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.

Mutual Funds Probably Better Option Than Individual Stocks

 

Jane Young, CFP, EA

Jane Young, CFP, EA

Mutual funds are a better option than individual stocks for most investors.  The decision to invest in mutual funds or individual stocks depends on the size of your portfolio, your investment knowledge, your level of time and involvement, your risk tolerance, your ability to make objective investment decisions and your tax situation.

Many investors don’t have enough money to adequately diversify their portfolio across a wide range of individual stocks.   To gain true stock diversification, you need to invest in companies of different sizes, in a wide range of different industry sectors and in a variety of different geographies. Mutual funds enable you to gain this broad diversification by pooling your money with a large number of other investors.

Additionally, mutual funds are professionally managed, making them ideal for individuals with limited investment knowledge or a limited amount of time to research and monitor individual stocks.  Most mutual fund companies have a large staff of managers and research analysts who analyze financial reports, visit companies and keep tabs on the economic and political climate.  It is very difficult for most     investors to devote the time and commitment needed to create and maintain a well-diversified portfolio of individual stocks.

Professional managers also have access to more timely information.  Many investors are tempted to buy and sell individual stock based on current events.  However, the market is relatively efficient which means it quickly responds to new information.  What seems like breaking news has probably already been factored into the price of the stock.

Unfortunately, diversification and professional management does not come without a cost.  Most mutual funds charge an annual management fee of between .25 and 1.25%.

Additionally, when investing your own money it is hard to stay objective.  We have a natural inclination to emotionally react to changes in the market and to become emotionally attached to specific stocks.  It is easier for mutual fund managers to make objective decisions.  Performance is usually better when we stay on course and history shows us that investors in individual stocks trade more frequently than mutual fund investors.

Mutual funds can also be a better option for investors who are risk adverse. By investing in a broadly diversified portfolio of mutual funds, most of your risk will come from fluctuations in the market.  A portfolio comprised of several individual stocks is generally more volatile.  It also carries a higher risk of losing money if a company, whose stock you own, has financial problems or goes out of business.

A disadvantage to owning mutual funds, instead of individual stocks can be a lack of control on when you pay capital gains. This is especially true if you are in a high tax bracket and a lot of your money is invested outside of retirement accounts.  When fund managers sell stock, gains must flow through to the investors as they are earned, not when the fund is sole.

Beneficiary Designations Trump Your Will

Jane Young, CFP, EA

Jane Young, CFP, EA

You really don’t want the state deciding how your money is distributed when you die, so be sure to specify how you would like your assets divided.  In Colorado this is most commonly accomplished through the use of a will or beneficiary designations, in more complicated situations a trust may also be used.

Virtually, any financial account can be divided using a beneficiary designation, but it is most commonly used with retirement accounts, life insurance policies and annuities.  Assets distributed through a beneficiary designation will pass to heirs outside of probate.  In addition to assets with a beneficiary designation, assets that are held in joint name or that are designated as “transfer upon death” (TOD) will also transfer outside of probate.

Beneficiary designations and TOD accounts supersede your will, so it is of upmost importance to keep your designations current.  This is especially important when there is a major change in your life such as a marriage, divorce, or death.  Beneficiary designations are legally binding and will be enforced regardless of any changes in your relationships.

You can also transfer your real estate using a beneficiary designation. According to Steve Ezell, a local Estate Planning Attorney, this type of transfer can be accomplished with a “Beneficiary Deed”.  A Beneficiary Deed does not go into effect until death so you will have full ownership of your home while alive and you home will transfer outside of probate.  In an effort to avoid probate, many people deed property to their children and themselves. However, this could create complications if you later decide to sell your home.  It could also affect your possible Medicaid eligibility. 

Probate is the process of legally distributing your assets upon death.  In Colorado, this is usually a relatively simple and inexpensive process.  According to the Colorado Bar Association, the Uniform Probate Code has dramatically simplified probate.   Currently, over 90% of Colorado estates are not court supervised allowing the personal representative to do most of the administration.

Most individuals need a will to control the disposition of everything in their probate estate, this excludes accounts in joint name, distributed by beneficiary or distributed by TOD.  If you want all of your financial assets distributed through your will, leave your beneficiary designations blank or list the estate as the beneficiary. 

When dividing your assets with beneficiary designations or a will, Steve Ezell suggests you consider the use of percentages rather than specific dollar values.  Over time, as you make changes to your various accounts, percentages can help you maintain the desired proportion of assets to be distributed to each heir.  Additionally, identify both primary and contingent beneficiaries, just in case your primary beneficiary dies before you. Should a primary beneficiary predecease you, you will need to specify if their share goes to the remaining beneficiaries or the deceased beneficiaries’ children.

Beneficiary designations and wills are both effective tools, if you utilize them and keep them current.

