Grandparents Should Consider Financial Aid When Contributing to 529 Plans

Jane Young, CFP, EA

Jane Young, CFP, EA

With the high cost of college many grandparents want to help their grandchildren with college.   One of the best ways to accomplish this can be through the use of 529 plans.

A 529 plan allows you to invest money for college with tax free earnings and tax free withdrawals, as long as the money is used for qualified higher education expenses.  Your grandchildren can use this money at any eligible post-secondary institution.  In Colorado your 529 contribution is deductible on your state income taxes.  Additionally, the owner of a 529 plan can change the beneficiary of a 529 plan as the needs of grandchildren change.

There are special gift tax benefits when contributing to a 529 plan.  The current annual gift tax exclusion is $14,000.  This means that both grandparents can gift up to $14,000 to each grandchild.  Additionally, with 529s you can make a one-time contribution of up to $70,000, if you treat the contribution as if it were made over 5 years.

Unfortunately, if your grandchildren are eligible for need based financial aid, utilizing a 529 plan for your grandchildren’s college expenses can hurt their chances of getting financial aid.  The amount invested in the 529 is not reported on the FAFSA (Free Application for Student Aid) but payments made to cover college expenses are included in the student’s income.  This income will reduce the student’s financial aid by 50% of the amount of the payment.

To avoid this problem you can transfer ownership of the 529 to the parent’s name before the student applies for financial aid.  For financial aid purposes a parental 529 is considered an asset and only 5.64% of the value is considered when calculating needs based aid.  About a dozen states do not allow transfer of ownership on 529 plans – ownership transfers are allowed in Colorado.

Alternatively, you could initially contribute to a parental 529 plan but you would lose the state income tax deduction and you lose control of the account.  The owner of the 529 account can change beneficiary designations and can spend money from the account, subject to a 10% penalty if not used for qualified college expenses.  Loss of control could be a concern in the case of divorce or blended families.

Another way to avoid an adverse impact to financial aid is to delay use of the grandparent’s 529 until January 1st of the student’s junior year in college.  Contributions after this day will have no impact on the student’s eligibility for financial aid.  You won’t have to report the 529 as an asset on FAFSA and the contributions from the account are not reported as student income.   This is a viable option if the student has other resources to pay for college up to this point and they still have enough college expenses to use all of the funds in the 529 account.

Supercharge Your Career for Long Term Financial Security

office pictures may 2012 002Proactively managing your career is essential to your long term financial success.  While traditional financial planning is important, it’s crucial to invest in yourself and your career.  The return you can earn from a serious commitment to your career may be better than any investment return you may reasonably achieve.  Strategic attention to your career can result in increased long term income opportunities, a job you love, job security and resources to build your investment portfolio.

It’s too easy to become comfortable and complacent with your situation and settle for less compensation and job satisfaction than you deserve.   The first step toward supercharging your career is to understand yourself.  Evaluate what makes you happy and where your passions and talents lie. Consider how you can best utilize your skills, interests, and experience. Research potential opportunities in your current field as well as in new career fields.  Information about a variety of careers,and what they pay, is available in the Department of Labor’s Occupational Outlook Handbook www.bls.gov.ooh.  Information on salaries can also be found on www.payscale.com and www.salary.com.

After doing your research and identifying some career opportunities, decide on your definition of career success and develop a plan to achieve this.   Career success is not based on luck but on strategic planning, action and commitment.  Establish some long and short term career goals to keep you on track toward meeting your plan.

To help achieve success, think of yourself as a brand of one.  In everything you do, consider your image and how people perceive you.  You have a reputation to build and maintain which should demonstrate trust, dependability, competency, enthusiasm and professionalism.  Don’t think of yourself as an employee but as a company of one who is working to bring success to your current firm.  This in turn will bring you success.  Be reliable and meet your commitments, proactively resolve problems and look for smarter ways to do business.  Do what is needed to get the job done, don’t lose site of the big picture, and focus on the bottom line.  Work strategically and watch for opportunities to meet the needs of your boss and your team.

Nurture relationships, be a team player, and keep a positive attitude.  Continually demonstrate how you can be of value to your boss, colleagues and clients.  Work in a collaborative manner and help others look good and get ahead.  Develop a strong personal network and find a mentor to assist you with your current job and exciting options for the future.

Proactively stay abreast of industry and technological changes. Seek out opportunities to learn and grow through continuing education and formal education.  You will experience more success if you embrace change and innovation.

Your career and ability to earn a good living can be your greatest financial asset – manage and nurture it to maximize your financial security.

Give the Gift of Financial Wisdom this Christmas

Jane Young, CFP, EA

Jane Young, CFP, EA

This year, the best Christmas gift for your adult children may be the gift of financial wisdom. Unfortunately, most young adults successfully graduate from school without a practical understanding of personal finance.  Starting out with a solid foundation and some smart financial habits can help your children live a happier, more fulfilling life.

Upon graduation from school, young adults are starting with a blank slate.  They are probably accustomed to a frugal lifestyle that is more about friends and experiences than expensive cars and fancy restaurants.  Before they take on a host of new financial commitments, encourage them to establish a lifetime habit of living below their means and saving for the future.  Work with them to develop a budget, establish an emergency fund and save for the future.  Help them to avoid the common tendency to increase their expenses in lock step with their income.  They can experience more freedom and opportunity by living below their means and gradually increasing their standard of living.

Another concept that is not taught in school, is the difference between good and bad debt.  Help your children understand the danger of high interest rate credit cards and consumer debt.  Encourage them to limit the number of credit cards they use and to get in the habit of paying credit card balances in full every month.  Also explain the importance of establishing a good credit rating by paying their bills on time.  Help them understand that low interest, tax deductible mortgage debt can be useful where high interest credit card debt can be very detrimental to their financial security.

