Casey Clay Hall's Finance Blog

401(k) Plan Rollover Options

2016-10-10T12:00:00.000-05:00

Option One: Keep your assets in a previous employer’s 401(k) plan.

Advantages
• No immediate action is required.
• Investments remain tax-deferred until withdrawn.
• Account funds can be borrowed if plan loans are permitted.
• Partial distribution or installment payments may be available.
• Assets are typically protected from creditors and legal judgements.
• Penalty-free withdrawals are permitted if separated from service at age 55 or older.
• May have lower administrative or investment fees and expenses than a new 401(k) or IRA.

Disadvantages

• Contributions of new money may no longer be accepted to the plan.

• Investment choices and ability to transfer assets among investments may be limited.

• Distribution options may be restrictive or limited regarding the timing and amount.

• Cannot convert traditional 401(k) assets to Roth 401(k) if plan does not offer Roth 401(k).

• May have higher administrative or investment fees and expenses than a new 401(k) or IRA.

• Managing savings left in multiple plans can be complicated.

Option Two: Roll over your assets to a new employer’s 401(k) plan.

Advantages

• Investments remain tax-deferred until withdrawn.

• Account funds can be borrowed if plan loans are permitted.

• Assets are typically protected from creditors and legal judgements.

• Penalty-free withdrawals are permitted if separated from service at age 55 or older.

• Required minimum distributions (RMDs) can be delayed past age 70½ if still working.

• May have lower administrative or investment fees and expenses than a new 401(k) or IRA.

Disadvantages

• Investments from old plan may need to be liquidated before rolling over to new plan.

• Rolling over company stock from previous employer may have negative tax consequences.

• Investment choices and ability to transfer assets among investments may be limited.

• Distribution options may be restrictive or limited regarding the timing and amount.

• Cannot convert traditional 401(k) assets to Roth 401(k) if plan does not offer Roth 401(k).

• May have higher administrative or investment fees and expenses than old 401(k) or an IRA.

Option Three: Roll over your assets to an Individual Retirement Account (IRA).

Advantages

• Investments remain tax-deferred until withdrawn.

• Investment choices not available in a 401(k) plan may be available in an IRA.

• Multiple retirement accounts may be consolidated to an IRA to simplify management.

• IRA distribution amounts and timing can be at the discretion of the account owner.

• IRA assets may be converted to a Roth IRA at the discretion of the account owner.

• May have lower administrative or investment fees and expenses than a 401(k) plan.

Disadvantages

• Account funds cannot be borrowed from an IRA as with a 401(k).

• Investments from a 401(k) plan may need to be liquidated before rolling over to an IRA.

• Rolling over company stock from a 401(k) plan may have negative tax consequences.

• Penalty-free withdrawals are generally not permitted before age 59½ with some exceptions.

• Required minimum distributions (RMDs) cannot be delayed past age 70½ even if working.

• May have higher administrative or investment fees and expenses than a 401(k) plan.

Option Four: Receive your assets as a cash distribution.

Advantages
• Immediate access to the assets in the 401(k) plan.

Disadvantages
• Total distribution taxed as ordinary income in one year.
• Possible early withdrawal penalty if under age age 59½.
• Removes tax-deferred growth status on savings.
• Reduces savings designated for retirement.

Permanent Life Insurance

2016-09-22T12:00:00.000-05:00

Life insurance companies generally offer two types of policies: temporary and permanent. The temporary, often called term life insurance, can provide an insured person a fixed death benefit for an increasing premium amount as he ages or a declining death benefit for a fixed premium amount as he ages. The premiums must increase and/or the death benefit must decrease because the probability of dying increases with age, which makes the cost of life insurance higher for older people than for younger people. Term life insurance is considered temporary because at some point, the premiums for the cost of insurance will equal the death benefit for the policy, which makes the policy worthless. Some term life insurance consumers did not like the idea of paying higher premiums as they age for a fixed death benefit or paying the same premiums as they age for a declining death benefit, so the insurance companies invented permanent life insurance.

The permanent, often called whole life insurance, can provide an insured person a fixed death benefit amount for his whole life with a fixed premium amount for his whole life. The premiums do not increase with age because the premiums are more than the actual cost of the life insurance. The insurance company applies part of the premiums to the cost of insurance and the excess portion of the premiums to a cash account for the insured person. When the insured person dies, the life insurance death benefit will be paid first from that person's cash account, and then any shortfall will be paid by the insurance company. As the insured person's cash account balance increases, the portion of the death benefit that will be paid by the insurance company decreases, possibly down to zero. Because the insurance company has a decreasing death benefit liability, it does not need to increase premiums as the insured person ages, and it can stop charging premiums once the insured person's cash account is large enough to pay the entire death benefit.

Consumers should recognize permanent life insurance is simply term life insurance with the added feature of a savings or investment account. Both term life and whole life can charge a fixed premium amount for a decreasing amount of life insurance coverage as the insured person ages. The difference is the whole life death benefit will remain constant because the increasing cash account balance will replace the declining insurance coverage, while the term life death benefit will decline because it has no cash account to replace the declining insurance coverage. The trade-off is whole life insurance must charge the insured person higher premiums than term life insurance in order to accumulate that cash account balance. Consumers may prefer to purchase term life insurance for the lower premiums and then contribute the difference in premiums to their own savings or investment account, separate from the insurance policy.

Mortgage Refinance

2016-09-06T12:00:00.000-05:00

Mortgages are loans you obtain to buy a home and usually charge you a fixed interest rate for the life of the loan. Mortgage interest rates have been relatively low the past five years compared to historical averages. Recently, it has been a good time to refinance mortgages that have high interest rates from more than five years ago. A mortgage refinance allows you to pay off your current mortgage and obtain a new mortgage with a lower interest rate. Interest rates are still at historically low levels, so now may be a good time to refinance your mortgage if you have not already. The following examples show how a mortgage refinance could be beneficial.

Several years ago, you obtained a $150,000 mortgage at 6% interest for 30 years, and your monthly payment is $899. Since that time, you have paid down your mortgage balance to $120,000 and want to refinance at a lower interest rate. You could refinance the $120,000 mortgage at 4% interest for 30 years, and your new monthly payment would be $573. The refinance significantly reduces your monthly payment amount. However, this would restart your 30-year mortgage payment schedule and extend the time required to pay off your mortgage.

To avoid extending the payment years on your mortgage, you could refinance your 30-year mortgage to a 15-year mortgage. Your current mortgage balance of $120,000 at 6% interest for 30 years requires a monthly payment of $899. Your new refinanced mortgage of $120,000 at 4% interest for 15 years would require a monthly payment of $888. The lower interest rate could allow you to reduce the mortgage payment years without increasing your monthly payment amount.

You could alternatively refinance to a 30-year mortgage at a lower interest rate but continue to make your same monthly payment. Your current mortgage balance of $120,000 at 6% interest for 30 years requires a monthly payment of $899. You could refinance the $120,000 mortgage at 4% interest for 30 years and continue monthly payments of $899. This would allow you to pay off the refinanced mortgage in approximately 14.7 years rather than the full 30 years as scheduled.

If you are interested in refinancing, compare your current mortgage interest rate to the current average interest rate for new mortgages with the same number of payment years as your mortgage. If your current interest rate is more than 1% higher than the current average rate, contact mortgage lenders to request refinancing quotes. Their quotes should show you the terms of the new mortgage and the refinancing costs. Mortgage refinancing is not free, so your mortgage interest savings need to be more than the refinancing costs. The refinancing costs may be more than your mortgage interest savings if you have few years of payments remaining or the new interest rate is not significantly lower than your current rate. You may receive "no cost" refinancing offers that simply add the refinancing costs into your mortgage balance, so you pay the cost over time rather than up front. The "no cost" refinancing can ultimately be more expensive because you will also pay interest on the refinancing costs that are rolled into your mortgage balance.

Mortgage lenders are not a fiduciary, which means they are not required to do what is best for you. The lenders have an incentive for you to refinance even if it does not save you money because they will collect their refinancing fees from you either way. You may want to contact a CFP® professional who is not your lender if you need unbiased advice regarding your mortgage.

FAFSA Schedule Changes

2016-08-18T12:00:00.000-05:00

The Free Application for Federal Student Aid (FAFSA) should be completed by every student planning to attend college the next school year. The FAFSA not only allows students to possibly receive financial aid from the federal government but also from state governments and from the colleges themselves. The financial aid may be need-based or non-need-based, and the students have full liberty to accept or decline the financial aid offers received as a result of the application.