Retirement Tips for All Ages

Jane Young, CFP, EA

Jane Young, CFP, EA

It’s always a challenge to balance between current obligations and saving for retirement.  A good start toward meeting your retirement goals is to get your financial house in order.  Create a spending plan that helps you live below your means.  Maintain an emergency fund of at least four months of expenses and pay off high interest consumer debt.    Establish a habit of saving at least 10% of your income.  If you are getting a late start, you may need to save 15-20% of your income.

Develop a retirement plan to determine how much you need to save on a monthly basis and how large a nest egg you will need to comfortably retire.  There are many on-line calculators available to help you run retirement numbers.  However, they are only as accurate as the data that you input and the assumptions that the model uses.  You may want to hire a fee-only financial planner to run some figures for you.

Work toward maximizing contributions to your employer’s retirement plan; take advantage of any employer match that may be provided.  Once you have contributed up to the level of your employer’s match, consider contributing to a Roth IRA.  A painless way to steadily increase your contribution percentage is to increase your contribution whenever you get a raise.  If you are self-employed, or your employer doesn’t offer a retirement plan, contribute to a SEP, Simple or an IRA.  If you are maxed out, increase your contributions as the maximum contribution limits increase or you become eligible for a catch-up contribution at age 50.

Invest your retirement funds in a diversified portfolio made up of a combination of stock and bond funds that invest in companies of different sizes, in different industries and in different geographies.  Generally, your retirement savings is long term money, so avoid emotional reactions to make sudden changes based on short term market fluctuations.  Develop an investment plan that meets your timeframe and investment risk tolerance and stick to it. 

Don’t use your retirement funds as a savings account for other financial objectives.  Unless you are in a dire emergency, don’t take distributions or borrow against your retirement funds.  When you change jobs, don’t cash out your retirement plans.  Roll your funds over to an IRA or a new employer’s plan.    Avoid sacrificing your retirement savings to fund college education for your children.

As you near retirement age, there are several ways to stretch your retirement dollars.  Retirement doesn’t have to be all or nothing.  Consider a gradual step down where you work a few days a week or on a project basis.   Try to time the payoff of your mortgage with your date of retirement.  Consider downsizing to a smaller home or moving to a more economical area.  Establish a retirement spending plan that provides funds for things you value and helps you avoid frivolous spending on things that don’t really matter.

Asset Allocation – the Foundation of Your Portfolio

Jane Young, CFP, EA

Jane Young, CFP, EA

Your asset allocation serves as a foundation from which to build your investment portfolio.  An asset allocation identifies the types of investments and the proportion of each you plan to hold in your portfolio.  At a very general level most investments are broken into three categories: stocks, interest earning, and real estate.  Each of these broad categories can be broken down further into hundreds of different options.   The two factors that usually drive an asset allocation are the timeframe in which you will need your money and your personal risk tolerance.  Generally, we strive for a diversified portfolio that provides the highest rate of return for the level of risk we are willing to take.

The first step in developing an asset allocation is to evaluate your current situation and determine when the money you are investing will be used.  Money that is needed in the short term should be placed in interest earning investments, not in real estate or the stock market.  Interest earning investments, such as money market accounts and CDs, are secure but usually provide a rate of return below the rate of inflation.  While it’s important to keep your short term money safe, too much in interest earning investments will stifle the long term growth potential of your portfolio.

Once your short term money has been secured, you can create a diversified portfolio that supports your investment timeframe and risk tolerance.   A great way to diversify is through the use of low cost mutual funds.  Mutual funds enable groups of individuals to pool their money to buy a large number of different companies or government entities.  Mutual funds enable you to maintain a diversified asset allocation by investing in funds with different objectives.  Consider selecting funds that invest in a variety of stocks and bonds in large, medium, and small companies within different industries and different geographical regions.  Your goal is to maintain diversification so that when one category is doing poorly it may be offset by another category that is performing well.   A diversified asset allocation allows you to spread out your risk so you don’t have dramatic losses if a given company or asset class performs poorly.   Additionally, by spreading your asset allocation over a broad range of investments, you may have opportunities that would have been too risky in an undiversified portfolio.

Your asset allocation is the framework of your portfolio – establish a plan that meets your objectives and stick with it!  Avoid making changes to your asset allocation based on emotional reactions to short term changes in the market.   Over time, your portfolio will get out of balance due to fluctuations in the market.   I recommend adjusting your portfolio by rebalancing on an annual basis.  In addition to keeping your asset allocation on target, the need for rebalancing will result in selling stock when it is high and buying when it is low.

