Deposits at FDIC-insured institutions are now insured up to at least $250,000 per depositor through December 31, 2013. On January 1, 2014, the standard insurance amount will return to $100,000 per depositor for all account categories except for IRAs and other certain retirement accounts which will remain at $250,000 per depositor. (This supersedes the October 3, 2008 changes.)

May 20, 2009

NEW YORK — Cracking into retirement savings early is the tax equivalent of standing on a street corner burning $10 bills.

Hard times have more people doing it anyway.

Early withdrawals from Individual Retirement Accounts and 401(k) plans trigger taxes and penalties that can really add up. There are exceptions, but only for some people who use the money to buy a first home, or pay for higher education or other items.

Many people have at least a vague understanding of all this, but that isn’t stopping them.

The number of companies reporting early withdrawals for hardship from 401(k) and 403(b) plans (the non-profit version of 401(k)s) rose from 15% in October 2008 to 44% last month, according to a recent Watson Wyatt study that polled executives at 141 U.S.-based companies using an online questionnaire.

Many more clients than usual asked about early withdrawals from retirement savings this tax season, according to Michael Eisenberg, a certified public accountant at Eisenberg Financial Advisers in Los Angeles, who is a member of the AICPA’s Financial Literacy Commission.

Eisenberg advises strongly against early withdrawals; none of his clients ended up taking money out, he says.

The federal tax penalty for taking money out of a 401(k) or IRA before age 59 1/2 is 10% of the amount of the distribution. That levy goes on top of any tax owed on the amount. State taxes and penalties may also apply, and they vary.

So, an early withdrawal of $1,000 from a 401(k) or IRA would generate tax on that amount, plus a federal penalty of $100, plus possible state taxes and penalties.

There are exceptions that allow penalty-free early withdrawals from retirement savings, though they differ depending on whether it’s an IRA or 401(k).

For IRAs, the taxpayer may be able to avoid a penalty (but not tax) if he or she uses the money for one of several reasons, including:

*To buy a home (if qualified as a first-time homebuyer under IRS rules).

*To pay for higher education for the immediate family.

*To pay for unreimbursed medical expenses over 7.5% of adjusted gross income.

*To pay for health insurance if the taxpayer has been unemployed for a certain period.

For 401(k)s, the taxpayer can make an early withdrawal without a penalty in several cases, including if he or she:

*Leaves the employer in the year he or she turns 55 or older.

*Uses the money to pay unreimbursed medical expenses over 7.5% of adjusted gross income.

Knowing the exceptions can save people from making common mistakes, according to Ed Slott, an IRA expert and author of numerous books including “Your Complete Retirement Planning Road Map.”

For example, the laid-off often use 401(k) money to foot the bill to go back to school; they assume wrongly that the education exception that applies for IRAs carries over to 401(k)s. The 10% penalty then applies;

“That’s a mistake a lot of people make, and actually go to court to argue a case they can’t possibly win,” says Slott.

Instead, the smart thing to do would have been to roll the money into an IRA and pay for education from there, he adds.

Rande Spiegelman, vice president of financial planning at the Schwab Center for Financial Research, says making an early withdrawal should be a last resort, “somewhere right before homelessneess and/or starvation.”

Early withdrawal deletes all potential for future tax-deferred compounding, to say nothing of the taxes and penalties that can wipe out more than half of the amount withdrawn.

“Better to borrow or beg (but not steal) before raiding your retirement,” says Spiegelman.

Eisenberg advises clients who are thinking about hitting up a 401(k) to consider a loan from the 401(k) instead. A caveat here is that if the employee leaves the company with the loan outstanding, it is considered income and tax will be due on it.

By Arden Dale
A DOW JONES NEWSWIRES COLUMN

Commenting on the House Savings Recovery Act introduced this week, Rep. Ed Royce (R-Calif.) said, “Along with our struggling economy, over the past 16 months, millions of Americans have seen their personal savings and retirement accounts hit hard. Americans should be given every opportunity to help rebuild their savings. “

Royce continued: “If our economy is going to experience long-term sustainable growth going forward, we have to encourage savings and investment. This is a step toward getting capital back into the financial system and putting our country on the path back to recovery.”

Among other things, the Savings Recovery Act would increase contribution and catch-up limits. It would also extend the tax credits that families get for contributing to a 529 plan.

The act would also double the Social Security earnings limit from $14,161 to $28,320, thereby allowing more Americans to increase their income without being hit by the Social Security earnings penalty.

Further, it would suspend the capital gains tax on newly acquired assets for the next two years, in order to provide tax relief to investors and seniors. It would suspend dividend income through 2011 and raise the amount of capital losses allowed against ordinary income to $10,000.