Students desiring financial aid for the 2016-2017 school year were able to submit their FAFSA as early as January 1, 2016 using their income tax return information from the 2015 calendar year. This presented a problem because most taxpayers do not have their prior year's income information ready on January 1 because their income tax return filing deadline is not until April 15. The federal government decided to change the FAFSA schedule to alleviate this problem.

Students desiring financial aid for the 2017-2018 school year will be able to submit their FAFSA as early as October 1, 2016 using their income information from the 2015 calendar year. Most taxpayers should have their prior year's income information ready before October 1 each year because they will have submitted their tax returns by then. This schedule change was made permanent, so students desiring financial aid for the 2018-2019 school year will be able to submit their FAFSA as early as October 1, 2017 using their income tax data from the 2016 calendar year.

Submitting the FAFSA as early as possible is important because students who apply early typically receive more financial aid offers than students who apply later. The states and schools have different deadlines on when they must receive the FAFSA data, and some offer their financial aid packages on a first-come, first-served basis. The schedule change should make the FAFSA filing process easier because most students will have the income tax return information they need by October 1 each year. Go to fafsa.ed.gov for additional details regarding the FAFSA.

Return vs Gain vs Yield

2016-08-01T12:00:00.000-05:00

The performance of investments is commonly evaluated with percentage measurements such as yield, gain, and return. What is the difference between these measurements?

Yield is the income you receive from an investment, calculated as the amount of income distribution divided by the value of your investment. If you have a $100 investment that pays out $5 of interest or dividend income per year, then the annual yield is 5%.

Gain is the change in value of your investment, calculated as the price change divided by your original investment price. If you pay $100 for an investment, and the value increases to $110, then the gain is 10%. If the value decreases to $90, then the gain is negative 10%, meaning a loss.

Return is a combination of yield and gain, calculated by summing the income plus the price change and then dividing by the original investment price. If you pay $100 for an investment, it pays out $5 of income, and its value increases to $110, then your total return is 15%.

Although the yield, gain, and return percentages may all be used to evaluate investment performance, investors should recognize they measure different types of performance.

Property Tax Is An Unfair Tax

2016-07-05T12:00:00.000-05:00

Most taxes we pay are transactional-based. You pay income tax when you earn paychecks. You pay sales tax when you purchase products. You pay capital gains tax when you sell investments. You may pay gift tax when you give away assets. There is one tax we pay that is not based on a transaction: property tax. You do not pay property tax because you buy real estate or sell real estate. You pay property tax simply because you own real estate. Is that fair to homeowners?

Because most taxes are paid as a result of money changing hands, we can reduce the amount of taxes we pay by strategically planning our financial transactions. For example, you can pay less income tax by earning smaller paychecks or pay less sales tax by purchasing fewer products. You cannot pay less property tax by spending less time in your home. The only way you can avoid paying property tax is to not own a home or other real estate in areas that have a property tax.

The amount of property tax you pay is usually based on the market value of the real estate you own, so you can somewhat limit property tax you pay by purchasing a home with a lower market value. However, you have little control over the future market value of your home and the future property tax you will pay. When the property taxing authorities say your home value increased, your property tax will increase also. You realized no financial gain from the appreciation of your home value, but you must still pay for that appreciation through a property tax increase.

Taxes that are transactional-based are justifiable because the taxpayer has either realized a financial benefit from the transaction or had some ability to limit the financial impact of the transaction. Property tax is unfair because the taxpayer does not realize a financial gain from simply owning the real estate and cannot freeze the market value of the real estate on which the property tax is calculated. Rather than annually tax the market value of real estate owned, a more fair method would be to treat real estate the same as any other investment asset, by which the owner only pays capital gains tax on the property appreciation at the time of sale.

Marriage and Income Taxes

2016-06-06T12:00:00.000-05:00

Do married couples pay more or less income tax than single people? It depends on the individual incomes of each married partner. If each partner has taxable income of more than $75,950 per year, then they probably pay more income tax as married than they would as single. If one partner has taxable income of more than $60,750 per year and the other partner has taxable income of more than $91,150 per year, then they probably pay more income tax as married than they would as single. If one partner has taxable income of more than $41,300 per year and the other partner has taxable income of more than $190,150 per year, then they probably pay more income tax as married than they would as single. Why do married couples often pay more income tax than they would if they were single?

If you review the current federal income tax brackets, you may notice the tax brackets for married couples are not all double the tax brackets for single people. For taxpayers in the 10% or 15% marginal tax brackets, the taxable income ranges for married couples are double the taxable income ranges for single people, but for taxpayers in the 25% or higher marginal tax brackets, the taxable income ranges for married couples are less than double the taxable income ranges for single people. This can effectively penalize higher-income individuals who decide to get married. For example, two single individuals each with taxable income of $90,000 per year will not have any of their income taxed above the 25% marginal rate when single, but after getting married, they will have $28,100 of their combined income taxed at the 28% marginal rate.

We have a progressive federal income tax system, in which high-income people pay higher tax rates than low-income people. A progressive tax system does not mean married couples should pay higher income tax rates than single people. The combined income of a married couple is usually the same as the sum of their individual incomes; therefore, combining their incomes after marriage should not cause either of them to pay higher income tax rates. A more fair system would be to make the taxable income ranges for married couples exactly double the taxable income ranges for single people at every marginal tax bracket. This currently applies to the 10% and 15% marginal tax brackets but should be equally applied to the 25% and higher marginal tax brackets. We should not penalize any couples for getting married by possibly making them pay higher income tax rates.

All amounts referenced above are based on the 2016 federal income tax rate schedules.

Charitable Donations of Appreciated Securities

2016-05-16T12:00:00.000-05:00

If you donate appreciated securities you have owned for more than one year (long-term capital gain property) directly to an IRS-qualified charitable organization:

1. You can avoid paying capital gains tax on the appreciated value of the securities.

2. You can include the market value of the donated securities in your itemized deductions.

Because the securities are donated rather than sold, capital gains tax from selling the securities does not apply. The securities must be donated in-kind rather than sold to cash before donation.

The market value of a publicly traded security donated to charity is calculated as the average of the high price and low price on the date of transfer to the charitable organization.

If you donate appreciated securities you have owned for one year or less (short-term capital gain property), you can only deduct your cost basis in the securities (the price you paid for it).

IRS 50% limit tax-exempt organizations:

1. Donations of cash and short-term capital gain property are deductible up to 50% of AGI.

2. Donations of long-term capital gain property are deductible up to 30% of AGI.

IRS 30% limit tax-exempt organizations:

1. Donations of cash and short-term capital gain property are deductible up to 30% of AGI.

2. Donations of long-term capital gain property are deductible up to 20% of AGI.

For donations exceeding the above limits, the IRS allows you to carryforward the unused deduction amount for up to five years.

After applying the above limits, your charitable donations may also be subject to the overall limit on itemized deductions.

If your adjusted gross income (AGI) in 2016 exceeds $259,400 for filing single or $311,300 for married filing jointly, your total itemized deductions will be reduced by the smaller of:

A. 80% of your itemized deductions affected by the limit, or

B. 3% of the amount by which your AGI exceeds $259,400 if filing single or $311,300 if married filing jointly.

Example: If your 2016 AGI is $600,000 for married filing jointly and itemized deductions are $30,000, your itemized deductions would be reduced by $8,661. ($600,000 - $311,300 = $288,700 x 3% = $8,661)

In this example, increasing your charitable donations would not further reduce your itemized deductions. Only an increase in your AGI would further reduce your itemized deductions.

Your itemized deduction for charitable donations is not reduced if you are subject to Alternative Minimum Tax (AMT). The itemized deduction for charitable donations is allowed under both the regular income tax calculation and the AMT calculation.

Social Security File And Suspend Deadline

2016-04-25T18:00:00.000-05:00

April 29, 2016 is the deadline for which individuals currently between ages 66 and 70 can file and suspend their Social Security benefits in order to delay their own benefits while at the same time allowing their spouses or dependents to receive benefits on their records. Individuals must file and suspend benefits before this deadline if they wish to delay their own benefits while allowing their spouses or dependents to receive benefits on their records. Individuals who suspend benefits after this deadline will cause the benefits their spouses or dependents are receiving based on their records to be suspended at that same time. Under the new rules, any spousal or dependent benefits available on an individual’s record will only be paid when that individual is currently receiving benefits.

Individuals who have earned enough work credits can file for their Social Security benefits any time between ages 62 and 70, but can suspend their benefits only between their full retirement age and 70. The full retirement age is 66 for those currently eligible to suspend benefits. Individuals cannot meet the file and suspend deadline of April 29, 2016 if they are younger than age 66 as of that date. They may be old enough to file for Social Security benefits, but they would not be able to suspend their benefits until reaching their full retirement age, which would occur after April 29, 2016. Because individuals younger than age 66 are not yet old enough to suspend their Social Security benefits, they should not yet file for benefits unless they are ready to begin receiving benefits at this time.