Stock Market Investing Requires a Long Term Perspective

 

Jane Young, CFP, EA

Jane Young, CFP, EA

The recent volatility in the market has prompted some investors to question the future direction of the stock market.  Unfortunately, the stock market is impacted by so many factors that it is impossible to predict short term movements.  Over the long term, the stock market has always trended upwards but the path has been anything but smooth.   We could be on the tipping point before a major correction or at the beginning of a long bull market – we just don’t know. 

As a result of this uncertainty, it is impossible to effectively time the market.  Not only do you need to accurately predict when to sell but you also need to know when to re-enter the market.  Even if you select the right time to sell, there is a good chance you will be out of the market when it makes its next big move.  

To compound this issue, decisions to buy and sell are frequently driven by short term emotional reactions.   The fear of losing money can trigger us to make a sudden decision to sell, or the fear of missing an opportunity can cause a knee jerk reaction to buy.  We need to resist these very normal emotional reactions and maintain a long term focus.  The stock market should only be used for long term investing.  If you don’t need your money for at least five to ten years you are more likely to stay invested and ride out fluctuations in the market. 

If you lose your long term perspective, and react to short term emotional reactions, you can get caught up in a very detrimental cycle of buying high and selling low.  An example of a common cycle of market emotions begins when the market drops and you start getting nervous.   Over time you become increasingly fearful of losing money and end up selling your stock investments after the market has dropped considerably.   Then you sit on the sidelines for a while, waiting for the market to stabilize.  The market starts to rebound and you decide to jump back in after that market has gone back up.  Afraid of missing a great opportunity, you buy at the market peak.   This is a self-perpetuating cycle that can be very harmful to your long term investment returns.

To avoid the temptation to time the market and react to emotional triggers, keep a long term perspective.   Focus on what you can control.  Maintain a well-diversified portfolio that is in line with your long term goals and your investment risk tolerance.  Live within your means and maintain an emergency fund of at least four months of expenses.  Invest money that you will need in the short term into safer interest earning investments.   By limiting your stock market investments to long term money, you will be more likely to stay the course and meet your investment goals.

What to Do When You Lose Your Job

Jane Young, CFP, EA

Jane Young, CFP, EA

Breathe – Losing a job seems like a huge catastrophe when it happens, but it could free you up to pursue new opportunities.  Most jobs are lost due to a reduction in workforce, over which you have no control.   Try to move through this transition with grace.  It’s not personal;  try to avoid becoming sad, angry or bitter.    This process is difficult for everyone involved, and the person letting you go may be in a position to hire you in the future.

Carefully Review Your Severance Package – Make sure you fully understand and agree with the terms of your severance package.  Don’t hesitate to consult an attorney if you are unclear or disagree with the terms of your separation agreement

File for Unemployment – If you were laid off due to no fault of your own, you may be eligible for unemployment benefits.   Unemployment may not be available while you are covered by a severance package.

Review Your Budget – Review your expenses and cut-back on unnecessary expenses.  Develop a new spending plan that will help you cover expenses until you find a new job.   Hopefully, the combination of your emergency fund, severance pay and unemployment will cover your necessities until you find a new job.  To make ends meet, you may need to consider short term assignments or part time work.

Arrange for Health Insurance – Review options available through Cobra as well as insurance on your own.  If you are married, look at health insurance options through your spouse’s employer.

What’s Next?    You have just received the gift of freedom, to make a career change.  Do you want to continue in your current career or do you want to pursue something new?   How much training, education, time and money will it take to pursue your dream career?

 Update Your Resume and Start Job Hunting  – Update your resume and start looking for a new job.  Take advantage of services that may be offered by the outplacement firm hired by your previous employer.  If you decide to return to school, you may need to pursue a part time job while you re-tool.

Build and Nurture Your Network – Most jobs are found through word of mouth.  It’s essential to do a lot of networking.  Let all of your contacts know that you are job hunting and what you are looking for.  Actively maintain accounts on Facebook, Linked In and Twitter to help you with your job search.  It’s also advisable to have personal business cards made so potential employers can reach you more easily.

Use Your Time Wisely – Treat looking for a job as a job.   After a week or so, you should keep your days structured.  Spend your time working toward getting a new job, getting your life organized and taking care of your health.  This is a very stressful time, be sure to eat well and get plenty of exercise.

What is Financial Planning?

Jane Young, CFP, EA

Jane Young, CFP, EA

I’m sure you hear the term “Financial Planning” on a regular basis but you may not be sure what it really means.  Financial planning is an on-going, comprehensive process to manage your finances in order to meet your life goals.  The process includes evaluating where you are today, setting goals, developing an action plan to meet your goals and implementing the plan.  Once you have addressed all the areas of your financial plan you should go back and review them on a regular basis.