It’s also important for them to understand some basic investment concepts including the power of compounding.  For example, if they invest $100 per month for 30 years for a total investment of $36,000, in 30 years with a return of 6%, their money can grow to over $100,000 due to compounding.   They have the benefit of time! By investing early, they have tremendous opportunity to grow their money into a sizable nest egg by retirement.

Understanding the importance of diversification and the relationship between risk and return is also essential.  Encourage your kids to avoid putting all of their eggs in one basket and help them understand that getting a higher return requires taking more risk.  It’s best to invest in a variety of investment options with different levels of risk and return.  Caution them that anything that sounds too good to be true probably is.  There is no free lunch!

To augment the personal wisdom that you can share, consider buying your kids a book on personal finance for Christmas.  Some books to consider include The Richest Man in Babylon by George S. Clason, Coin by Judy McNary, The Young Couples Guide to Growing Rich Together by Jill Gianola and the Wealthy Barber by David Chilton.

Taking Social Security Early Not the Best Option

Jane Young, CFP, EA

Jane Young, CFP, EA

The best time to take Social Security is a personal decision based on your financial situation, health, lifestyle, family longevity and when you stop working.  Social Security will provide you with the same total amount, if you live to the average life expectancy, regardless of when you take it.   The full retirement age for most people is between 66 and 67.  You can begin taking reduced benefits as early as 62 or you can wait and take an increased benefit as late as age 70.  If you begin at 62 your benefit is reduced by about 30%, if you take Social Security after your full retirement date your benefit will increase 8% per year until age 70.

You will probably benefit from taking Social Security at full retirement or later.  Unless you have a serious medical condition, there is a good chance you will live longer than the Social Security average life expectancy.  Social Security life expectancy tables are based on 2010 data and lag what can be reasonably expected.  They indicate a 65 year old male will live to around 84.3 and a 65 year old female will live to around 86.6.  Taking Social Security later is like buying longevity insurance.  It can provide you with more money later in life which can help put your mind at ease, if you are worried about out living your money.

If you are still working it can be especially detrimental to take Social Security before your full retirement age.  In 2015 you will lose $1 for every $2 earned over $15,720.   Once you reach full retirement age there is no limit to how much you can earn.   However, taxation of your Social Security benefit is based on your overall earnings.  If you take Social Security after you stop working a smaller portion of your benefit is likely to be taxable.  Additionally, if you continue to work and delay Social Security you may be able to increase your total Social Security benefit. The Social Security Administration annually recalculates benefits for recipients who are still working.

The decision on when to take Social Security is significantly impacted by your marital status and your spouses expected benefit.  If you have been married for at least ten years you have the option to take the greater of 50% of your spouse’s benefit or your full benefit. If you wait until your full retirement age you can start taking 50% of your spouse’s benefit, let your benefit grow, and switch back to your full benefit at age 70.   If you take the spousal benefit prior to your full retirement age you cannot switch back to your own benefit at a later date.  If you have been married for at least 10 years, and your spouse dies, you are eligible for the greater of your benefit or 100% of your spouse’s benefit.

More information about your Social Security benefit is available at www.ssa.gov.

Successful Habits of Wealthy People

Jane Young, CFP, EA

Jane Young, CFP, EA

Many believe that wealthy people are lucky or are born into their wealth but this myth is largely dispelled by research conducted by Thomas Corley.  Thomas Corley, CPA, CFP is president of Cerefice and Co. and the author of Rich Habits: The Daily Success Habits of Wealthy Individuals.  Over a five year period, Thomas Corley interviewed 233 millionaires and 128 people living in poverty.   Through these interviews he uncovered many daily activities that differentiated the two groups.  His research indicates that we have control over our destiny with our daily actions and habits.  It’s not always easy, but we can create our own luck by engaging in activities that will lead to greater financial success.  Over 85% of American Millionaires are self-made and are the first generation of wealth in their families.

Thomas Corley found that good habits are the foundation of success.  He discovered successful people have many good habits interspersed with a few bad habits where unsuccessful people have many bad habits with a few good habits.  Below are some of his findings on habits or daily activities practiced by successful people.

Successful people are goal oriented, 95% write down their goals and 81% maintain a To-Do list.  They don’t procrastinate and are focused on accomplishing things.   They are proactive, take control of their lives, and get things done.  They don’t let events or other people control their priorities.  Unsuccessful people are not goal oriented and can become easily distracted.  They don’t have goals to keep them grounded and focused on the end result.

Successful people eat healthy and exercise, 76% of the wealthy exercise aerobically 4 days per week. They rarely overindulge or binge, if they slip it’s a planned overindulgence on special occasions.  Eating well and exercise improves the immune system and energy levels which results in greater productivity.  Unsuccessful people have no consistent day to day control over their health.

Successful people place great value on relationships.  They are focused on others rather than themselves.  They understand the importance of networking and look for reasons to reach out to their contacts.  They don’t waste time in negative relationships with people who are only concerned about themselves.

Successful people engage in moderation.  They keep their thoughts and emotions in check and avoid obsession, addiction, extravagance, jealousy, envy and fanatical behavior.  People enjoy their company and feel comfortable being around them.  Unsuccessful people are more likely to live in conflict with little control over their lives.

Successful people are constantly engaged in self-improvement.  They watch very little TV and read for self-improvement.  They keep up with changes in their profession and devote time every day to better themselves.

Finally, successful people have a positive attitude.  They are happy, enthusiastic, confident and well balanced.  They feel empowered and take control of their lives rather than allowing outside forces to determine their destiny.  Have you taken control of your destiny?