IRA Qualified Charitable Distribution

2016-03-03T12:00:00.000-06:00

The current tax law allows individuals age 70.5 and older to exclude from their gross income Qualified Charitable Distributions (QCDs) of up to $100,000 per year from their Individual Retirement Accounts (IRAs) and have the QCDs apply toward their Required Minimum Distributions (RMDs) for the year. IRA distributions to the IRA owner that are contributed to charity do not qualify; the distributions must be paid directly from the IRA to the charity.

Assume a 71-year-old gentleman wants to donate $5,000 to a qualified charitable organization. He distributes $5,000 from his IRA to his checking account and then writes a check to the charity. The $5,000 distribution from his IRA will be included in his gross income for the year. If he does not itemize deductions on his tax return because his standard deduction is higher, the gentleman will not receive any tax benefit from his $5,000 charitable donation. The additional $5,000 of gross income may also cause a larger portion of his Social Security benefits to be taxable.

Assume that same 71-year-old gentleman instructs his IRA custodian to write a $5,000 check from his IRA made payable to a qualified charitable organization and has the custodian send the check directly to the charity. He never takes possession of the $5,000 distribution from his IRA, so the amount is excluded from his gross income and ignored as part of his tax deductions. Therefore, he realizes the full tax benefit of his $5,000 charitable donation regardless of whether he itemizes deductions on his tax return. Also, his IRA distribution sent directly to charity will not increase the amount of his Social Security benefits that are taxable.

This tax law has existed for nearly a decade, but Congress historically extended the law in only one-year increments as part of larger legislation packages. Congress made permanent this tax law among several others with the passage of the PATH Act of 2015.

Spouse Inherited Retirement Accounts

2016-02-02T12:00:00.000-06:00

Individuals who have an IRA (individual retirement account) or other retirement plan account can designate a beneficiary to receive the remaining money in their account after their death. If you are the beneficiary of your spouse's IRA, you should consider your options for inheriting the account after your spouse dies. Generally, you should prefer options that allow you the most flexibility for IRA distributions, which would be to take withdrawals from the IRA before your age 59.5 without penalty and/or delay withdrawals from the IRA past your age 70.5 without penalty.

When you inherit an IRA from your deceased spouse, you can transfer the IRA assets to your own IRA, transfer the the assets to an Inherited IRA, or distribute the assets in a lump-sum. The lump-sum distribution is usually the worst option unless you need all the money immediately because the entire IRA balance will be included in your taxable income for that year, which can push you into a higher marginal tax bracket and cause you to pay higher income taxes that year.

If you transfer the assets to an Inherited IRA, you can withdraw from the account at any age without penalty, and you can delay Required Minimum Distributions from the IRA until the year your spouse would have turned age 70.5. If your spouse was already older than age 70.5, you must begin Required Minimum Distributions the year following your spouse's death. This option is best if you are younger than age 59.5 and your spouse was your age or younger than you.

If you transfer the assets to your own IRA, the inherited money is treated the same as your own money in your own IRA. You cannot withdraw from the IRA before your age 59.5 without penalty, and you must take annual Required Minimum Distributions from the IRA after your age 70.5. This option is best if you are older than age 59.5 and your spouse was your age or older than you.

The above rules apply to IRAs with before-tax contributions, such as the Traditional IRA, SEP IRA, or SIMPLE IRA. However, the Roth IRA, which contains only after-tax contributions, should be considered separately because of different rules regarding Required Minimum Distributions.

When you inherit a Roth IRA from your deceased spouse, you can transfer the Roth IRA assets to your own Roth IRA, transfer the the assets to an Inherited Roth IRA, or distribute the assets in a lump-sum. A lump-sum distribution from the Roth IRA is usually the worst option unless you need the money immediately. Although the Roth IRA distribution is excluded from taxable income for that year, all future investment earnings on assets outside the Roth IRA will be taxable; whereas, the investment earnings could have been tax-free if earned on assets in the Roth IRA.

If you transfer the assets to an Inherited Roth IRA, you can withdraw from the account at any age without penalty, and you can delay Required Minimum Distributions from the IRA until the year your spouse would have turned age 70.5. If your spouse was already older than age 70.5, you must begin Required Minimum Distributions the year following your spouse's death. This option is usually not best because you can avoid the Required Minimum Distributions with the next option.

If you transfer the assets to your own Roth IRA, the inherited money is treated the same as your own money in your own Roth IRA. You can withdraw from the Roth IRA after your age 59.5 without penalty, and you have no Required Minimum Distributions from the Roth IRA after your age 70.5. For withdrawals before your age 59.5, only the earnings portion is subject to tax and penalty; the basis is always tax-free. This option is usually best because it provides the most flexibility for your Roth IRA distributions.

When inheriting an IRA or Roth IRA from your spouse, you should consider your current age, the age of your deceased spouse, when you will need the IRA money, and the type of IRA you are inheriting. Consult with your financial advisor to determine which inheritance option is most appropriate for you based on your financial plan. Refer to IRS Publication 590 for additional details regarding distribution options for IRA beneficiaries.

College Financial Aid Formula

2016-01-06T12:00:00.000-06:00

Paying for college is a major financial challenge for most families. Fortunately, financial aid may be available to help them with the cost. Students can apply for need-based and non-need-based financial aid by submitting the Free Application for Federal Student Aid (FAFSA). A student's financial need is calculated as the difference between the cost of attending college and the expected family contribution toward paying that cost. In other words, the cost of attendance minus the expected family contribution equals the student's financial need.

The cost of attendance (COA) is the total cost of tuition and fees, books and supplies, room and board, transportation, and miscellaneous personal expenses. The COA is different for different schools depending on their specific costs. The higher the COA is for a school, the higher the student's financial need will be for that school. So students attending higher-cost schools will generally receive more financial aid than economically-similar students attending lower-cost schools. In some cases, a student who cannot qualify for financial aid at a low-cost community college may qualify for financial aid at a high-cost private university.

The expected family contribution (EFC) is more complicated. The EFC is how much the family is expected to be able to pay for college based on both the student's and the parents' income and assets. 50% of the student's income that exceeds $6,300 per year (the standard deduction amount) and 20% of the student's assets are considered available to pay for college. Up to 47% of the parents' discretionary income and up to 5.64% of the parent's non-retirement assets may be considered. The parents' contribution is divided by the number of children they currently have in college, so the more children in college, the lower the expected contribution from the parents.

The amount of financial aid a student is eligible to receive can increase when either the COA increases or the EFC decreases. Families should submit the FAFSA for every year they have a student attending college to determine how much financial aid they are eligible to receive.

Why to Delay Social Security to Age 70

2015-12-14T12:00:00.000-06:00

This article is based on information from “Fitting Social Security into a Retirement Income Plan” presented by Wade Pfau, Ph.D., CFA in October 2015.

Social Security claiming strategies have become a hot topic. The claiming strategies attempt to evaluate when an individual should begin receiving Social Security benefits, between ages 62 and 70. The decision process for single people without dependents is pretty simple, but the decision process is more complicated for married couples who must also consider the value of spousal benefits and survivor benefits. Social Security claiming decisions are especially important for lower-income and middle-income families because Social Security may be the main source of income for them in retirement.

Individuals who start receiving Social Security benefits at their full retirement age will receive their full benefit amount. Full retirement is age 66 for people born before 1955, between ages 66 and 67 for people born from 1955 to 1960, or age 67 for people born in 1960 and later. Individuals can start receiving retirement benefits anytime between ages 62 and 70, but Social Security will adjust their benefit amount based on when they start benefits relative to their full retirement age. People who start benefits at age 62 will have their full retirement benefit permanently reduced by 25% to 30%, and people who delay benefits to age 70 will have their full retirement benefit permanently increased by 24% to 32%. This increase is why it can be advantageous to delay Social Security benefits to age 70.