Financial planning should be comprehensive – covering all areas of your financial life.  The primary areas of your financial plan should include retirement planning, insurance planning, tax planning, estate planning and investment management.    Depending on your situation, your financial plan may also address areas such as budgeting and debt management, college funding, employee benefits, business planning and career planning.  Comprehensive Financial Planning is very thorough and can take a lot of time and energy to complete.  I recommend breaking it into bite size chucks that can be easily evaluated, understood and implemented over the course of time.  

You can work through the financial planning process with a comprehensive financial planner or you can tackle it on your own.  If you decide to hire a financial planner, I encourage you to work with Certified Financial Planner who has taken an oath to work on a fiduciary basis.  An advisor, who works as a fiduciary, takes an oath to put your interests first.

The first step of the financial planning process is to evaluate where you are today.  Tabulate how much money you are currently spending in comparison to your current income.  Calculate your current net worth (assets less liabilities).  Evaluate the state of your current financial situation.  What is keeps you up at night and what should be prioritized for immediate attention?

The next step is to devise a road map on where you would like to go.   Think about your values and set some long term strategic goals.  Using this information develop some financial goals that you would like to achieve.  Once you have identified some financial goals, a plan can be devised to help you achieve them.

Select the area you would like to address first.  Most of my clients start with retirement planning and investment management.  There is a lot of overlap between the different areas of financial planning but try to work through them in small manageable chunks.  Otherwise you may end up with a huge, overwhelming plan that never gets implemented.

Once you have worked through all of the areas in your financial plan you need to go back and revisit them on a regular basis.  Some areas like investments, taxes and retirement planning need to be reviewed annually where other areas like insurance and estate planning can be reviewed less frequently.  Keep in mind that financial planning is an on-going, life long process.

Financial Advice after Losing a Spouse

Jane Young, CFP, EA

Jane Young, CFP, EA

After the funeral is over and everyone has returned home you are faced with the overwhelming task of getting your financial affairs in order.  It’s natural to feel disinterested, distracted and confused with all the decisions that need to be made.  Over the next few years you may feel like you are in a fog and you may have trouble concentrating. During the first couple years be easy on yourself and avoid making any major decisions.  You may be approached by a lot of people trying to give you advice and sell you products, avoid any major changes or decision for at least a year.  Don’t buy or sell a house or make major decisions on where you want to live, avoid any major changes to your investments and avoid making any significant gifts to charity or family members at this time.  Be aware of salespeople who use scare tactics to coax you into making decisions before you are ready.  Take it slow, give yourself time to grieve.   In a few years you may have a completely different perspective on how you want to proceed. 

There are some things that need to be done right away.  Initially it is important to be sure you have enough liquidity to cover your living expenses.  Start by getting organized – if you have always handled the household finances you know what bills need to be paid and where all of your assets are.  If not review all of your current bills and go through the credit card statement and check register to get handle on bills that will need to be paid.  Pull together all of your financial statements to understand your current situation.  Evaluate you current income situation to be sure you have enough money to cover your expenses.

Relatively soon you will want to apply for any benefits for which you may be entitled.  This may include Social Security, Veterans Benefits, Life Insurance or a Pension.   If you spouse was working, be sure to contact their employer to apply for any unpaid wages or survivor benefits.  This is also a good time to make sure you have adequate health insurance.  You should also contact your home and auto insurance company to make sure your coverage is intact.

At this point you may want to assemble a financial support team to help you through this difficult time.  Depending on the complexity of your situation, it may be helpful to hire an Estate Planning Attorney, a Certified Public Account and a fee-only Certified Financial Planner to help you settle the estate, file tax returns, retitle assets and eventually develop of financial plan.  Ask friends and colleagues to recommend and help you select trusted professionals.

More to Rental Property Than Meets the Eye

 

Jane Young, CFP, EA

Jane Young, CFP, EA

With low interest rates and the fear of another drop in the stock market, many people are looking for alternative ways to earn investment income.  Many investors find the tangible nature of real estate appealing.  Although real estate may seem like the logical alternative to stocks and bonds, investment in real estate can be very complex, time consuming, and wrought with risk. 

Before buying, perform a realistic cash flow analysis on the income and expenses associated with the property you are considering.  Begin with start-up expenses associated with acquiring the property, including the down payment and any necessary improvements. Next tabulate the routine expenses that you will incur with a rental.  These may include mortgage payments, insurance, property taxes, home owner’s association dues, routine maintenance, and legal and accounting fees.  As a rule of thumb, maintenance and repairs run about 1-2% of the market value of your home, depending on the home’s condition.  Also consider an emergency fund to cover large unexpected repairs. 

Managing rental real estate can be very time consuming.  Seriously think about whether you want to manage the rental yourself or you want to hire a property manager.  Do you have the time and the desire to manage the property? If you do it yourself, you will need to market the property, evaluate potential renters, maintain the property, respond to tenant issues, collect rent payments and potentially evict tenants.   You also may want to learn about fair housing laws, code requirements, lease agreements, escrow requirements, and eviction procedures.  If you don’t have the time or the temperament to manage the property, consider hiring a property manager.  Property management fees usually run about 10-12% of rental income.

