What Is An HSA And Why Should I Participate?

September 10, 2021

An HSA is a type of tax-deferred account designed to help you save for your health care costs for current and future years. An HSA essentially works like an IRA for medical expenses. However, it differs from a Flexible Spending Account (FSA) in that money not spent in a calendar year can remain in the account to be used in future years – or retirement.

HSAs are only available to you if you have coverage through a qualifying high-deductible major medical health plan, referred to as an HDHP. If you can participate in an HSA, you should know these facts:

  • You can fund HSAs with pre-tax income up to $3,600 for an individual and $7,200 for a family in 2021. There is an additional catch-up contribution of $1,000 for those ages 55 and older. You can withdraw the money tax-free for medical care as well as prescription drugs.
  • You can also make contributions directly to an HSA via deposit for the prior tax year until the tax filing deadline (generally April 15th).
  • The minimum HDHP deductible for 2021 is $1,400 for an individual and $2,800 for family coverage. You may not contribute to an HSA if a low deductible insurance policy covers you.
  • The amount of your HSA contribution directly reduces your taxable income. This is done so that you will pay tax on less income overall.
  • Any money not spent in the year contributed grows tax-deferred in the investment account you choose from those available under your plan.
  • If withdrawn for non-medical purposes before age 65, the money will be taxed as ordinary income and will incur a 20% penalty as well. However, once you turn 65, you may withdraw the funds for any non-medical purpose without this penalty.
  • If you change employers, you can transfer HSA accounts, similar to a rollover from one 401(k) to another.

ACTION ITEMS:

1. Consider participating in an HSA if you want to choose your doctor and control your medical costs.

2. Be aware that an HSA with a high-deductible health plan may not be the best option for those who have ongoing medical conditions and treatments.

3. If you plan to defer much of your HSA balance until retirement, make sure to invest for the long term among the investment options available to you.

Why You Should Max Out Your HSA Before Your 401(k)

September 10, 2021

Considering that most employers are offering a high-deductible HSA-eligible health insurance plan these days, chances are that you’ve at least heard of health saving accounts (“HSAs”) even if you’re not already enrolled in one. People who are used to more robust coverage under HMO or PPO plans may be hesitant to sign up for insurance that puts the first couple thousand dollars or more of health care expenses on them, but as the plans gain in popularity in the benefits world, more and more people are realizing the benefit of selecting an HSA plan over a PPO or other higher premium, lower deductible options.

For people with very low health costs, HSAs are almost a no-brainer, especially in situations where their employer contributes to their account to help offset the deductible (like mine does). If you don’t spend that money, it’s yours to keep and rolls over year after year for when you do eventually need it, perhaps in retirement to help pay Medicare Part B or long-term care insurance premiums.

Not just for super healthy people

But HSAs can still be a great deal even if you have higher health costs. I reached the out-of-pocket maximum in my healthcare plan last year, and yet I continue to choose the high-deductible plan solely because I want the ability to max out the HSA contribution. Higher income participants looking for any way to reduce taxable income appreciate the ability to exclude up to $7,200 per year from taxes for family coverage (plus another $1,000 if turning age 55 or older), even if they end up spending the entire amount each year. It beats the much lower FSA (flexible spending account) limit of $2,750 even if out-of-pocket costs may be higher.

Even more tax benefits than your 401(k)

Because HSA rules allow funds to carryover indefinitely with the triple tax-free benefit of funds going in tax-free, growing tax-free and coming out tax-free for qualified medical expenses, I have yet to find a reason that someone wouldn’t choose to max out their HSA before funding their 401(k) or other retirement account beyond their employer’s match. Health care costs are one of the biggest uncertainties both while working and when it comes to retirement planning.

A large medical expense for people without adequate emergency savings often leads to 401(k) loans or even worse, early withdrawals, incurring additional tax and early withdrawal penalties to add to the financial woes. Directing that savings instead to an HSA helps ensure that not only are funds available when such expenses come up, but participants actually save on taxes rather than cause additional tax burdens.

Heading off future medical expenses

The same consideration goes for healthcare costs in retirement. Having tax-free funds available to pay those costs rather than requiring a taxable 401(k) or IRA distribution can make a huge difference to retirees with limited funds. Should you find yourself robustly healthy in your later years with little need for healthcare-specific savings, HSA funds are also accessible for distribution for any purpose without penalty once the owner reaches age 65. Non-qualified withdrawals are taxable, but so are withdrawals from pre-tax retirement accounts, making the HSA a fantastic alternative to saving for retirement.

