3 Things You Need To Know About Preferred Stock ETFs (Mianly, Tax-efficient yield: unlike a bond, the payments you receive are dividends and therefore taxed at a preferential rate to interest income.)

Cory Mitchell for ETFdb writes: Preferred stocks are just one popular market segment accessible through ETFs. Almost every corner of the global financial landscape can be traded via ETF, and with U.S. interest rates at all time lows, preferred shares and the ETFs associated with them are attracting additional investor attention [see also our visual guide to The Cheapest ETF For Every Investment Objective].What’s the Appeal?

A preferred share is like a hybrid between a common stock and a bond. When you buy preferred shares, you own a piece of the company and in exchange receive fixed dividend payments, which are set at issuance, along with the par value of the preferred stock.

The main benefits of owning preferred shares are:

• Tax-efficient yield: unlike a bond, the payments you receive are dividends and therefore taxed at a preferential rate to interest income.
• Predetermined dividend rate: With a preferred share you know what the dividend is. Unlike a common share where the dividend rate can be changed at any time, with a preferred share all provisions are laid out at issuance so you know your expected return. It is important to note though that there are different types of preferred shares. “Rate Reset” preferreds pay a fixed dividend up to the reset date, at which point the company can implement a new rate that will remain in effect until the next reset day [seeVisual Guide To Investing In Preferred Stock ETFs].
• Diversification: Preferred shares typically have a low correlation with bonds and common stocks since they are hybrid of the two.
• Higher Capital Structure Rank: In the event the company goes insolvent, preferred shareholders rank higher than common shareholders in their right to liquidation proceeds. Preferred shareholders are also paid out their dividends before common equity holders receive theirs. This provides more security than common shares.
• Lower Volatility: Preferred shares typically trade around the par value, making them less volatile than common stock, but more volatile than bonds. Preferreds represent the middle ground between bonds and common stock.

The main drawbacks are that capital appreciation is likely to be lower than what is available in the common equity market, and preferred shareholders don’t receive voting rights.

ETFs offer a way to own a basket of preferred shares, which provides more diversification than just owning a single stock, and is more efficient than buying multiple stocks. The iShares S&P 500 US Preferred Stock Index Fund (PFF) and the PowerShares Preferred Portfolio (PGX) are two of the largest and most popular ETFs in the space.

Interest Rates Matter

Like a bond, interest rates have an inverse effect on the price of preferred shares. When interest rates rise, this puts downward pressure on the price. When interest rates fall, this puts upward pressure on the price of preferred shares.  This is because the dividend payment is fixed, so if interest rates rise, the price will fall so that the new yield on the security is market competitive. Similarly, when interest rates fall, the price will rise to reduce the yield and once again make it market competitive [see 10 Questions About ETFs You've Been Too Afraid To Ask].

As Mariela Jobson–Vice President and portfolio manager at iShares–points out though, preferred shares are a hybrid; therefore you can’t expect the same direct price-to-interest rate relationship that’s seen in the bond market. Like common stock, a rosy outlook and rising interest rates due to a strong economy may also help bolster preferred shares, somewhat offsetting the negative price effect of rising interest rates.

The current Federal Reserve policy has been to keep rates low. The current target rate midway through 2013 is 0 to 0.25%, and has been since late 2008. The low yield offered in money market instruments has increased the popularity of higher yielding preferred shares. Preferred shares are likely to continue to hold prominence in a low interest rate environment, but will decline if interest rates are forced up. Unlike bonds though, preferred share ETFs are a hybrid, and therefore will likely be less negatively affected by rising interest rates.

Not All Preferred Stock ETFs Offer High Yields

One of the key benefits of preferred shares are that they typically offer attractive yields, but not all ETFS actually deliver on that.

For the 10 ETFs in the ETFdb Preferred Stock category, the range in yield varies from 6.02% down to 0.71% as of July 2, 2013. When putting investment dollars to work, picking the right preferred shares ETF matters.

Below, we highlight the top performing funds in the category according to dividend yield (as of July 10, 2013)  [see also How To Pick The Right ETF Every Time].