Car Buying Tips

Jane Young, CFP, EA

Jane Young, CFP, EA

Aside from a home, purchasing a vehicle will probably be your single largest expenditure, so it merits some serious consideration and in-depth research.  The decision on what to buy should include budget, practicality, safety, reliability and cost of ownership.  A vehicle is a very expensive depreciating asset. Unless you have a large disposable income it’s advisable to buy a practical car.  If your heart is set on a more extravagant sports car or luxury car consider buying an older model, used vehicle.   Cars have become a status symbol but there are plenty of less expensive ways to express your style and status – many of which are better long term investments.

Ideally, save your money to purchase a used car that is about 2 to 3 years old with cash.  The car will be greatly depreciated and you get a relatively new car for much less than a brand new car. If paying cash is unrealistic, work with your bank or credit union to get pre-approved for a loan.  This can give you a good idea of what you can afford.  As a general rule, your household budget on vehicle expenses should not exceed 20% of your take home pay.  This includes car payments, gas, insurance and maintenance.

Decide how much you want to spend and make a list of your must have features.  Conduct some on-line research to narrow down the range of possibilities.   The following websites can provide price quotes and information on the cars you are interested in – Edmunds.com, Truecar.com, KBB.com (Kelly Blue Book) and NADA.com.  Once you have settled on a couple of options do some further research to find the invoice price.  Generally the dealers actual cost is the invoice price, less about 3% to 5% for factory hold backs.

Now you’re ready to negotiate the purchase of your new car.   Get quotes from several dealers and make it clear that you want to focus on the total cost to buy the vehicle, with cash.  Don’t let them side track the conversation with discussions about monthly payments, trade-in deals and financing options where it is harder to decipher the true cost of the vehicle.  If purchasing a new car, inform the salesperson that you have done your homework and you have a good idea of what the dealer paid for the car.  They will try to focus on the MSRP (Manufacturers Suggested Retail Price).   Let them know you have quotes from other dealers and you are ready to buy a car for their cost (not the MSRP) plus a reasonable profit.

When buying a used car, you can get reasonable purchase prices on Edmunds.com and KBB.com.  You can probably get a better deal through a private seller than with a dealer.  Before signing the papers, get a vehicle history report form Carfax.com or Autocheck.com and have the car inspected by a good mechanic.

Is Long Term Care Insurance Right for You? – Part 2

Jane Young, CFP, EA

Jane Young, CFP, EA

As mentioned in my previous post, about 75% of the population will spend $10,000 or less on Long Term Care (LTC) and about 6% will spend over $100,000.  You may not need extended LTC but due to the significant costs, the possibility should be addressed in your financial planning.  According to the U.S. Department of Health and Human Services the average monthly cost for long term care in 2013 was $1343 for adult day care, $3,500 for assisted living, $4,000 for home health care and $6,500 for nursing care.  Based on cost increases over the last 5 years, it’s reasonable to assume that LTC will continue to increase about 5% annually.  If we assume a current LTC cost of $5,000 per month, with a compound inflation rate of 5%, the annual cost of LTC in twenty years could be $159,197.  Although the probability of needing LTC for an extended period of time is low, if you need care, it can quickly diminish your retirement nest egg.

Based on the danger of depleting your savings, LTC insurance may seem like a logical option but the cost can be significant and it’s not without risk.  The cost of LTC insurance is dependent on your age, your health, the daily benefit, the benefit period and the inflation protection.  Below are some average LTC insurance rates for individuals with a standard health rate, a daily benefit of $150, a benefit period of 3 years and a 3% compound inflation growth option.  The average LTC care insurance rate for a single person age 55 is $2,007 per year, the rate for a couple both 55 is $2466, and the rate for a couple both age 60 is $3,381.

If you decide to purchase LTC insurance, compare prices and work with a couple of different brokers who work with several companies.   Companies have different niches where some may have the lowest prices for those in their 50’s while others may focus on clients who are in especially good health.  A good insurance broker can help you select the best provider for your situation.

You also want to purchase LTC insurance from a high quality company, this is not the place to go with the low cost provider.  Select a company with a reasonable chance of being solvent down the road, when you need the coverage.  Over the last several years, 10 out of the top 20 providers have stopped providing LTC insurance.  Additionally, as a result of higher than anticipated LTC costs, low interest rates and a larger than expected number of people holding on to their policies, LTC insurance companies have significantly raised their premiums.  Many older policies have had premium increases in excess of 20% – 40%.  Although industry insiders claim to have a better handle on this going forward, there is still a risk of premium increases in the future.

Do You Need Long Term Care Insurance? – Part 1

Jane Young, CFP, EA

Jane Young, CFP, EA

As retirement grows closer the decision on how you will cover potential long term care expenses becomes a serious concern.   Unfortunately, with the high cost of long term care (LTC) and the high cost of long term care insurance there is no easy solution.  LTC refers to services or support to help you with medical or non-medical personal care needs.   LTC can provide assistance with cognitive impairment and activities of daily living such as eating, bathing, dressing, using the toilet and assistance with incontinence.  About 80% of all LTC is provided in the home.

LTC expenses can be paid with a combination of personal or family savings, LTC Insurance and government assistance.  Generally Medicare does not cover long term care.  Medicare will provide 100 days of skilled nursing care following a 3 day stay in the hospital.  Medicaid will pay for LTC after most of your assets have been depleted but Medicaid is usually limited to skilled nursing home care.

The decision to purchase LTC insurance is straight forward for the affluent who can self-insure and for those with little or no assets who must rely on Medicaid for their LTC expenses.  The decision is more complicated for those who can’t afford to self-insure but want to protect their assets to provide a livelihood to a surviving spouse, an inheritance to children or want to avoid being a burden to family.