Making the most of all your savings options

To summarize, when prioritizing long-term savings while enrolled in HSA-eligible healthcare plans, I would strongly suggest that the order of dollars should go as follows:

  1. Contribute enough to any workplace retirement plan to earn your maximum match.
  2. Then max out your HSA. (For 2021, the maximum annual contribution, including employer contributions, is $3,600 for single coverage and $7,200 for family coverage, plus a $1,000 catch-up contribution for HSA holders age 55 and older.)
  3. Finally, go back and fund other retirement savings like a Roth IRA (if you’re eligible) or your workplace plan.

Contributing via payroll versus lump sum deposits

Remember that HSA contributions can be made via payroll deduction if your plan is through your employer, and contributions can be changed at any time. You can also make contributions via lump sum through your HSA provider, although funds deposited that way do not save you the 7.65% FICA tax as they would when depositing via payroll.

The bottom line is that when deciding between HSA healthcare plans and other plans, there’s more to consider than just current healthcare costs. An HSA can be an important part of your long-term retirement savings and have a big impact on your lifetime income tax bill. Ignore it at your peril.

How We Are Deciding Which Spouse’s Insurance Plan To Use

September 10, 2021

My husband recently changed careers and is starting with his new employer at the end of this month. We’re all very excited about the transition as a family, but we have a very important decision to make: are we going to stay covered under our current health insurance plan that I have through work or are we going to move over to his plan? Or should the kids join my husband on his plan while I stay on my own? Decisions. Decisions.

How do you decide whose health insurance to use?

When both partners have benefits through work, it’s a good idea to re-examine your family coverage each year. Here are some of the things that we are considering as we decide which benefits to choose. These questions might trigger some points that are important to you and your family as well as you make your decision whether to stay put or move on to your spouse’s plan:

Questions to ask

  1. Are our current doctors considered in-network under my husband’s plan (especially the kids’ doctors)?
  2. Do my husband and I like the primary doctor options who fall in-network under his plan?
  3. If my husband has employee-only coverage at work, does his employer cover his monthly premium? (mine does)
  4. How do the monthly premiums and deductibles compare to what’s available under our current plan?
  5. Once we hit the deductible, how much is our coinsurance (the percentage we are responsible for paying)?
  6. Is a high deductible health plan (HDHP) an option with his employer and how much, if anything, does his employer contribute to a health savings account on his behalf?
  7. Are there any upcoming specialists we’ll need to see? Surgeries any of us will need? If so, are they covered? And how much would we be responsible for paying?
  8. Are there any specific medications we know we’ll need that are not covered under my husband’s plan?

These are some of the things we’ve started to consider. Thinking through your situation and coming up with your list of questions like these, or points that you want to be sure you address, will help you choose the coverage that best meets your needs. Be sure to break down the costs and compare apples to apples when choosing the right health insurance plan and steer clear of common mistakes that are often made during enrollment.

When you need to switch mid-year

It’s important to note that our decision happens to fall during my open enrollment period at work, but if it were outside of my company’s open enrollment period, my husband’s change in employment status (and thus his new eligibility to be covered under a health plan) would be considered a qualifying life event and we’d have a short time frame (typically 30 days) to make changes to our health plan.

How To Choose A Healthcare Plan

September 10, 2021

Depending on the choices you have, choosing a healthcare plan can be frustrating – with different plans that have different structures and costs, how will you know which one is best for you and your family?

Start with any tools your employer offers

Your benefit provider may offer access to tools that help with this decision, so check for that as a first step for a more personalized answer based on the plan options available to you. It may be some type of quiz or interactive process that asks you to make a rough prediction of your anticipated healthcare needs – if you have a tool like that, definitely start there. Doing so won’t commit you to a particular plan, but it can help you narrow the options based on your answers.

Beyond using the decision support tools that may be offered, there are a few key things to consider. Here’s how to choose.

It’s all about balance

Big picture, choosing the best plan for you and your family comes down to whichever plan balances your personal healthcare needs with care that you can afford – no one wants to find themselves underinsured, but lots of people end up over-insuring. In some cases, that’s intentional – lots of people tell us they’d rather know they are covered just in case, and we can’t argue with that if you know the trade-offs you’re making. If instead you’re trying to find the best value without overpaying, it may require a little more legwork.