Ticker Symbol	ETF Name	Annual Dividend Yield (%)	Expense Ratio
SPFF	Global X SuperIncome Preferred ETF	6.15%	0.58%
PGX	PowerShares Preferred Portfolio	6.09%	0.50%
PGF	PowerShares Financial Preferred Portfolio	6.01%	0.60%
PSK	SPDR Wells Fargo Preferred Stock ETF	5.00%	0.45%

Bottom Line

Preferred shares are a hybrid between common stocks and bonds, offering a fixed dividend but no voting rights. An ETF allows you to buy a diversified basket of preferred shares with the convenience of one purchase. Not all preferred share ETFs are created equal, though, and annual dividend yields vary drastically, so choose carefully. Preferred share prices move inversely to interest rates, so if interest rates rise this will put downward pressure on the price. But since preferreds also have common stock characteristics, the negative impact of rising interest rates is likely to be somewhat subdued relative to the impact on bonds.

Advisers, Gens X-Y Find Common Ground with ETFs

• MURRAY COLEMAN for the Wall St Journal writes: 
While most older investors stick to traditional mutual funds, exchange-traded funds are appealing to the generation that has grown up with them.

That could be key for advisers seeking younger clients.

At stake is an estimated $1 trillion a year in wealth expected to be transferred by older investors to younger generations over the next four decades. Those up-and-comers, often referred to as Generations X and Y, range in age from 18 to their upper-40s.

By some counts, the Gens X and Y population has already surpassed that of baby boomers who are near or already in retirement. Despite such a shift in demographics, those younger investors make up just 3% of the advisory industry's client base, say analysts at Cogent Research.

Other recent research supports such views. In a survey of more than 1,000 independent advisers, Charles SchwabCorp. SCHW +1.02% (SCHW) found that 65% of those surveyed predicted that Gens X and Y, along with women, would become a driving force in profitability five years from now. But only 14% listed those types of investors as an immediate priority.

"Generation X and Y investors haven't grabbed much attention from advisers yet," says Linda York, a Cogent vice president. "They're generally less-advanced in their careers and less-affluent in terms of their savings."

But a common ground might be forming as more advisers turn to ETFs.

Almost half of affluent investors under the age of 30 own ETFs, according to Cogent. That compares to less than 10% usage by older first- and second-wave baby boomers with $100,000 or more in investable assets.

At the same time, more than 70% of U.S. advisers say they now use such funds, Ms. York points out. "ETFs are letting advisers refine their approaches to investment management," she says.

That's a key when dealing with younger mass-affluent clients, says Matt Reiner, chief investment officer at Atlanta-based Capital Investment Advisors in Atlanta, with $1.1 billion in assets. "With more affluent investors, we can use institutional-level mutual funds that require higher minimum investments," he says. "With a bigger pool of assets, we can also buy enough individual securities to build well-diversified portfolios."

In 2011, his firm helped to launch a separate advisory service, Wela Strategies. Its portfolios are almost entirely made up of ETFs, providing an opportunity for many of Capital Investment's more sophisticated strategies to be made available to investors with as little as $10,000 in assets, Mr. Reiner says.

The startup has attracted about $60 million in assets so far. "ETFs give us the ability to adapt a management process that's based on institutional-level research to manage portfolios for younger and mass-affluent investors," Mr. Reiner says.

Big brokerages such as Bank of America's BAC +2.00% (BAC) Merrill Lynch are also trying to make inroads with mass-affluent investors, largely through online and phone-based services to manage portfolios. A host of software firms have sprouted up touting Internet-based advice as well.

"Increasingly, we're seeing advisers putting together portfolios of ETFs as an appealing and cost-effective way to service younger investors," says Aite Group analyst Sophie Schmitt.

In some cases, technology and demographics are coming together to make more advisers sit up and take notice of mass-affluent investors, says C.J. Rendic, founder of Parallel Advisors in San Francisco with about $500 million in assets.

About half of the firm's client base is comprised of Gens X and Y investors, he estimates. Part of that is due to the adviser's proximity to technology mavens such asGoogle Inc. GOOG +0.30% (GOOG) and Salesforce.com Inc. CRM +2.19% (CRM). But another factor that Mr. Rendic points to is that most of the firm's advisers and managers are in their 30s or 40s.

His staff is adept at communicating through social media, he adds, and relates to wealth-management issues facing Gens X and Y as they grow older. The combination has led the firm to promote an investment philosophy built around low costs, tax efficiency and transparency, Mr. Rendic says.

"The lower fee structures and index-bias presented by ETFs seem to resonate with Gen X and Gen Y investors. They've become a key part of our growth," he says.

Mutual Funds and ETF Tax Differences

IV Lions writes: Let’s look at one common tax difference between exchange traded funds (ETFs) and mutual funds. Should an investor redeem their shares with a mutual fund, the fund will often need to sell some of the portfolio to meet the redemption request. If the assets sold generate capital gains (the manager sells the positions for more than they bought them), the fund is required by law to pass these on to remaining shareholders.

