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17th October 2017

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Planning

Tara Unverzagt August 7, 2016 No Comments

Think about Medicare BEFORE turning 65

While talking to a friend who recently turned 65, he asked “Do you warn your clients about all the decisions they have to make when they turn 65?” I thought he was talking about planning for Social Security and the best strategy for collecting your benefits. In fact, he was talking about Medicare. And no, I don’t normally talk to my clients about that and decided I should.

As you approach 65, you have a few months to decide what kind of Medicare you want. Perhaps you didn’t know there was more than one flavor of Medicare, which is where problems can start. Unfortunately, you could be faced with late enrollment penalties if you aren’t ready to make the decisions. While signing up on time is important, you have the opportunity to change your Medicare choices annually.

If you receive Social Security, you will automatically be signed up for Medicare on the first day of the month that you turn 65. My birthday is June 23, so Medicare can start on June 1st for me. If you are on Social Security because you are disabled, you will also automatically be signed up for Medicare, even if you are not 65.

It’s common, and often a good idea, to delay taking Social Security until you are 70. If you decide to wait to take Social Security, you will have to take action to enroll in Medicare at 65.

Being “automatically signed up for Medicare”, is actually an over simplification because there are four parts to Medicare, Part A, B, C, and D. When you are automatically signed up, you are signed up for “Original Medicare” Part A and B. That may not be what you want to do, though.

Part A covers things like hospitals, hospice care, home health care, and skilled nursing facility care. Part B covers doctors and other health care providers, outpatient care, home health care, some medical equipment, and other health care needs outside a facility.

You have a choice between Original Medicare and Part C, Medicare Advantage Plans. If you choose Original Medicare, you choose the doctors and facilities you want to go to for health care needs.

Most people pay Medicare taxes as part of their payroll taxes when they are working. If you do, Part A is free and Part B typically costs $104.90 per month. High income individuals and couples may pay more. You may also end up paying a late enrollment penalty if you don’t sign up during your initial eligibility period.

With the Part A and B Original Medicare plan, you typically pay a deductible before Medicare starts to pay. You also pay a copayment (for example 20% of fees charged or possibly a flat fee such as $10 or $20 per visit) for service from your doctor or facility. There are no out of pocket limits with Original Medicare.

With Medicare Part C, Advantage Plans, you are limited to a select group of doctors and facilities, similar to an HMO or PPO. As a matter of fact, you might be able to continue your current plan. For example, if you are currently using Kaiser Permanente in Southern California, you can continue to use them with the Medicare Advantage Plans (some services and fees may be different on Medicare). Medicare Advantage Plans have all the same coverage that Medicare Part A and B have and your specific plan may have extra coverage like vision, hearing, and/or dental.

If you choose to enroll in a Medicare Advantage Plan, you are still part of and pay for Part A and B, the same as on the Original Medicare, but you may also have to pay an additional Part C premium payment. Often you don’t have a deductible, such as with HMOs, but you may have co-payments. If your Advantage Plan is a PPO (preferred provider organization), you may have reduced deductibles and co-payment verses Original Medicare.

You may want to choose Medicare Advantage to stay with your current doctors and facilities at a lower rate. If you’d like to have more choices, you may want to choose Original Medicare. Don’t wait until you turn 65 to look into and consider your options or you may end up paying more. Starting a year or two before, will give you plenty of time to consider all the options.

In the future, we’ll look at Medicare Part D, Prescription Drug Coverage and supplemental insurance. It’s not easy growing older and it’s worth planning for a successful transition.

You can find out more about Medicare at Medicare & You 2016.

Contact me, if you’d like to know about this or other financial planning, investment, or tax topics. If you found this article useful, subscribe to have all articles emails to you.

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Tara Unverzagt July 18, 2016 No Comments

Index funds are safe, right?

My last article showed how you could work towards a carefree retirement like my grandfather had by looking at your spending and saving choices today. Your spending and saving decisions are the number one behavior that affects your financial life. Once you have that under control, you hopefully have money to invest. What do you do now?

What Now?

