beneficiary, however, you will need that person's permission to adjust any of the policy's provisions. Caution: Naming your estate as beneficiary will subject the policy proceeds to claims by creditors of the estate. 3:57:16 PM]

15 Buy the policy and pay your premium Once your life insurance application has been approved and you pay your initial premium, you'll be issued a policy. However, because an insurance policy is a legal contract, make sure you thoroughly understand all of its provisions before signing it or paying your premiums. Ask an insurance agent or financial professional for help, if necessary. Review your insurance need periodically The amount of life insurance you need may change over time, so you should periodically review your life insurance coverage. It's especially important to review your coverage when a major life event occurs (such as the purchase of a home, birth or adoption of a child, or change in marital status). Tax considerations Income Tax Premium payments not deductible Life insurance premium payments are generally not tax-deductible expenses. Policy loan proceeds generally not taxable When you take out a loan against your life insurance policy (except a policy classified as a modified endowment contract (MEC)), the amount you receive is not considered taxable income. This rule applies even when the loan is larger than the amount of premiums you have paid in (except in the case of a policy classified as a MEC). Example(s): You own a life insurance policy (non-mec) with a cash value of $20,000. Your basis in the policy is $14,000. You decide to take a policy loan to pay your daughter's college tuition. Under the terms of your policy, you are allowed to take a loan for an amount up to 90 percent of the policy cash value--in this case, $18,000 ($20,000 x 0.90). You are not currently subject to tax on the amount of the loan, even though the loan is larger than your basis in the policy. Caution: If you cancel your policy while there is a loan balance outstanding, you may be subject to income tax on the amount of the loan. Policy loan interest not deductible Interest you pay on a policy loan is not a tax-deductible expense when the loan is for purposes other than business or investments (plus any accrued but unpaid interest). Policy cancellation may be taxable If you cancel (surrender) your policy for cash, the gain on the policy is subject to federal income tax. The gain on a canceled policy is the difference between the net cash value and loan forgiveness amounts and your policy basis. Caution: You may be subject to surrender charges. Check your policy. Caution: Policy fees and expenses are usually charged against the policy in the first few years. As a result, policy surrenders during the first few years of the policy may provide little cash value. Caution: If you surrender your policy while there is a loan balance outstanding, you could be subject to income tax on the amount of the loan (plus any accrued but unpaid interest). Policy lapse may be taxable If you allow your policy to lapse, you could be subject to income tax even if you don't receive any cash from the policy. A policy lapse can occur when you stop paying premiums and don't have cash values available that can be used to pay the premiums. If you have an outstanding policy loan, it is possible you could be subject to tax on the amount of the loan plus any accrued but unpaid interest. Death benefits generally not subject to federal income tax 3:57:16 PM]

16 Policy death benefits are generally not subject to federal income tax. One notable exception is when the policy has been sold or otherwise transferred for valuable consideration by one policy owner to another, subjecting it to the transfer-forvalue rule. Gift and Estate Tax Policy proceeds not considered gift to beneficiary When the proceeds of your life insurance policy are paid to a beneficiary, they are not treated as a gift for federal gift and estate tax purposes. Policy premium payments generally not subject to federal gift and estate tax When you are the owner of a policy on your own life, with another party as the beneficiary, premium payments made by you are not considered a gift to the beneficiary for federal gift and estate tax purposes. If, however, someone else pays the premiums on a policy you own, the premium payments are considered a gift to you and may be subject to the tax. Policy premiums paid by another on your behalf generally qualify for the annual gift tax exclusion. Policy proceeds included in estate value in some cases The proceeds of a life insurance policy are included in the value of your estate if you held any incidents of ownership at any time during the three years before your death or if the proceeds are payable to you or your estate or executor. Incidents of ownership include (among other things) the right to change the beneficiary, take out policy loans, or surrender the policy for cash. Policy proceeds often exempt from state inheritance tax In many states, life insurance proceeds are exempt from state inheritance taxes. Questions & Answers Should you buy term insurance or cash value life insurance? It depends upon your personal circumstances. The first issue to resolve is not what type, but how much life insurance you should buy, and how long you need coverage. You may determine that the amount of coverage you need is so large that the only affordable way to get the coverage is by purchasing lower-premium term insurance. Or, you may consider buying cash value life insurance because you have a long-term need for coverage. With cash value life insurance, does your beneficiary get the death benefit plus the cash value amount? Maybe. Check the policy. Many cash value policies are written in such a way that the beneficiary receives only the face amount of the policy at death. The cash value is applied to partially pay off the death benefit. There are policies that will pay the beneficiary the face amount plus the cash value, but the premiums tend to be higher. Don't just assume that your policy will pay both amounts--check the policy and/or ask your agent. What is the difference between universal life insurance and traditional whole life insurance? Both are types of cash value life insurance, but there are important differences between the two. Generally, whole life is designed with fixed, level premiums and provides for a level death benefit. Some flexibility is provided, however, through dividends paid on participating policies that can be used to offset premiums or increase the death benefit, thus creating a degree of flexibility. Universal life policies, by design, offer adjustable death benefits and flexible premiums that can be changed. Another big difference is the reporting of the policy elements in a universal life policy. Unlike many other types of cash value policies, universal life policies are divided into three elements--protection, expense, and cash value. This unbundling of the policy elements allows you to see the specific charges for each component of your policy, which makes it easier to read reports on your in-force policy and could make it easier when comparing universal policies from different insurance companies. How is variable life insurance different from participating whole life? 3:57:16 PM]

17 Variable life is a type of whole life policy with fixed premiums. Variable life is designed so that the policy's cash values and death benefits are related to and vary according to changes in the performance of the underlying investments you've chosen. The policy usually has a guaranteed minimum death benefit that is paid even if the underlying investments have performed poorly. As a policyowner, you are usually offered several investment options for your cash values, and you assume all of the investment risk. Unlike whole life, there is no guarantee of minimum cash values. Refer a friend To find out more click here IMPORTANT DISCLOSURES Fee-only financial planning and investment advisory services are offered through George Financial Advisors, a registered investment advisory firm in the state of California. Appointments are available in our offices in Los Gatos, Palo Alto and Scotts Valley. See for more information. The information presented here is not specific to any individual's personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice. The receipt of this document shall in no direct or indirect way be construed or interpreted as a solicitation to sell or offer to sell investment advisory services to any residents of any state other than the state of California or where otherwise legally permitted. We are legally empowered to provide investment advisory services to residents of California and certain other states. Certified Financial Planner Board of Standards Inc. owns the certification marks CFP, CERTIFIED FINANCIAL PLANNER and federally registered CFP (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board s initial and ongoing certification requirements. Copyright 2014 George Financial Advisors LLC All Rights Reserved Prepared by Broadridge Investor Communication Solutions, Inc. Copyright :57:16 PM]