Some additional risks to consider when renting property include the possibility of major damage inflicted by a tenant, drawn out eviction processes, and law suits for negligence and safety issues.

After evaluating your expenses, do some income projections.  Research rents paid for similar properties in your target neighborhood.   Be sure to incorporate a reasonable vacancy rate.  According to the Colorado Division of Housing, the average vacancy rate in Colorado Springs has been about 6%, for the last 4 quarters.

Include the tax benefit of deducting depreciation into your analysis.  To calculate annual depreciation, divide the initial value of your rental home, not including land, by 27.5.  Unfortunately, you will probably have to recapture (repay to the IRS) this deduction upon sale of the property at a maximum rate of 25%.

Subtract your projected expenses from your projected income to determine your net profit.  Will the net profit you expect to gain from the property compensate you for your capital, time and risk?  In addition to the profit from rental income, be sure to factor appreciation of your property into your analysis.  Additionally, if you have a mortgage, your equity will increase every year as you pay off your mortgage.

Covering the High Cost of College Can Require Team Work, Diligence and Compromise

Jane Young, CFP, EA

Jane Young, CFP, EA

With soaring college expenses, few families can afford to cover the costs associated with putting their children through four years of college on top of daily living expenses and the need to save for retirement.   To avoid sacrificing your retirement savings and accruing large student loans, to finance your children’s college education, engage them in the process.  For most families, it is reasonable for the cost of college to be a shared responsibility between you and your children.

Start early by encouraging your children to get good grades, to participate in extracurricular activities, and to volunteer in the community.   While in high school, encourage your child to enroll in Advanced Placement and International Baccalaureate courses that provide high school and college credit.  Your child could have several college courses completed before graduating from high school.  This could save you thousands of dollars. 

Explore all forms of financial aid even if you think you may not be eligible.  You may be surprised, especially if you have several children attending college at once.  Additionally, do your research and be open-minded with regard to the colleges you consider.  Some schools that seem too expensive may have excellent financial aid packages for your situation.

If you find yourself in the common place where you earn too much for financial aid, but not enough to pay the full ride of four year college education, research the availability of merit scholarships.   While your child is still in high school, thoroughly research the availability of scholarships.  Talk to the high school guidance counselor and check with community organizations.  Once in college your child should talk to the financial aid officer, department heads and professors for potential scholarship opportunities.  Also check on-line resources including CollegeBoard.com, CollegeNet.com, and Fastweb.com.  Every year many scholarships go unused because qualified candidates don’t apply.  

Your child can dramatically decrease the cost of tuition by attending a community college for the first two years and then transferring to a four year university.  Many universities have arrangements with local community colleges to transfer credits earned toward the first two years of a bachelor’s degree.    The cost of tuition at a community college is usually less than one half of that at a four year university. 

Another way to reap tremendous savings is for the student to live at home and attend a local school.  In 2014 the cost of tuition and fees at the University of Colorado is about $12,600 and the cost of room and board is about $13,000. 

If after exploring the options above, the cost of college is still beyond your reach; your student may need to work while attending college.  To help pay for tuition, your student may need to work 30 hours a week and take a lighter class load.  Graduating in five years may be better than incurring huge student loans.

Don’t Let Financial Scare Tactics Steer You Off Course

 

Jane Young, CFP, EA

Jane Young, CFP, EA

It’s a formidable task to sort through the barrage of financial information from all the various media sources.  It can be difficult to separate fact from fiction.  Information is often slanted when a reporter or writer has a subtle personal or political bias.  Even heavily biased information can appear objective if the messenger has a strong belief that their story is factual.   While it’s always necessary to filter information for personal bias, financial messages designed to intentionally mislead can be especially harmful.  We are constantly bombarded by advertisements and headlines that deliberately twist the facts to scare us and encourage us to buy products or services.

All of this may sound obvious; we should be smart enough to recognize when someone is trying to sell us something or trying to pull something over on us.  However, we have to be diligent to differentiate between legitimate news and sensationalism.  Producers and editors of financial magazines, television shows, and newsletters use exciting headlines to increase circulation and keep people tuned in.   It is common for the media to exaggerate negative information to generate an emotional reaction.  As an investor, you need to keep dramatic headlines in perspective and avoid changing course based on media hype.

A more sinister scare tactic is the threat of impending doom used by some unscrupulous people to sell products such as gold, variable annuities, and financial newsletters. Recently several gold dealers have been running compelling marketing campaigns to convince you that the financial world is on the brink of disaster.  They use well known actors with an authoritative flare to scare you into believing your only salvation is gold. Depending on your situation, it may be logical for you to have some amount of gold in your portfolio.  However, you don’t need to convert your entire portfolio to gold just because a few gold dealers imply they have exclusive access to top secret information predicting imminent financial demise.