By Money Management Executive
April 24, 2009

 Evolution or Revolution?

The title of this Outlook, “The Future of Investing,” is a theme that will take the evolving years to resolve, let alone the next few days. Still, PIMCO is an organization that loves a challenge. All of us here today would agree that the answer to both questions will be highly dependent on the evolution of the global economy, and when it comes to those questions PIMCO has excelled because of its long-term secular outlook. It has paid dividends for our clients for over 30 years and it should do so now as well. The fact is, that the future of investing will depend on the long-term future of the global economy – its nominal growth rate and the distribution of that growth between public and private interests. And so we should start at the beginning, or perhaps at the top, of our top-down process – the future of the global economy.

 I. Future of the Global Economy

The future of the global economy will likely be dominated by delevering, deglobalization, and reregulating, yet if so, it is important to state at the outset that we do not envision a mean reversion, cyclically oriented future, but instead a new world where players assume different roles, and models relying on bell-shaped/thin-tailed outcomes based on historical data are less relevant. Historical models look backward while modern-day finance is being fast forwarded and reconstituted almost as we speak.

 1) Delevering – The prior half-century of leveraging and the development of the amorphous shadow banking system was growth positive. Major G-10 economies became dominated by asset prices and asset-backed lending most clearly evidenced in housing markets. Excess consumption was promoted, and investment based on that consumption followed in turn. Savings rates in many countries including Japan, the U.K., and the U.S. fell towards zero as the reliance on rainy day thrift faded. Deleveraging of business and household balance sheets now means those trends must reverse, and as they do, growth itself will slow, bolstered primarily by government spending as opposed to the animal spirits of the private sector.

 This topic is one which literally could take hours to discuss, and at PIMCO forums and Investment Committee meetings, it does. There are those of us here as well as highly respected economists outside of PIMCO who would suggest destruction as opposed to slow growth, and they may have a minority, but not insignificant, case. Much depends on the effectiveness of policy responses and the simplistic answer to a simplistic question. Can global financial markets and the global economy heal by pouring lighter fluid on an already raging fire? Can too much debt be cured by the issuance of even more debt? Must the debt supercycle come to an end by crashing and burning or does the world keep breathing with a whimper instead of a bang? We shall see, but there is a near certain probability that the financially based global economy of the past half-century will not return, nor will we experience the steroid driven growth excesses that it facilitated.

 2) Deglobalization – Lost in the wondrous descriptions of finance-dominated, Bretton Woods-initiated, global growth has been the adrenaline push provided by global trade and indeed portfolio diversification into a multitude of markets – developed or developing. Yet historians point out that globalization is not an irreversible phenomenon – witness the aftermath of WWI and nearly three decades of implosion. Now the beginning signs of trade barriers – “Buy American” and “British jobs for British workers” among them – as well as government support of locally domiciled corporations (banks and autos) suggest an inward orientation that is less growth positive. Additionally, “financial mercantilism” is an added threat – a phenomenon that speaks to growing pressure on banks to retreat from international business and concentrate on domestic markets.

 3) Reregulation – Academics, politicians, investors, central bankers and everyday citizens are questioning the economic philosophy that idolized free markets and their ability to self-regulate. The belief in uncapped and unregulated incentives producing unlimited upside but nearly always cushioned downside losses is fading. While Sarbanes-Oxley was a well publicized but relatively toothless response to the dot-com bust of nearly a decade past, today’s politicians have gained the upper hand, driven by a citizenry that has recognized the unbalanced, disproportionate distribution of incomes. The efficient market thesis, so prevalent in academic theory and market modeling is now in retreat, and perhaps rightly so. In its place, we will experience less efficient but hopefully less volatile economies and markets – monitored and controlled by government regulation. Executive compensation, of course, is just the poster child. Government ownership and control of vital financial and manufacturing institutions will politely be described as “industrial based” policy and “burden sharing,” but we should have no doubt that we will move significantly away from the free market model that has dominated capitalistic countries for the past 25 years.

 With the top-down framework for future global economic growth in place, let’s take a look at PIMCO’s outlook for the future of investing – evolution or revolution.

