General Responsibilities of an Estate Administrator
When a person dies a probate proceeding may be opened. Depending on state law, probate will generally open within 30 to 90-days from the date of death.
One of the probate court’s first actions will be to appoint a legal representative for the decedent and his or her estate. The legal representative may be a surviving spouse, other family member, executor named in the decedent’s will or an attorney. We will use the term “estate administrator” to refer to the appointed legal representative. The probate court will issue Letters Testamentary authorizing the estate administrator of the decedent to act on the decedent’s behalf. You will need the Letters Testamentary to handle the decedent’s tax and other matters.
In general, the responsibilities of an estate administrator are to collect all the decedent’s assets, pay creditors and distribute the remaining assets to heirs or other beneficiaries. As an estate administrator your first responsibility is to provide the probate court with an accounting of the decedent’s assets and debts. Some assets may need to be appraised to determine their value. All debts will need to be verified and creditor claims against the estate must be filed. How to verify a federal tax debt is covered in the Getting Information from the IRS page. How to get IRS to file a creditor claim in the probate proceeding is covered on the Getting the IRS to File a Proof of Claim in a Probate Proceeding page.
Tax Responsibilities of an Estate Administrator
A decedent and their estate are separate taxable entities. So if filing requirements are satisfied, an estate administrator may have to file different types of tax returns.
First, an estate administrator may need to file income tax returns for the decedent (Form 1040 or 1040-SR series). The decedent’s Form 1040 or 1040-SR for the year of death, and for any preceding years for which a return was not filed, are required if the decedent’s income for those years was above the filing requirement. For help, see the Filing the Final Tax Return(s) of a Deceased Taxpayer page.
Second, an estate administrator may need to file income tax returns for the estate (Form 1041). To file this return you will need to get a tax identification number for the estate (called an employer identification number or EIN). An estate is required to file an income tax return if assets of the estate generate more than $600 in annual income. For example, if the decedent had interest, dividend or rental income when alive, then after death that income becomes income of the estate and may trigger the requirement to file an estate income tax return. For help filing an income tax return for the estate see Filing the Estate Income Tax Return (Form 1041) page.
If the estate operates a business after the owner’s death, the estate administrator is required to secure a new employer identification number for the business, report wages or income under the new EIN and pay any taxes that are due. Publication 1635, Understanding Your EIN PDF (PDF) provides information about this requirement.
Some or all of the information you need to file income tax returns for the decedent and their estate may be in the decedent’s personal records. The IRS can help by providing copies of income documents (Forms W-2 or 1099 for example) and copies of filed tax returns or transcripts of tax accounts. If you need these items see the Getting Information from the IRS page.
Third, an estate administrator may need to file an estate tax return (Form 706). Estate tax is a tax on the transfer of assets from the decedent to their heirs and beneficiaries. In general, estate tax only applies to large estates. For help with determining whether an estate tax return is required and how to file it, see the Estate and Gift Taxes page.
Additional information on the duties of an estate administrator is available in IRS Publication 559, Survivors, Executors and Administrators.
As our Investment Products & Portfolio Manager, Thomas McDonald, puts it, “Not all real estate income is created equally.” Understanding the durability of real estate income allows investors to better identify which assets may have a higher likelihood of delivering returns, even during periods of great uncertainty.
CrowdStreet · Posted May 21, 2020
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We’ve spent a good bit of time on this site talking about the different types of investors and the advantages and disadvantages to various investing styles. But, the one thing that remains consistent across all investors is the fact that they want to make money, and they want to be able to use the money they make to generate more.
As you might guess, what you invest in is just as important as you’re investing style. And while there are literally thousands of potential investments you could or may pursue over the course of your investing career, many types of investments have similar characteristics, both in terms of how they generate income and how much.
In fact, when you get right down to it, there are three broad types of income you can generate:
- Earned Income
- Portfolio Income
- Passive Income
Any money you ever make (other than maybe winning the lottery or receiving an inheritance) will fall into one of these income categories. And each income category has its own set of benefits and drawbacks. Additionally, successful investors (i.e., Specialists) have good reason to prefer certain types of income over the others.