This redemption process carries on all year and if the net result is a year-end realized capital gain then this burden is reported to remaining shareholders, who may not be expecting a tax bill (especially if they bought their shares towards the end of the year, or the fund experienced large unrealized losses during the year – a real 2008 nasty).

The potential for this unexpected tax burden may be avoided with an ETF as the redemption process is different. ETFs may create and redeem shares with in-kind transactions that are not considered sales and therefore don’t create tax events. This is great news for the retail investor as it avoids the potential tax burden associated with mutual funds redemption process.

However, ETF’s are not all born equally and may have their own tax pitfalls which I will address in a separate blog. It is critical to understand the tax treatment of your ETF in order to avoid any surprizes such as an unexpected K1.

BackOps raises $7M to grow workforce of moms making business better / BackOps provides cloud-based accounting, HR, and finance services on a subscription basis. Its approach combines software with the expertise of a crowd sourced pool of stay-at-home moms who help businesses keep their back office operations running smoothly.

Rebecca Grant for VentureBeat writes: BackOps is assembling an army of moms dedicated to supporting small businesses.

BackOps provides cloud-based accounting, HR, and finance services on a subscription basis. Its approach combines software with the expertise of a crowd sourced pool of stay-at-home moms, known as “riveters,” who help businesses keep their back office operations running smoothly.

Today the company announced raising $7 million to add more riveters into its ranks and scale its platform.

Founder and CEO Kristen Koh Goldstein spent 15 years working in finance and serving as a Chief Financial Officer, helping startups with their back office operations. She said there was a reverse financial incentive to stay efficient and that the various components of the back office often don’t communicate with each other. She was spending as much as a third of her time coordinating back office vendors and saw an opportunity to create a service that would take care of all of this, so business owners could focus on their business.

Backoffice software has been around for a long time. NetSuite, Salesforce, SAP, Zoho, Intuit, WorkDay (and more) all offer technology along these lines. BackOps stands out by including a highly-trained, educated workforce of women in its service to provide an extra (and significant) layer of support.

“There are so many rote, repetitive processes to running a small business and they can be so inefficient and ridden with human error,” Goldstein said in an interview with VentureBeat. “Most small businesses don’t have an internal staff of people to handle these tasks or run complicated software, so they are stuck. Our experience for CEOs is different. We allow them to take care of the back office needs in just 10-to-15 minutes a week. If they have any questions or concerns, they can immediately contact someone who is uniquely qualified to answer that question.”

BackOps customers receive an automated email every week with an overview of what is happening. All documents are stored in the cloud and real-time information is accessible from a central dashboard. Customers receive notifications whenever they need to log in and make approvals.

Each business is also assigned a “platoon” of riveters for those times when a human touch is needed, which Goldstein said is often for entrepreneurs without a lot of experience or resources. The riveters are a vetted force of stay-at-home moms who spent most of their professional lives helping to run businesses. Many have MBAs or CPAs, but left to raise a family. BackOps allows them to maintain a career from home.

“We systematically strip women of their professional identity at their most productive years, and this isn’t ok,” Goldstein said. “Women shouldn’t have to give up being home with their kids for a cubicle job existence. This field isn’t as time-sensitive as others, but people still get penalized for taking advantage of flexibility or standing up to leave at 4 o’clock. BackOps means moms don’t have to choose between their kids and their job.”

Goldstein talked about “mommy magic time” — or the hours between 4 and 8 pm when it is important to spend time with kids. She said riveters can work when they are able, but don’t have to worry about leaving for baseball games or dance recitals. The riveters make up a collaborative community and step in to help each other when needed. BackOps is on track to have 200 riveters and customers by the end of the calendar year and this financing will support that growth. The company is also releasing new software products on “2 week sprints” and will continue to keep up this pace.

Shervin Pishevar’s Sherpa Ventures and e.ventures co-led this round, with participating from Google Ventures and seed investor CrunchFund and Mark Pincus. This is the first investment for Sherpa Ventures, and Pishevar said in a statement that BackOps is a defining company in the sharing economy space.

Women in the workplace has been widely discussed over the past year. Marissa Mayer’s assumption as Yahoo CEO while pregnant and controversial no-work-from-home policy, as well as the popularity of Sheryl Sandberg’s Lean In have caused people in the tech community, as well as across the business world, to consider more closely how our society deals with working mothers. It can be difficult to rejoin the workforce after taking time off, but many parents feel strongly about being at home with their kids. Koh said that many companies are adopting progressive policies that are flexible on the surface, but there is still a stigma associated with taking advantage of that flexibility. Change has to come from the top, and also from startups developing innovative solutions to this problem.