Let’s look back to what happened before 1980. That’s more realistic going forward than to expect a return of the high flying 1980s. For those who survived the 1980-2010 roller coaster with savings intact, interest rates could go up long term, but “normal” pre-1980 interest rates were just a few percentage higher than current interest rates and the stock market is a bit high, but about where it should be.

Buying low and selling high is still the way to make your money work for you. Unfortunately, the way we’re wired, we love to buy high, when investments are exciting. Then we want to throw in the towel when prices are low. This is a formula for failure.

Stocks are often the investment to emphasize but sometimes more in bonds are called for. Sometimes cash is king, when interest rates are super low and the stock market is valued high (sound familiar?) Most people think this ratio depends on your age, but that’s not the only parameter to look at when deciding your “asset allocation,” or how much you invest in bonds vs stocks vs cash vs any other investment choice.

A huge portion of money today is being invested in basic, low fee investments, like index funds and ETFs (Exchange-Traded Funds). You won’t “beat the market” but you’ll do as well as the market, right? Maybe, maybe not. Not all index funds and ETFs are created equally. You still need to do your homework on the fees and what they invest in. And know that when you buy an index fund to “match the market”, you’re choosing to buy the big losers as well as the high flyers.

Sears was in the Dow until 1999 when it went from a high of over $60 in 1998 and tanked to below $40 in in 1999. If you were invested in the “index” you would have held Sears to the bottom before being rid of it. Individual stock holders could sell long before it hit bottom. Sears wasn’t removed from the S&P 500 until 2012 when its value was below the required threshold to be in the S&P 500.

The index funds have helped investors that buy individual stocks because the index funds have distorted the price of some stocks and created market inefficiencies. When a bunch of money goes into an index fund raising a particular stock price higher than it should be, it’s a great time for someone who owns that stock to sell and take a profit. The person with the index fund will just hold on to it while the price peaks and then sinks. On the other hand, if a stock is undervalued, the index doesn’t take advantage of the bargain and buy more shares. And, as in the case of Sears, the index may hold on to a tanking stock that should be sold.

In addition, asset allocation at any given point has been shown to be far more important to wealth accumulation than what particular stock or bond you buy. If you always keep the same asset allocation, you will sometimes be over invested in stocks and under invested in bonds (see below for a time when investing heavily in bonds made sense) or vice versa. While no one has a crystal ball telling them the highs and lows of a market, there are usually pretty good signs that an asset class is in the range of the bottom or the range of the top. Right now both stocks and bonds, overall, are overvalued. What will you do?

The answer to that question is not simple or straightforward. It depends on your individual situation. The internet will give you great generic advice, but I’ve never met a generic person. Talking to a professional can help you sort through your priorities and risk tolerances. For example, someone that has a million dollar income will deal with risk tolerances differently than someone who is living pay check to pay check. If you are planning for just retirement, you will plan differently than if you have to pay for your kids’ college before retirement.

What Happened?

Investing was far easier for my grandfather then for you or me. Interest rates were pretty steady, between 2% and 5% most of his life. In retirement, interest rates went soaring to a peak of 15% in 1980, the highest interest rates of all time. Having reliable, steady, high interest rates in retirement is so sweet!

The stock market was a roller coaster during his lifetime, as it has always been and always will be. The Dow Jones Index went from around 1350 to as high as 7000 before returning to below 3000 before he died in the early 1980s. If you were invested in stocks back then, utilities were where you found the best growth. The Dow Jones Utility Index went from just over 10 in the early 1940s to as high as 160 by the 1980s, or about a 7% annual return.

Life changed in the 1970s when I was a kid and my parents were saving for the future. Interest rates went crazy, as did inflation. From the “bumping along” 2%-5% rates, interest rates shot up in the late 1970s to early 1980s. This turned all investing heavy into bonds and the stock market was flat 1965 to 1972. Life was uncertain and scary for most of us. Buying a house with a mortgage interest rate as high as 20% was daunting to many, prohibitive to most. Grandpa’s generation was happily retired invested in bonds at those high rates with a steady retirement income as a result.

