Money Management

Do investors benefit when a company buys its own stock?

QSome prominent companies have recently lost heavily buying back their own stock. In the past, you've said that investors tend to benefit from such programs. Do you think that's still the case?

A Yes. True, buying stocks in a volatile market is just as risky for companies as it is for individuals. However, by reducing the number of shares outstanding, a buyback program can help boost a company's per-share earnings and consequently raise its stock's price.

If the company has strong growth potential, it figures to recoup its stock losses. So buybacks stand to benefit investors in the long run. Of course, the program works out better when the company buys shares after sharp price drops instead of before them. Still, just as dollar-cost averaging—steadily investing a fixed amount in stocks, through thick and thin—can prove profitable for an individual investor, so can a consistent buyback program benefit a company, and ultimately, its shareholders.

But, warns investment guru Warren Buffett, beware of buybacks undertaken for "ignoble reasons"—for instance, to jack up the value of corporate managers' stock options. In a nutshell, don't let a buyback program influence you to put your money into the stock of a company whose outlook is dubious.

When you inherit a jointly owned asset

QI've just sold a property for $300,000 that my deceased brother and I owned jointly. We bought it for $120,000—of which $70,000 came from me—and it was worth $240,000 at the time he died. What's my taxable capital gain on the sale?

A Your tax basis is your original cost—$70,000—plus the value of your brother's share when you inherited it. Since he contributed 5/12 of the purchase price ($50,000/$120,000), his share was worth $100,000 at his death (5/12 of $240,000). So your basis is $70,000 plus $100,000, or $170,000, and your gain on the $300,000 sale is $130,000.

Guidelines for expanding 401(k) plan investment choices

QSome of our employees complain that the investment options offered by our group's 401(k) plan are too limited. What's the general practice in this regard?

A The average plan provides more than a dozen investment choices, according to a recent survey by Buck Consultants, a Secaucus, NJ, firm. Core options include large-cap stock, equity index, international stock, bond, and money-market funds. Many plans also offer asset allocation funds (sometimes called lifestyle funds) that provide a mix of equity and income securities in different ratios, attuned to investors at various ages or with particular objectives. And some plans allow participants willing to pay brokerage fees to invest in a broad range of individual issues.

Keep in mind that adding more investment choices increases the risk of confusion on the part of less sophisticated plan participants. To help participants make investment decisions, you can give them educational materials such as explanations of investment concepts, asset-allocation models that reflect historical returns of different asset classes, and worksheets for estimating retirement-income needs. But don't recommend specific investments; you may get sued if they underperform.

Getting rid of mortgage insurance

QI recall reading in your column some time ago that a new law speeds up the cancellation of private mortgage insurance by lenders, but I'm still paying premiums. What's holding things up?

A As we explained at the time, the law applies only to mortgages taken out after July 29, 1999. If you have an older loan that was sold to Fannie Mae or Freddie Mac, the institution servicing it must automatically cancel PMI after the mortgage term is half over. This action, which was formerly at the servicer's option, became mandatory last year. Fannie Mae also generally requires PMI cancellation if the ratio of the loan balance to your home's market value is 80 percent or less (Freddie Mac's threshold is 75 percent). To prove that, you'll probably have to shell out $250 to $400 for an appraisal.

The odds that Fannie Mae or Freddie Mac owns your mortgage are fairly high, but even if that's not the case, other mortgage lenders tend to follow their rules. It certainly pays to find out where you stand by checking with your loan servicer. If your loan was made before 1993, you may have been charged a year's advance premium for PMI, so you could be due a substantial refund on cancellation. And whatever the size of the refund, your future savings on unnecessary monthly premiums should well compensate you for the appraisal cost.

If your child is college bound, 529 may be your lucky number

QI keep seeing references to "529 plans" for college savings. What are they, and should I consider one for a child I hope to send to an out-of-state university?

A Section 529 of the Internal Revenue Code provides tax breaks for qualified state-run college savings programs. Although your lifetime plan contributions—which can exceed $100,000 per student in most states—aren't tax deductible on your federal return, earnings grow tax-free and, thanks to a recent change in the law, they won't be taxable when withdrawn to pay certain future college expenses.

Most states let nonresidents participate in their programs, and in all states the funds can cover the costs of attending an out-of-state school. But if the plan is the prepaid-tuition type, rather than a general college savings plan, you may not get the full value of the account if the money goes out of state.

The state manages the plan's investments, but you control how and when the money is paid out. Be mindful, however, that starting in 2002, the federal government will assess a penalty—10 percent—on plan earnings not used to defray education expenses. You'll also have to report such earnings on your federal return. For more information, see "How to pump up college savings," Jan. 25, 2002.

When a divorced couple sells their jointly owned home

QMy wife and I split up in 1999 after living in our home for less than two years, but the divorce settlement allowed her to continue to occupy it. Now we're selling the place, and as joint owners we'll divide the $100,000 profit equally. Since she's eligible for the $250,000 home sale exclusion, will it cover my share as well?

A No, but you won't be taxed on your half of the profit regardless. The time your ex-wife lived in the house under the terms of the divorce counts as part of your period of ownership and use, so each of you can claim a $250,000 exclusion.

Borrowing from a pension account more than once

QI need to borrow from my pension plan to meet an upcoming installment obligation. I'm permitted to borrow a maximum of $50,000. By borrowing less than that now, can I take a second loan next year if I have to?

A Yes, but perhaps for a smaller amount than you expect. Let's say you borrow $30,000 on May 1, 2002. During the 12 months ending April 30, 2003, you'd be able to borrow up to $20,000, but not more, even if you've repaid part of the first loan.

If you take another loan after that one-year period, the borrowing limit would be $50,000 minus the highest loan balance outstanding during the preceding 12 months. Suppose you pay off $3,000 of your $30,000 loan on Nov. 15, 2002, reducing the balance to $27,000. On or after Nov. 16, 2003, you could borrow up to $23,000 ($50,000 minus $27,000).

Edited by Lawrence Farber,
Contributing Writer

Do you have a money management question that may be stumping other doctors, too? Write: MMQA Editor, Medical Economics magazine, 5 Paragon Drive, Montvale, NJ 07645-1742, or send an e-mail to memoney@medec.com (please include your regular postal address). Sorry, but we're not able to answer readers individually.

Lawrence Farber. Money Management.

Medical Economics

2002;7:150.