BackOps is based in San Francisco.

The Experts: The Biggest 401(k) Mistakes to Avoid

Journal Reports for the Wall St Journal writes: What is the biggest mistake people make with their 401(k)s? The Wall Street Journal put this question to The Experts, an exclusive group of industry and academic thought leaders who engage in in-depth online discussions of topics from the print Report. This question relates to a recent article about how IRA payments may avoid state income tax and formed the basis of a discussion in The Experts stream on July 11.

Carl Wiens

The Experts will discuss topics raised in this month's Investing in Funds & ETFs Report and other Wall Street Journal Reports. Find the finance Experts stream, watch recent interactive videos and explore a host of other exciting online content at WSJ.com/WealthReport.

Also be sure to watch investment adviser Tom Brakke(@researchpuzzler), blogger Mike Piper (@michaelrpiper) and University of California, Berkeley, Professor Terrance Odean in an interactive video chat that aired on July 8 in which they  discussed strategies for coping with market volatility.

Terrance Odean: Don't Hold On to Your Own Company's Stock

What is the biggest mistake people make with their 401(k)s? Buying and holding their employer's stock in a 401(k). If your company gives you stock, by all means take it. But sell it soon after you are allowed to do so. If your company does great, you may regret not having loaded up on its stock, but not as much as you will regret losing your life savings along with your job if your company folds (as happened to some Enron employees who had 100% of their 401(k) plan invested in Enron stock).

Terrance Odean is the Rudd Family Foundation professor and chairman of the finance group at Haas School of Business, University of California, Berkeley.

Manisha Thakor: Act According to Your Age

The biggest mistake I see with 401(k)s is being too conservative in their investment approach when they are young and too aggressive with their investment approach when older.

It's understandable. When you first start investing in a 401k the $50, $100 or more that you are contributing a pay period feels like a huge bite out of your paycheck. Thus a natural tendency is to want to protect that hard-earned money. Yet because this money is intended not to be accessed until you are at least 59½ years old, your early years are exactly the ones where you should be taking the most risk. When a person is in their 20s, 30s and early 40s I like to see them as close to 100% in equities as they can stomach in their 401(k).

Conversely, I notice individuals in their late 40s and into their 50s often panicking that they did not save enough early on, so they try to make up for lost time by increasing the aggressiveness of their portfolio holdings. A better option would be to save more and plan to work a wee bit longer. The compound effect of those two activities, statistically speaking, will give you greater odds of getting where you want to go versus swinging for the fences with a hyperaggressive allocation when you don't have the years to make up for a significant loss of principal.

Manisha Thakor (@ManishaThakor) is founder and chief executive of Santa Fe, N.M.-based MoneyZen Wealth Management LLC.

Sheryl Garrett: Stop the Excuses and Save More

There are many common mistakes we see; however, I'd have to say that the biggest one is lack of sufficient savings. If you haven't been saving at least 10% of your gross income since your 20s, you're probably not saving enough for retirement.

Some people fear that the market is too volatile or risky for them to invest. Others argue that they just can't afford to save or save much right now. Well folks, it rarely gets any better. If you can't afford to save for your future now, what's going to change? When you're in the accumulation phase, volatility can work to your advantage. Time becomes your enemy as the power of compound interest can't work for you.

Start or increase your savings rate by 2%. You'll hardly notice it. After three to six months, bump it up another 2%. Over time, you'll get your savings rate up to the place it needs to be. Give yourself some time, but be persistent.

Sheryl Garrett (@SherylGarrett) is founder of the Garrett Planning Network Inc.

Tom Brakke: Different Features, Different Pitfalls to Avoid

It really depends on the features of a particular 401(k) plan. Some people put too much into their company stock, for example. Borrowing against the plan can inhibit the building of a long-term nest egg. Often, people invest in too many different investments, usually based upon past performance figures. All of those approaches are problematic.

The right strategy will depend on the available options in the plan, which are determined by the plan sponsor rather than the investor. Too often, the options have fees that are too high. A simple, cheap index-fund approach is probably the best for most people, but many plan sponsors don't provide that alternative. That's unfortunate.

Tom Brakke (@researchpuzzler) is a consultant, writer and investment adviser who specializes in the analysis of investment decision making and the communication of investment ideas.