Individuals who are at the greatest risk for needing LTC are those with a history of a chronic condition such as high blood pressure or diabetes, or have family members with a history of a chronic condition.  You may also have a higher risk if you are in poor health or have poor diet and exercise habits.  Women are at greater risk than men because on average, they live 5 years longer.

According to a study using a microsimulation model performed by Kemper, Komisar and Alecxih, on average people currently turning 65 will need LTC for three years.   They found that 3 out of 10 people will rely on family for their care for more than 2 of these years.  They also found that 2 out of 10 people will need care for over 5 years.  Overall, their analysis indicated that 50% will have no out of pocket expenditures for LTC, 25% will spend less than $10,000 and 6% will spend over $100,000.

Additionally, based on information from leading insurance actuaries, the Association for Long Term Care Insurance reported that someone who buys a LTC insurance policy, with a 90 day elimination period, at age 60 has a 35% chance of using it before they die.  They also reported that the average stay in a nursing home is 2.3 years for men and 2.6 years for women. Most care is provided at home but statistics on this are limited.

My next column will address the cost of LTC and LTC insurance and the pros and cons of purchasing LTC insurance.

Timeless Tips for Investment Success

Jane Young, CFP, EA

Jane Young, CFP, EA

You don’t need to employ a lot of sophisticated techniques and strategies to become a successful investor.  The most effective tools for investment success are simplicity, patience, and discipline.  Below are some guidelines to help you get the most from your investments.

Invest for the long term.  Evaluate your situation, set some goals, create a plan and stick with it.   Keep money that you may need for emergencies and short term living expenses in less volatile investments such as money market accounts, CDs and bonds.   Investments in the stock market should be limited to money that isn’t needed for at least 5 years.  If you keep a long term perspective with the money invested in the stock market you will be less likely to react to short term fluctuations.

Maintain a diversified portfolio.  Your portfolio should be comprised of a variety of different types of investments including stocks, bonds and cash.  The stock portion of your portfolio should include stock mutual funds that invest in companies of different sizes, in different industries and in different geographies.  Don’t chase the latest hot asset class and don’t act on the hot stock tip your buddy shared with you at happy hour.  Create a diversified portfolio and rebalance on an annual basis.  It’s also advisable to avoid investing more than 5% in a single security.

Don’t Time the Market.  Many studies have found that market timing just does not work and can be detrimental to your portfolio.  The so-called experts really have no idea what the market is going to do.  Many analysts earn a living by projecting future market fluctuations when in reality they are no better at predicting the future than you or me.  Peter Lynch sums it up perfectly with the following quote – “More money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.”

Keep Your Emotions in Check. The stock market is volatile and there will be years with negative returns.   Limit investment in the stock market to money you won’t need for several years.  Have patience and stay the course.  As experienced after the 2008 correction, the market will eventually rebound.  Don’t succumb to media hype and fear tactics claiming things are different this time. There have always been, and always will be, major events that trigger dramatic fluctuations in the stock market.  Don’t panic this will pass.  Sir John Templeton once said, “The four most dangerous words in investing are: “This Time is Different!”

Be tax smart but don’t let taxes drive your portfolio.  Where possible maximize the use of tax advantaged retirement vehicles such as 401k plans and Roth IRAs.  Place investments with the greatest opportunity for long term growth in tax deferred or tax free retirement accounts.   Save taxes where it makes sense but don’t intentionally sacrifice return just to save a few dollars in taxes.

The Secret to Financial Freedom is Living below Your Means

Jane Young, CFP, EA

Jane Young, CFP, EA

Over the years I have observed that a comfortable retirement and financial security can best be achieved with reasonable lifestyle choices.  One of the biggest detriments toward reaching financial independence is spending beyond your means and spending on things you don’t really need.  You don’t necessarily need millions of dollars to retire comfortably but you need to follow a lifestyle that minimizes your living expenses while allowing you to indulge on things or experiences that are really important to you.  Good financial planning requires a balance between current expenses and saving for the future. 

Many Americans have a habit of systematically increasing expenses in lock step with salary increases.  Along with a big raise or promotion comes the inclination to buy a bigger house or a new car.  As we progress through our careers, earning a higher income, we continually take on more financial obligations becoming hand-cuffed to our jobs and our bills.  By increasing your lifestyle every time your income increases you can get caught up on an endless treadmill, trapped with a lot of debt for a house and cars that may be more than you really need.  I’m all for enjoying some of the benefits that come from all your hard work but it’s prudent to spend below your income.   Avoid the temptation to live an extravagant lifestyle and compete with your neighbors, colleagues and friends.  Instead, take pride in following a solid financial plan by saving for the future to achieve greater financial freedom.

As a rule of thumb, save or invest at least 10 – 20% of your income and maintain a buffer of 4 to 6 months of expenses to cover emergencies or a change in your ability to earn a living.  Try to keep your housing expenses below 28% of your gross income; this includes your mortgage payment, insurance and taxes.  Avoid systematically increasing your expenses.  Give yourself some breathing room in case you want or need to make a career change.  Save for the future and keep your options open.  As your income rises automatically put a larger portion into savings and retirement.

To keep expenses under control, examine what is important to you and set some priorities.  You have worked hard and you deserve some of the nice things in life but spend your money on things or experiences that genuinely make you happy.   If you want a really nice house you may decide to spend less on vehicles, vacations and clothing.  If you love taking extravagant vacations consider buying a smaller home and less expensive used vehicles.  Never buy on impulse – always look for ways to save money on the purchase of things you decide are important to you.  

Prioritize your spending to live below your means, save for the future and focus on what truly brings you joy.