 II. The Future of Investing

Whether evolution or revolution it is important to recognize that the aftermath of an economic and investment bubble transitioning from levering to delevering, globalization to deglobalization and lax regulation to reregulation leads to an across-the-board rise in risk premiums, higher volatility and therefore lower asset prices for a majority of asset classes. The journey to a new stasis is a destructive one insofar as it affects previously assumed wealth. Rough estimates suggest that as much as 40% of global wealth has been destroyed since the beginning of this delevering process. In essence, asset prices, which are really only the discounted future value of wealth creation, go down – not only because that wealth creation slows down but because it becomes more uncertain. In such an environment, equity interests in the form of stocks, real estate or even high yield bonds become re-rated. Those who believe that capitalism is and will remain a going concern and that risk taking – over the long run – will be rewarded, must recognize that those rewards spring from beginning prices and valuations that correctly anticipate the global economy’s future growth path and volatility. In terms of that old maxim “buy low – sell high,” this means at the minimum that an investor during this period of re-rating must “buy low.”

 In turn, investor preferences towards risk taking, even when correctly calculated and modeled must be considered. Peter Bernstein has for several years counseled that policy portfolios structured for the long run and based on historical return statistics should be reconsidered. The standard pension or foundation approaches to policy portfolios are being challenged, he asserts, and PIMCO agrees. Stocks for the long run? Home prices that cannot go down? The inevitable levering of asset structures to double or quadruple returns relative to risk-free assets? These historical axioms must now be questioned. In fact, as of March 2009, the superiority of risk-asset returns are not what many assume them to be. For the past 10, 25, and 40 years, for example, total returns from bonds have exceeded those for common stocks.1 Home prices have declined a staggering 30% since their peak in late 2006, and have barely kept up with inflation for the last century according to Case-Shiller statistics. Commercial real estate when ultimately mark-to-market over the next several years will likely show similar results. In short, our stereotyped conceptions of what makes money are being challenged. As Bernstein says, there is no predestined rate of return. And a PIMCO corollary would counsel that future rates of return will be dependent on the beginning price and future growth rates and risk preferences that cannot necessarily be derived from historical models. Government policies will also play an important role, especially insofar as they impact long-standing property rights and capital structures. What I have previously described as a CQ – a common sense quotient – may take precedence over IQ and quantitative analysis in future years. How much of a benefit, for instance, did the renowned risk modeling of some of our major competitors produce over the past several years in terms of their bond funds and derivative-related products as compared to PIMCO’s? We invite comparison, not only of our own risk models, but our collective common sense quotient.

 What then does common sense tell us about future asset returns? Let’s revisit our previous conclusions on the developing environment for some clues. They include: delevering, deglobalization, reregulation leading to slow global growth, a heightened risk aversion, a distrust of conventional investment model portfolios, and a greater emphasis on surviving as opposed to thriving. If valid, then an investor or an investment committee would likely stress the bird in the hand – as opposed to the one in the bush; stable and secure income – as opposed to uncertain capital gains; a government-regulated utility model – as opposed to innovative yet risky venture capital investments. At current price levels, to cite one example, the current income from corporate bonds is higher and certainly more secure than the dividend income from stocks.2 A return to an era reminiscent of the first half of the 20th century is not unimaginable where stocks were viewed as subordinated income producers with yields exceeding their senior bond companions on the liability ladder.

 But let me not go too far in suggesting that asset classes near the perimeter of risk have no future. They do if only because they eventually will be priced right. In fact, PIMCO intends to participate in the management of many of them, and as argued previously should be well and healthily positioned to do so. Our recent launch of a global multi-asset fund featuring tail-risk protection is just one example. The potential participation in TALF and other government-sponsored levered structures is another. Still, the tide seems to be going out and as Buffet suggests, all swimmers are being exposed, swimming suits or bare-bottomed naked.

 There are a host of investment implications that one can subjectively conclude from this outgoing tide, although they have not been officially endorsed by our upcoming secular forum. It seems to me, though, that one has only to ask what investments were positively affected by the previous long-term cycle of levering, deregulation, and globalization in order to imagine which ones will do poorly as the trends reverse. A short list might read as follows:

 (1) The Dollar – As the center of structured finance and the shadow banking system, the dollar was bolstered as it sold paper to the rest of the world. To date, its recent strength seems counterintuitive. Weakness may more accurately describe its future.

 (2) Credit – Lax regulation and increasing leverage squeezed risk premiums and spreads to historically overvalued levels. We are now moving in full reverse.

 (3) Equity – In addition to the previous conclusions, it is evident in retrospect that narrow risk premiums in credit markets facilitated narrow equity premiums in stocks if only because they seemed cheap by comparison and allowed corporations to borrow cheaply and buy back their own stock.

 (4) Emerging Market Globalization and lax lending standards re-rated emerging and developing country financial markets to unrealistic levels. Eastern Europe is likely the first to fall.