What are the premiums?

Before you start comparing the details of each plan, make sure you factor in this cost, which is the one thing you can count on spending no matter what for your healthcare. It can be tempting to choose the lowest premium, and if you expect to use your plan very little beyond preventive care services (which are covered 100% under most plans), then that may be all you need to consider.

If you think there’s any chance you’ll need to use your healthcare, then keep looking beyond the premium.

How does the coverage differ under each plan?

Make sure the plan you choose actually covers your needs. If you want to keep your primary doctor and other providers, make sure they are in-network so you don’t end up paying more for their services. See the extent to which any procedures or prescription drugs you’re expecting to need over the next year are covered as well.

A few more things to consider:

  • If you or a dependent have chronic health issues and one spouse has access to a plan with lower deductibles and co-pays, make sure that child or spouse is on that plan.
  • If you have traditionally had your entire family on one plan but both spouses have health coverage available, you should start looking into whether your doctors and providers are in the networks of both plans. If so, see if it may make sense to go ahead and put the spouses on different plans. Even if your company isn’t charging a premium for “covered” spouses, it may be less expensive overall to be on different plans.
  • As always, take a good look at any pending issues such as braces, lasik, etc. that are in your family’s future and plan accordingly.

How much might you have to pay out-of-pocket?

It’s important to compare the different ways you’ll share the costs of your care with your insurance company through co-pays, deductibles and coinsurance. You may also want to compare out of pocket maximums if you anticipate large expenses for the year. 

Is there an HSA option?

If you’re looking for a healthcare option that also offers the ability to save for future medical expenses, even into retirement, you may want to pay special attention to any HSA-eligible plans. This article goes into the details of how these aspects work.

Why give Health Savings Accounts a look?

If your employer is contributing to your HSA, that’s free money that can help to offset your out-of-pocket costs since your employer is essentially putting some of that money into your pocket. (Your HSA is your money so you can take it with you when you leave or retire.) If you plan to contribute to the HSA, calculate how much you can save in taxes. (You can get the same tax benefit by contributing to an FSA for health expenses, but the contribution limits are lower and you probably won’t want to contribute as much since the FSA is mostly “use it or lose it.”)

A case study: how one mom chose her plan for her family

As a real-life example, one of our coaches worked with someone who was trying to decide between a traditional PPO plan with a $1,000 family deductible versus an HSA-eligible plan with a $2,600 family deductible. The coverages would have been similar for her, but she was concerned by potentially having to spend so much out-of-pocket to reach her deductible under the HSA plan.

When we factored in the premium difference, we found that the PPO plan premiums were an extra $49 a month or $588 a year. In addition, her employer was willing to contribute $2,000 to her HSA. So, by choosing the HSA-eligible plan, she would basically be saving $2,588, which turned out to be more than the difference in the deductibles. Even if she spent the whole $2,600, she’d still be ahead under the high deductible plan.

In addition, if she decided to contribute an additional $3,000 to her HSA, she would save another $720 in federal taxes at the 24% tax bracket (not including state taxes or the tax savings on any future earnings in the account).

Of course, your numbers will be different, and your decision may not be as simple based on other factors. The lesson here is that you need to consider all of the factors, not just the premiums and the deductibles.

Choosing the ideal plan

Choosing a healthcare plan is a highly personal decision and there’s no perfect way to go about the decision without a crystal ball to tell you how the year ahead will go. Definitely take advantage of any decision-support tools your employer is offering, then check that against other possible scenarios in your life.

There are things you can anticipate such as braces, ongoing treatments or childbirth, but even the best laid plans can go awry with your health. The ideal plan for you is the one that covers the most likely scenarios you and your family will encounter without paying too much for coverage you don’t need.

Why You Should Treat Your HSA Like An IRA

September 10, 2021

Would you raid your Roth IRA or 401(k) to pay for car repair bills? I suppose if you have no other choice, you might. But ordinarily, we want to use our tax-advantaged retirement accounts only as a last resort because we want that money to grow tax-free or tax-deferred for as long as possible.

The HSA is the only account that allows us to make pre-tax contributions and withdraw them tax-free. Why then are we so willing to tap into our HSAs for medical expenses?