Gradual Retirement Can Ease Stress and Cash Flow

Jane Young, CFP, EA

Jane Young, CFP, EA

As the average life expectancy increases retirement is starting to look very different.   We may be less likely to completely stop working on a fixed, predetermined date.  As the traditional retirement age of 65 approaches many are considering a more gradual transition into retirement.

One advantage of easing into retirement includes the ability to supplement your cash flow and reduce the amount needed to be withdrawn from your retirement savings.  If you continue working after 65 you may be able to earn enough to delay taking Social Security until 70.  This will provide additional financial security because your Social Security benefit increases 8% per year from your normal retirement age to age 70.  The normal Social Security retirement age is between 66 and 67.

Abruptly going into retirement can be very traumatic because careers provide us with a sense of purpose, a feeling of accomplishment and self-esteem.   Your social structure can also be closely tied to work.  By working part time before completely retiring, you can gradually transition into the new phase of your life.   As you approach retirement age the grind of working 40 to 50 hours per week can become very trying.   Working part time allows you to stay engaged with your career while taking some time to relax and pursue other interests.

According to a 2012 study by the Bureau of Labor Statistics, more people are working beyond age 65.  In 2012 about 18.5% of Americans over 65 were still working vs. only 10.8% in 1985.  A study reported by the Journal of Occupational Health and Psychology stated there are health benefits from working part time during retirement.  This may be attributed to less stress and a more balanced life while experiencing the mental stimulation gained from continued engagement at work.

Gradually transitioning into retirement may be more practical for someone who is self-employed.  However, the concept of phased retirement is a hot topic among human relations firms and departments.  Phased retirement programs usually involve working about 20 hours a week with some element of mentoring less experienced workers.  Formal phased retirement programs are still rare but they are gaining popularity.  A 2010 study by AARP and the Society for Human Resources Management found that about 20% of the organizations polled had a phased retirement program or were planning to start a one.  In fact, the federal government just launched a phased retirement program.

Before signing up for a phased retirement plan, take steps to fully understand the impact it may have on your benefits.  If you are under 65 there may be restrictions on your health insurance.   Additionally, some pension calculations are based on your final years of salary, working fewer hours at this time could negatively impact your benefit.  Also avoid situations where you are only paid for 20 hours a week but still work 30 or 40 hours to get your job done.

Don’t Let Emotions Derail Your Investment Portfolio

Jane Young, CFP, EA

Jane Young, CFP, EA

Emotions may be the single biggest detriment to your investment success.  We try to approach investments from a logical perspective but we are emotional creatures and money can stir-up intense feelings. The most common emotions are fear and greed which can lead us to overreact and sell low when the market is down and buy high when the market is at a peak.  Both actions are harmful to the performance of your investment portfolio. We can’t ignore emotions but we can better understand our emotional triggers and learn how to manage them.

You can minimize emotional reactions to fluctuations in the stock market by creating a plan.   With some planning you can establish a diversified asset allocation that incorporates your investment timeframe, financial goals and tolerance for risk.  A well designed asset allocation can ensure that money needed in the short term is placed in safer fixed income investments while long term money is invested in higher return, higher risk investments like stock mutual funds.   As a general rule, money needed in the next five years should not be invested in the stock market.  If you position your short term money in safer, less volatile investments such as money markets, CDs and bonds, you will be less likely to overreact   and act on emotion.

When you invest in the stock market prepare yourself for volatility including some years with negative returns.  Over long periods of time, the average return in the stock market has been around 9%, much higher than the average return for fixed income investments.  However, stock market returns are not level.  In some years, stock market returns will be higher than average and some years they will be lower than average. If you are prepared for this and maintain a long time horizon you will be more likely to stay on course.

Be wary of sensational news reports that claim the world is coming to an end and everything is different this time.  The stock market goes through cycles and there will always be scandals, bubbles and crises getting blown out of proportion by the media, financial pundits or financial companies trying to sell you something.  An example of this is commercials that use fear tactics to encourage you to buy gold and silver. They prey on the fear and uncertainty investors experience during a significant market drop.

Buying on emotion can also be detrimental to the long term performance of your portfolio.  We have a natural fear of missing an opportunity.  Avoid chasing the latest hot asset class or following the crowd because you don’t want to miss out.  Assets performing well this year may be next year’s losers and investments with abnormally high returns aren’t sustainable.  Don’t get swept up in the euphoria, keep your portfolio diversified where assets that perform well this year can buffer against those that aren’t performing well.

Slow and steady wins every time!

Avoiding the Stock Market Can be a Risky

Jane Young, CFP, EA

Jane Young, CFP, EA

You may be hesitant to invest in the stock market because it feels too risky.  However, consider the risk you are taking with your financial future by avoiding the stock market.  The primary reason to invest in the stock market is the potential for a much higher return, especially in low interest rate environments.  Most of us need the potential for long term growth provided by the stock market to meet our retirement needs.  If you invest all of your money in fixed income you may struggle just to keep up with inflation and you run the risk of outliving your money.

Historically, stock market returns have been almost double those earned by bonds.  According to the Ibbotson SBBI (stock, bonds, bills and inflation) report, between 1926 and 2014 the average annual return on Small Stock was 12.3%, Large Stock was 10.1%, Government Bonds was 5.5%, Treasury Bills was 3.5% and Inflation was 3%.  This illustrates that investing at least some of your portfolio in stock can provide a much greater opportunity than fixed income to meet your financial goals.

Investing in the stock market is not without risk.  As with all investments, we must take on greater risk to earn a greater return.  However, there are many ways to help manage the volatility of the stock market.  Before investing in stocks make sure your financial affairs are in order.  Pay off your credit cards, establish an emergency fund and put money that will be needed over the next five years into less volatile fixed income investments.  The stock market is for long term investing.  It can provide the opportunity to earn higher long term returns but you can count on some volatility along the way.  By creating a buffer to cover short term needs you will be less likely overreact to fluctuations in the market and sell when the market is down.