 Many of these trends, of course, have now reversed course, direction, and magnitude, and there will come a point where those low and lower prices, as well as the potential for successful policy healing, will favor what is now in disfavor. For now, however, let it be simplistically said that the trend is your friend and that the ad hoc, disjointed and anemic policy responses of government appear to be too little, too late. Investors should therefore favor stable income as opposed to speculative growth or the subordinate liability structures of most private market balance sheets. Shake hands with the government is and has been our motto although the contractual certainty of a government handshake may now be questioned in an increasingly number of marginal areas.

 Another way to summarize our caution would be to quote a recent comment by Barton Biggs. “I am a child of the bull market,” he said which upon further elaboration meant that he bought on cyclical dips with the expectation of riding mean reversion to an upward sloping trend line of prosperity and ultimately higher peaks. In a sense, we are all children of the bull market, although some of us are more mature than others – a bull market of free-enterprise productivity and innovation, yes, but one fostered by a bull market in leverage, deregulation and globalization that proved unsustainable in its excesses. We now must view ourselves as chastened adults, forced into acknowledging a new reality that is dependent upon bear-market delevering and debt liquidation to deliver us to our new and ultimate restructured destination – wherever it lies. Thus, while historians might describe these years as an evolution, for those of us living it day-by-day it most assuredly has the feel of a revolution. Much like Irving Fisher’s “permanently higher plateau” of prosperity that was quickly turned on its head in 1929, those who would forecast a “permanently lower valley” of despair might similarly be off the mark. Yet there should be no doubt that the bull markets as we’ve known them are over and that the revolution is on. Investing is no longer child’s play.

Bill Gross, CIO PIMCO
 

It sounds redundant: Put a tax-deferred investment, like a variable annuity, inside an already tax-deferred IRA or retirement account? But the wisdom of such a move is actually subject to much debate.

In fact, fifty five percent of all variable annuity assets are in IRA rollovers and qualified retirement accounts, such as 401(k) s, 403(b) s and Keogh accounts, according to the National Association of Variable Annuities (NAVA), Reston, Va.

Financial advisors often recommend that clients put annuities in qualified plans or IRAs primarily for their insurance benefits and income guarantees, according to a 2006 NAVA study. Seventy percent of the 1,000 advisors polled cited the variable annuity death benefit—a guarantee that when the policyholder dies, the beneficiary receives the greater of the market value or original principal–as one of three top reasons for advocating using variable annuities inside qualified plans or IRAs. Sixty-six percent named guaranteed lifetime income, and 61 percent listed living benefits.

The majority of respondents also reported that they favored variable annuities in IRA rollovers as a way to manage client investments in a large number of funds from a large number of mutual fund families.

Another top reason: The Guaranteed Lifetime Minimum Withdrawal Benefit. With this common feature, the annuitant is promised, at minimum, a return of all contributions—regardless of how the underlying investments perform. This guarantee can come in the form of regular withdrawals paid over a specific period. The most popular type promises withdrawal rates of at least 5 percent annually for life starting at age 65. Many insurers step up the withdrawal rate annually if the annuity is held for at least 10 years.

Questions
But is it appropriate to put an already tax-deferred retirement account inside another tax-deferred instrument? Many financial advisors believe it does not make sense. Investors, they say, can do a better job diversifying IRAs or 401(k)s to get high risk-adjusted rates of return, as well as income over the long-term. Their other big beef: The high cost of variable annuity insurance and fund management fees reduces the client’s return on tax-deferred investments.
Jeffrey D. Voudrie, financial planner and president of the Legacy Planning Group, Johnson City, Tenn., says one of the main arguments for using a variable annuity inside an IRA is flawed due to the high cost.

Most variable annuities sold through commission-based advisors have mortality and expense charges of 1.45 percent. This is an annual fee that is charged against the entire value of the account–not the original investment. On a $500,000 investment, that can amount to $7,250 the first year. If the value of an account doubles in 10 years, the cost would rise to $14,500 that year, he says.

There are also mutual fund management fees, ranging from 70 basis points to 1.5 percent. Plus optional living benefit riders cost more than 60 basis points annually. As a result, the average variable annuity charges range from 200 to 300 basis points annually.

“That’s $10,000-$15,000 each year on a $500,000 investment—and that expense increases as the value of the account increases,” Voudrie argues. “Do you really think it costs $10,000-$15,000 a year to cover the cost of the insurance associated with (for example, the death benefit)? Of course not.”