You should also be on the alert for unethical firms who use scare tactics to sell variable annuities and financial newsletters.  Some unscrupulous salespeople try to scare people into making inappropriate purchases in variable annuities by preying on their need for security.  A variable annuity may be a good option, but don’t be tricked into buying something you don’t want or need due to exaggerated threats about a pending financial disaster.  Additionally, I have recently observed a newsletter editor greatly exaggerate the impact of recent legislation to encourage people to buy his newsletter.

Appealing to our sense of fear is an age old sales gimmick.  Be on your guard, marketing campaigns have become very sophisticated.  Before making any changes, fully understand what you are buying and make sure it fits into your overall financial plan.  Avoid emotional reactions to media hype and salespeople claiming to predict the future in order to sell their products.

Tax Implications of Gifting to Children

 

 

Jane Young, CFP, EA

Jane Young, CFP, EA

Many of you have worked hard and have saved all your life to achieve financial security and a comfortable nest egg.  However, due to current economic conditions your children may be struggling to pay their bills, buy their first home, or start saving for retirement.  You may want to help them right now, when they really need it, but you aren’t sure about the tax consequences.  There is good news! Over the last few years, the tax consequences to gifting have become much less onerous.  

Taxation on gifts is regulated as part of a combined gift and estate tax.  In 2014 everyone has a lifetime combined estate and gift tax exemption of $5.34 million.  If you are married, you have a combined exemption of $10.68 million dollars.  

Additionally, you can annually gift up to $14,000 to any number of recipients without chipping away at your lifetime exclusion of $5.34 million.  Generally, gifts to your spouse or a qualified charity are not subject to gift and estate tax.  If you exceed the annual gift limit of $14,000 to a single individual, you are required to file a gift tax return (Form 709) to report your gift.  However, you will not owe any taxes until you exceed your lifetime exclusion of $5.34 million.  Once the combined exclusion of $5.34 is exceeded, tax is imposed on the person gifting or transferring the assets, not the recipient.

You may want to make gifts to various friends or family members to help them through a rough patch or you may want to reduce your net worth to avoid or minimize estate tax.  By gifting up to $14,000 per year to several different individuals, you can reduce the amount of money that may ultimately be subject to estate tax.  For example, if you are married and have married children with a total of five children, both you and your spouse can each give $14,000 to each child, $14,000 to their spouses and $14,000 to each one of your grandchildren – every year.   This comes to a total of $252,000 in gifts per year that can be legally removed from you estate and avoid estate taxation.

According John Buckley, a nationally recognized Estate and Business Planning Attorney, gifts that are used for most education and medical expenses are not subject to the $14,000 annual gift tax limit.  Direct payment must be made to the educational institution or medical provider and not to the recipient. This is a huge benefit since many gifts are given to cover education expenses. 

Gifting can be a great way to minimize estate tax if you have a large net worth.  However, most of us save just enough to cover our retirement needs.  The desire to help family and friends is very natural, but avoid the temptation to gift money, especially to children, at the expense of your own financial security and retirement.

Protect Your Family Against a Loss of Income

Jane Young, CFP, EA

Jane Young, CFP, EA

In addition to an emergency fund for unexpected short term expenses, you need to protect yourself and your family from a long term loss of income.  If you have a spouse or children who are dependent on your income, you should consider term life insurance and long term disability to provide them with income should you die or become disabled.  If you have no dependents, you should consider long term disability to cover your own living expenses if you become unable to work.  

Although, life insurance can be a dirty word, low cost level term insurance is relatively inexpensive and provides an important safeguard for those who are dependent on your income.  Some common reasons to buy life insurance are to replace income, pay-off a mortgage, and to put your children through college.  The most economical way to meet these needs is through the use of level term insurance.  The amount of insurance you need depends on your objectives for getting insurance.   The term of the insurance should be based on the timeframe during which you need to replace income or pay for other major expenses.   When you buy level term insurance, you have a guaranteed level premium and a guaranteed death benefit, assuming you pay your premiums on time. Unlike whole life insurance, term insurance is pure insurance, there is no investment element.  Once the term has expired there is no residual value. 

It is common to buy level term insurance to cover 20 or 30 years until such time the kids have made it through college or your home is close to being paid off.  To save money, you may consider purchasing several policies with different terms and different objectives. For example, if your mortgage will be paid off in ten years, your kids will be out of college in 20 years and you want to provide your spouse with income replacement for 30 years, buy three policies with terms that correspond with the timeframes of your objectives.