You can also buffer stock market risk by creating a well-diversified portfolio comprised of mutual funds invested in stocks or bonds from a variety of different size companies, different industries and a variety of different geographies.  Investing in a single company can be very risky but investment in mutual funds can reduce this risk.  When investing in mutual funds your money is combined with that of other investors and invested, by a professional manager, into a large number of stocks or bonds.  Investing in a large number of companies enables you to spread out your risk.

Dollar cost averaging, where you automatically invest a set amount on a regular basis – usually monthly or quarterly, can also reduce risk.  Rather than investing a large amount all at once, when the market may be high, you gradually invest over time.  With dollar cost averaging you buy more shares when the market is low and fewer shares when the market is high.

Invest in Roth IRAs with Caution

Jane Young, CFP, EA

Jane Young, CFP, EA

A Roth IRA can be an excellent vehicle to save for retirement but it’s not without limitations.  With a Roth IRA you invest after-tax dollars that grow tax free and can be withdrawn tax free in retirement. This can be beneficial unless you are currently in a high tax bracket and anticipate being in a lower tax bracket in retirement.

Income limitations can be a significant downfall with Roth IRAs.  During your highest income years you may be ineligible to invest in a Roth IRA and there can be substantial penalties for making ineligible contributions.  In 2015 the income limit for someone filing single begins at $116,000 and the income limit for someone filing married filing jointly begins at $183,000.  If you make a contribution and your income exceeds the limitations, you have until your tax deadline, including extensions to withdraw your contribution.  It’s easy to inadvertently make ineligible contributions and there aren’t many red flags to alert you to the problem.  If you don’t withdraw excess contributions within the deadline you will incur a 6% penalty for every year the money remains in your Roth IRA.

Also be careful not to exceed the annual Roth IRA contribution limits.  In 2015 the contribution limit for investors under 50 is $5,500, if you are over 50 you can make an additional catch-up contribution of $1,000. Also keep in mind that Roth IRA contributions can only be made with earned income.

If your earnings exceed the income limitations and you still want to participate in a Roth IRA, you may have several options.   Your employer may offer a Roth 401k in addition to a traditional 401k.   With a Roth 401k, your employee contributions can go into the Roth option but the employer match must go into a traditional 401k.  A second option is to convert a traditional IRA to a Roth IRA but the amount converted is taxed as regular income in the year of conversion. As a refresher, with a traditional IRA and 401k you invest with before tax dollars and you pay regular income tax on the full amount when you withdraw the money.  Finally, you can consider investing in a non-deductible IRA and immediately convert it to a Roth IRA, also known as a backdoor Roth IRA.

Initially, the backdoor Roth sounds like the perfect solution because there is no income limitation on a non-deductible IRA and it’s funded with after tax dollars. Theoretically, immediate conversion to a Roth IRA should be tax free. The hitch comes from the IRS rule requiring you to aggregate all of your IRAs and proportionately include money from all IRAs in your Roth conversion.  Traditional and rollover IRAs are comprised of pre-tax dollars so the proportion of the conversion coming from these IRAs will be taxed as regular income.  Although backdoor Roth IRAs can be complex but they can be a good option if you don’t own other IRAs.

Tax Diversification Can Stretch Retirement Dollars

Jane Young, CFP, EA

Jane Young, CFP, EA

Most investors understand the importance of maintaining a well-diversified asset allocation consisting of a wide variety of stock mutual funds, fixed income investments and real estate.  But you may be less aware of the importance of building a portfolio that provides you with tax diversification.

Tax diversification is achieved by investing money in a variety of accounts that will be taxed differently in retirement.   With traditional retirement vehicles such as 401k plans and traditional IRAs, your contribution is currently deductible from your taxable income, your contribution will grow tax deferred and you will pay regular income taxes upon distribution in retirement.  Generally, you can’t access this money without a penalty before 59 ½ and you must take Required Minimum Distributions at 70 ½. This may be a good option during your peak earning years when your current tax bracket may be higher than it will be in retirement.

Another great vehicle for retirement savings is a Roth IRA or a Roth 401k which is not deductible from your current earnings.  Roth accounts grow tax free and can be withheld tax free in retirement, if held for at least five years. If possible everyone should contribute some money to a Roth and they are especially good for investors who are currently in their lower earning years.

A third common way to save for retirement is in a taxable account.  You invest in a taxable account with after tax money and pay taxes on interest and dividends as they are earned.  Capital gains are generally paid at a lower rate upon the sale of the investment.  In addition to liquidity, some benefits of a taxable account include the absence of limits on contributions, the absence of penalties for early withdrawals and absence of required minimum distributions.

Once you reach retirement it’s beneficial to have some flexibility in the type of account from which you pull retirement funds.  In some years you can minimize income taxes by pulling from a combination of 401k, Roth and taxable accounts to avoid going into a higher income tax bracket.  This may be especially helpful in years when you earn outside income, sell taxable property or take large withdrawals to cover big ticket items like a car.  Another way to save taxes is to spread large taxable distributions over two years.

Additionally, by strategically managing your taxable distributions you may be able to minimize tax on your Social Security benefit.   Your taxable income can also have an impact on deductions for medical expenses and miscellaneous itemized deductions, which must exceed a set percentage of your income to become deductible.  In years with large unreimbursed medical or dental expenses you may want to withdraw less from your taxable accounts.

Finally, there may be major changes to tax rates or the tax code in the future.  A Tax diversified portfolio can provide a hedge against major changes from future tax legislation.