George Papadopoulos: Maximize Contributions as Early as Possible

With so many potential mistakes to choose from, it is no easy task to pick the biggest: undercontributing, not signing up for the plan because "we cannot afford it" (you cannot afford to not afford it!), picking high-cost funds (sometimes the fund lineup does not have any low-cost funds), not diversifying, not rebalancing at least once a year, borrowing from the plan to pay off other debts, not rolling over the plan to an IRA after switching jobs, and on it goes. If I must pick one, I think the biggest mistake is not maximizing contributions at the earliest possible time to take full advantage of the compounding and tax savings.

George Papadopoulos (@feeonlyplanner) is a fee-only wealth manager in Novi, Mich., serving affluent individuals and families.

Christian Magoon: Apathy Is Not the Answer

401(k)s are often treated as second-class citizens by investors when it comes to monitoring performance, fees and asset allocation. This might be explained by the fairly painless contributions that workers make to 401(k)s or the mind set that accessing 401(k) funds is years, if not decades, away. Whatever the case, many investors allow apathy to be the primary investment strategy in these retirement engines. Sadly, for many workers 401(k) assets will be the primary source of income in their golden years.

Christian Magoon (@ChristianMagoon) is founder and chief executive of YieldShares, an income-focused ETF sponsor.

Rafael Pardo: Capture the Full Benefits of Your Employer's Matching Contribution

People often make the mistake of failing to contribute the amount required to trigger the maximum amount of matching contributions that their employer will make to their 401(k) retirement accounts. Many employers will match an employee's 401(k) contributions up to a certain percentage of the employee's regular salary in stepwise increments. For example, consider an employer whose retirement plan provides that the employer will match up to 5% of the employee's regular salary in the following manner: By matching with a 2.5% contribution for the first 2.5% of regular salary contributed by the employee and by matching with another 2.5% contribution for the second 2.5% of regular salary contributed by the employee. Based on this example, an employee who contributes 2% of regular salary would fail to trigger any matching contribution by the employer. And an employee who contributes 4% of regular salary would trigger only a 2.5% matching contribution by the employer. By failing to contribute more, both employees end up leaving a significant amount of money on the table: As I've previously written in this column, harnessing the power of compounding is critical to having sufficient retirement savings. If you don't capitalize on the full extent of your employer's matching contribution, you make the journey toward retirement security more of an uphill climb than it needs to be.

Rafael Pardo (@bankruptcyprof) is the Robert T. Thompson Professor of Law at Emory University, where he specializes in bankruptcy and commercial law.

Greg McBride: What Seems Safe Is Risky

People don't save enough and don't invest aggressively enough in their retirement savings. Investing too conservatively compounds the problem of not saving enough because the meager savings will not grow into a sufficient nest egg when hunkering down in conservative, low-return investments. Over the long haul, what is considered safe—cash and bonds—is actually quite risky, while what is considered risky—equities—is actually a much safer bet to get you to your long-range financial goals. Especially for young people, it is urgent to harness the power of compounding provided by higher return investments. But even those on the cusp of retirement may need this money to last a quarter century or more, so a healthy allocation to equities is warranted.

Greg McBride (@BankrateGreg) is a senior financial analyst and vice president for Bankrate.com, providing analysis and advice on personal finance.

Michelle Perry Higgins: Hands Off That Account!

What is the biggest mistake people make with their 401(k)s? Tapping into their funds today, thinking they won't need them tomorrow. I've seen so many people try to rationalize that pulling out retirement funds to meet immediate pressing needs is OK. I completely understand how challenging it is for Americans to pay their bills on a monthly basis. Everything from the mortgage to their children's sports activities is a drain on finances, and that makes things difficult. It can sometimes be easy to justify present wants as being more important than future needs. However, you must make your retirement savings a priority and don't procrastinate in adding to your 401(k) account. Most importantly, do not withdraw your retirement savings until you are well into your golden years. If you can do that, I promise that you will thank me later.

Michelle Perry Higgins (@RetirementMPH) is a financial planner and principal at California Financial Advisors.

Matt Hougan: The Secret's In the Saving

Mistake 1: Not saving enough.

Mistake 2: Being too conservative (you probably need more equity exposure than you think).

Mistake 3: Having a concentrated position in company stock. (Your job is tied to the company's success; isn't that enough?)

Mistake 4: Did I mention not saving enough? That's really the only mistake that matters.

Matt Hougan (@Matt_Hougan) is president of ETF analytics and global head of editorial for IndexUniverse LLC.

Charles Rotblut: No Second-Guessing

There is a large amount of evidence showing that people do not manage their 401(k) plans in a disciplined manner. Rather, they choose funds at the time they start the plan and then panic and sell those funds when they see a 401(k) statement during the midst of a bear market. Compounding matters is that many people do not even truly understand what they are investing in.