Many people buy life insurance but few people have long term disability insurance.  No one lives forever, but during your prime earning years the probability of becoming disabled is higher than that of dying.  According to the Social Security Administration, over 1 in 4 people who are currently 20 years old will become disabled before age 67.   About 69% of all private sector employees have no long term disability insurance.  If you have loved ones who are dependent on your income, you should consider buying long term disability insurance.

When shopping for life insurance and long term disability shop and compare prices. Do your research and get quotes from several companies with low fees and commissions.  Consider working with insurance brokers who work with a variety of different insurance companies.  They can provide you with information on premiums from several insurance companies along with the companies’ financial strength rating.

Investing in a Volatile Market

 

Jane Young, CFP, EA

Jane Young, CFP, EA

Here are some things you should keep in mind when investing in the stock market; the market will fluctuate, there will be years with negative returns, the stock market is for long term investing, and the media and prognosticators will greatly exaggerate negative information to create news and get attention.  If you keep this in mind, you can dramatically improve your long term investment returns and sleep better at night.  Based on numerous studies conducted by DALBAR, the average investor earns several percentage points below the market average due to market timing and emotional reactions to market fluctuations.  It’s how we are wired.  When the market goes up, we feel good and we want don’t want to miss out on the opportunity to make money.  As a result, we buy stock when the market is at its peak.  On the flip side, when the market drops we worry about losing money, and sell when the market is at the bottom.  It’s hard to make money in this cycle of buying high and selling low.  When investing in the stock market, try to avoid overreacting to the inevitable short term fluctuations in the market.

Other factors that can help you ride out dramatic fluctuations in the market include establishing a solid financial foundation and maintaining an asset allocation that meets your investment timeframe.  Establish a solid financial foundation by living within your means, minimizing the use of credit, and maintaining an emergency fund of 3 to 6 months of expenses.  A strong foundation helps you avoid pulling money out of the stock market at inopportune times should an emergency arise. 

Once you have established a strong financial foundation you can start investing in the stock market.  One key to success with stock market investing is establishing an asset allocation that’s in line with the timeframe in which you will need money.  Money that is needed in the short term should not be invested it the stock market.  As a general rule, do not invest any money needed within the next five years in the stock market.  Over long periods of time the stock market has trended upward, but in the short term there have been periods with substantial drops.  Give yourself time to ride out the natural fluctuations in the market.  

Additionally, it is important to diversify your money across a wide variety of investments.  You can reduce the amount of risk you take by diversifying across different companies, municipalities, industries, and countries.  When one type of investment is doing poorly, another may be doing well.  This helps to buffer the losses you may experience in your portfolio.  An excellent way to diversify is through the use of a variety of different types of mutual funds.  Mutual funds pool your money with money from others to invest in a large number of companies or government entities based on a predefined investment objective.

Pay Down Debt or Save and Invest?

 

Jane Young, CFP, EA

Jane Young, CFP, EA

The decision to pay off debt or save and invest money is a common dilemma.  The best solution largely depends on the type of debt you are dealing with and the interest rate that you are paying.  Not all debt is created equal; high interest rate, non-deductible debt, like credit card debt and consumer financing, is generally a bad use of debt. On the other hand, low interest, tax deductible debt such as a mortgage or a home equity loan is generally a more favorable use of debt.  Financially, it’s usually wise to own your home and few of us can afford to pay cash. 

If you have a lot of consumer debt or a large credit card balance with a high interest rate, you are probably spending a substantial sum just to cover the interest.  You need to pay more than your minimum payment to start working down the debt.  It’s important to pay down debt, but you also need to maintain some liquidity to cover unexpected expenses.  There is no magic formula for how much of your available cash should be used to pay down debt and how much should go toward building your emergency fund.  Everyone needs an emergency fund, and I generally I recommend maintaining an emergency fund equal to about four months of expenses.  However, if you are drowning in credit card debt consider using half of your money to pay down debt and the other half to build up an emergency fund until you have around $2,000.  Continue along this path a while longer, if you want to build a larger emergency fund.

 Without an emergency fund you could fall into a never ending debt spiral.   If you don’t have an emergency fund, you may be forced to run up credit card debt again when the inevitable emergency arises.    

As you make progress toward paying off debt, you may wonder if you should invest some money for retirement or your other financial goals.  Generally, you should prioritize paying down debt if the after tax interest rate on your debt is higher than your expected after tax investment return.  When considering the possibility of investing some of your funds, factor in the risk associated with investing your money.   Investing is subject to fluctuations in the market, but there is no market risk associated with the interest you save by paying down debt.

 Additional factors that may enter into the decision to invest some of your money include the opportunity to get an employer match on a 401k contribution and the potential tax deduction you could receive from contributing to a retirement plan.

