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 firstname.lastname@example.org.
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 email@example.com
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
It’s that time of year to dig through the files and prepare your tax return for 2015. As I prepare tax returns and talk with clients I realize there are some tidbits of the tax code that aren’t obvious that could save you money or problems down the road. I thought I’d share them.
When deducting “medical insurance premiums” the IRS includes dental and qualified long term care. It does not include life insurance, disability, and other types of insurance. And do remember to provide premium payments, along with any “out of pocket” expenses for dentist, doctors, labs, prescriptions, to your tax preparer. You may not be able to use them, but you might be surprised. They have to add up to more than 10% of your Adjusted Gross Income (AGI) or 7.5% of AGI if you were born before 1951.
Did you know you can deduct acupuncture treatments as a “medical expense”? You can also deduct much of your travel expenses for medical treatment, even if that includes a plane trip. You cannot deduct nonprescription drugs, supplements, or health clubs. You can deduct the cost of weight loss programs, if it’s in response to a disease, like diabetes or high blood pressure. The cost of the program is deductible, the cost of food or other items is not.
When you donate to a charity, you should make sure it’s really a 501(c)3. This is the tax code the IRS uses to determine that an organization is a non-profit charity. If it’s not a 501(c)3, you cannot deduct a contribution to the organization. You may still choose to donate, it just doesn’t affect your taxes. Any organization that is political in nature (a candidate or a political party would be included here) would not be a 501(c)3. Churches, schools, and other government organizations are automatically 501(c)3s.
Taxes paid for your car registration may or may not be deductible. In some states, like California, your car registration is based on the value of your car, that registration fee is deductible. In some states, like Illinois, the fee is based on the type of vehicle (car, truck, motorcycle, etc.) that is not deductible.
Real Estate Taxes
When you deduct your real estate taxes for itemized deductions, all real estate tax can be deducted. That includes second homes, extra lots that might be associated with your property, and in cities, if you “own” your parking spot, the property taxes on those can be deducted too.
Calculating the Cost Basis of Your Home
When calculating the cost basis for your home, vacation home, or rental (easiest if done as you live in your house and not left to when you sell the house), you can add improvements that increase the value of the house to the basis, but you can NOT include repairs. So fixing a leaky faucet doesn’t get added to your basis while repiping your house does. You also cannot add paint, wallpaper, and carpet to your cost basis EXCEPT if you are doing a major remodel or renovation, in which case you can include all the repairs and remodeling as well as actual improvements to the structure. You can find more information about cost basis in another posted article.
When you sell your house, if you meet certain criteria, you are exempt from paying taxes on $250,000 of gain for one person and $500,000 for a couple. You can take this exemption more than once, as long as you meet the criteria each time. You do not need to buy another home to take advantage of this exemption. If you end up selling at a loss, you do not get to realize the loss unless it is a business property. You can also take the loss on a home if it’s sold by an estate after death, even if it was a personal home, not a business property.
Is Your Child Really a Dependent?
You can take a child as a dependent if they live in your house and you pay most of their living expenses. If they move out of the house, and they have income, even as little as $4,000 of gross income (i.e. what they were paid or investment income), you won’t be able to declare them as a dependent. If you pay for more than half of the support of any relative, whether they live with you or not, you may be able to declare them as a dependent. That includes stepchildren, step-nieces & nephews, half-siblings, children-in-laws, parent-in-laws, aunts, uncles, adopted children. But if they have gross income you may not, even if they have no taxable income.
The tax code is vast and complex. Many people think they can deduct things that they can’t and they also miss deductions that can reduce their taxes. If in doubt, you can look at the publications on irs.gov. Publication 17 is often a great place to start and will refer you to other publications that have more details on particular topics. Or ask your tax preparer.
If there’s a tax topic that you’d like me to explore or a question answered, you can contact me at www.southbayfinancialpartners.com.
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.
I recently had a conversation about buying individual bonds versus a bond mutual fund. I’m always amazed that investment advisors believe that buying individual bonds is a bad idea. The most cited reason for not holding individual bonds is that you get a terrible price compared to the “Big Boys” at a mutual fund. But the difference in price is less than the 1% that the Big Boys are charging you annually to manage your bond fund (and some funds have much higher annual management fees).
Another argument is that the Big Boys get a much better price when selling. I argue that the Big Boys are probably selling far too often. I’m a big believer in buy and hold, especially with bonds. Get a bond ladder in place and hold the bonds until maturity. You don’t have a selling commission and you get full face value for the bond. Why sell and potentially lose money?
Some say that “you never know when you’re going to need the money NOW!” My first response to that is, “If you have a plan in place with a proper Emergency and Set Aside Fund, you won’t need to liquidate your bonds NOW.” And my second response is, “Does that mean you’re not going to invest in stocks? Because being forced to sell at a bad price is far more likely with equities than bonds.”
I’ve also heard it said that you can’t diversify and will have larger holdings in each bond. This argument implies that if a company defaults on a bond you own, you’ll be out a lot of money. I only recommend buying investment grade bonds which are highly unlikely to default. That’s not to say that investment grade bonds never default, investing your money always carries risk, but an investment grade bond defaulting is not as likely as stock prices falling.