Fee-only financial planners, like Jane King, president of Fairfield Financial Services, Wellesley, Mass., prefer to invest IRA rollovers in no-load, low-cost mutual funds. King diversifies in growth and value stock funds, international funds, bonds and money funds for attractive risk-adjusted rates of return. Her retired clients use up their non-retirement savings assets first, leaving the retirement account to grow in value–even while taking the minimum required distributions. As a result, the tax-deferred IRA can be left to a child as an inherited IRA. The child can then take distributions based on his or her life expectancy.

A report by the New York law firm, Milberg LLP, says the insurance features of the variable annuity are not likely to justify sales of the product, because the insurance tends to be actuarially worth only a fraction of the higher fees. Those high fees, the report suggests, go toward profit and high sales commissions.

However, John Huggard, estate planning attorney and author of “The Truth About Variable Annuities–Debunking The Myths,” Parker-Thompson Publishing, disagrees.
The biggest flaw in the high-cost argument is the incorrect assumption that variable annuities are more expensive to own than other qualified investments, such as mutual funds, he contends.

For example, the average cost of owning a variable annuity in a qualified plan is about 2.9 percent. This includes fees paid to money managers, commissions, trading costs and insurance costs. But the average annual cost of owning an A-share mutual fund held in a qualified retirement account is about 3.23 percent.

“The average stock mutual fund held in a qualified retirement account is 33 basis points more expensive to own on an annual basis than a similar variable annuity held in a qualified retirement account,” says Huggard.
Huggard refutes those who argue that the practice of placing a variable annuity inside a qualified plan or rollover IRA results has no benefit because it duplicates the benefit of income tax deferral. “The duplication argument would have validity only where a variable annuity offered some income tax deferral as its sole benefit,” he said.
However, Huggard stresses that people put a variable annuity inside a tax-deferred IRA or 401 (k) to get insurance coverage. They are willing to pay the annual fees and charges to protect principal.
Those guarantees include:
· The guaranteed death benefit.
· Guaranteed minimum withdrawal benefits.
· Guaranteed minimum income benefits: With these, an annuitant can receive a guaranteed dollar amount in monthly income–regardless of how the contract’s investments perform.

Annuities in IRAs, he says, also can help transfer wealth to family members. For example, a variable annuity beneficiary can withdraw in installments over his or her life expectancy. The undistributed amount continues to grow tax-deferred.

In some states, a business owner’s Self-Employed Retirement Plan (SEP) may be subject to creditor claims. So, for example, a doctor concerned about lawsuits, could transfer the SEP to a variable annuity to obtain creditor protection.

In addition, Huggard notes, having a qualified plan in a variable annuity can reduce or eliminate the income tax burden facing beneficiaries who inherit qualified plans. An “earnings enhancement benefit (EEB)” rider, which is only available in variable annuities, can reduce or eliminate income taxes on inherited qualified plans, he says. Additional cash at the annuity owner’s death may help beneficiaries pay the income taxes on inherited money.

If you consider a variable annuity, always evaluate the financial strength of the insurance company and all the fees involved. This is particularly important today because A.M. Best, Standard & Poor’s, Fitch and Moody’s have downgraded the financial strength of many insurance companies due to the ongoing financial crisis.

By Alan Lavine

 Pension plans of all stripes saw their asset values decline steeply in the fourth quarter and full year in 2008, according to a survey by consultant Mercer.

The results show that the median corporate plan had a fourth-quarter loss of 12.6%, public plans run by such entities as municipalities and teachers unions lost 14%, and foundations and endowments lost 13.7%.

For all of 2008, corporate plans had median losses of 25.7%, public plans lost 26.8%, and foundations and endowments lost 25.9%, according to the survey by Mercer Investment Consulting Inc.

By asset class, Mercer’s survey showed pension plan gains only on fixed income investments, with domestic core fixed-income portfolios gaining a median of 2.9% for the fourth quarter and 2% for the full year of 2008. International debt portfolios rose a median 6.8% for the quarter and 7.3% for the year. However, high-yield debt portfolios lost a median of 15.3% for the quarter and were down 22% for the year.

Bond performance wasn’t enough to overcome poor stock performance across the board for pension plans. No matter whether the portfolio contained domestic, international, large-cap or small-cap stocks, all declined by a median of more than 19% for the quarter and year. Similarly, investing styles, whether core, value or growth, produced double-digit losses.

The best-performing stock portfolio style for the quarter was in international value, which lost a median of 19.5%; the best for the year was domestic small-cap value, with a loss of 32%. The worst-performing for the quarter was domestic small-cap growth, with a median loss of 26.6%; for the year, it was international growth stocks, with a median loss of 45.7%.

Real estate portfolios were similarly grim. U.S. real estate securities suffered a median loss of 38.3% during the fourth quarter and a full-year 2008 loss of 37.2%. Global real estate securities delivered a median loss of 30.6% for the quarter and a 46.6% loss for the year.