Let’s dig a little bit deeper…
Earned income is any income that is generated by working. Your salary or money made from hourly employment (regardless of whether that salary or hourly income came from working for someone else or from your own “consulting”) is considered earned income.
Some activities that generate earned income include:
- Working a job
- Owning a small business
- Any other activity that pays based on time/effort spent
While earned income is the most common mechanism for making money, its obvious downside is that once you stop working, you stop making money. Additionally, because the amount of money that is made through earned income is directly proportional to the time and effort you spend working, it’s difficult for someone to make more earned income without either learning a new (or more valuable) skill or working longer hours. Additionally, earned income is taxed at a higher rate than any other type of income.
One huge benefit of earned income over the other income types is that you generally don’t need any startup capital in order to make earned income, which explains why most people rely on earned income from the start of their working life. In fact, earned income is a great way to start your investing career, as it allows you to save up cash that will help you generate the other two types of income…
Portfolio income is any income generated by selling an investment at a higher price than you paid for it. Some people refer to portfolio income as “capital gains,” because that’s how the money is taxed by the federal government.
Some activities that generate portfolio income include:
- Trading (buying/selling) Paper Assets — Paper assets refer to things like stocks, bonds, mutual funds, ETFs, CDs, T-bills, currencies or other types of futures/derivatives. Stock market investing is the most common generator of portfolio income
- Buying and Selling Real Estate (specifically the profit from the sale)
- Buying and Selling of any other Assets — Antiques or cars, for example, or other types of collectibles that have appreciated in value
There are a number of downsides to portfolio income; for example:
- It often takes a good bit of knowledge and experience to learn how to make money trading paper assets. Unless you have inside knowledge of the companies you’re trading, you must learn to read financial statements or how to analyze market trends if you hope to beat the market
- You often have little control over your investments, other than your ability to buy or sell. For example, buying stock in a company still affords you no day-to-day control over the operation of the company, and therefore little day-to-day control over your investment
- Generating portfolio income generally requires you to have money to invest upfront. Even large gains are inconsequential when the investing amounts are very small
- Portfolio income is often taxed at very high rates — equivalent to earned income in many cases
Portfolio income certainly has some advantages over earned income. Once you have the knowledge and experience to generate portfolio income on a consistent basis, you can continually reap the benefits (compound your return) by reinvesting after each sale. Additionally, any portfolio assets held long-term are generally taxed at a lower rate.
Passive income is money you get from assets you have purchased or created. For example, if you were to buy a house and rent it out for more money than it costs you to pay your mortgage and other expenses, the profit you make would be considered passive income. As another example, if you owned a business that could operate independently of your working for it, any money that you make from the business would be considered passive income (of course, if the businesses success was limited by the number of hours you worked, the income you made would be considered “earned income”).
Some activities that generate passive income include:
- Rental Income or Note Income from Real Estate
- Business Income (assuming it’s not earned based on amount of time/effort spent — that would be Earned Income)
- Creating and Selling Intellectual Property — Books, Patents, Internet Content, etc
- Affiliate or Multi-Level Marketing
There are some major benefits to passive income over the other two types of income:
- Passive income is generally recurring income; once the investment is made, and assuming it is a good investment, the income will continue to come in month-after-month or year-after-year, with little additional work by you. This means that you can essentially “retire” and still continue to grow your net worth
- Investments that generate passive income usually allow the owners active control over the investment. For example, if you owned an apartment building or a corporation, you would have say in the day-to-day operations that would ultimately impact the success of your investment
- Passive income investments often allow for the most favorable tax treatment. Corporations can use profits to invest in other passive investments (real estate, for example), and take tax deductions in the process. And real estate can be “traded” for larger real estate, with taxes deferred indefinitely
- Because it is generally possible to closely approximate the return (or at least the risk) you can expect from passive investments, these investments can often be funded using borrowed money. For example, a good business plan can attract angel funding or venture capital money. And real estate can often be acquired with a small down payment (20% or less in some cases) with the majority of the money borrowed
As you might suspect from the above overview, many people consider passive income the holy grail of investing, and the key to long-term wealth.