The basic argument for why to delay Social Security benefits can fit into the idea of Pascal’s Wager. Blaise Pascal was a philosopher who argued we should believe in God because the consequences of believing in a God who does not exist are much less than the consequences of not believing in a God who does exist. Similarly, one could argue that we should delay claiming Social Security benefits because the consequences of delaying are much less than the consequences of not delaying. If you start benefits early and you die early in retirement, then you probably made a good decision because you received some benefits before you died. If you start benefits late and you die early in retirement, then there is minimal harm done because you died before spending all the money you saved for retirement. The biggest disadvantage to delaying benefits and dying early is you will leave a smaller inheritance because you need to spend more of your savings in the early years of retirement, but by dying early, you will certainly leave a larger inheritance than you would have if you had lived a long life. If you start benefits early at age 62 and live long enough to spend everything you saved for retirement, then your spending after that point will be limited to your smallest possible Social Security benefit. If you start benefits late at age 70 and live long enough to spend everything you saved for retirement, then your spending after that point will be funded by your highest possible Social Security benefit. Using Pascal’s Wager, we can see that the consequences of delaying benefits and dying before spending all your money are not as bad as the consequences of claiming benefits early and spending all your money before you die.

Social Security claiming decisions often revolve around a breakeven analysis. A breakeven analysis solves for the age you would need to live beyond to realize the advantage of delaying Social Security. The breakeven point is usually around age 80 to 84. If you expect to die before the breakeven age, you would start benefits early, but if you expect to live beyond the breakeven age, you would delay benefits to later. Framing the question around a breakeven analysis often causes people to claim benefits early in case they die before reaching age 80 to 84. However, this protects against the wrong risk. People should consider delaying benefits in case they live beyond age 80 to 84. If you delay benefits and die before reaching the breakeven age, you will not feel bad about making the wrong decision because you will be dead!

Social Security should really be considered as longevity insurance. Social Security provides longevity risk protection because delaying benefits means you will receive higher benefits for life regardless of how long you live. Risk averse individuals realize even more benefit from delaying Social Security because they have less aggressive investment portfolios and are not sacrificing as much upside potential on the investment value of their benefits. Social Security is like insurance because it is an inflation-adjusted lifetime annuity backed by the government and can provide spousal, family, and survivor benefits.

Although Social Security should be thought of as insurance rather than an investment, delaying Social Security can also be advantageous from an investment perspective. The claiming age choice was meant to be actuarially fair based on calculations from the Social Security reform legislation in 1983. However, interest rates have declined since then. The Social Security actuaries in 1983 based their calculations on the underlying assets for Social Security earning a 2.9% compounded real (inflation-adjusted) return. For comparison, the current real yield on 30-Year TIPS is 1.2%. Attempts to achieve a higher return than this would require taking more investment risk than is present with Social Security. Also, average life expectancy has improved since the 1983 actuarial calculations. The calculations were based on the whole population, but wealthier individuals have longer life expectancies than the population average, and therefore have more reason to delay benefits. Couples also benefit from having a joint life expectancy, in which there is a higher probability that at least one spouse will live longer than average, and the surviving spouse will receive the higher benefit amount between the two of them.

There is sometimes confusion on what is the return from delaying Social Security. The benefit amount increases by 8% for each year Social Security is delayed, but that is not the return. The relevant return is the 2.9% compounded real return assumed earned on the underlying assets for Social Security based on the average life expectancy from the 1983 actuarial calculations. Calculating the compounded real return from delaying Social Security requires you to assume an age of death because you must consider the total income received over a lifetime. The compounded real return is 3.2% for a healthy male who delays benefits from age 62 to age 70 and lives the current average life expectancy. The compounded real return is 4% for a healthy female who delays benefits from age 62 to age 70 and lives the current average life expectancy. The compounded real return is 5.2% for a healthy couple who delays benefits from age 62 to age 70 and lives the average joint life expectancy to age 90. These are inflation-adjusted returns, so add the inflation rate to these figures before comparing them to the compounded nominal return that we normally see quoted in investment return data. Even though it is more appropriate to consider Social Security as insurance, delaying benefits still looks attractive from an investment perspective.

Delaying Social Security can improve portfolio sustainability, or allow an individual to spend more with the same amount of assets. Assume a 62-year-old retired single woman has an $800,000 investment portfolio and wants to spend $60,000 per year in retirement. Her Social Security benefit options are $22,500 per year starting at age 62, $30,000 per year starting at age 66, or $39,600 per year starting at age 70. She withdraws from her investment portfolio each year the difference between her $60,000 spending and her Social Security benefit amount. If she claimed Social Security at age 62, she would receive $22,500 per year from Social Security and withdraw $37,500 per year from her portfolio. Her portfolio withdrawal rate would be 4.69%, which is the annual withdrawal amount divided by the initial portfolio balance. If she claimed Social Security at age 70, she would withdraw $60,000 per year from her portfolio from ages 62 to 70, and then starting at age 70, she would receive $39,600 per year from Social Security and withdraw $20,400 per year from her portfolio. She should segregate $316,800 from her $800,000 portfolio, which represents 8 years of the age-70 benefit amount, to fund the 8 years of lost income by delaying benefits to age 70. That would leave her $483,200 remaining in the portfolio to fund her withdrawals of $20,400 per year starting at age 62, which is the difference between her $60,000 spending and age-70 benefit amount. In this case, her withdrawal rate would be 4.22%. This shows that delaying Social Security to age 70 can reduce the portfolio withdrawal rate, and a lower withdrawal rate means the portfolio can fund more years of withdrawals. If she were not interested in funding more years of withdrawals, she could instead increase her annual withdrawal amount and have the same probability of portfolio depletion as she would have had by claiming Social Security at age 62.

Any plan for delaying Social Security assumes your investment portfolio can support larger withdrawals between retirement and starting Social Security to fully fund your spending those years. By claiming Social Security early at age 62, you would not withdraw from your investment portfolio as much in the early years of retirement compared to how much you would have needed to withdraw early by delaying Social Security to age 70. However, by claiming Social Security early at age 62, you would depend on your investment portfolio for more income in the later years of retirement and could fully deplete your investment portfolio sooner in retirement than you would have by delaying Social Security to age 70.

Another way to evaluate the investment value of delaying Social Security benefits is to calculate the present values of the lifetime benefits received based on a discount rate and an assumed life expectancy. Delaying Social Security will look more attractive in evaluations that assume a lower discount rate or a longer the life expectancy. Assuming a life expectancy to age 90 and a real discount rate of 0% or 2%, the present value of Social Security benefits starting at age 70 is higher than the present value of benefits starting at age 62, and the present value of the needed investment portfolio when starting benefits at age 70 is lower than the present value of the needed investment portfolio when starting benefits at age 62. The opposite would be true when assuming a real discount rate of 6%, in which case the present value of benefits starting at age 62 would be higher, and the present value of the needed investment portfolio when starting benefits at age 62 would be lower. However, earning a 6% compounded real return, which would be a higher nominal return after adding inflation back in, would be difficult over an 8-year period. If you were to invest the Social Security benefits in the stock market, you would be taking a relatively secure, government-backed insurance product and subjecting it to the investment risks of the stock market.

Delaying Social Security benefits can also provide some tax planning opportunities. People who have stopped working but have not yet started Social Security benefits may currently have low incomes and low marginal tax rates as a result. They could realize income these years by making Roth conversions or selling capital gains to take advantage having that income taxed at their currently low marginal tax rate. For example, a 62-year-old couple whose income is limited to $20,600 of Roth conversions and $74,900 of long-term capital gains and qualified dividends would owe $0 in federal income tax. This can also help their tax situation later in retirement because the Roth conversions will lower their RMDs from the tax-deferred accounts, and realizing the capital gains will increase their cost basis in the after-tax accounts.

There are several arguments people use for why they should claim Social Security early. Some arguments make more sense than others. Having a terminal illness is one compelling reason to claim benefits early. The breakeven analysis usually shows the breakeven point around age 80 to 84, so you may want to claim benefits early if you have a valid medical opinion from a doctor that you will not live that long. However, you should also remember the value of survivor benefits. If your spouse’s Social Security benefit is lower than yours, his or her benefit amount will step up to your benefit amount after your death, so delaying your benefits can increase both your benefit and the survivor benefit your spouse will receive. Healthy people may want to claim Social Security early when viewing the breakeven analysis because they think the breakeven age of age 80 to 84 is too far away. However, age 80 to 84 is currently less than average life expectancy for 62-year-old people, so they have a better than 50% chance of living beyond that age. They should try to keep in mind Pascal’s Wager and the insurance value of Social Security.

Retired people may need to claim Social Security benefits early if they do not have enough savings to independently support themselves during the years they would be delaying benefits. Ideally, they would continue working if they did not have enough savings to support themselves until age 70 without Social Security, but this may not be possible if they are forced into early retirement due to uncontrollable circumstances. Unfortunately, not having the flexibility to delay Social Security means they must claim the lower benefit amount at an early age and lock in a permanently reduced standard of living.