Investing has always been complicated, but probably more so today than ever before. We think 1980-2010 was “normal”, but it’s no longer relevant. Our journey through our working and retirement life is nothing like Grandpa’s journey. So while he taught me a lot, I have to figure out this one myself.

The information given here is general in nature. If you would like to know how it pertains to your particular situation click “contact” above. If you found this or any of the other articles interesting, please subscribe at the bottom of this page.

photo by https://www.flickr.com/photos/ecotravols/

 

Tara Unverzagt July 5, 2016 No Comments

I Want a Carefree Retirement

Knee deep in debt, Bob and Carol were trying to decide if they should raid their retirement account to pay for the rest of the kids’ college education or if they should take on more student loan debt. Both choices made them sick to their stomach to think about. Either way, they couldn’t see a comfortable retirement in their future. It’s a situation that’s all too common today.

Life was different during our grandparents’ era. My grandfather, for example, went to college and paid for it himself. He became a civil engineer. My grandmother owned a beauty salon and together they raised three children. All three kids went to college, paid for with cash from my grandpa’s job and savings and their children paid for part of the expenses with summer job money. All three kids went on to live very nice middle class lives. Grandpa retired to a life of leisure full of golf. Grandma’s retirement revolved around church, singing in the choir, helping her friends, and taking care of the house. They liked to travel, especially to Florida for the winter.

It would be lovely if that was how our lives went, but it isn’t, we’re more likely to be in Bob and Carol’s situation. In Grandpa’s days, having debt would have been an embarrassment as well as scary. Coming out of the Great Depression, you might buy something on lay away, where you paid a little every week until you fully paid for the item and took it home. Otherwise, owing someone money was frowned upon.

Somewhere along the way, the finance companies talked us into thinking it was ok to use debt to pay for everything. You could buy anything on a credit card and make low monthly payments. Nowadays, many don’t even own their car. You carry the debt for the car that’s owned by the dealer. [Debt can be helpful see Use Debt to Your Advantage]

Grandpa had it right by not using debt to pay for goods. Using debt to buy consumables like a car or everyday items will make you poor. Once you take on debt, your expenses go up with debt payments. A $25,000 car turns into a $450 per month payment for five years or over $28,000 total. If you saved that $450 per month BEFORE you bought your car and invested it, you would only need to put aside $22,500 and you could do it in just over four years. That’s almost a $6,000 difference. What could you do with $6,000?

For many of us, our retirement years will be very different than our grandparents’ retirement. My grandpa had a pension, plenty of savings, Social Security at 65, he didn’t have to deal with high health care costs, and was debt free his whole life. I don’t have a pension, won’t be eligible for full Social Security benefits until 67, will have to pay for more of my health care costs, and cope with a home mortgage. And many will be dealing with their kids’ college debt as they try to retire. We will have to work a lot harder to get that comfortable, carefree life, plus we will live much longer lives than previous generations. How will we fill all those extra years and how will we pay for them?

Some people don’t want to retire at 65, they love what they do. My advice to these people is keep working. There’s a good chance you can work until 70 or even 80 and still have plenty of years to relax in retirement. The extra money will help finance those extra years. If you’re to the point where you need a change, consider a completely different job using the expertise you’ve gained. For example, you could teach math instead of working as an engineer. You could also consider a more relaxed job involving a hobby. One of my clients loved playing tennis and ran the club house at his tennis club when he retired. He was able to see his friends, make a little money, and play tennis for free. Or if you’ve saved enough to last a long retirement, you could consider volunteering at a charity that inspires you. You won’t make money, but will have purpose in life which research has shown is a key component to successful aging.

So why do we need to work longer these days than in Grandpa’s time? A lot of factors come into play. The only retirement plan most of us have today are the ones we fund. Companies decided they didn’t want to take on the risk of investment markets not doing well, so they pushed the risk on their employees. Healthcare costs have gone up and companies push more of the cost to the employees. More people are self-employed where you pay for everything and everything is going up in price.

Life has become much more complicated to manage. Today, we expect to have choices. Some people want to be able to pay more for insurance to go the doctor of our choice while others want to save money on their insurance and don’t care which doctor they go to. While choices are good it can be hard to know which choice is right for you.