Making the most of your HSA

Yes, there’s no tax or penalty on those withdrawals since that’s what they’re meant to be used for. But HSAs can also be a tax-free retirement account since the money grows to be tax-free if used for medical expenses at any time, including retirement.

Since there’s a pretty good chance you’ll have some health care costs in retirement, you can count on being able to use that money tax-free. (If you keep the receipts for health care expenses you pay out-of-pocket, you can also withdraw that amount tax-free from the HSA later since there’s no time limit between the medical expense and the withdrawal.) You can also use the money penalty-free for any expense after age 65, although it would be taxable just like a pre-tax retirement account.

An example

Let’s say you contribute $3k per year to an HSA and don’t touch the money for 30 years. If you just earn an average of 1% in a savings account, you will have over $105k. But if you invest that $3k each year and earn a 7% average annual return, you’ll end up with over $300k or almost 3 times as much!

That’s why I recently decided to take advantage of our company’s switch to a new HSA custodian by transferring my HSA funds from a savings account to an HSA brokerage account. Since I don’t intend to touch this money for a few decades, I can invest it more aggressively and hopefully earn a higher rate of return. In the meantime, I’ll just pay my health care costs out of my regular income and savings.

Take care with any fees

One little hiccup that I noticed is that my custodian charges a $3 fee for the brokerage account if I don’t keep at least $5k in the savings account. At first glance, it’s tempting to keep $5k in the savings account to avoid that fee but the $36 a year in fees is only .72% of the $5k. That means if I can just earn more than an extra .72% in the brokerage account, I’ll be ahead. Given historical returns, I think that’s a pretty good bet.

Guidelines for making the most of your HSA

Here are some guidelines to make the best use of your HSA:

  1. First, make sure you have an adequate emergency fund to cover health care expenses. If not, ignore everything in this blog post until you do.
  2. If you have the option of a health care plan with an HSA, consider getting it. The premiums are lower so you generally save money in the long run if you’re in good health.
  3. Try to max out your contributions. (If you do it through payroll deductions into a section 125 cafeteria plan, you can also avoid FICA tax on the contributions). Aside from getting the match on your 401(k) and paying off high interest debt, this is generally the best use of your money because  the contributions are both pre-tax and can be withdrawn tax-free (for health care expenses).
  4. If you have  a brokerage option, invest as much of your HSA as you can in a portfolio that’s appropriate for your time horizon and risk tolerance. (Make sure your expected returns justify any fees you may have to pay.)
  5. Don’t touch your HSA money unless you absolutely need to. Instead, use your regular savings (see #1) to cover medical expenses.
  6. Keep the receipts for any health care expenses you pay out-of-pocket since you can withdraw those amounts from your HSA tax-free anytime.
  7. Have tax-free money to help cover health care expenses in retirement!

The Ins And Outs Of Credit Scores

February 25, 2021

We sometimes view our credit scores the same way we look at household appliances or cars: we don’t think very much about how they work, but when we do, it’s usually because something has gone wrong and is causing us discomfort or inconvenience (often both). However, understanding how it works can help you maintain a better score (and better appliances) so when you need it, it will work best for you.

Here’s a closer look at what influences our personal credit scores and why this information is important.

Why does your credit score matter?

There is the obvious, of course. When you want to borrow money, good credit means you can get the loan you need and at a competitive rate. There are also some less obvious reasons to keep your credit score looking good, because your credit history can also affect:

  • Your ability to get the job you want
  • How much you pay for insurance
  • Renting an apartment or home
  • Paying a security deposit (or not) for utilities and cell phones

How credit scores are determined

Our friends at the credit reporting agencies here in the U.S. (Experian, Equifax, TransUnion) rely upon the following set of weighted credit behaviors when calculating credit scores:

  • Paying on time (35%) – Late payments hurt. Use your bank or credit union’s auto-pay feature to avoid late payments.
  • Utilization (30%) – Keep credit card balances below 30% of your credit limit. This is why carrying around a “maxed out” credit card hurts your score. Although keeping or opening a second card with a zero balance can help your overall utilization ratio, the maxed-out card can still hurt your score. Credit reporting agencies count your per-card utilization as well as your overall credit utilization.
  • Length of credit history (15%) – Having “older” loans and credit accounts helps your score because it indicates experience with managing credit. Closing older accounts and opening new lines of credit can lower your score because these actions reduce your average credit age.
  • Variety of credit lines (10%) – Having a combination of both installment loans (e.g., car or student loans) and revolving credit (e.g., credit cards) helps your score somewhat. However, this only accounts for 10% of your score, so opening up additional credit lines just to round out the mix isn’t going to help your score very much (and if not managed well, might hurt your score).
  • Number of inquiries (10%) – Whenever you apply for new credit (personal loan, auto, student loan, credit card, mortgage, etc.), this results in the lender performing a credit check. These credit checks are recorded on your credit history and can affect your score for up to one year. They only account for 10% of credit score, so the best practice here is to not open too many new lines of credit within a 12 month period.

Which actions and behaviors affect your score the most?

Whether you are trying to repair an iffy credit history or you simply want to make sure your stellar credit score remains that way, here is a breakdown of the major things we should and shouldn’t do in order to have good credit:

DEFINITELY DO:

  • Check your credit score for free at sites like CreditSesame or CreditKarma. Checking your own credit score does not count as an inquiry and will not lower your score.
  • Pay the bills on time, every time. This action alone affects your credit score more than anything else.
  • Keep revolving balances (credit cards) below 30% of the borrowing limit. Aim for paying them off in full every month so you don’t carry a balance and pay interest on it every month. Loan balances have the second largest impact on your credit score.
  • If you miss payments and a loan is sold to a collection agent, pay this off as fast as you can, even if it means selling possessions or taking on an extra job. Collections items are like a heavy anchor on your score and constitute a financial emergency.

AVOID DOING:

  • Opening additional lines of credit if you don’t need them.
  • Opening several new lines of credit all at once.
  • Ignoring late notices. The next step is often a call or letter from a collection agent (and a nosedive for your credit score).
  • Paying someone to “repair” your credit. This is an additional cost for doing something you can do yourself.
  • Borrowing from your retirement plan at work (401(k), 403(b), etc.) to pay off debt balances. There are exceptions, but avoid this unless you are facing more serious consequences, such as filing bankruptcy.

Like any good financial habit, creating and maintaining a healthy credit history (and therefore, a healthy credit score) requires some knowledge and effort. Fortunately, the two criteria that carry the most weight – paying on time and limiting balances – are well within our control.

The Difference Between Federal And Private Student Loans

January 21, 2021

With average cost of college being north of $20,000 for a public in-state school, student loans have become a big part of how families pay for college. Most student loans are classified as either federal or private. Federal student loans are loans made or guaranteed by U.S. government and private loans are essentially non-federal student loans made through lenders such as banks, credit unions, state agencies or schools. There are important differences between these loan types and knowing the difference can help you make the most informed decision.

The main types of federal student loans are:

Direct Subsidized Loans – typically for undergraduate students with financial need. Student loan interest is paid by the government while the student is in school at least half-time, during the 6 month grace period after college and possibly if student loan payments are delayed.

Direct Unsubsidized Loans – can be used by undergraduate and graduate students regardless of financial need. Interest accrues while the students are in school, during the grace period and during any student loan payment delays and is added to the loan principal. You can pay the interest while you’re in school to mitigate this difference between direct and indirect if you are able.

Perkins Loans – low interest loans for undergraduate, graduate or professional students with financial needs.

Direct PLUS Loans – graduate or professional students and parents of dependent undergraduate students typically use this loan to pay for college. To qualify, the borrower must not have an adverse credit history and the student must be enrolled at least half time.

Federal loans typically offer more benefits than private loans such as:

  • Lower interest rates, in general
  • Loan forgiveness options based on public service employment, certain occupations or certain payment plans
  • A variety of options to modify payments if you experience a hardship such as permanent disability or financial hardship
  • Lack of credit checks, in general

However, these benefits also come with harsh consequences for default such as possible wage garnishments, difficulty discharging if you file for bankruptcy and even forfeited tax refunds and Social Security payments.

Private loans vary per lender, but typically private loans share these characteristics:

  • Interest rates tend to be higher than most federal student loans
  • Variety of interest rates and repayment periods
  • Loan forgiveness programs are not available
  • Fewer options if you find yourself going through a financial hardship. This varies per institution, so before getting a private loan ask about repayment programs if you experience a hardship
  • Credit check and/or a co-signer may be needed to get loan

As long as your loans are classified as student loans, the interest you pay is eligible for deduction, and that’s true for both federal and private loans. The bottom line is that before you opt for any student loans, make sure you know the difference. Many students find themselves learning about the difference the hard way, once it’s too late to go back and find other ways to pay.