Some people claim Social Security early because they fear the financial instability of the Social Security program, so they want to receive their benefits before it goes bankrupt. Social Security was originally intended to pay out benefits equal to the revenue it collected, but that has not been the case. Social Security is paying out more than it is collecting due to improving mortality rates, declining fertility rates, and overly generous benefits relative to worker contributions. The 2014 Social Security trustees report projected the Social Security trust fund will be depleted in 2032, but Social Security would not disappear at that time. Starting in 2033, new contributions to the Social Security trust fund would still cover 75% of benefit payments. A solution as simple as raising the current 12.8% Social Security payroll tax to 15.68% at this time would cover the projected funding needs for the next 75 years. There are several other reform options being discussed, such as increasing the maximum taxable earnings, raising the full retirement age, and reducing the cost-of-living-adjustments, which could extend the life of the Social Security program.

Another argument people use for claiming Social Security early is they could invest their benefits in the stock market and earn a higher return than they would realize from delaying Social Security. However, you have to make an unreasonable assumption about the return you could earn on your invested benefits. You cannot simply base your return assumption on the long-term performance history of the stock market because you have to consider your limited chances of achieving that return over a short 8 years, from ages 62 to 70. By investing Social Security benefits, you are taking a safe asset and making it risky.

Another argument people use for claiming Social Security early is to decrease the sequence risk on their investment portfolio. This is because delaying Social Security requires you to take larger withdrawals from your portfolio in the early years of retirement, which can hurt the longevity of your portfolio if you experience a lot of market volatility in those years. This sequence risk would be true if you are trying to fund the initial years of retirement from a volatile investment portfolio, but you can reduce this risk by segregating from your portfolio an amount equal to 8 years of the age-70 Social Security benefits and investing that portion more conservatively. Delaying Social Security is like buying an income annuity at a better rate than anything available in the annuity market. You can put that amount representing 8 years of Social Security benefits in a safe investment because you do not need a high rate of return on that portion of your portfolio in order for delaying benefits to be advantageous.

There is no universal answer for when to claim Social Security. Individual circumstances regarding life expectancy, marital status, risk tolerance, investment assets, and other income sources will affect the decision process. Social Security is best evaluated as part of a comprehensive retirement plan.

Short-Term Disability Insurance

2015-11-30T12:00:00.000-06:00

Disability insurance allows individuals to receive payments equal to some percentage of their earned income during a period of time when they are unable to work and earn income due to either a short-term or a long-term disability they have suffered. Short-term disability insurance provides coverage for disabilities lasting weeks or months, depending on the policy, while long-term disability insurance usually provides coverage for disabilities lasting multiple years. Long-term disability insurance is appropriate for many working individuals because they do not have adequate savings accumulated to live without earned income for multiple years or the remainder of their lives. However, most people can do without short-term disability insurance if they have a sufficient emergency fund to cover their necessary expenses during a few months without income.

Assume a company offers employees the option to purchase short-term disability insurance that will cover a disability lasting up to six weeks. After a one week waiting period, the insurance benefits will replace 55% of the employee's earnings over the remaining five weeks of the disability coverage period. So an employee who earns $1,000 per week could receive disability insurance benefits of $550 per week over a maximum of five weeks for a total of $2,750. For this coverage, the employee must regularly pay disability insurance premiums equaling 42 cents per $100 of income, so if the employee earns $1,000 per week, the premiums would be $4.20 per week. Over a 50-week work year, that amounts to premiums payments of $210 per year.

In the above example, the employee is paying $210 per year to protect against a potential loss of up to $2,750 of earned income. The employee could probably do without this short-term disability insurance coverage if he would just increase his emergency fund savings by $2,750. He could accumulate that amount by contributing the $210 per year to a savings account for 13 years. If the employee expects to suffer a short-term disability within the next 13 years, he could possibly receive enough disability insurance benefits to recover all the insurance premiums he paid, but if 13 years pass without a disability, he will not collect more than he has paid. Workers who have a very limited risk for suffering a short-term disability and are able to maintain a large enough emergency fund to cover a few months of their necessary expenses are probably safe going without short-term disability insurance.

Budget Deal Changes Social Security Claiming Options

2015-11-09T12:00:00.000-06:00

The Bipartisan Budget Act of 2015, recently enacted on November 2nd, includes some rule changes for Social Security. The new law eliminates a couple claiming strategies that married couples could use to maximize the total benefits they receive from Social Security. The rule changes will not apply to individuals who have already implemented these claiming strategies.

The file and suspend strategy allowed an individual to file and suspend his Social Security benefits once he reached full retirement age so his spouse could begin collecting spousal benefits on his record while he continued to accumulate delayed retirement credits. Under the new law, an individual can still file and suspend his benefits after he reaches full retirement age, but when he suspends his benefits, any benefits his spouse is collecting on his record will also be suspended. Therefore, filing and suspending benefits will provide no advantage compared to simply delaying benefits. Individuals who filed and suspended benefits at full retirement age also reserved the option to later receive a lump-sum payment of all the benefits they would have received since they filed and suspended, but this option will no longer be available. These new file and suspend rules do not apply to people who have already filed and suspended or people who will file and suspend within 180 days of the law being enacted, or approximately before April 30, 2016.

The restricted claim strategy allowed an individual who had reached full retirement age to restrict her Social Security application to spousal benefits only so she could continue to delay her own benefits for the purpose of accumulating delayed retirement credits. Under the new law, individuals will no longer be able to restrict their claims to just spousal benefits, even if they have reached full retirement age. Individuals will now receive the higher of their own benefit or their spousal benefit, without the ability to delay their own. The same changes will apply to divorced individuals who are eligible to collect spousal benefits on the record of their ex-spouse. These new restricted application rules do not apply to people who reach age 62 before January 1, 2016. The claiming options are not changing for surviving spouses; they will still be able to restrict their claims to either survivor benefits or their own benefits while they continue to delay the other.

Another effect of the new budget deal is Medicare Part B premiums will not be increasing as much next year as previously planned. Part B premiums were expected to increase 52% next year for all new enrollees and Medicare beneficiaries who are not yet collecting Social Security or do not have premiums withheld from their Social Security. The cost increase will now be partially financed by a new loan, so Part B premiums are expected to increase just 15% next year for those individuals. Medicare beneficiaries will be charged an additional $3 per month until the loan is paid back.

The removal of these Social Security claiming options may be viewed as a negative for many married couples since they will not be able to collect as much benefits as previously planned, but on the positive side, changes that reduce the amount of benefits Social Security must pay per year will extend the number of years Social Security will be able to pay benefits.

Retirement Withdrawal Strategies

2015-10-12T14:00:00.000-05:00

The following information is based on a presentation by Dr. William Reichenstein regarding “Tax-Efficient Withdrawal Strategies” by Kirsten Cook, William Myer, and William Reichenstein, and published in the Financial Analysts Journal for March/April 2015.

Conventional wisdom for portfolio distributions is to withdraw from taxable accounts first, then from tax-deferred accounts, and lastly from Roth accounts. This withdrawal strategy is recommended by the three largest mutual fund companies: Vanguard, Fidelity, and American Funds. This improves the longevity of a portfolio compared to the opposite strategy of withdrawing from Roth accounts first, then from tax-deferred accounts, and lastly from taxable accounts. However, this strategy does not evenly distribute the tax liability over an investor’s lifetime. Bunching up the tax-deferred withdrawals maximizes the tax liability in those years, and bunching up the Roth withdrawals minimizes the tax liability in those years.

The portfolio longevity can be extended by spreading out the tax-deferred withdrawals over an investor’s lifetime. Each year, the investor would first withdraw from the tax-deferred account to maximize taxes paid in the 15% tax bracket, and then withdraw from the taxable account for any additional need that year. Once the taxable account is fully depleted, the investor would continue to withdraw from the tax-deferred account each year to maximize taxes in the 15% bracket, and then withdraw from the Roth account for any additional need that year. This way the investor never pays more than 15% tax on withdrawals from the tax-deferred account. Withdrawals from the taxable account would not trigger taxes more than 15%, assuming the realized capital gains are long-term, and all withdrawals from the Roth would be tax-free. This strategy can also reduce the RMDs after age 70.5 because the earlier withdrawals from the tax-deferred account reduced the balance on which the RMDs are calculated.