The truth is, your retirement success is not affected as much by the outside world, as by your spending and saving habits. Just like always, spending less than you make leads to financial success. If you lose a job, you have to cut back. If college is too expensive, you can to consider a less expensive college, try two years at a community college (no one asks where you completed your Freshmen and Sophomore year), or have your child participate in a work/study program to help pay the cost of college. A much bigger part of your paycheck goes to healthcare which means you have to cut back somewhere else. Your car? Your home? Your hobbies? You have to choose insurance and retirement programs to meet your needs. That takes education and planning.

Take a moment to visualize your future self. What do you want your life to be like? Feel how comfortable life would be if you could choose to work, play golf, or travel. Then look at what could get in the way of getting to that retirement. What can you do now, in the next year that is totally achievable to help make sure you achieve that retirement? Is your comfortable retirement worth enough to make a commitment to your one year plan? When you’re tempted to spend money on those lower priority items, think about your future self and consider “paying” him/her by putting that money in your savings account instead.

Control your spending and save for your future. Think about working a little longer since you’re going to live a little longer. You too can have that comfortable retirement that my grandparents lived.

Contact me if you’d like a carefree retirement.

To find out ways to invest for retirement, check out Part 2: Index funds are safe, right?

Photo by Extra Zebra; https://www.flickr.com/photos/23438569@N02/

 

Tara Unverzagt June 22, 2016 No Comments

What About RoboAdvisors?

RoboAdvisors have become popular recently. They provide a way for you to input what your goals are and the RoboAdvisor will come up with a plan just for you (and a million other people just like you). They are popular because they’re pretty easy to get started and their fees are very cheap, far cheaper than personal advisor. And they do a good job for what they do. I had a conversation with my hair stylist yesterday about why you might want a “person” to be your advisor.

In the middle of the conversation, another stylist came over to get advice on what color to use on her client. She said her client wanted highlights, but thought her ends (her last highlight color) were too light, she wanted darker highlights this time. The stylist was confused because the ends were the color that she would have picked for the client also.

My stylist said that perhaps the ends were the right color, but there was too much of that color. He pointed out that sometimes when clients say a color is too light, it’s really just that they want less of that color, not a darker color. My stylist pointed out a way to help the client get more information so she could make the right decision. The other stylist walked away to review the choices with her client.

After the other stylist left, I said “And THAT is why a RoboAdvisor isn’t the best solution for everyone. Sometimes, a client misunderstands what the issues are. A robot can’t have that discussion with you.”

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Plan to Win

I spent last weekend bicycle racing, my favorite activity! It was the Master State Championship, so considered a “big race” to some and a stepping stone to the National Championships for others. Thinking about how racers deal with “big races” whether it’s the local weekend race or the World Championship, I realized how similar it is to investing and financial planning.

Everyone approaches both with wishful thoughts of “making it big”. Some are instantly pulled back by fear. Fear and doubt can make even the fastest person a loser. Often, fear prevents a racer from even showing up to the race, which is a guaranteed way to not win. Life is risky. That has to be accepted first. Then you can start looking at ways to limit failure and maximize gains.

Having a plan is a great way to start. But a plan that is ignored will get you nowhere. In bike racing, many people hire a coach to help make and execute a plan. I can’t tell you how many great racers will start to change their plan or equipment as they get closer to the “big race”. Change at the last minute is usually a great way to fail at meeting your goals.

Why do they do it? Fear. They think that if they work harder, longer, or have better equipment, that would guarantee a win. It usually leads to overtraining, poor recovery, bad form, and discomfort in the big race. If they worked their plan that is making them stronger and faster, they would actually be enhancing their chance of success far more. Coaches can be great at helping you stay focused on the plan, if you listen to them.

So how does this relate to investing? Many times people don’t make a plan because they’re afraid to think about that big college bill or if they’ll have enough money to live the way they’d like in retirement. Face it head on with a plan outlining how you’re going to make it happen. If you can’t do everything you want, it’s best to know that up front and get the most you can. Without a plan you are likely to miss out on goals that you could have achieved if you had a plan.