In Part III of this article, we’ll put it all together to help you understand how the combination of investing types and income types can be used to achieve financial freedom.
Editor’s Note: This week, we asked our readers whether they have allocated any new funds to exchange-traded funds (ETFs) over the past six months.
If you’re not familiar with ETFs, they’re collections of stocks that share a common theme, like sector or index. They’re not actively managed, so they’re less expensive and post better performance than most mutual funds. They can also serve as an excellent tool for diversification.
However, in spite of these benefits, our readers were fairly evenly split between those who had purchased ETFs since February and those who had not.
This is surprising because when we asked in December if readers planned to allocate any new funds to ETFs in 2019, almost 80% of our respondents said that they were interested in doing so.
Why aren’t readers buying ETFs?
It could be that we’ve been waiting to rebalance our portfolios and holding out for a clear buying opportunity. We could have also diversified through other investment vehicles.
It’s clear, though, that when it comes to investing in ETFs, our readers have a firm grasp of what they’re looking for.
According to this week’s survey, when considering investing in an ETF, our readers are interested in several factors, like performance, sector, cost and preference – but generating income tops the list by a landslide.
For this reason, we’ve called on a friend from our sister e-letter Liberty Through Wealth, ETF Strategist Nicholas Vardy, to explain his top strategies for generating income using ETFs.
As an expert in ETF investing, Nicholas is the perfect guide to help our readers meet their 2018 end-of-year financial resolutions. Please enjoy his column below – and then consider “walking the walk” and meeting your income goals by allocating new funds to ETFs.
– Mable Buchanan, Assistant Managing Editor
I’ve written before about the remarkable flexibility of ETF investing.
With more than 2,000 ETFs trading on U.S. stock exchanges… you can assemble a portfolio of strategies to achieve almost any investment objective. ETFs allow you to bet on U.S. and foreign stocks, bonds, commodities or currencies – almost any asset class under the sun.
Say you believe in a market melt-up – that stocks are set to soar in the coming months. Well, you can increase your bets by investing in leveraged ETFs.
Say you believe the opposite – that the stock market is on the brink of a major collapse. ETFs allow you to profit handsomely by betting against markets.
It recently occurred to me, however, that I had yet to explore the crucial area of income investing.
In other words, how can ETFs provide you with a steady and reliable source of income? Below are three ETFs with very different income-generating strategies that do just that.
1. Dividend Aristocrats
When most investors want to generate income, they think first of buying high-dividend stocks.
This is harder than it looks. You need to do more than just identify companies that pay a high dividend. You also need to make sure they can keep paying it.
Enter the Dividend Aristocrats.
Dividend Aristocrats are S&P 500 companies that have increased dividends every year for at least 25 consecutive years. The good news is you don’t need to invest in each of the 53 Dividend Aristocrats to make money from them.
Today, you can simply buy the ProShares S&P 500 Dividend Aristocrats ETF (CBOE: NOBL). This rock-solid dividend-paying ETF currently yields 2.3%.
2. Real Estate Investment Trusts
Real estate investment trusts (REITs) allow investors to buy shares in commercial real estate portfolios that receive income from a variety of properties.
Equity REITs lease space and collect rents on the properties. They then distribute that income as dividends to shareholders.
Mortgage REITs lend money to real estate owners and operators through mortgages and loans or mortgage-backed securities. With more than 225 publicly traded REITs in the U.S., it’s tough to separate the wheat from the chaff.
The Vanguard Real Estate ETF (VNQ) does just that by investing in the small cap, midcap and large cap segments of the equity REIT market. Its low fees, 4.2% dividend yield and low correlation to the stock market make it a favorite among income investors.
3. Municipal Bonds
Municipal bonds are issued by a state, municipality or county to fund critical local projects, such as schools, highways and bridges. A general obligation bond is issued by government entities and not backed by revenue from a specific project, such as a toll road.
A revenue bond pays principal and interest through the issuer and is funded by sales, fuel, hotel occupancy or other taxes.
As investment-grade securities, municipal bonds are often less risky than corporate bonds.
Municipal bonds are exempt from federal taxes and most state and local taxes. That makes them especially attractive to investors in high-income tax brackets.