By Lynn Cowan
Of DOW JONES NEWSWIRES

The handful of U.S. bond-fund managers who avoided last year’s market bloodbath by hiding out in Treasurys now say they favor owning corporate and mortgage bonds and selling U.S. government debt.

PIMCO, Vanguard, Morgan Stanley and First Pacific Advisors funds that gained from about 5% to a stunning 49% while the Standard & Poor’s 500 stock index plunged 37% last year are inclined to take a bit more risk.

They’re sticking to mortgage-related debt and other bonds supported by the Treasury or the Federal Reserve. And they are cautiously buying corporate bonds.

“Investment-grade credit is very attractive,” said Gregory Davis, head of bond indexing at Vanguard and portfolio manager for its Long-Term Bond Index Fund (VBLTX). The fund gained 8.6% in 2008, making it one of the top-performing U.S. bond funds last year, according to investment researcher Morningstar Inc.

For corporate bonds, “a lot of bad news is priced in, including defaults and downgrades,” Davis said.

Top-performing fund managers are selling or paring their holdings of U.S. Treasurys, one of last year’s best-performing assets. The $2 trillion in new bonds the Treasury is expected to issue this year will likely weigh on prices.

Meanwhile, other government programs to bail out the credit markets, say by guaranteeing bank debt, will make Treasurys less attractive, managers say.

“As policy maneuvers are implemented and make the way through the system, prudent investment managers are going to be reducing their risk-free exposure and going more towards risk products,” meaning anything besides Treasurys, said Steve Rodosky, manager of PIMCO Long Duration Total Return Fund (PLRIX), which gained 12.4% last year.

By comparison, the Barclays Capital U.S. Aggregate Bond Index rose 5.24% in 2008. A wide range of bond funds took huge losses as volatility and illiquidity in credit markets made trading dicey, and investors fled most assets in favor of the safety of Treasurys — slamming holdings in corporate debt, mortgages and even municipal bonds.

If more investors follow these managers’ strategy into corporate debt and mortgages and out of Treasurys, the government will end up paying more to finance its growing deficit. And investors who have hung onto Treasurys bought in the current rally could see their portfolios take a nosedive.

Copying The Fed

One strategy that successful managers say has some legs is to buy debt that the government is also buying.

That strategy lends itself to holding mortgage-backed securities and debt sold by the big housing finance agencies including Fannie Mae (FNM), Freddie Mac (FRE), Ginnie Mae and the Federal Home Loan Banks.

The Fed has purchased $24.6 billion in agency debt since December, and aims to buy up to $100 billion, in the hope of lowering mortgage rates and reviving the housing market.

First Pacific Advisors’ New Income Fund (FPNIX), which rose 4.8% last year, is keeping the biggest chunk of its cash in mortgage-backed securities.

Thomas Atteberry, who helps run the fund and was named Morningstar’s fixed-income manager of the year for 2008, plans to keep that segment around 42% of the fund. He also has about 20% of the fund in agency debt. Both benefit from having the Fed as a major buyer, in addition to the government taking over Fannie and Freddie last year, effectively guaranteeing those entities.

“The Fed will keep those capitalized because it needs the institutions to implement policies in the mortgage space,” Atteberry said.

Companies that are explicitly benefiting from policy actions are likely to have the best opportunities, said Rodosky, who also manages the PIMCO Extended Duration Fund (PEDIX). That fund gained 49% last year, predominantly by holding Treasury and agency zero-coupon bonds that perform well in a declining rate environment, he said.

Debt sold by banks that is guaranteed by the Federal Deposit Insurance Corp. should do well, he said.

Also, debt sold by firms that have issued FDIC-backed notes but trade on their own rating have good potential relative to the risk involved, he said.

Goldman Sachs Group Inc. (GS), Citigroup Inc. (C) and Morgan Stanley (MS) have issued FDIC-backed bonds.

Still, “there are going to be some losers in this process, despite the government guarantees,” he said. Several institutions are likely to be consolidated.

“Not every bond out there is money good,” he said.

Company Debt Looking Better

Several managers recommended investment-grade debt, rated at least Baa by Moody’s Investors Service or BBB by Standard & Poor’s, saying the yield compared to benchmark Treasurys is advantageous.

Corporate bonds rated A or higher carry yields 4.66 percentage points over Treasurys, according to an index compiled by Merrill Lynch. That spread skyrocketed to as much as 5.90 points in early December, after generally being below 1.5 points until late 2007.

Wide spreads mean there’s a good opportunity for those bonds to improve as the gap narrows, Vanguard’s Davis said.

