By SCOTT HANSON
MONEY MATTERS
03-NOV-05
Q:
What do you think about owning preferred stocks in a portfolio? I rarely see anyone recommend them, but they seem like they make a lot of sense. Dividends on many of them pay 6 percent to 7 percent. What are the risks in owning preferred stocks? Should I own these instead of bonds or stocks? _ Lisa, Sacramento, Calif.
A:
Don't let the name "preferred" fool you. These stocks aren't necessarily better than common stocks. While they receive preferential treatment in some areas, they have their drawbacks as well.
Preferred stocks act a bit like stocks and a bit like bonds. They represent equity ownership in companies, as stocks do, and they provide high dividends, similar to bonds. They don't come without any risks, however.
Unlike bonds, preferred stocks do not have guaranteed payments or maturity dates. If a company runs into financial trouble, investors could wind up with nothing. In the event of a bankruptcy, all other creditors, including bondholders, would receive their money before preferred stock holders. If a company prospers, its common stock could double or triple in value, but its preferred stock could experience little price increase.
One advantage preferred stocks have over common stocks is that dividends must be paid to preferred stockholders before anything is paid to common stockholders. In this area, preferred stocks receive preferential treatment.
Preferred stocks tend to perform poorly when interest rates are rising. As the market demands higher interest rates, outstanding issues of preferred stocks look less attractive and, as a result, their prices could fall.
Like many investments, preferred stocks may be appropriate for a piece of one's portfolio, but they should not take the place of owning stocks and bonds as well.
Q:
I will be 65 in a few months and need to make a decision about what to do with three tax-sheltered annuities I have in amounts of $30,000, $90,000 and $130,000. My husband and I are getting by with our pensions and Social Security income, so taking straight life annuities doesn't seem to make sense. If we set one up as an annuity, do you recommend rolling the others over to ensure something to be left for our five children? _ Kay, Carmichael, Calif.
A:
There is nothing magical about turning age 65 when it comes to a tax-sheltered annuity (403b). You are not required to do anything with them until you turn age 70-1/2.
If generating income is a priority to you at this time, you can turn one of your TSAs into a life annuity, but that is not the only way to receive income from the plan. You can also choose to receive interest from the plans, leaving the principal intact. The best way to leave your TSAs to your children is to roll them into one IRA and list each of your children as a beneficiary of your IRA. Upon your death, your kids can receive the proceeds without probate, and each will have an option to continue growing his or her funds tax-deferred inside the IRA.
Q:
I have a question concerning Roth 401(k) plans. As an employer, can we offer our traditional 401(k) plan that is already in place and add the Roth 401(k) as well? If we can, how does this affect the contribution limits for each plan? _ Mark, El Dorado Hills, Calif.
A:
Yes, as an employer you can offer both a traditional 401(k) and the new Roth 401(k) come January. Whether your employees choose to put their contributions into the traditional plan or the Roth plan, all employer contributions go in on a before-tax basis.
The contribution limits on 401(k) plans apply to the total amount contributed into both types of plans. An employee can contribute a maximum of $15,000 in 2006 into 401(k) plans. The employee can split the contribution between the plans but cannot contribute $15,000 into both.
For those who are 50 and older, the "catch-up" provision on 401(k) plans will be $5,000. That means next year these individuals can save as much as $20,000 in their tax-advantaged retirement plans.
(Scott Hanson, CFP, is a senior adviser with Hanson McClain, an investment advisory company and registered principal with Securities America, member NASD/SIPC. E-mail questions to questions@moneymatters.com.)