The biggest downside of municipal bonds is that they are illiquid. Offering a tax-free yield of 5.6%, the PIMCO Municipal Income II ETF (PML) offers a terrific alternative to investing in municipal bonds directly.
A Diverse Source of Income
Of course, there are many other strategies to generate income for your portfolio. These include investing in master limited partnerships, high-yield bonds or preferred stock, or even selling options.
Here’s the challenge: To assemble and monitor a portfolio of investments that covers such a wide range of income sources takes more hours than there are in a day.
But as I’ve demonstrated, the good news is there are ETFs for each… And you can invest in them at the click of a mouse.
Investing in a diverse portfolio of income-generating strategies has two additional benefits…
First, you generate much higher income than you would by, say, investing in an S&P 500 index fund. A model ETF income portfolio I track daily yields 6%. That’s more than triple the current 1.9% yield on the S&P 500.
Second, by investing in a portfolio of diverse strategies, you ensure you’re not betting on a single source of income. That means you’re virtually assured of generating income no matter the state of the market.
The bottom line? ETFs allow you to look beyond the conventional strategies of generating steady income in your portfolio.
Investors typically have a choice between risk and return: If you want higher returns, you need to accept more risk or volatility in exchange. The same dynamics are true for income investments where greater yields often come with higher credit or interest rate risk. For example, junk bonds offer higher yields than Treasuries given their higher credit risk.
When building a portfolio, retirees must balance these risk factors with their income requirements. Bonds are often pitched as a sure-fire way to reduce risk and increase income, but they can be risky during low interest rate environments and turbulent times.
Let’s take a look at why bonds may be riskier than they appear on the surface, and how to find the right balance between income requirements and risk in your portfolio.
How Bonds Can Be Risky
Bonds are often pitched as a low-risk asset class given their low volatility and liquidity preference over equities. As a result, retirement portfolio allocations typically shift from stocks to bonds as investors seek more income and less volatility. Bond funds enable investors to easily shift asset allocations without having to deal with individual bonds.
Despite their reputation, there are a couple key risk factors to remember:
- Interest Rate Risks: The inverse relationship between interest rates and bond prices make low interest rate environments risky for bondholders. While lower bond prices aren’t important for investors holding until maturity, portfolios that hold bond funds could see significant value loss if interest rates move higher.
- Credit & Liquidity Risk: The COVID-19 pandemic has underscored the credit and liquidity risks facing the bond market. If the Federal Reserve hadn’t stepped in as a buyer of corporate bond ETFs, the market could have seen a significant contraction as credit quality deteriorated and buyers dried up.
These risks are exacerbated by the growing popularity of bond funds. For example, a bond that is downgraded to junk status might experience a sudden sell-off from a range of investment-grade bond funds. The selloff could result in fire sale prices for some bond issues, and consequently, steep losses for investment-grade bond funds.
Diversifying Risk Across Asset Classes
Your portfolio should reflect both your risk tolerance and income expectations. While bonds may provide more income than equities, over-allocating your portfolio to bonds could lead to significant risk concentration. Diversifying across different asset classes can help mitigate that risk that ensures that your portfolio has the right level of risk for your tolerance.
Some asset classes to consider include:
- Real Estate: Real estate investment trusts (REITs) hold a portfolio of real estate properties and tend to be uncorrelated with stocks, bonds and other conventional investments that investors may hold in their portfolios.
- Blue Chip Equities: Blue chip equities are large-cap companies that tend to be less volatile than other equity asset classes. In addition, equities tend to have an inverse correlation with bonds, making them a great diversification tool.
- Commodities: Commodities, such as gold or crude oil, can be a great way to diversify a portfolio away from just stocks or bonds. The downside is that these assets do not generate any income and capital gains may be limited.
- Private Equity: Accredited investors can participate in private equity deals or retail investors can purchase mutual funds with exposure to private companies. While these investments are higher risk, they can be a great diversification tool.
Diversification involves finding assets with prices that are not correlated with the rest of your portfolio. If one area of your portfolio underperforms, other parts of your portfolio may outperform and help lessen the blow to overall returns. The goal is to reduce risk in order to boost your overall risk-adjusted returns over time.