“If we see even a stabilizing economy, we can see outperformance in this sector,” he said.

Part of Vanguard’s gains can be attributed to engaging in less trading than more actively-managed funds, because it’s designed to match the characteristics of the Barclays Capital U.S. Government/Credit Bond Index, Davis said.

That Barclays index rose 5.7% in 2008.

In matching the index, the fund’s biggest holdings include General Electric Co. (GE) and AT&T Inc. (T).

GE’s bonds, rated AAA, sold off sharply last year as a broader crisis of confidence led investors to demand higher yields on all company debt, but ended 2008 much closer to where they started.

David Armstrong, who helps oversee the Morgan Stanley Long Duration Fixed Income Fund (MSFIX), also has focused on companies that have conservative operating and financial leverage and are able to withstand a severe recession.

“It is hard to judge the depth and duration of the economic contraction so we are concentrating on credit quality,” Armstrong said.

The fund returned 10.9% in 2008. It started last year with about 30% in corporate bonds, less than its benchmark, anticipating more weakness in the economy than many others were positioned for. The fund is now up to 45% in company debt, largely through the addition of high-quality industrial names, he said.

He noted a number of high-quality issuers have issued debt recently, including Wal-Mart Stores Inc.(WMT), McDonald’s Corp. (MCD) and Emerson Electric Co. (EMR).

Treasury Rally Over

Bond managers expressed the most distaste for Treasurys, which helped several avoid the market’s pitfalls last year. They expect Treasury bond prices to fall, pushing yields up, hurt by the same policies that help other assets. The government is incurring a lot of debt by buying other securities and propping up financial markets, let alone the massive economic stimulus package expected to be approved in the next month or so.

“We’re going to see rates back up on the longer-dated paper,” Davis said. “There is a lot of supply to be digested.”

Still, uncertainty about the economic outlook for 2009 has First Pacific Advisors’ Atteberry cautious.

Enough policy questions remain to keep him from aggressively adding to holdings he already had.

For example, legislation to amend bankruptcy laws to allow judges to change mortgage terms could wreak havoc for the mortgage market, where investors focus intently on how long a given mortgage will be outstanding or be refunded.

Also, speculation that the government wants to help a lot of home purchasers lock in mortgage rates close to 4.50% for 30 years means those owners will have little incentive to move, also affecting how long a mortgage will actually be outstanding, Atteberry said.

“These are fundamental changes to the rules of the mortgage space, so prudence tells you to back away,” he said.

Reflecting that view, the fund has about 31% in cash or cash equivalents, he said.

“There are a lot of policy moves and I think people should wait and see what the rule changes look like,” Atteberry said.

By Deborah Levine

Transfer & Gifting

I was having a conversation with a wealthy individual this week and after we were done talking about how much money he had lost in the markets I suggested that perhaps he should give some of what he has left away. He looked at me like I was from outer space.

During periods of difficult markets, it may seem superfluous to speak of giving wealth away, whether planning for beneficiaries, charities or other potential recipients. But this is one of the areas in which difficult markets can help in the process of transfer to a greater
effect than in more bullish times.

One aspect of difficult market years is that it provides some relief in that transfers of wealth to younger generations are made much easier. Whether giving wealth away to trusts, charities or other people, a depressed value can help to minimize taxes and other administrative problems associated with building an estate plan.

Gifting

• Gifts of securities held by your broker on your behalf are not considered completed until the position is credited to the donee’s account. If the security is held in registered form in the name of the owner, the gift is not completed until the registered owner has formally changed on the corporate books.

• Gifts of cash are not considered to have been completed until the check is paid by the bank on which it is drawn, not when the check is given to the donee. A client can save gift and estate taxes by making gifts sheltered by the annual gift tax exclusion before the end of the year. An individual can give $12,000 per person per year (a married couple can provide separate gifts of $12,000 each for a maximum total of $24,000 in 2008) to an unlimited number of individuals without incurring gift taxes but cannot carry over unused exclusions from one year to the next.

• Given that 2008 has been a difficult year for market returns, now may be the right time to consider the rescission of gifts made earlier in the year when their values may have been substantially higher. A rescission is always easier to accomplish during the year in which the gift was given and may now allow for more securities to be gifted than when the prices were higher.

• Taxpayers should check with their tax advisors regarding the advantages, disadvantages and process of gift rescission and whether it may be a useful strategy to employ given their tax situation.

Direct Charitable Contributions from an IRA

For taxpayers who are age 70½ or older and who own IRAs (or Roth IRAs), charitable gifts can now be made from their retirement accounts, paid directly by the IRA trustee, achieving important tax savings.