A withdrawal strategy to extend the portfolio longevity even further would be to convert from the tax-deferred account to a Roth account each year the amount that would allow the investor to maximize taxes paid in the 15% tax bracket. The investor would withdraw 100% of the retirement need from the taxable account in these years. Once the taxable account is fully depleted, the investor would withdraw from the tax-deferred account each year to maximize taxes in the 15% bracket, and then withdraw from the Roth account for any additional need that year. This withdrawal strategy extends the portfolio longevity because it depletes the least tax-efficient portion of the portfolio first (the taxable account) and shifts more assets to the most tax-efficient portion of the portfolio (the Roth account). The longevity advantage depends in part on the size of the taxable account.

Building on the Roth conversion strategy, an investor could make two separate Roth conversions at the beginning of each year, with each conversion equaling the amount to maximize taxes in the 15% bracket. At the end of the year, the investor recharacterizes the Roth conversion that has the lower balance and keeps the Roth conversion that has the higher balance. This is valuable because taxes are paid on the amount converted, not the investment growth on the amount converted. Suppose the investor makes a $50,000 conversion of stocks and a $50,000 conversion of bonds at the beginning of the year. The stocks grow to $60,000 and the bonds decline to $40,000. The investor would recharacterize the conversion of bonds to avoid paying tax on that $50,000 conversion but keep the conversion of stocks and pay tax on that $50,000 conversion. The $10,000 of growth on the stocks is tax-free because the $50,000 was put in the Roth. If the opposite happened, where stocks fall and bonds rise, the investor would recharacterize the conversion of stocks and keep the conversion of bonds.

To amplify this strategy, you could make three or more separate Roth conversions of different asset classes at the beginning of each year and recharacterize all of them at the year-end except for the best performing asset class. You could actually have as many as 21.5 months to decide which of the Roth conversions to recharacterize if you converted on January 1 and waited until October 15 of the following year to file your tax return. If your other taxable income is more than you estimated, pushing you into a higher tax bracket, you could recharacterize just the portion of the Roth conversion that pushes you into the higher tax bracket. Roth conversions, rather than withdrawals, from tax-deferred accounts allow more control of taxable income because of the ability to recharacterize any portion of the Roth conversions.

You should look for opportunities to withdraw from tax-deferred accounts in years when the tax rate will be unusually low. Ideally, you would keep some funds in the tax-deferred accounts in case there are high medical expenses or charitable contributions in the late years of retirement. You would want to distribute from the tax-deferred accounts in those years with high medical expenses or charitable contributions because your tax rate may be much lower in those years due to the large amount of itemized deductions.

This withdrawal strategy analysis attempts to minimize the average of marginal tax rates on tax-deferred withdrawals and conversions. The study assumes the marginal tax rate equals the marginal tax bracket, but this is not always the case. The marginal tax rate may differ from the tax bracket due to special factors regarding the taxation of Social Security benefits, the increase in Medicare premiums, the phase out of itemized deductions and personal exemptions, changes in the long-term capital gains tax rate, and the Medicare surtax on net investment income.

In summary, the goal of these withdrawal strategies is to minimize the taxes paid over your lifetime. This is done by timing the realization of income to maximize the use of lower tax brackets in all years and minimize the years when income falls into higher tax brackets.

College Savings Questions

2015-08-18T12:00:00.000-05:00

A common financial goal for parents is to send their children to college. Their options for paying the cost of attendance are to use income earned in the same years as the costs are incurred, borrow funds that must be repaid after the children complete college, or liquidate savings accumulated before the children attend college. Most parents want to save for at least a portion of the college costs because they would prefer to earn interest on savings rather than pay interest on loans. Their question then becomes, how much should they save for college? The answer depends on several assumptions.

How many years until the child begins college, and how many years will the child attend college? The fewer years until the child begins college, the more dollars that will need to be saved, because the invested savings has less time to grow to the amount eventually needed. And the more years the child will attend college, the more dollars that will need to be saved, because the total cost will be higher by adding those additional years.

What will be the cost of attendance at the college the child will attend? This depends on how much is the current cost and at what rate the current cost will inflate from now until the child completes college. Obviously, the higher the current cost or the higher the inflation rate of that cost, the more that will be need to be saved to cover the future cost. The most difficult part of this question is guessing what college the child will attend, as the cost of expensive universities can be double or more the cost of cheaper universities.

What type of account will hold the college savings, and what rate of return will that savings earn? Using a 529 education savings plan rather than a regular taxable investment account may require less be saved for college because 529 plan withdrawals for qualified education expenses are exempt from income taxes. And investing the savings in the stock market rather than holding the savings in cash may require less be saved for college because over the long-term the stock market has historically achieved a higher rate of return than cash.

Determining how much to save for college may require parents to make several assumptions about their children's future. No college savings plan will perfectly predict the inflation rate of college costs and the investment return on college savings, but planning with the best known information at the time and revising the plan as more assumptions become clear will provide parents the best chance of achieving their goal of sending their children to college.

Reverse Mortgages Explained

2015-07-20T12:00:00.000-05:00

Reverse Mortgage is the informal term for a Home Equity Conversion Mortgage. Home Equity Conversion Mortgages were established by Congress in the Housing and Community Development Act of 1987 and are regulated by HUD and insured by the FHA. Reverse mortgages allow homeowners age 62 and older to borrow against the equity in their homes by pledging their homes as collateral while still retaining full ownership of their homes. Reverse mortgages are similar to home equity loans but have different features that may make them more attractive for some borrowers. Like any product, reverse mortgages are not appropriate for all consumers, but homeowners should understand the program so they can make educated decisions with respect to their retirement plans.

To qualify for a reverse mortgage, the youngest borrower must be age 62 or older. The borrowers do not need to be married. They can be other family or friends, as long as both are age 62 or older. In Texas, if a couple is married, both must be over age 62 and borrowers on the reverse mortgage. In all states except Texas, if one spouse is under age 62, he/she can be a non-borrowing spouse and later assume the reverse mortgage when the borrowing spouse dies if he/she is age 62 or older at that time. The borrowers cannot have existing mortgages or liens on their home because the reverse mortgage must be the first deed of trust. If they do have existing liens, they must bring cash to closing and/or use the reverse mortgage proceeds to pay off all existing liens. The borrowers must live in the home as their primary residence and keep current the property taxes and homeowners insurance. They must demonstrate their willingness and capacity to pay the property taxes and insurance by showing a history of payments and statements of current income and assets. Their credit score is not considered.

Once the borrowers have qualified for a reverse mortgage, they are required to attend a counseling session about the reverse mortgage that is independent from the lender involved. The lender cannot pay for or be present at the counseling session. The average fee for this session is $75 to $125. The borrower will pay a mortgage origination fee that is based on a formula related to the amount being borrowed. The lender is allowed to charge an origination fee of $2,500 minimum to $6,000 maximum. The borrower will also be responsible for paying several third-party closing costs such as appraisal, flood certificate, title insurance, notary, recording, etc. which can vary depending on the third-parties selected.

The interest rate on the reverse mortgage will depend on market rates at the time of origination. The interest rate can be fixed or adjustable. About 75% of borrowers select the adjustable rate. With a fixed rate reverse mortgage, all funds available to the borrower must be distributed to the borrower at the closing, regardless of how much the borrower needs at that time. The adjustable rate allows the borrower to borrow only what is needed over time and usually results in less interest accrued. The adjustable rate reverse mortgage can be monthly-adjustable or annually-adjustable. The annually-adjustable will have about one-half percent higher interest rate initially. The monthly-adjustable has a lifetime increase cap of 10% over the starting interest rate. The annually-adjustable has an annual increase cap of 2% and a lifetime increase cap of 5% over the starting interest rate.

The borrower will also be required to pay FHA mortgage insurance premiums as a percentage of the amount borrowed. The upfront mortgage insurance premium depends on how much of the reverse mortgage proceeds are distributed during the first 12 months of the loan. If less than 60% of the loan-to-value is distributed during the first 12 months, the upfront insurance premium is 0.5% of the amount distributed. If more than 60% of the loan-to-value is distributed during the first 12 months, the upfront insurance premium is 2.5% of the amount borrowed. In addition to the upfront insurance premium, the reverse mortgage will also have an ongoing insurance premium of 1.25% per year which is added to the balance owed over the life of the loan. This makes the effective interest rate on the reverse mortgage equal the market interest rate of reverse mortgages plus 1.25%.

A majority of reverse mortgage borrowers select the adjustable-rate mortgage for the variety of home equity disbursement options. They can draw some of the home equity at closing through an initial disbursement. They can draw the home equity over a set period of time or for life through monthly disbursements. They can use the reverse mortgage as a credit line and only draw money when needed, thereby limiting the interest accumulated on the loan. These options can even be used in combination. The home equity available to distribute will depend on the value of the home, the age of the borrower, and the interest rate. The older the borrower, the more he/she can borrow because the total loan balance will be repaid sooner at his/her death. The lower the interest rate, the more he/she can borrow because the loan will accumulate less interest to be repaid at his/her death. The limit on the home value that can be considered for a reverse mortgage is $625,000, so even if a home is worth millions, only the first $625,000 of value can be considered.