Strategies to Diversify Risk with Income
Risk tolerance must be balanced with income expectations when building your portfolio. While diversifying into equities may increase diversification, the decrease in allocation to bonds could translate to lower income in retirement. The good news is that there are several strategies that you can use to increase portfolio income and diversification.
Some popular income-generation strategies include:
- Selling Options: Covered calls and other option strategies can generate an income from a stock portfolio that’s above and beyond what’s possible with dividends. The only trade-off is typically less upside potential over time.
- Sector Focus: Some stock market sectors generate more income than others—such as utilities or energy pipelines. By investing in these sectors, you can generate greater levels of income while retaining exposure to equities rather than bonds.
- Real Estate: Real estate investments generate income from rents while still retaining the possibility for capital appreciation. In addition, some of these investments provide tax benefits for investors that further increase their attractiveness.
If you’re interested in generating income by selling options, the Snider Investment Method provides a done-for-you strategy to manage risk and maximize income. Snider Advisors’ Lattco platform includes a covered call screener that makes it easy to identify opportunities and build out a portfolio while only making a handful of trades each month.
The Bottom Line
Investors always have a choice between risk and return—and these same principles apply to income generation. When balancing risk with income requirements, it’s helpful to seek out the right asset allocation (e.g., stocks versus bonds) and identify subsets of each asset class that generate the most income to meet your retirement goals.
If you’re interested in generating income from stock options, try our free e-courses to learn how to build the right strategy. If you’re looking for a hands-off approach, contact us to learn more about our asset management solutions.
Creating passive or residual income is the ultimate investment dream for many, and it can be achieved via real estate. In fact, savvy investors have been using real estate as a way to create residual income for decades. What exactly is residual income? Simply put, it is income that continues to be generated after the initial effort has been expended.
Unlike linear income, which is compensation that comes in the form of wages, commission, or salary, residual income allows you to continue seeing benefits long after the initial “work” has been done. Stock dividends, interest on notes, and rental property income are all examples.
If you’re interested in creating residual income through real estate, here are a few pointers:
Know your real estate investment options
There are several different ways to create residual income opportunities via real estate, and it’s important to research each one to determine what’s best for you and your goals. Consider these options:
- Investment properties: An investment property is one purchased with the sole purpose of earning revenue. It could be a commercial space you’ll lease out or a residential rental unit. Not only will this type of investment provide potential appreciation and tax benefits over the long term, but it can also provide residual income in the form of monthly rent (after expenses).
- Private equity funds: This is a collective investment fund that pools the money of many investors to invest in real estate, and real estate experts who have very stringent underwriting standards often run them. Keep in mind that these funds traditionally carry high investment minimums but can generate up to 20 percent of any profits earned (depending on the fund).
- Real estate investment trusts (REITs): These are primarily large portfolios of income-producing real estate, which are required by law to distribute 90 percent of their earnings to investors each year. There are both traded and nontraded REITs, with traded tending to correlate with market activity. REITs produce dividends similar to stocks.
Be smart about residual income
As you start out, be smart about the programs and types of investments you choose. If you decide to purchase a few investment properties, for example, be sure to research and use state and local incentive programs. Always look into HUD and pre-foreclosure options, which could allow you to purchase your first properties at a considerable discount.
You should also consult with your accountant to ensure that you’re up-to-speed on tax benefits, as they are one of the positive benefits that come from investing in real estate.
Identify who will manage the property
The premise of residual income is that you have little to no work to put in after the initial investment. If you choose REITs or PE funds, then you’re all set. But what if you choose investment properties?
Although most of the work will happen initially (making updates to the property, etc.), with real estate, there are always a few things that need to be taken care of here and there. Who will collect the rent? How will tenant issues be taken care of? Who will repaint when a tenant moves out?
From the beginning, be sure to determine how this work will be taken care of. Will you do it yourself? Will you hire a property manager? Calculate these costs when you’re evaluating your investment options.
Putting it together
Regardless of how you choose to pursue earning residual income, the most important aspect of investing in real estate is the calculation and evaluation of every opportunity that comes your way. Figure out which approach makes the most sense for your situation and come up with residual income goals that are attainable.