As part of the Emergency Economy Stabilization Act of 2008, Congress has extended the charitable donation incentives through 2009, limiting the amount allowed to $100,000 per taxpayer from either IRAs or Roth IRAs per year, excluding the amount from distributions to taxable income. A married couple can donate $200,000 per year. If the purpose of the charitable intention is to maximize donations without paying any additional tax, then donations for 2008 must be made by the end of the year. Afterwards, a second donation can be made in 2009. All donations must be paid directly to the charity from your IRA/Roth IRA trustees, who must then provide detailed written substantiation (receipts) to prove the donations were made and are eligible for treatment.

Also, please note that assets in 403(b) plans, 401(k) plans, pensions and other retirement plans are ineligible for this tax-free treatment.

Charitable Contributions

The timing of charitable contributions can have an important impact on year-end tax planning. Charitable contributions should be timed so as to obtain the maximum tax benefits for the year. If a taxpayer plans to make a charitable contribution in 2009, he or she should consider making it this year instead if speeding up the deduction would produce an overall tax savings (e.g., because the taxpayer will be in a higher marginal tax bracket in 2008 than in 2009).

• On the other hand, a taxpayer who expects to be in a higher bracket in 2009 may wish to consider deferring their contributions.

• In making any sizeable charitable contributions, the contributions should be made, to whatever extent is possible, in appreciated capital gain property that would result in a long-term capital gain, if sold. That way, a deduction generally is obtained for the full value of the property, such as shares of stock, etc., while any regular income tax on the appreciation in value is avoided. One caveat to this deduction is that for tangible property this favorable treatment is only available if the donated item is related to the exempt purpose of the donee charity.

• An additional consideration is that gifts made with short-term capital assets are limited only to a deduction equal to the purchase price of the asset.

This is a very emotional time for individuals when it comes to the discussion of money. But if you plan to make gifts to family or charities, it is wise to put emotions aside and let the figures do the talking. With that in mind, make sure you have a professional help with these decisions. Mistakes can be costly.

Beginning as of January 1st, 2008, a plan participant may now directly rollover from eligible retirement plans (including all qualified plans, 403(b) and 457(b) plans) to a Roth IRA, subject to Roth IRA limitations. The conversions for 2008 are only available to taxpayers with $100,000 or less in adjusted gross income (AGI), as in prior years.

Taxpayers should be aware that the actual conversion process is not tax-free. The taxpayer must include in gross income the taxable portion of the conversion amount; but they are not generally subject to penalties for premature distribution.

Given the difficult market environment during 2008, now may be a particularly attractive time to consider a Roth conversion. Since the Roth conversion is in itself a taxable process, the taxpayer would benefit from converting securities now that may represent a lower valued basis on which the taxes are assessed. If a taxpayer has already made a Roth conversion in 2008, and experienced a loss in portfolio market value, there may be an opportunity to benefit from a Roth IRA Re-characterization.

In a re-characterization, the conversion/contribution is effectively undone; the assets are shifted from the account which received the initial contribution/conversion to the account which will subsequently maintain the assets.

There may be several reasons for a re-characterization, including a failure to meet Roth eligibility requirements (Modified Adjusted Gross Income in excess of $100,000 for example, or an individual who has elected to file Married Filing Separately), conversion of required minimum distribution amounts due on the IRA or a failure to meet the 60-day rollover contributions.

If the conversion took place during a year of significant market declines, a re-characterization back to an IRA and then a subsequent, later conversion may result in less tax. Caution must be exercised in re-characterizing, and then later reconverting, as a failure to follow the time guidelines can create a failed conversion as a Premature Reconversion. The general rules are that a taxpayer must wait until the later of either the beginning of the year following the year in which the conversion occurred or thirty days after the re-characterization is completed. Also, because gains in a re-characterized account may create tax problems in earnings on excess contributions, the taxpayer should consult with their tax advisor to see if re-characterization may be a worthwhile opportunity.

If you are not currently eligible to make a deductible contribution to an IRA or a Roth contribution, now may also be a good time to consider making non-deductible contributions to an IRA in anticipation of converting the proceeds at a future date to a Roth IRA. If you do so, then the only taxable portion of the conversion would be the appreciation of holdings being converted. In 2010, the AGI limitation for Roth conversions will be lifted, making then a good time to consider conversion.

There are some complications if the taxpayer has other traditional IRA accounts, so this primer should only be the first step in your investigation regarding your transactions. Please consult with your tax advisor before considering conversion to a Roth IRA. Mistakes may be costly and irreversible.