Some will argue that your principal in the bond isn’t protected against inflation. Is any investment “protected” against inflation? Inflation exists and we are always trying to beat inflation. The cash you put in any investment is going to devalue at the same rate, you aim to have the return (growth and income) outpace that devaluation. Money used to buy bonds in a bond fund will be affected by inflation the same as money used to buy an individual bond.
Another concern with bond funds is that it’s not always obvious what you are buying. The Big Boys might appear to “beat the market”, but this is achieved by taking on increased risk with lower grade bonds (which have high yields due to high risk) or by using derivatives (futures and options) that can definitely raise yields in good times, but can also go very badly in bad times.
It seems to me that the Big Boys have done a wonderful job marketing and selling to the masses that you can only invest in bonds if you go through them. I argue, individuals can do just as well or better at a given risk level by investing in individual bonds.
All information provided is general in nature and not meant to be advice for you in particular. I can’t predict the future, the discussion above is my best guess given the current data that’s available to me. If you’d like to know more about how this topic relates to your situation or are looking for a financial planner, contact me.
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.
- California does not have a tax advantage for California residents.
- 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.
- If you rollover your Illinois account to another state, it will be included in your Illinois income.
- 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.
People don’t normally think about Girl Scouts and financial planning together. Common thoughts are more along the lines of cute little girls in green, camping, and of course cookies. But a lot goes on to make those camping trips happen. And cookie sales are really an owner-run small business. Like any family or business, a troop has chores to do, conflicts to overcome, projects to plan (that might require buying insurance in case anything goes wrong,) and a budget to balance.
As a Girl Scout leader for twelve years, I most enjoyed watching the girls learn financial planning, Girl Scout Style. I knew they’d apply these financial skills in their personal lives in the future. Here are the key lessons learned by Girl Scouts.
- The girls learned that it’s ok to dream about fun adventures. We started each year determining what the troop wanted to do.
- Financial planning starts with a desire to buy or experience something.
- Write down your goals and dreams, short term and long term.
- What are your daily/weekly/monthly expenses? Girl Scouts pay for snacks, meeting supplies, field trips, badges. Families have food, shelter, clothes, medical expenses, and transportation. These are actually just short term goals.
- What are your required long term expenses? In Girl Scouts, there are handbooks & badge books to buy at each level, replacing/repairing tents for camping, and ceremonies. In a family you have cars and appliances to replace, a roof to replace/repair, college education, retirement. These areas need to fit in the budget too.
- Most people, whether Girl Scouts or not, want to help their community or a charity by donating money, time, or talent.
- After making sure the basics are covered, it’s nice to have a reward to look forward to. Both Girl Scouts and families dream about going trips, making big purchases, and having money for extras/luxuries. It easier to get through the day to day expenses if there’s a fun dream to look forward to.
- Look at what your income sources are. Are you able to make more money? Do you want to?
- Girl Scouts income sources include dues, fall product sales (nuts, magazines, and/or calendars), cookies sales, money earning projects (babysitting nights, carwashes, etc). Family income sources include jobs, investments, pensions, and inheritance.
- The girls and their chaperones can work harder at the Girl Scout fundraisers or do more money earning projects to increase their income. Families can choose to work longer hours to get more income, invest in more education to get a better job, or save money to buy investmentsthat provide more money in the future.
- The fun part of money is obviously spending it. Really, the main reason we work, Girl Scouts or family members, is to make money to spend.
- When choosing how to spend money, have a plan based on your goals. All stakeholders need to be involved, including Girl Scouts, Leaders, and parents in a . Involve all members in the family, including kids, in family financial decisions.
- It’s easier to make choices and sacrifices if everyone is involved. You may have to cut back on eating out to buy the clothes you want. You may want to cut back on the short term goals to get to your long term goals faster.
- Set realistic goals based on realistic income – you can’t spend more than you make in the long run.
- Don’t waste money because you don’t have goals. It’s easy to mindlessly buy things. With a goal, you can ask “do I want this or do I want more money in the Dream fund?”
- Understand the value of money when you make purchases. With your goals in mind, you can determine if a purchase is appropriate. Is the item you want to buy worth more than progress towards your Dream?
- Monitor, Celebrate, Reflect, and Plan your next Dream
- Monitor your progress and adjust income and/or expenses to stay on track.
- Periodically revisit the dream goal to ensure it’s still what you really want. Is it worth the sacrifices you may have to make?
- After you realize your dream goal, celebrate successfully reaching your goal.
- Reflect on what went right, wrong, how you could do better next time.
- Once a goal has been completed (short or long term goal), it’s time tolook forward to what’s next.
Remember: to safely navigate your life without emergencies, plan instead of react. As Benjamin Franklin said, “If you fail to plan, you plan to fail.” Guarantee success with a plan in place and track your progress.
Whether you’re a Girl Scout troop, a family, or an individual, setting goals, making a plan, and monitoring progress will help you get what you want out of life. Goals sometimes change and plans shift, but you’re still further ahead than wandering around in the dark. The more focused you are on your goals, the easier it will be to reach them.