Enhancements to a Winning Strategy

SPECIAL TO THE TIMES

Mary Kaptur arrived in Los Angeles in 1937 with $100 in her pocket and a bachelor's degree in business administration.

Today, she's almost a millionaire.

Hard work over a varied career in bookkeeping and office management jobs had a lot to do with it, but so did a no-nonsense approach to money.

"I got out of school during the Depression," said Kaptur, 83, who grew up in Missouri and earned her University of Kansas diploma on a scholarship. "You learn to manage your money when you don't have much."

You also learn to plan for the future, she says. She applied those lessons through the years as she pursued a working life that included stints bookkeeping for movie stars such as Merle Oberon and Jeanne Crain. She saved, kept her expenses in line, and taught herself about investing by reading books and magazines.

"I always saved and had enough to live on," said Kaptur, who is single and has no children, in summing up her attitude. She saw people around her "just spend and live to the hilt" and not worry about later financial security, and she was determined she'd never be one of them.

In retirement, Kaptur, who enjoys good health and an active social life, has been able to reap the rewards of all those years of prudent financial management. Her portfolio of real estate, stocks and bonds is worth nearly $1 million, and her investments and Social Security provide her with a very comfortable annual income of about $70,000.

She turned to Money Make-Over for advice on getting better returns from her investments, on IRA strategies and on making sure her estate is being set up as tax efficiently as possible.

"You are a very astute investor," Brent Kessel, a fee-only Certified Financial Planner in Santa Monica, told Kaptur after he reviewed her portfolio. "You manage your investments better than the vast majority of people I meet with."

Kaptur has about $442,000 in equity in a seven-unit apartment building just outside Beverly Hills and valued at $550,000, and more than $100,000 in equity the Westwood co-op where she lives. Her holdings also include about $105,000 in long-term municipal bonds; $80,000 in individual stocks, including shares in U.S. telecommunications, financial services and energy companies; $45,000 in Fannie Mae mortgage bonds; $38,000 in bonds and cash in an individual retirement account; $5,000 in Dean Witter MSDW Competitive Edge BIT, a new growth mutual fund; and $25,000 cash in a savings account.

Kessel was particularly impressed with the way Kaptur has handled her income property, bought in the early 1960s for $102,000. Through the hot markets of the '70s and '80s, when many real estate investors were selling their properties or borrowing against them to buy others only to regret it later as the market chilled, Kaptur just held on. The building provided her with $40,000 in income in 1996.

What some would fancy as investment savvy, the down-to-earth Kaptur, who grew up in a family that didn't have a lot of money for extras, regards as just plain good sense. She's been responsible for her financial well-being since her early 20s, when she decided to leave her steady but low-paying job in Kansas City, Mo., for the promise of California.

It was a gamble, but one that paid off eventually as she made a life for herself here. Today, Kaptur enjoys her money within reason, but she always keeps an eye on her bank balance. She sees to it that all her interest and dividend income--about $16,000 in 1996--is reinvested. She recently spent $10,000 to redecorate her co-op, for instance, but she was quick to add that she immediately put herself back on a budget. Her main monthly expenses include about $1,000 a month for taxes, maintenance and other building expenses for her co-op and $900 for the mortgage on her apartment building. She owns her car, a 1995 Ford Contour, outright.

Kaptur is well aware that her wealth is such that her heirs, who will include her sister's children and grandchildren, would be likely hit with estate taxes, and she has been looking into ways to address that issue.

One way to minimize estate taxes is through life insurance, which is a good solution for someone who, like Kaptur, will be bequeathing an illiquid asset such as real estate. And, in fact, Kaptur is particularly concerned that her heirs be able to keep the apartment building, which provides a good source of income, and not have to sell it to pay estate taxes.

She has been investigating increasing the death benefit on her life insurance to help her heirs cover federal estate taxes.

A smart move, Kessel told her. Her current cash-value policy provides a $104,000 death benefit. After researching the issue, Kessel recommended converting her existing whole-life policy to a single-premium whole-life policy from Great West Life Assurance Co. It would provide a death benefit of about $216,000, and if she buys it through Charles Schwab & Co., there would be no surrender charges should Kaptur need to cash in the policy herself.

Readers should note that buying cash-value life insurance is not a simple decision. You should do everything you can beforehand to make sure you understand all the ramifications of purchasing a particular policy. In regard to estate planning, there are further considerations involving the naming of beneficiaries.

Kessel offered Kaptur another tip: convert her traditional IRA into a Roth IRA. She'd benefit in a number of ways.

The Roth IRA, created by last year's federal tax legislation and now available to taxpayers who qualify, can be a good choice for well-off retirees who, like Kaptur, don't want or need the required annual distributions (and accompanying tax liability) of traditional IRAs and who want to spare their heirs a tax burden. That's because, in most cases, Roth distributions will not be taxed. A retiree can take out any amount of money at any time, or none at all. And money inherited from a Roth IRA also carries no income-tax liability.

Kessel did some 10-year Roth-vs.-traditional IRA-comparison calculating, based on an average annual return of 8% for the $38,000 in question, and based on a 28% federal tax rate and a 9.3% state tax rate. First, the conversion: If Kaptur used non-IRA funds to pay the taxes associated with the conversion (which she would want to do to avoid a 10% penalty) and didn't take any distributions, she would have $81,812 in the account by the time she is 93. Now, the traditional IRA: The account itself would contain $10,536 after 10 years; she will already have received $28,852 in required minimum distributions. The future invested value of the amount in conversion taxes that she didn't have to pay would equal $20,303. Altogether, that would add up to $59,691. Net advantage to converting: $22,121.