Strategically Withdraw Money for Retirement

Jane Young, CFP, EA

Jane Young, CFP, EA

After years of contributing money to 401k plans and Roth IRAs you are finally ready for retirement and face the dilemma of how to best withdraw your retirement savings.  Many retirees have several sources of income such as pensions, social security and real estate investments to help cover their retirement needs. Review your annual expenses and determine how much you need to pull from your nest egg for expenses that aren’t covered by other income sources.

One way to manage your retirement income needs is to create three buckets of money.  The first bucket is for money that will be needed in the next twelve months.  This money should be fully liquid in a checking, savings or money market account.  The second bucket is money that will be needed over the next five years.  At a minimum, hold money needed in the next five years in fixed income investments such as CDs and short term bond funds.  By investing this money in fixed income investments it is shielded from the fluctuations in the stock market; avoiding the agonizing possibility of having to sell stock mutual funds when the market is down.

Consider buying a rolling CD ladder where a CD covering one year of expenses will mature every year for the next four to five years.  After you spend your cash during the current year a new CD will mature to provide liquidity for the coming year.

The third bucket of money is your long term investment portfolio.  This should be a diversified portfolio made up of a combination stock mutual funds and fixed income investments.  Every year you will need to re-position investments from this bucket to your CD ladder or short term bond funds to cover five years of expenses.  Rebalance your long term portfolio on an annual basis to keep it well diversified.

In conjunction with positioning your asset allocation for short term needs, you need to decide from which account you should withdraw money.  Conventional wisdom tells us to draw down taxable accounts first to allow our retirement accounts to grow and compound tax deferred, for as long as possible.  Gains on money withdrawn from a taxable account are taxed at capital gains rates where withdrawals from a traditional retirement account are taxed at regular income tax rates and withdrawals from Roth IRAs are generally tax free.

Withdrawing all your money from taxable accounts first isn’t always the best solution.  You need to analyze your income tax situation and strategically manage your withdrawals to avoid unnecessarily going into a higher tax bracket.  Additionally, the taxation of Social Security is graduated based on income.  After starting Social Security, you may be able to minimize taxation of your benefit by taking withdrawals from a combination of taxable, traditional retirement and Roth accounts.  Do some tax and financial planning to strategically minimize taxes and maximize your retirement portfolio.

Selecting the Right Asset Allocation

Jane Young, CFP, EA

Jane Young, CFP, EA

When investing money, one of the first decisions to be made is your asset allocation.  Asset allocation is the division of your assets into different types of investments such as stock mutual funds, bonds, real estate or cash.  In order to maximize the return on your portfolio it’s crucial to maintain a well-diversified asset allocation.  According to many financial experts, asset allocation may be your single most important investment decision, more important than the specific investments or funds that you select.

There is no one size fits all; the right asset allocation is based on your unique situation which may change as your circumstances or perspective changes.  Some major factors to consider include investment time horizon, the need for liquidity, risk tolerance, risks taken in other areas of your life and how much risk is required to achieve your goals.

Arriving at the appropriate asset allocation is largely a balance between risk and return.  If you want or need a higher return you will have to assume a higher level of risk.  If you have a long investment time horizon, you can take on more risk because you don’t need your money right away and you can ride out fluctuations in the market.  However, if you have a short time horizon you should minimize your risk so your money will be readily available.

If you want to minimize risk, invest in fixed income investments such as money market accounts, certificate of deposits, high quality bonds or short term bond funds.   If you are willing to take on more risk, with the expectation of getting higher returns, consider stock mutual funds.  Generally, avoid investing money needed in the next five years into the stock market.   However, the stock market is an excellent option for long term money.

Regardless of your situation, the best allocation is usually a combination of fixed income and stock mutual funds.  With a diversified portfolio you can take advantage of higher returns found in the stock market while buffering your risk and meeting short term needs with fixed income investments.

Once your target asset allocation is set, rebalance on annual basis to stay on target.   Rebalancing will automatically result in selling investments that are high and buying investments that are low.  Avoid changing your target allocation based on emotional reactions to short term market fluctuations.    Stick to your plan unless there are major changes in your circumstances.

If you are unsure where to start, a good rule of thumb is to subtract your age from 120 to arrive at the percentage you should invest in stock market.  In the past it was customary to subtract from 100 but this has increased as life expectancies and the time one spends in retirement have increased.   In the final analysis, select an asset allocation that meets your specific needs and gives you peace of mind.

Save Money in Retirement

Jane Young, CFP, EA

Jane Young, CFP, EA

There are many ways to stretch your retirement dollars without dramatically impacting your lifestyle.  Start by evaluating what is of great importance to you.  Create a plan that encourages you to spend on things and experiences that are important to you and helps you reduce expenses in low priority areas.

Depending on your priorities, a decrease in housing expenses may provide tremendous cost savings.   If you live in a city with a high cost of living, consider relocating to a lower cost city – ideally one closer to family.  According to Forbes, some of the most affordable cities in 2014 include Knoxville, Birmingham, Tampa, Virginia Beach and Oklahoma City. 

Downsizing is another great way to reduce expenses.  Now that you’re retired, your housing needs have probably changed.  Downsizing can help you reduce expenses on mortgage, insurance, taxes, utilities and maintenance.  In addition to saving money, you may be ready for a different lifestyle, a new floor plan (living on one level) and a new neighborhood that better meets your needs throughout retirement.

In retirement there are opportunities to save on vehicle expenses.  Assuming you are no longer commuting to work every day, you should be able to save on gas and maintenance for your vehicle.   Additionally, many retired couples don’t need two vehicles, selling a second car can save on car payments, insurance, taxes and maintenance. 