People also often invest emotionally. You want to buy low and sell high to be successful. While people know this intellectually, they often do just the opposite. They get excited as an investment price or the stock market goes up. As the prices go down people get scared and want to get out of the scary situation. Before you consider making a change to your investments first stop and think through whether you are making decisions based on emotions or information.

A solid plan will help you figure out where you are going and how you will get there. A financial advisor can help you build a solid plan and help you relax so you can maximize your plan with periodic reviews. Just like a training schedule, the plan is going to be different during different seasons (diversification targets will need to be updated occasionally). Your advisor can help you adapt your plan for the seasons as well as to address your personal goals in a thoughtful way. With or without an advisor, make a plan. Remember “not showing up” is a guaranteed way to not win. The more you follow and trust your plan, the more likely you are to win.

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Tara Unverzagt April 6, 2016 No Comments

What happens when you’re gone?

I was asked recently why one would establish a trust when estate planning. If you have a “simple situation”, a trust isn’t necessary. A simple situation would be if you and your spouse have only been married once, are still married, are US citizens, and don’t have children. If you want and expect your assets to go to your surviving spouse, you probably don’t need a trust. You may not even need a will. Many states have “default” actions when someone passes away that usually include assets being transferred to a surviving spouse.

If your estate is large or you have plans other than leaving your assets to your spouse, you may want to invest in a trust. A trust can help minimize estate taxes and control how your assets are distributed. If you have kids and do or don’t want to leave assets to them, a will may be sufficient, but the state and federal government can overrule your will. Also, a trust can give more options in transferring assets to a charity. If it’s important to you that your assets be distributed in a certain way, you will want to consider a trust.

Executing a will incurs probate tax which can be 2% to 7% of your assets. Since probate involves lawyers, you may have additional legal costs if there are disagreements on how assets should be distributed. The cost of a trust is approximately $2,000 and may need to be updated at various points of your life at additional expense. With a will or trust, you won’t have Federal estate tax if your assets total less than $5,430,000 in 2015 (this amount changes every year). If your assets are over this amount, you may be able to avoid some or all Federal estate taxes. You may have state taxes that vary from state to state.

If you have remarried, you also will want to consider a trust. In some states “surviving spouses”, even in a second marriage, have a right to claim up to half the estate. If there are children from more than one marriage, a trust is the best way to ensure assets are distributed the way you want.

To help minimize estate taxes, trusts can be generated at death. From a living trust that is active during your life, people often generate a marital trust at death to provide funds to a surviving spouse for the spouse’s life, with remaining assets going to the children upon the spouse’s death. This is usually paired with a family trust which has assets go directly to the children at death but retaining income for the remainder of the surviving spouse’s life. In some cases, there are more than two trusts generated to take care of various family members.

Most parents with special needs family members understand that they require special estate planning. A special needs trust can help them maximize the benefit of their resources after they pass. A trust can also help articulate what will happen to special needs family members and minor children. You can name a person to manage your financial assets and a different person to take care of your family members’ personal health and wellbeing.

If your situation is more complex than the “simple situation”, it’s important to contact an Estate Planning Attorney that understands the current laws. A good lawyer will also write provisions into a trust to automatically change as laws change. If you have a “simple situation” you will still want to research how your state handles assets on a person’s death. You may be surprised at what you learn.

If you’re comfortable with your assets going to your spouse and/or children in whatever way the state indicates, you don’t need a trust. If you care about what happens to your assets after death, a trust is sometimes the best way to go. A will can be contested which delays distribution, can be expensive, and may end in assets being distributed inappropriately. If you document your wishes in a trust, the courts make sure the instructions are executed as written.

All information provided is general in nature and not meant to be advice for you in particular. If you’d like to know more about how this topic relates to your situation, contact me at tara@southbayfinancialpartners.com.

Tara Unverzagt April 4, 2016 No Comments

Use Debt to Your Advantage

Debt has fueled much of the growth in the world over the last four decades. Debt has made many business owners, investors, and individuals wealthy. But debt has also been the ruin of many businesses, investors, and individuals.