Also in the Roth's favor is that if Kaptur makes the conversion this year, her tax obligation would be spread out over the next four years.

Kessel offered a few suggestions to better diversify her other investments. About 27% of these are in U.S. large-company stocks, 4% are in real estate stocks and 69% are in long-term municipal and mortgage bonds.

"What I asked myself was, 'How can we keep the risk parameters the same but improve the rate of return by having a better allocation?' " Kessel told Kaptur.

He suggested a mix of 15% large-company stocks, 7% international stocks, 6% U.S. small-company stocks and 3% real estate stocks. The total percentage of bond holdings would remain the same ($21,000 of the $38,000 in her IRA represents corporate bonds that recently matured).

To achieve the realignment, Kessel recommended selling five of her individual stocks and a bond whose values have increased little or not at all so she can avoid capital gains taxes.

The proceeds, about $31,600, would be divided among four mutual funds: $16,000 in Vanguard Index-Trust Small Capitalization Stock Portfolio (five-year average annual return: 17.9%), $6,000 in Vanguard International Value (five-year average annual return: 11.8%), $6,000 in Fidelity Worldwide (five-year average annual return: 15.9%), and $3,600 in Vanguard International Equity Index Emerging Markets (fund is less than 5 years old).

Kaptur has been most reluctant to put money into mutual funds, preferring to invest in ways she can follow directly herself, but Kessel reassured her, saying that he picked these funds for their disciplined managers and for their low expenses.

"My main concern is getting the overall maturity of your bonds down," Kessel told Kaptur by way of explaining his next recommendation. Long-term bond prices are more sensitive to interest-rate changes than those of shorter-term bonds, he explained.

Once Kaptur converts her IRA into a Roth, he said, she could put $21,000 from the recently liquidated bonds into two mutual funds: $11,000 would go into Vanguard Bond Index Intermediate-Term (three-year average annual return: 10.7%) and $10,000 into Strong Short-Term Global Bond Fund (three-year average annual return: 9.0%).

In addition, Kessel suggested that Kaptur consider refinancing her apartment building's mortgage at a lower rate. She is currently paying 8.23% interest on an adjustable-rate loan with a balance of $108,000. An adjustable-rate loan at even, say, 0.67 of a percentage point lower, for example, would, once she recoups her closing costs, save her about $1,800 a year. Her interest-cost savings would be even greater, he said, if she wants to accelerate her mortgage payoff by making, say, two extra payments each year.

On a related note, Kessel advised Kaptur to buy earthquake insurance for her apartment building, something she has been avoiding because of high premiums and deductibles. Kessel dismissed that objection, pointing out that this is an investment she needs to protect. Shelling out, say, $50,000 to meet a deductible would be a lot cheaper than paying hundreds of thousands of dollars in repairs or, in a worst case, losing the building altogether.

Kaptur pronounced herself pleased with Kessel's suggestions, saying she is going to follow most, if not all, of them.

"You have done a very thorough job," Kaptur told Kessel in her straightforward way. "I really appreciate it."

*

Lynda Natali is a regular contributor to The Times. To participate in Money Make-Over, send your name, age, phone number, income, assets and financial goals to Money Make-Over, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053. Questions or comments can be left at (213) 237-7288.

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This Week's Make-Over

* Investor: Mary Kaptur, 83

* Occupation: Retired

* Gross annual income: About $70,000

* Financial goal: Address estate-planning concerns; get independent professional opinion on investments.

Current Portfolio

* Real estate: About $442,000 equity in seven-unit apartment building with estimated value of $550,000; more than $100,000 equity in Westwood co-op

* Individual retirement account: About $17,000 in corporate bonds and $21,000 in cash

* Bonds: About $105,000 in long-term municipal bonds; about $45,000 in Fannie Mae long-term mortgage bonds

* Individual stocks: About $80,000 in individual stocks in U.S. telecommunications, financial services, energy and other companies. The largest of these holdings are in Chevron, US West Commercial Group, Mid Ocean, Time Warner, Fremont General, US West Financial II.

* Mutual fund: About $5,000 in Dean Witter MSDW Competitive Edge BIT

* Cash: $25,000 in savings account

Recommendations

* To save on taxes for herself and her heirs, and to earn better after-tax returns, Kaptur should convert her traditional IRA into a Roth IRA.

* Make new life insurance arrangements to better help heirs pay estate taxes.

* Add international-stock and U.S. small-company equities to her portfolio, through mutual funds rather than by buying individual stocks.

* Add diversity to bond holdings by buying mutual funds that invest in short-term and intermediate-term bonds.

* Refinance apartment building mortgage to save on interest; obtain earthquake insurance for the property.

* Recommended Mutual Funds:

Stock funds:

* Vanguard Index-Trust Small Capitalization Stock Portfolio (800) 523-8398

* Vanguard International Value

* Vanguard International Equity Index Emerging Markets

* Fidelity Worldwide (800) 544-8888

Bond funds:

* Vanguard Bond Index Intermediate-Term

* Strong Short-Term Global Bond (800) 368-1030

Meet the Planner

Brent W. Kessel is the principal of Abacus Financial Planning, in Santa Monica. In addition to providing fee-only advice, the company manages money for individuals, small businesses and charitable foundations.

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