Vehicles are a depreciating asset where you can lose thousands of dollars by simply driving a car off the lot. Save money by resisting the temptation to buy a new car.  Internet sites such as Edmunds.com and Kelley Bluebook (kbb.com) make it easy to research prices to negotiate a good deal on a used vehicle.   Additionally, where possible, buy your vehicles with cash and avoid high interest car loans.

In retirement, you have more time to focus on saving money. Use this time to shop and compare, watch for specials and utilize coupons.  Evaluate your home, auto and health insurance and compare prices and features provided by different companies.  Save on cell phones, internet and television by comparing service offerings and negotiating prices.  Consider doing chores around the house that you previously hired someone else to do and cook more to save on eating out.

Having more time can also result in saving on travel expenses.  A more flexible schedule, allows you to avoid peak season and get reduced rates on airfare, lodging and restaurants.  May and September are great months to travel and get some good deals.  You can also save by flying during the week.   Travel sites such as Tripadvisor.com, Cheaptickets.com, RickSteves.com and Vacation Rental by Owner (VRBO.com) can also help maximize your travel dollar.

Finally, avoid the temptation to over spend on children and grandchildren.  You will probably need most of your money to cover retirement spending needs.  Give your family the gift of your love and time rather than your money.

Looking to the Future as a Widow

Jane Young, CFP, EA

Jane Young, CFP, EA

During the first few years of widowhood you need to take care of yourself and give yourself time to grieve.  During this time it’s best to focus on issues that need immediate attention and avoid making long term financial decisions.   Everyone’s timeframe is different, but after a few years you may be ready to start looking toward the future.   Initially, this may be difficult and very emotional.  It’s not unusual to take two steps forward and one step back.  Take it slow and gradually start creating a plan for your future.

Before the loss of your husband, you set goals and dreams together.  It’s very hard to let go of those dreams and start planning for a future on your own.  Many widows feel they are betraying their husband by changing their plans.  This is simply not true, now that your husband is gone your situation is different, and you need to chart a course that meets your new situation.

Start by identifying your values and what is truly import.  Make a list of what you want and need in your life.   It may help to evaluate different areas of your life and identify your needs and desires in different categories such as: family, health, social, faith, financial, community and continuing education.   Using this information, set some broad goals to be achieved over the next five years as well as some long term goals. Some big decisions may come out of this process including where and how you want to live.  Do you want to live in a new city, new house or maybe downsize to something easier to maintain?  If you are still working, do you want to make some career changes?  Do you want or need to go back to school? How do you want to spend your time and money over the next five years?

Once you have identified your goals, develop a financial plan that will enable you to put your plans into action.  Your financial plan needs to provide a balance between your long term needs and your short term goals.  Evaluate your current situation.  Identify your current net worth, your current income and your current expenses.  Are your expenses in alignment with your goals or do you need to make some adjustments?  This is your opportunity to adjust your lifestyle and spending habits to support your goals.

In developing your financial plan, set aside funds for major expenses such as college tuition, a new vehicle or home maintenance.  You should also consider paying off card debt and maintaining an emergency fund of at least four months of expenses.   Do some planning to be sure you’re saving enough for retirement.   If you are in retirement, ensure you have enough funds to cover your projected expenses throughout retirement.  Finally, budget some money just for fun -to do some traveling or pursue some hobbies.

Minimum Liability on Car Insurance Not Adequate for Most Drivers

 

Jane Young, CFP, EA

Jane Young, CFP, EA

The state of Colorado requires you to carry liability insurance in case you injure someone or damage someone’s property.  Colorado law requires liability insurance of at least $25,000 for bodily injury per person, $50,000 bodily injury per accident and $15,000 for property damage.   The law also requires insurers to offer uninsured/underinsured motorist coverage and medical coverage unless you waive them.   Generally, they also offer optional comprehensive, collision, towing and rental car coverage. 

However, the liability requirements set forth by the state of Colorado are not adequate for most car owners.  The amount of liability coverage you need is dependent on your net worth or what you have to lose, if you are at fault for an accident.  If you cause a serious car accident, where several people are injured, the medical expenses could easily cost hundreds of thousands of dollars.  With minimum liability coverage, your insurance is only obligated to pay $50,000.  In this situation, an attorney representing the injured parties would probably sue you for the rest of the medical expenses.  If you don’t have any assets this would be a futile effort, but if you have a lot of assets, this could wipe you out. 

As a general rule, according to Darrell Wilson a local insurance agent who operates Alliance Insurance Group of Colorado Springs, anyone with a reasonable level of assets should carry liability insurance of $250,000 – $500,000 for bodily injury per person, around $500,000 for bodily injury per accident and $250,000 – $500,000 for property damage.  He suggests looking at your personal situation to assess how much you have at risk.

In addition to liability insurance, be sure to carry adequate uninsured/underinsured motorist coverage.  According to Wilson, between 1 in 3 and 1 in 4 motorists are either uninsured or underinsured.  This coverage provides protection if you are in an accident caused by someone with inadequate insurance.  It’s advisable to set your uninsured/underinsured motorist coverage to levels similar to your liability limits.

If you have a reasonable level of assets you should also consider an Umbrella Liability Policy equal to 1 to 2 times your net worth.  Umbrella Liability insurance is usually above and beyond the coverage provided by your auto and home policy, but verify this with your insurance agent.

It’s advisable to meet with your agent to review your insurance coverage at least once every two years.  Periodically, you should also compare the rates you are paying, but make sure you are looking at comparable policies.  In addition to price, evaluate an insurance company’s financial stability and their record of customer satisfaction with previous claims.  On the internet, you can find information on financial stability through A.M. Best or Standard and Poor’s, and information on customer satisfaction through JD Power or Consumer Reports.   Also ask your friends and family for referrals, just about everyone has some experience with car insurance.

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