Possibly the biggest advantage a reverse mortgage has over other types of home loans is the absence of required mortgage payments. The borrowers have no personal liability to repay the reverse mortgage debt as long as one borrower is still living in the home and paying the property taxes and insurance, or until the youngest borrower reaches age 150. Yes, one hundred and fifty. Changes in the home value or the debt balance have no effect on the mortgage repayment requirements during the borrower's lifetime. The borrower remains the sole owner of the home until his/her death. If the borrower decides to sell the home before his/her death, the reverse mortgage debt must be repaid in full at the time of sale.

Once the last borrower dies, his/her heirs will inherit the home with a reverse mortgage they cannot assume, so the debt must be repaid in one of three ways. The heirs can sell the home for more than the reverse mortgage balance, pay off the reverse mortgage debt, and keep the net proceeds. This is probably the best option if the home value is more than the mortgage debt. The heirs can pay the reverse mortgage lender 95% of the fair market value of the home, which will remove the reverse mortgage debt. This may be the best option if the home value is less than the mortgage balance, and the heirs want to retain ownership of the home. The heirs can transfer ownership of the home to the reverse mortgage lender for the lender to sell and are given six months to move all personal property out of the home. This may be the best option if the home value is less than the mortgage balance and the heirs do not want to retain ownership of the home.

In cases where the reverse mortgage debt is more than what the heirs must pay to remove the debt or more than what the lender can sell the home for after acquiring ownership, the FHA mortgage insurance will apply to cover the lender's loss. The premiums for this insurance are paid by all reverse mortgage borrowers as part of their loans to protect for those cases when the mortgage debt grows above the home value. Only about 30% of homes require the FHA insurance to cover a loss, where the other 70% of homes still have adequate equity to fully repay their reverse mortgage balance. The reverse mortgage industry could not operate without this FHA insurance because lenders would not otherwise accept such a large risk of loss.

Reverse mortgages have experienced a negative stigma in the past due to bad information sharing by the uninformed. Reverse mortgages have been subject to more research lately because of the aging population generating new interest. As a result, reverse mortgages are gaining more acceptance in the financial community and are less often considered an option of last resort. Reverse mortgages are being used not only by those in need, but by those who simply want to supplement their retirement spending. Surveys show positive feedback from reverse mortgage consumers. Over 90% say their reverse mortgage has partially to fully met their financial needs, provided them financial peace of mind, and had a positive effect on their lives. Reverse mortgages have allowed many homeowners to improve retirement portfolio duration and hedge longevity risk. Reverse mortgages are not appropriate for everyone, but for some, reverse mortgages can be a valuable part of their retirement plans.

Sources Cited: Georgetown Mortgage Reverse Mortgage Seminar Presented May 2015

Safe Harbor 401(k) Plan

2015-06-30T12:00:00.000-05:00

A 401(k) plan is a retirement savings plan sponsored by an employer that allows employees to defer a portion of their compensation into tax-advantaged retirement accounts. A traditional 401(k) plan must pass certain nondiscrimination requirements called the Actual Deferral Percentage (ADP) test and the Actual Contribution Percentage (ACP) test which compare the employee and employer contributions for non-highly compensated employees to highly compensated employees. These tests help ensure the 401(k) plan is benefiting the non-highly compensated employees as well as it benefits the highly compensated employees. If a 401(k) plan does not pass the nondiscrimination tests, the employees may have additional limits placed on their ability to participate in the plan so that all the employees will benefit fairly. The administrative difficulties with nondiscrimination testing can be avoided if the employer chooses to designate the plan as a Safe Harbor 401(k) plan. A Safe Harbor 401(k) plan is deemed to satisfy the ADP and ACP tests if the employer makes a minimum matching contribution or non-elective contribution to all employees' 401(k) accounts. The employer must either (1) match employees' deferral amounts $1 for $1 on their first 3% of compensation deferred plus $0.50 for $1 on their next 2% of compensation deferred for a total match equal to 4% of their compensation, or (2) contribute at least 3%, but no more than 6%, of employees' compensation regardless of the employees' deferral amounts. If the employer contributes anything in addition to one of these formulas, the ADP and ACP tests will then apply. These employer contributions must be 100% vested at all times, meaning the employees retain ownership of all the employer contributions regardless of when they terminate employment. A 401(k) plan may qualify as Safe Harbor 401(k) by meeting other requirements, but using one of these employer contribution formulas is the simplest way to avoid the administrative requirements of nondiscrimination testing.

How Much To Save For Retirement

2015-06-03T12:00:00.000-05:00

Young adults have a difficult decision to make when they start earning a regular income. Should they start saving for retirement now or wait until later in life to start saving? Young adults who start saving early can save a lower percentage of their income for retirement, but people who wait until later in life to start saving will need to save a higher percentage of their income for retirement. This difference exists because more years of contributions to savings allows for more years of investment growth on savings, a phenomenon known as compound interest. The chart below provides a rough guideline of how much you should save for retirement based on when you start saving for retirement. For example, the chart shows if you start saving 40 years before retirement, you only need to save 5% of your income per year until retirement, but if you wait to start saving 30 years before retirement, you will need to save 11% of your income per year until retirement. The message is clear: the later you wait to start saving, the more you will need to save.

If You Start Saving This Many Years Before Your Retirement Begins	You Should Save This Percent of Your Income Until Retirement Begins
40	5%
39	5%
38	6%
37	6%
36	7%
35	7%
34	8%
33	8%
32	9%
31	10%
30	11%
29	12%
28	13%
27	14%
26	15%
25	17%
24	18%
23	20%
22	22%
21	24%
20	27%

I prepared this chart with the following assumptions. I first calculated what amount would need to be accumulated at retirement to support 30 years of retirement spending equal to 80% of annual income before retirement based on a 5% annual rate of return after retirement. I then calculated what amount would need to be saved per year for the number of years until retirement to accumulate the amount needed at retirement based on an 8% annual rate of return before retirement. I then divided the required annual savings by the annual income to calculate the percentage of income to save. These assumptions are not appropriate for all individuals, so contact your financial planner for a personalized evaluation of how much you should save.

Value Averaging

2015-05-05T12:00:00.000-05:00

Would you rather buy an investment at a low price or a high price? Would you rather sell that investment at a low price or a high price? Most of us know that to earn investment profits, you need to buy at low prices and sell at high prices, but executing that strategy is easier said than done. The application of Value Averaging to your investment plan can provide the guidance you need for buying and selling based on your investment goals.

Value Averaging requires you to define your goal amount and time horizon. For example, you want to grow your your account balance to $50,000 over the next ten years. You divide the $50,000 by ten years to find your account needs to increase $5,000 per year from a combination of your account contributions and investment growth on your contributions. Your initial cash flows could look like the following. You contribute $5,000 at year-one start, and with 10% investment growth in year-one, your account balance is $5,500 at year-one end. So you contribute $4,500 at year-two start to reach $10,000, and with -5% investment loss year-two, your account balance is $9,500 at year-two end. So you contribute $5,500 at year-three start to reach $15,000, and with 0% investment growth in year-three, your account balance is still $15,000 at year-three end.

The example above shows that Value Averaging requires you to contribute less to your account in years following investment growth and contribute more in years following investment losses. In effect, you are buying less when prices have become high, and you are buying more when prices have become low. Value Averaging can also apply in reverse when depleting an account, in which you sell more of the investment when prices are high and sell less when prices are low.

Value Averaging benefits our behavior in addition to our finances. We all want to buy low and sell high to realize gains on our investments, but many investors mistakenly sell low because they think recent losses will continue and buy high because they think recent gains will continue. Value Averaging forces investors to resist those inclinations and forget the recent past. As a result, Value Averaging can provide us the guidance needed to maintain our investment plans.

Personal Finance Annual Checklist

2015-04-01T12:00:00.000-05:00

Financial planning is not a one-time event; it is an ongoing process. Changes in your life may require changes to your financial plan. The following financial matters deserve your attention at least annually. Contact your financial planner if you need assistance.

Review your year-end paychecks and W-2 wage statements to make sure your income, deduction, and withholding amounts for the previous year were correctly reported to the IRS.

Gather all your income statements and expense records to prepare your income tax return. File your tax return using the IRS Free File at freefile.irs.gov, or a tax preparation software program, or the services of a tax preparation company. Remember to file both federal and state, if applicable.