The reality is that with a little effort and discipline, a person with even nominal knowledge of investing can significantly increase the long-term performance of his 401(k) plan. Using an asset-allocation model from a reputable source (such as the one we have on AAII.com) can help you determine which asset classes you should be invested in. Then pick the lowest-cost funds for each asset class. Once a year, review your allocations and adjust your portfolio back to target if each fund's allocation has strayed five percentage points or more off target (e.g., your target large-cap stock allocation is 30%, but large-cap stocks now only account for 24% of your portfolio's value).

Alternatively, you can buy a target-date fund maturing near the year you turn 65 or 70. This fund handles all of the allocation decisions for you and is meant to be held into retirement. It may be more costly, but it requires less effort on your part.

Most importantly, do not second-guess your choices, especially during a bear market. The average holding period for a mutual fund is less than four years, according to research firm DALBAR. This short holding period causes the average equity-fund investor to realize a return about half of what they would have earned if they had just stayed invested and not second-guessed their decisions.

Charles Rotblut (@charlesrotblut) is a vice president with the American Association of Individual Investors.

Rick Ferri: Diversification Isn't Always the Answer

Oddly, 401(k) participants can be hurt by overdiversification. If a 401(k) plan has index funds, then they are the only investments needed in each asset class. If a plan doesn't have index funds, plan participants shouldn't overdiversify among several actively managed mutual funds within each asset class because this strategy actually lowers the probability for success.

In "A Case for Index Fund Portfolios," a newly released white paper I co-wrote, we show that a portfolio holding one actively managed fund in each asset class has a low probability of outperforming a similar portfolio holding only index funds. The odds get worse when an investor selects two or more actively managed funds in each asset class, which is often the case with participants in 401(k) plans. People do this because they believe they are diversifying their holdings, but this strategy actually lowers their probability for success.

The strategy with the highest probability for success is a portfolio of all index funds. However, if you don't have index funds in a 401(k) and must select from actively managed funds, then pick one actively managed fund per asset class and hope for the best.

Rick Ferri is founder of Portfolio Solutions LLC and the author of six books on low-cost index-fund and ETF investing. His blog is RickFerri.com.

Guarding Your "Tax" Identity From Being Stolen

Carole B. Sheffield for Anderson Kill & Olick, P.C. writes: Summer is upon us and the 2013 tax season is a distant memory — for most of us, including our estate planning and tax clients here at Anderson Kill. Yet, in 2012 I learned firsthand why the 2012 tax season might continue indefinitely, thanks to the successful efforts of a tax identity thief who fraudulently claimed our son's 2011 tax refund.

The stolen refund was truly an eye-opener because there were no conventional clues. On the contrary, it was a rejected, electronically "e-filed" IRS Form 1040 personal income tax return that triggered an eight-month journey into the unknown with the IRS to resolve our son's refund fraud case.

Our son was and is not alone. Tax identity theft is on the rise. Little has been written on the topic from the victim's perspective. Thus, the purpose of this article is to share the details of the IRS tax fraud resolution process — and to warn clients how to protect themselves from identity theft.

Tax Identity Theft Defined and Discovered

Tax identity theft occurs when someone illegally uses a taxpayer's name and Social Security number to fraudulently claim a refund. The actual filed tax return appears authentic, except that the attached Form W-2 is entirely falsified and the reported wage and withheld tax data are completely fabricated.

The typical scammer e-files early in the tax season, before the unsuspecting victim may have even received the required W-2 and 1099 forms. Then, when the victim files, the legitimate tax return is rejected by the IRS because the system shows that a return has already been filed. In the meantime, the fraudulent refund has been deposited to the thief's prepaid credit or debit card.

Scope of Tax Refund Fraud and Cost

Tax authorities consistently report the same trend — tax identity theft has been rising significantly since 2008. From 2008 to partial year 2012, tax identity theft cases increased by more than 650 percent.

Tax year 2011 offers the most comprehensive statistical picture. The IRS processed about 145 million returns in 2011 and of those returns filed, approximately 1.5 million returns were confirmed tax identity theft victims, representing a cost in stolen refunds of more than $5.2 billion.