The “final exam” of my MBA involved a business simulation. Each study group was tasked to run a business manufacturing hairdryers. My study group was mostly made up of bankers. When our door shut at the start, the bankers immediately said, “We need to get a line of credit.” I said, “We’re starting with a lot of available cash.” They explained that bankers only loan you money when you have money. At some point down the road, we may need money, but we should secure it in the beginning. That 10 minutes was more valuable to me than the two years that led up to it. Indeed, “down the road” the hairdryer market was booming, but we didn’t have enough cash to build a new plant. That line of credit provided the opportunity to grow our business. Our study group ended with millions of dollars more than any other study group. We had that line of credit right when we needed it while the others were just starting to negotiate with the banks.

This was a lesson in how debt can make you wealthy. The other side of that coin occurred as the housing boom went bust in 2008. There were a lot of people who borrowed money to buy a house, but didn’t have the funds to pay the debt. They lost their house and their wealth.

Debt helps magnify your return. If you want to buy a house, most people can purchase a bigger house with a loan than if they only used savings to purchase the house. If the value of that house goes up, there is a larger gain on the larger investment. But if the value of that house goes down, there is a larger loss.

So how do you use debt to your advantage? As the bankers in my MBA study group pointed out, you will only get debt when you have money. The more money you have, the more debt you will be allowed to carry. If you think like a banker, and only incur debt that you can pay off, you can use it to your advantage.

You can’t predict what’s going to happen to the housing market in the next 2-5 years, but the longer you are in the housing market, the more likely you are to see the value grow above what you invested. If you plan to stay in the housing market for the long haul, it’s fine to incur debt to purchase your home. But make sure you have enough funds to pay the mortgage for 6-12 months, even if you lose your job. This should be part of your Emergency Fund. If you don’t have enough savings to make future mortgage payments, you may find yourself in the position that so many people did in 2008 and risk losing your home.

When you buy a car, you do not typically expect it to increase in value. As a matter of fact, as soon as you drive a new car off the lot, it loses value. Buying a car with debt increases the cost of the car and therefore increases your loss. If you have a 10%, five year loan on your $20,000 car, you are really paying $25,500 for the car. In addition to the decrease in the value of the car, you are losing an extra $5,500 from interest payments. Many people lease a car instead of buying. Keep in mind this is just building the loan costs into the price of the car. Typically it’s easy to hide higher loan costs in the “low” monthly payments of a lease agreement. The more expensive the car, the more you lose in value and interest paid.

In order to sell more cars, dealers often offer 0% loan deals. This can be a way of using debt to your advantage. If you can get a 0% loan for $20,000 and then invest that money in a bond giving you 4%, you win. Make sure you have the $20,000 to pay off the loan. If the 0% interest is only for a limited time, pay the balance as soon as the interest rate goes up. Typically, if you miss a payment, you will pay high fees and/or the interest charges. So make those payments.

Bottom line, you can use debt to make money, but you can also lose money with debt. Follow some basic guidelines to use debt to your advantage.

  • Make sure you have the cash to pay the debt on time. For long term debt, have enough in cash to make payments for 6-12 months.
  • Use debt to increase your income, like paying for college tuition, but not for consumables like going out to eat or a nicer apartment.
  • Use debt when you can invest those funds at a higher return or in a business that can make more income than the cost of the debt.
  • If the item you purchase is not an investment that can increase in value, pay cash.

Debt always increases risk, but the risk can be managed if debt is used wisely.

 

All information provided is general in nature and not meant to be advice for you in particular. If you’d like to know more about how this topic relates to your situation, contact me at tara@southbayfinancialpartners.com

Tara Unverzagt March 22, 2016 No Comments

Why Are Interest Rates So Low?

Bond prices go up when interest goes down. If you read the Wall Street Journal, they mention this fact a lot, especially these days, but what does it mean? It takes just a moment to understand this, but longer to have it become ingrained.