Download your most recent Social Security statement at www.socialsecurity.gov/myaccount and verify your earnings history has been correctly reported to the Social Security Administration.

Request free copies of your credit history reports from each of the three credit reporting agencies at www.annualcreditreport.com. You do not have to request all three reports at the same time, so you may want to request them separately at different times of the year, such as every four months.

File the FAFSA application at fafsa.ed.gov if you or your child plans to attend college this year in order for you or your child to potentially receive federal student financial aid.

Review your health insurance claims records for accuracy and determine how close you are to reaching your annual deductible. If you have already reached your annual deductible, you may to want to have additional elective medical expenses apply to this year rather than next year.

Review your automobile insurance coverage compared to the depreciated value of your vehicle and consider whether you can afford to increase your deductible in order to decrease your premiums.

Review your home insurance coverage compared to the fair market value of your home and replacement cost of your home contents to ensure you are adequately covered for potential losses. Document your home inventory as proof of ownership to your insurance company.

Check the appraisal district's annual assessment of your home value and compare the value to similar homes in your area to determine if you should protest the value before the deadline.

Retrieve your annual home property tax statement and pay your property taxes if your mortgage lender does not not automatically pay the taxes from your mortgage escrow account.

Check current home mortgage interest rates at www.freddiemac.com/pmms and compare to your current rate to determine if you should refinance your mortgage to a lower interest rate.

Check current savings account rates and certificate of deposit rates at www.depositaccounts.com to determine if you are earning a competitive interest rate at your bank or credit union.

Review your current investment allocation in comparison with your intended investment allocation and rebalance your investment accounts back to your intended allocation if needed.

Review the unrealized capital gains and losses in your investment accounts and consider whether to make investment transactions that would reduce your realized income for the year.

Check your account beneficiary designations or payable on death records with your financial institutions and update them based on births, deaths, marriages, or divorces in your family.

Review your estate plan documents such as a last will, living will, medical directive, and power of attorney. Discuss these documents with family members so they are aware of your intentions.

Complete your charitable donations before the year-end and document the value of those donations if you intend to itemize deductions on your income tax return for that year.

Update your balance sheet or net worth statement to track your current assets and liabilities.

Foreign Stocks And Currency

2015-03-16T12:00:00.000-05:00

American investors typically think of "the stock market" as the combined total stocks of companies located in the United States. However, the global stock market includes thousands of companies outside of the United States. The global market can be divided into two segments: domestic stocks and foreign stocks. Domestic stock investments are only affected by the stock prices of U.S. companies, but foreign stock investments are affected by both the stock prices of foreign companies and the currencies of the countries where those foreign companies are located.

Over the past several months, foreign stock prices have appreciated, but investors in the United States have not seen appreciation with their foreign stock investments. The reason is currency. During this same time period, the value of foreign currencies has declined relative to the U.S. Dollar. When foreign currencies decline, the value of foreign companies also declines measured in terms of the U.S. Dollar. So while the prices of foreign companies have increased in terms of their local currencies, the weakening of foreign currencies relative to the U.S. Dollar has more than offset that appreciation to cause a net negative performance of foreign stocks for U.S. investors.

Investors who do not want the value of foreign currencies to affect the performance of their foreign stock investments may consider adding a currency hedge product to their portfolios. The hedge can be accomplished by owning instruments that appreciate in value when the value of foreign currency declines. Owning these instruments comes with a cost, which can handicap an investor's overall performance if the hedge is held when foreign currency values are not declining. The investor must correctly apply or remove the hedge depending on the direction of foreign currency values for the hedge to provide added value. Investors who do not hedge may benefit from the additional diversification of foreign currency realized through foreign stock investments.

Social Security Spousal Benefits

2015-03-04T12:00:00.000-06:00

Individuals typically need to work and pay Social Security taxes for at least ten years to be eligible for Social Security retirement benefits. Married individuals who have never worked or paid Social Security taxes may also be eligible for retirement benefits. This is commonly referred to as Social Security spousal benefits. Married individuals and divorced individuals who were married at least ten years can receive the higher of their own retirement benefit based on their own earnings history, which would be zero if they never worked, or up to one-half of their spouses' benefit starting at full retirement age. The full retirement age is currently 66 for individuals eligible to begin receiving Social Security retirement benefits at this time. Married individuals who begin receiving spousal benefits before reaching their full retirement age may receive as little as one-third of their spouses' full retirement benefit. They must delay spousal benefits until their full retirement age in order to receive the maximum possible spousal benefit equal to one-half of their spouses' full retirement benefit. Unlike with individual benefits, spousal benefits do not receive delayed retirement credits for delaying benefits past full retirement age.

Update: The Social Security benefit claiming strategies discussed in the paragraph below are no longer applicable since the Bipartisan Budget Act of 2015 was enacted on November 2, 2015. Please click here to see how the new law changes the Social Security claiming strategies.

The availability of spousal benefits can provide for creative benefit claiming strategies. Married couples who will both qualify for Social Security benefits on their own earnings history may be able to maximize their combined lifetime benefits by combining two strategies informally known as "file and suspend" and "restricted claim". The higher earning spouse would "file and suspend" his benefits at full retirement age. The lower earning spouse would then file a "restricted claim for spousal benefits only" at her full retirement age. The higher earning spouse would remove his benefit suspension at age 70 after earning the maximum possible delayed retirement credits. The lower earning spouse would switch from the spousal benefit to her own benefit at age 70 after earning the maximum possible delayed retirement credits on her own benefit. This strategy is effectively the same as both spouses delaying Social Security benefits to age 70 but with the addition of one person receiving spousal benefits from full retirement age to age 70. The "file and suspend" and "restricted claim" are not appropriate strategies for all couples. A couple's optimal claiming strategy will depend on their age difference, benefit amounts, and life expectancy.

Depreciation Recapture Tax

2015-02-10T12:00:00.000-06:00

Business investments in real estate are subject to special tax rules. For most investments, when you sell an asset for more than you paid, you realize a capital gain on the difference between your purchase price and your sales price. Real estate is different because you are allowed a tax deduction for the depreciation of the asset which lowers your cost basis over time. The lowered cost basis means you will realize a larger gain on the real estate when you sell it. If you sell the real estate for more than you paid, the difference between what you paid for it and what you sold it for will be taxed as a capital gain, and the difference between what you paid for it and your depreciated cost basis will be taxed as depreciation recapture.

Let's consider an example. You purchased a rental house for $70,000 and were allowed to depreciate the rental house $20,000 over the time you owned it, so your cost basis is now $50,000. You sell the rental house for $100,000 and will pay tax on the full $50,000 difference between the sales price and your depreciated cost basis. The $30,000 difference between what you paid for the house and what you received from the house sale will be taxed as a capital gain, and the $20,000 difference between what you paid for the house and your cost basis in the house will be taxed as depreciation recapture.

The depreciation recapture on real estate is important to distinguish because it may be taxed at a different rate than normal capital gains. Capital gains on long-term investments, defined as those you owned more than one year, are taxed at 0%, 15%, or 20% depending on your income tax bracket. However, the gain attributable to depreciation recapture will be taxed at 25%. So in the previous example, the $30,000 long-term capital gain would be taxed at 15% or 20%, and the $20,000 depreciation recapture would be taxed at 25%. These tax rates apply to long-term investments only. For short-term investments, defined as those you owned one year or less, both the capital gain and the depreciation recapture will be taxed at ordinary income tax rates.

If You Start Saving This Many Years Before Your Retirement Begins	You Should Save This Percent of Your Income Until Retirement Begins
40	5%
39	5%
38	6%
37	6%
36	7%
35	7%
34	8%
33	8%
32	9%
31	10%
30	11%
29	12%
28	13%
27	14%
26	15%
25	17%
24	18%
23	20%
22	22%
21	24%
20	27%

If You Start Saving This Many Years Before Your Retirement Begins	You Should Save This Percent of Your Income Until Retirement Begins
40	5%
39	5%
38	6%
37	6%
36	7%
35	7%
34	8%
33	8%
32	9%
31	10%
30	11%
29	12%
28	13%
27	14%
26	15%
25	17%
24	18%
23	20%
22	22%
21	24%
20	27%

If You Start Saving This Many Years Before Your Retirement Begins	You Should Save This Percent of Your Income Until Retirement Begins
40	5%
39	5%
38	6%
37	6%
36	7%
35	7%
34	8%
33	8%
32	9%
31	10%
30	11%
29	12%
28	13%
27	14%
26	15%
25	17%
24	18%
23	20%
22	22%
21	24%
20	27%