Reporting Tax Identity Theft

If you find yourself a possible tax identity theft victim, act quickly and report your case to the IRS. On the IRS website (www.irs.gov), under "Taxpayer Guide to Identity Theft," the IRS provides critical reporting steps. You should file Form 14039, Identity Theft Affidavit, and contemporaneously:

• If you receive a notice or letter from the IRS, respond immediately to the name and number found in the notice or letter.
• If you suspect you are a victim of tax identity theft, as with our son's rejected e-filed return, or if you have conclusive evidence of tax refund fraud, immediately call the IRS Identity Protection Specialized Unit (IPSU) at 1-800-908-4490.

Case Opened — Expectations

Once your case is opened with the IPSU, expect regular IRS correspondence about every 45 days to provide a status update of its "research" necessary to complete your matter. The number of letters you receive depends on the success of the IRS in nabbing the perpetrator. It is the IRS's refund policy for tax identity victims that the IRS does not issue refunds until the alleged fraudster has been identified. In our son's case he received two such letters before his refund was electronically deposited into his bank account, without notice from the IRS.

Case Closed — Expectations

Hooray! The tax refund was received, with interest (as required under the Internal Revenue Code). What next? The IRS then wrote in mid-December 2012 to say it had placed an identity theft indicator on our son's account for his protection. Also, in late December the IRS assigned a unique six-digit IP PIN, or identity protection personal identification number, to ensure the IRS that his 2012 filed return would be "really from you."

Caution: The IP PIN was not easily found in the notice. In fact, early in this process an IRS agent warned me that the IP PIN would arrive "buried" in a notice. This was true. The IP PIN was found in an unassuming separate sentence nestled in the midst of the entire notice — it was difficult to find.

A final notice from the IRS, dated December 31, 2012, officially confirmed the tax fraud for much needed closure and advised that the notice be kept with our son's tax records.

Guard Your Tax Identity — Indefinitely

The IRS never told us how our son's tax identity was stolen. However, the IRS agent indicated that computer "hacking" into our son's place of employment was a strong possibility. The following tips are recommended to protect your tax identity from theft:

• Never carry your Social Security card or any documents containing your Social Security number or individual taxpayer identification number on them.
• Check your financial information online, frequently.
• Review your credit reports annually (Equifax, Experian and TransUnion).
• Keep personal information stored in your home securely.
• Maintain personal computer protection by using firewalls and anti-spam/virus software, updating security patches, changing your Internet account passwords often, and recording and keeping them in a secure location.
• Protect financial information by shredding documents before discarding them.
• Respond to genuine IRS correspondence promptly; however, do not click on links or open attachments from emails claiming to be from the IRS.
• Never give personal information over the phone, through the mail or on the Internet unless you have initiated the contact or you know the party.

Should you learn that you are a tax identity victim, please stay calm — the government stands behind you as a taxpayer and Anderson Kill is available to guide you through the resolution process.

How Not To Blow A Financial Windfall

Erik Carter for Forbes writes: Have you ever received a windfall of money and had no idea what to do with it? Actually, I’m sure you had lots of ideas of how to spend it but you may have felt conflicted about the best way to make the money work for you in the long run. Should you pay down debt, add to savings, or invest it and where?

This may not seem like much of a problem to have but according to the National Endowment for Financial Education, as many as 70% of Americans who will receive a sudden windfall will lose it all within a few years. Even worse, it can cause you to feel richer than you are and develop habits of overspending that can be hard to break once the windfall is gone. Even a seemingly one-time splurge like a luxury car will continue to cost you in higher maintenance and insurance bills long after the initial car purchase. So whether your windfall is from a prize, a tax refund, a bonus, a sale of a home, or an inheritance, here are some things to consider:

Do you have enough emergency savings?

Your first priority should be to have some money set aside in case of an emergency. Start with at least $1k in the bank to cover routine emergencies like car and home repairs. Ideally, you’ll want to build up enough savings to cover necessary expenses like your rent or mortgage, car payment, utility bills, and groceries for at least 3-6 months in case you’re ever in between jobs for that long. To be on the safe side, you may even want enough to cover 6-12 months. This money should be kept somewhere safe and accessible like a bank account or money market fund, not invested in anything risky.

Are you maxing the match in your employer’s retirement plan?

If not, you’re leaving free money on the table and there are not a lot of other places I know where you can get a 50-100% guaranteed return on your money. If your windfall is a bonus, you should be able to increase your retirement plan contributions for that paycheck. If not, you generally can’t write a check from your windfall to your 401(k) but there is a roundabout way of getting the money in there by temporarily increasing your retirement plan contributions and using the windfall to cover the shortfall in your paycheck.

Do you have any high interest debt?