Let’s start with an example:

If a bond has 3% interest (that is, you receive $3 for every $100 you invest in that bond every year), the bond starts out costing $1 for every $1 of bond. Therefore, a $10,000 bond would cost $10,000 and you receive $300 every year for holding the bond.

If interest rates went up to 3.5%, who would pay $10,000 for a 3% bond when you could invest $10,000 in a 3.5% bond now? You might be willing to buy that 3% bond for less. How much less? It would have to be enough less so that you get 3.5% for your investment.

The math requires algebra. Remember that class that you probably hated and wondered “when will I EVER use this?!” Well, here’s your opportunity. The math comes down to: if you can pay $1 for a bond with a 3.5% coupon, you would need to pay 3%/3.5% or .85 (i.e. 85 cents) to have a bond with a 3% coupon to be equivalent to a 3.5% payout.

What happened in the US from 2008 until recently? Interest rates came down so prices went up.

What’s happening now? The Federal Reserve has been trying to raise rates, but the demand for US bonds has also gone up. And the old rule “when demand goes up, prices go up” trumps the interest rule “when interest rates go up, price comes down.” The demand forces the price up which actually causes the interest rate to go down, despite the Fed’s desires.

We are living in interesting times.

 

Check out other articles on bonds and interest rates

 

Tara Unverzagt March 11, 2016 No Comments

Sold Your Home? Now What?

A client recently contacted me about selling their home to retire in a sunny, warm place. They wanted to know what information they would need to collect about the sale of their home for their taxes. There are many tax benefits to purchasing a home which are well known, like deducting interest payments on a mortgage. And tax reporting occurs when you sell your home. I wish I could say gathering the data to report the sale is simple, but it’s not. The following outlines what you need to track when you buy a home.

When selling your house, you will need to know the dates you purchased and sold your home, the selling price and expenses, and the adjusted cost basis of the home. The first three are easy to determine. The adjusted cost basis is not.

The cost basis of real property (land and anything built on or attached to it) is usually its cost. Your adjusted cost basis is your cost basis plus any increases or decreases as described below. I’ll refer to adjusted cost basis as “basis” from now on.

It is easiest to calculate the basis of your house as you go along. If you wait until you sell your home, you are likely to miss many expenses that could increase the adjusted basis. You might consider keeping a ledger (on paper or in a spreadsheet) that keeps track of your basis, much like you do for your checking account balance.

Some costs/expenses you incur during the buying, selling, and maintaining of your home are added to your basis while other expenses you can deduct during the year the expense is incurred. You can’t do both.

Some credits reduce your taxes this year, but also reduce your basis, so you DO pay tax on those expenses, just not now.

If you add the cost of a capital improvement to your basis and you later remove the capital improvement, you must also reduce your basis. For example, if you add a fence to your property, you would increase your basis. If you later replaced that fence, the cost of the original fence would be subtracted from your basis and the cost of the new fence would be added.

Keep in mind that expenses which add to your basis will result in the sale of your home having a smaller gain (the sell price minus the basis) and thus potentially less taxes owed. Credits that cause you to reduce your basis will result in a bigger gain on the sale of your home and therefore potentially increasing taxes.

If you’d like a summary of what expenses increase and decrease your basis, please contact me.

The information given here is found in the IRS’s Publication 17.

Tara Unverzagt February 19, 2016 No Comments

What’s up with 529 plans?

Let’s explore college planning for your children or grandchildren. There are so many great questions about the “best way” to get ready financially for college, but the answers are very complicated. There’s no way to cover this vast topic in one shot, so let’s look at one college saving method: the 529 plan.

If you haven’t heard of 529 plans, they are college saving accounts that are run by states. You can invest in the state where you are a resident or most any other state’s plan. Most people only look at their state, but if you are considering a 529 plan, it’s a good idea to look at what plan fits your needs best. That may be your state’s plan or another state’s plan.

I’ll use Illinois and California as examples of the differences between states. California has one 529 plan which is a savings plan. Illinois has four different plans which include saving plans and pre-paid tuition plans. I’ll just be addressing the Illinois Bright Start program here which is a savings plan similar to the California 529 plan.

