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Keep Emergency Money Separate

Q. I understand that families should keep cash on hand for emergencies equal to three to six months of living expenses. I have also read that a family’s investment portfolio should be diversified among stocks, bonds, real estate and other holdings.

What I have never understood is whether the portfolio should be accumulated after the emergency account is funded or whether the portfolio includes the emergency funds. Please advise.-- P.H.

A. Conservatively speaking, money reserved for emergencies is not considered a true part of a family’s investment portfolio.

Any money set aside for emergencies should be kept in accounts that are both easily accessible and not subject to the ups and downs of the market.

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This leaves you few options, virtually all of which pay minimal interest: bank accounts, money market accounts and certificates of deposit with staggered maturities.

You aren’t likely to get rich on such investments; in fact, they may barely keep pace with inflation. But they are very liquid and you won’t have to worry whether the stock market is in a bull or bear cycle if you need to tap the account. The idea is to have ready cash in the event of an accident, illness or other dire circumstance.

Your investment portfolio is an entirely separate matter. This should be diversified among a variety of investments--stocks, bonds, real estate and other holdings. The mix should vary according to your age and investment goals.

You should review your holdings regularly to be sure the portfolio is in balance with savings goals that change as you age. You may start out saving for a home purchase. Your children’s education may be your next major objective, then it’s on to retirement savings.

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You can find any number of thoughtful books on this subject at your local library or bookstore. And a qualified, trusted financial counselor--and I would recommend only for-fee planners--can help you plot your course.

Will Children Have to Pay Parent’s Debts?

Q. I am 78 years old with no estate and outstanding credit card balances totaling more than $20,000. When I die, will my children be required to pay off these debts? --J.K.

A. Your children will be required to pay off your debts with any assets from your estate. If your estate is nonexistent or minimal, any remaining debts not covered by the estate’s proceeds would not become the obligation of your children.

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Tax Code Treats Spouse as Having Pension Plan

Q. I am not covered by a pension plan at work. My husband is covered by one. Am I entitled to make a tax-deductible contribution to an individual retirement account on my own? I know my husband is not entitled to a tax-deductible contribution, but I think I should be. --M.A.E.

A. The government allows taxpayers to make tax-deductible IRA contributions if they meet either one of two requirements: They do not participate in a qualified pension plan through their employment or they do participate in such a plan but their earnings are low enough that they are permitted a tax deduction for their retirement savings.

However, even though you are not covered by a pension plan through your job, you are not entitled to make a tax-deductible IRA contribution unless your combined family income meets the federal guidelines for such contributions. Why? Because your husband is covered by a qualified plan.

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Under the reasoning of the tax code, if one spouse is covered by a pension plan, the married couple is treated as though both spouses are covered. The logic--if that word can be applied--is supposed to take into account community property laws and the fact that spouses generally benefit from the other’s pension plan. In reality, however, this is just another example of what many consider to be the “marriage penalty” imposed by the nation’s tax laws.

For you to enjoy a fully tax-deductible IRA contribution, your combined family adjusted gross income may not exceed $40,000. The deduction decreases gradually until ending completely at an adjusted gross income of $50,000.

Tax Consequences of Parent-to-Child Loans

Q. In a recent column you discussed no-interest loans from parents to children. You said such loans are permitted without tax consequences if the loans are less than $100,000 and the recipient had no investment income. Does it matter what the loan is used for? I want to lend my son some money so he can buy an interest in a business operation. Would this qualify as a “no tax consequences” transaction? --W.J.G.

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A. How the proceeds of a loan between parent and child are used are of no consequence. What matters is whether the borrower has investment income.

If the borrower has investment income, the loan must carry an interest rate equal to or greater than the “applicable federal rate,” an amount that floats with the market and is set every six months.

If the lender charges less than that rate (and the borrower has investment income), the forgone interest would be considered a gift from the lender and deducted from his or her lifetime gift limit of $600,000. The lender would also be required to claim as his or her own income the amount of interest the son receives on his investments.

If your son receives no interest income from investments, you may lend him up to $100,000 and charge less than the applicable federal rate (or even no interest at all) with no gift tax or income tax consequences.

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Again, it does not matter how the loan proceeds are used--except, of course, if they are spent on investments that generate interest. Any purchase of an ongoing business operation should be structured to generate income--not interest--for your son.


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