Finally, if you pay down your high interest debt and you want to pay your mortgage off early, consider the impact this could have on your tax deductions.  You also need to weigh this against the return you could earn, if the money is invested.

Investment Risk Comes in Many Forms

Jane Young, CFP, EA

Jane Young, CFP, EA

One of the first steps when investing money is evaluating your tolerance for risk.  The amount of return you can earn is heavily dependent on how much risk you are willing to take.   We generally associate investment risk with market risk, or the possibility of losing money due to fluctuations in the stock market.   The stock market is volatile and can be a high risk investment if you have a short time horizon.  However, over long periods of time, the stock market has trended upward.  It’s important to consider your tolerance for stock market risk when building your portfolio.  However, the risk of losing money due to a drop in the stock market is only one of many risks that can adversely impact your financial security.

Although fixed income investments are generally considered safer than the stock market, they are not without risk.  Fixed income investments can include CD’s, bonds, bond funds and cash accounts such as money market or savings accounts.  The most common types of risk associated with fixed income investments are interest rate risk and default risk.

Interest rate risk is the possibility of your bonds dropping in value when interest rates increase.  When interest rates increase, the value of an existing bond decreases to compensate for higher interest rates available on the market.  Generally, if you buy and hold an individual bond till maturity, you will get back the full face value plus any interest that was earned.   However, when you own a bond fund,  you don’t have control over when bonds within the fund are sold.  When interest rates rise, bond managers may be forced to sell bonds at inopportune times due to the large number of withdrawals.

Individual bonds have less interest rate risk than bond funds, but they have a higher degree of default risk.  Default risk is the possibility of losing your principal if the bond issuer becomes insolvent.  Bond funds are able to reduce the default risk by pooling your money with others and investing in a large number of different companies or municipalities.

 Treasury bonds and FDIC insured CD’s provide what is generally considered a risk free rate.  If held to maturity, there is very little chance of losing principal.  Your investment is insured by the Federal government against default risk, and you have control over when you sell.  The primary downfall with this type of investment is the extremely low rate of return.

Investing too much in extremely safe, low earning investments often results in inflation risk.  Money placed in “safe” investments with a low rate of return can’t keep up with inflation, resulting in a negative real return.   You also lose the opportunity to earn a reasonable rate of return needed to grow your retirement account.   It’s all about balance; you need to take some market risk to build and maintain your retirement account and stay ahead of inflation.

Should You Contribute to a Traditional 401(k) or a Roth 401(k)?

 

Jane Young, CFP, EA

Jane Young, CFP, EA

Many large employers have started offering employees the choice between a traditional 401(k) and a Roth 401(k).  However, only a small percentage of employees have elected to contribute to a Roth 401(k).  The primary difference between the two plans is when you pay income taxes.  When you contribute to a traditional 401(k) your contribution is currently tax deductible, but you must pay regular income taxes on distributions taken in retirement.  Contributions to a Roth 401(k) are not currently deductible, but you pay no income taxes on distributions in retirement.  As with your traditional 401(k), your employer can match your Roth 401(k) contributions, but the match must go into a pre-tax account.  

There are several differences between a Roth 401(k) and a Roth IRA.  In 2014, annual contributions to a Roth IRA are limited to $5,500 plus a $1,000 catch-up contribution if you are 50 or over.  Contribution limits on Roth 401(k) plans are much higher at $17,500 plus a $5,500 catch-up contribution, if you are 50 or over.  Additionally, there are income limitations on your ability to contribute to a Roth IRA, and there no income restrictions on contributions to a Roth 401(k).   Additionally, upon reaching 70 ½ you must take a required minimum distribution from a Roth 401(k).   You are not required to take a distribution from a Roth IRA at 70 ½.  However, you do have the option to transfer your Roth 401(k) to a Roth IRA prior to 70 ½ to avoid this requirement. 

The decision on whether to invest in a Roth or traditional 401(k) depends primarily on when you want to pay taxes.  If you are currently in a low tax bracket and believe you will be in a higher tax bracket in retirement, a Roth account may be your best option.  On the other hand, if you are currently in a high tax bracket and you think you may be in a lower tax bracket in retirement, a traditional 401(k) could be your best option.  A Roth 401(k) is generally most appropriate for younger investors who are just getting started in their careers or someone who is experiencing a low income year.  People who are in their prime earning years may be better off taking the current tax deduction available with a traditional 401(k). 

Unfortunately, it’s difficult for most of us to know if our tax bracket will increase or decrease in retirement.  It is also hard to know if tax rates will increase before we reach retirement.  From a historical perspective, tax rates are currently low and some believe future rates will be increased to help cover the rising federal debt.  Amid this future uncertainty, your best option may be to split your contribution between a Roth and traditional 401(k).  This will give you some tax relief today and some tax diversification in retirement.

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