The next priority should be paying off high interest debt like credit cards or payday loans. That’s because if the interest rate is over 6-8%, it’s more than you can reasonably expect to earn by investing that money instead. (You can use this Debt Blaster calculator to see how much interest you can save and how much sooner you can be debt free by putting extra money towards your debt, starting with the highest interest balances.) On the other hand, lower interest debt like mortgages, car loans, and many student loans can be considered good debt because you can typically earn more in the long run by investing the money than you would save in interest by paying those debts off sooner. Of course, there’s also the emotional factor of how you feel about being debt-free vs. having a larger nest egg.

Do you have access to a health savings account?

If you have a qualified high-deductible health insurance plan, this year you can contribute up to $3,250 for a single person or $6,450 for a family plus an additional $1k in either case if you’re over age 55. This money has the double tax benefit of going in pre-tax and coming out tax-free if used for qualified health care expenses. Unlike flexible spending accounts, anything you don’t use can be rolled over for a future year and can eventually be withdrawn after age 65 for any reason without a penalty (otherwise you have to pay taxes plus a 20% penalty for non-qualified withdrawals before age 65). Given the fact that you’re almost certain to have health care costs in retirement, there’s actually a good argument to try to cover your health care costs out-of-pocket and let your health savings account grow tax-free, especially if you’re allowed to invest the account in mutual funds for the long run. After all, you wouldn’t withdraw money early from your retirement accounts if there was no penalty, would you? Speaking of retirement…

Are you on track for retirement?

If you’re not sure, see if your employer or retirement plan provider has a tool like Financial Engines to help you project your retirement income or you can use our simple retirement plan estimator. If you need to save more, we already discussed how you can use a windfall to contribute more to your 401(k). You can also contribute up to $5,500 this year (plus another $1k if you’re over age 50) to a traditional or Roth IRA. The former may be tax-deductible and grows tax-deferred while the latter provides no tax benefit now but grows to be tax-free after age 59 1/2 as long as you’ve had the account open for at least 5 years. They can also be used penalty-free for education expenses or for up to $10k of costs related to a first-time home purchase.

Roth IRAs have an additional little-known benefit in that the sum of your contributions can be withdrawn tax and penalty free anytime for any reason. That means you can actually use it as part of your emergency fund too. If you do that, just be sure to keep the Roth IRA invested somewhere safe like a bank account or money market fund until you have enough emergency savings outside the account. At that point, you can invest the Roth IRA more aggressively for retirement.

If you earn too much income to contribute to a Roth IRA, there’s actually a backdoor way to get around that by simply contributing to a traditional IRA and then converting it into a Roth IRA since there is no income limit on conversions. The only caveat is that if you have other pre-tax IRAs, you’ll have to pay tax on part of the money you convert. However, you can avoid that as well by first rolling those other IRAs into your employer’s retirement plan.

If you’ve maxed out your retirement accounts but still want to save more for retirement, don’t be afraid of investing in a regular brokerage or mutual fund account too. Since you’ll have to pay taxes on these accounts, you’ll want to use them for your most tax-efficient investments like tax-free municipal bonds, individual stocks, and low turnover stock mutual funds. Stocks and stock funds are taxed at lower capital gains rates as long as you hold them for at least 12 months and you can benefit from their higher volatility by taking the inevitable losses off of your taxes. If you never sell them, they can eventually be passed on to your heirs tax-free. International stocks particularly make sense in taxable accounts since you’ll also be eligible to take the foreign tax credit on taxes paid overseas, which you can’t do in a tax-sheltered retirement account.

Finally, buying a home can also be considered part of your retirement plan. After all, having a paid-off home in retirement means not having to pay for housing, which could otherwise be a significant expense. You can also invest in real estate for rental income or free up the equity in your home by downsizing or taking a reverse mortgage. You can learn more about the steps in buying a home here.

Do you have future education expenses?

Only once you’ve gotten all your other ducks in a row should you set money aside for education expenses. After all, there is no financial aid for retirement. But if all your other needs are taken care of, you can save money that grows tax-free for qualified education expenses in 529 or Coverdell Education Saving accounts. 529 accounts also have estate planning benefits in that you can gift up to 5 years’ worth of annual gift-tax exemptions upfront (a total of $70k per person) without having to file a gift tax return. The money comes out of your estate but you can still control how it’s invested and how and for whom it’s used. You can learn more about these accounts at SavingforCollege.com.

Of course, you can always decide to use at least part of the money to treat yourself. Just be sure to weigh the temporary pleasure that this brings with the longer term satisfaction of having more financial peace of mind. Otherwise, your windfall could end up like this.