What are the advantages of saving for college in a 529 plan?

  • On the state level, there are often tax advantages on contributions.
  1. California does not have a tax advantage for California residents.
  2. Illinois has a deduction of up to $20,000 of Illinois income for a married couple. Illinois businesses can also get a tax break for matching contributions. And there’s a tax break for rolling over another state’s program into Illinois.
  • On the federal level, 529 accounts are somewhat like a Roth IRAs. Contributions are after-tax dollars while the account’s earnings and growth are tax free.
  • The accounts are professionally managed. If you don’t have an investment advisor or you aren’t comfortable managing your own investments, 529 plans can help you with investment decisions.

Are there disadvantages to investing in a 529 account verses other investment accounts?

  • At the state level, some of the advantages mentioned above can come back to haunt you.
  1.  If you rollover your Illinois account to another state, it will be included in your Illinois income.
  2. Since California doesn’t allow deduction on contributions, there is no recapture if you move the funds to another state.
  • Most 529 plans have low fees, but each plan is unique. Illinois has the same plan via advisors and direct with the state. The Advisor version can have almost 1% higher fees than the direct plan. If your account has $100,000, that’s almost $1,000 per year going to fees!
  • Most plans are with a particular investment company (for example, TIAA-CREF or Fidelity) and you will be limited to the investment options they allow. This doesn’t always represent the best choices for you.
  • On the federal and state level, if you don’t take the funds out to pay for qualified expenses, you may pay taxes on the earning and a penalty. I’ll discuss this further later.

What if my child doesn’t go to college or goes to a cheaper college than we expected?

  • Non-qualified distributions (distributions not used for tuition or fees) will be taxable and have a 10% penalty on the earnings if withdrawn.
  • You can use the funds if your child wants to go to graduate school or take vocational/advance skills classes.
  • You can change the beneficiary and use it for someone else’s educational expenses. Haven’t you always wanted to go to culinary school?
  • You can save it for the next generation’s education.
  • There are exceptions that can eliminate the penalty (but you will still pay taxes on the earnings), including: the beneficiary dies or becomes disabled, goes to a US Military Academy, or receives a scholarship.

How does a 529 account affect federal financial aid?

  • A 529 account is counted as an asset of the parent. Federal financial aid considers 5.64% of parents’ assets and 30% of their income “available” to pay for college and 20% of a student’s assets and all their income over $6,260.
  • A grandparent can also start their own 529 account for a grandchild. That account is not included in financial aid reporting.
  • The catch with a grandparent’s account is that the distribution is included in the child’s income the following year.
  • If a grandparent plans to have a 529 account with one year of tuition and fees, your grandchild could save it for their senior year. The funds would never be counted as assets or income for financial aid.

What are the advantages of using a retirement account to pay for college instead of a 529 account?

  • A Roth IRA or Roth 401(k) makes a good college saving tool. You don’t pay taxes or penalty on Roth distributions for principal that has been in the plan at least 5 years.
  • Retirement accounts aren’t counted toward assets for financial aid.
  • If you distributed the taxable earnings from a Roth IRA or Roth 401(k) or from a traditional IRA or 401(k), the funds distributed won’t be penalized (they will be taxed though)

What are the disadvantages of using a retirement account to pay for college instead of a 529 account?

  • The limit for a Roth IRA or Roth 401(k) contribution is $5,500 ($6,500 if you’re over 50) in 2016 and phased out for higher incomes.
  • Each 529 plan has its own limits, but many will let you contribute $300,000 or more at one time.
  • Grandparents should remember you will have to pay gift tax for contributions over $14,000 ($28,000 for married couples) to each beneficiary or up to $70,000 each using a special 5 year exemption, but requires a Form 709, Estate & Gift Tax form, to be filed for each grandparent.
  • Distributions will count as income towards financial aid the next year.

Whether you should use a 529, a Roth IRA/401(k) or other saving plan depends on your needs and expectations. You also need to think about everyone’s tax situation, likelihood of wanting financial aid or need based scholarships, and flexibility. There’s not one right answer for everyone.

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