Diversification into different types of assets is one of the most efficient ways to build a portfolio that will bring in the residual income you desire.
Ready to jump into a real estate career? Learn the steps it takes to get your real estate license and get started today!
Anthony Battle is a CERTIFIED FINANCIAL PLANNER™ professional. He earned the Chartered Financial Consultant® designation for advanced financial planning, the Chartered Life Underwriter® designation for advanced insurance specialization, the Accredited Financial Counselor® for Financial Counseling and both the Retirement Income Certified Professional®, and Certified Retirement Counselor designations for advance retirement planning.
There is one main reason to invest your money, and that is so you have more to spend someday. It makes sense and is achievable for everyone to build wealth through investing, and maybe you don't want to work anymore. At the very least, you would like to not have to depend on a paycheck. Several options exist for creating a sustainable income through investing in assets that provide you with good, consistent returns.
- Dividends, interest income, and rents are all asset classes that can provide a sustainable income for retirees when they're used correctly.
- Investing in stocks or in a local business can produce dividends, and buying real estate can result in rental income from a tenant.
- Interest income is the safest class when it's produced by bank products such as certificates of deposit or by government bonds.
- It’s important to consider inflation when you’re planning what assets you want to use to meet your retirement goals.
How to Get Started
Your job as an investor is to buy or create sources of dividends, interest income, and rents. There are a few other options, but these three asset classes of dividends, interest income, and rents cover the investing needs for a vast majority of the population. You can do one or all of the following:
- Generate dividends by investing in stocks or private businesses such as a local bar held through an LLC.
- Generate interest income by loaning money to banks in the form of certificates of deposit, to corporations or governments (e.g., investing in bonds and municipal bonds), or to individuals, in the form of peer-to-peer loans.
- Generate rent by investing in real estate and letting other people use property that is yours while paying you for it, whether an apartment, office or storage unit.
People talk all day long about the wealth of Warren Buffett or Bill Gates. That wealth is simply income generated by underlying assets they own.
Both men own all three types of assets and collect billions of dollars each year. Some less well-known millionaires prefer to build up a portfolio of mid-tier hotels or restaurant franchises. Others are more content owning investments at the local bank and taking lucrative dividends on a portfolio of stock shares.
Applying the Philosophy
When it comes to putting this into practice in everyday life, you might want to practice a few analysis steps for different potential investment opportunities. Say, for example, that you are considering buying $25,000 worth of shares of Johnson & Johnson stock.
Suppose that, based on the current dividend yield, you would be "buying" cash dividend income of $908 per year plus any growth. The company has raised its dividend every year for decades, so you could try and project out the future dividend income.
By taking this approach, you can compare different investments. Calculate the annual cash flow that would come from other dividend stocks and interest-bearing instruments such as bank CDs. Put time into looking at potential real estate investments and figure out what kind of rent-producing buildings fit within your means, and how much monthly cash flow these investments could provide.
Don't Forget About Inflation and Taxes
Once you have begun collecting your dividends, interest, and rents, adjust them once a year for the rate of inflation and compare your “real,” after-tax income from year to year. Over time, the graph should be pointing upward so that your standard of living is increasing as you age.
Inflation counts, especially when you want to know how far your dollars go. It doesn’t matter as much how many dollars you have in the bank. What matters more is how many cheeseburgers you can buy with those dollars. It is your money’s purchasing power that counts.
How you get there, and what your ultimate investment portfolio turns out to be, is what remains to be uncovered. There are many self-made millionaires who have never owned a single share of publicly traded stock in their lifetime and never plan on doing so, either. How you put this in practice is entirely up to you, your temperament, and your resources.
Posted by Kindra K.
How to Calculate Current Assets
If you’re a new business owner, or a veteran looking to brush up on your accounting skills, we go over the definition of current assets, how to calculate current assets, different types of current assets, as well as non-current assets, current liabilities, long-term liabilities and more. Continue reading below to discover all there is to know about current assets, or use the provided jump links to navigate to a section that may answer your question on how to calculate current assets.