How To Find A Real Estate Agent

January 21, 2021

Because this is the person who will be guiding you through the biggest financial and legal transaction of your life, search for your real estate agent with almost as much care as you hunt for your home.

Look around your neighborhood

Is there a name that you see over and over again in the neighborhood you’re buying or selling in? Chances are, that person has the inside scoop on what’s out there and can offer insights about the neighborhood that an agent unfamiliar with the area won’t have. Beware of an agent who is over-worked though — you may be spending more time with an assistant, while the lead agent makes all the money. You want all of your contact to be with the person whose name will be on the sign and on the contract.

Look online

If you’re moving out of town or aren’t able to identify any neighborhood experts, the National Association of Realtors® website is one place to search for agents in your area who use the registered designation of REALTOR® — that title identifies a real estate professional as a member of the association and someone who agrees to abide by their code of ethics and has passed the REALTOR® exam.

HomeGain.com is another online resource that let’s you screen real estate agents. HomeGain founder Bradley Inman says buyers and sellers who use the site can expect to get about seven proposals from agents who want to represent them.

When using the Internet, be aware that agents pay for listings on some sites, so you may not be finding all of the best agents who could meet your needs. With that in mind, use the search results to check experience level, education and recent sales in your area. Then set up interviews with at least three candidates and be sure to check references.

Ask around for references

Ask everyone you know who has bought or sold a home for their recommendations — and ask specific questions such as:

  • What were the agent’s strengths and weaknesses?
  • Did the agent demonstrate knowledge of the home buying/selling process and the market?
  • Did the agent generate results (new properties for buyers to see or prospective buyers for a seller’s property)?
  • Was the agent attentive to clients’ specific needs and schedules?
  • Did the agent communicate well with the other party’s agent?
  • Most important, did the agent have integrity?

Don’t forget to ask other professionals who work with agents for their input. Check with your mortgage broker, banker, attorney and financial advisors. Ask other agents who they respect and why.

Know how your agent will be paid

When a real estate agent facilitates a purchase or sale of property, he or she receives a percentage of the sale amount as their compensation. Commissions generally run between 5 percent and 7 percent. By law, commissions are negotiable, but you’ll find that 6 percent is standard with most established agencies.

That commission is split between the listing agent and the buyer’s agent. The money comes from the seller, but you can be sure it’s built into the home’s price tag.

What to look for if you’re selling

If you’re selling your home, interview at least three agents, checking background and recent sales performance in your area, and expect each to outline his or her plans for marketing and selling your home. A listing, or seller’s, agent should also be able to advise you on ways to make your home more attractive to potential buyers.

Setting the price

Make sure your agent has a realistic (though perhaps optimistic) sales price target — setting the price too high can be as much of a problem as setting it too low. Your agent should be able to justify a particular asking price, providing support (comps, or comparable homes that have sold in the past few months) that it is in line with current market conditions.

The listing agreement

Once you decide on a listing agent, you will sign a listing agreement, which is a contract that shows what the agent is obligated to do, the price you want, the terms under which you will sell your home and the commission you will pay. The length of the agreement is negotiable, but make sure you understand that you may be giving the agent exclusive rights to sell the home until the agreement expires.

Going it alone

Eleven percent of home sellers sold their home without the assistance of a real estate agent. Some sellers find a middle ground, hiring professionals for flat fees to do some of the work, such as running open houses or listing the home on the local Multiple Listing Service (MLS) , while managing most of the sale themselves.

Whether you’re buying or selling, doing it yourself or not, you’ll need to build a team of professionals for at least some of the process. Make sure they’re the best.

How To Choose A Financial Planner

January 21, 2021

Before you set out to find a financial planner, take some time to think about what you want a planner to do for you. Once you have determined what you’re looking to get out of a relationship with a planner, it is easier to find one who offers the services you desire. So before you start contacting planners, take a moment to think about what you want to accomplish – investment help, retirement planning, or a comprehensive financial plan.

You’ll probably want to interview at least three planners before you choose the one to work with. You may want to consider asking people you know if they work with someone they would recommend. Ask your other advisors as well, your CPA or attorney may have a few planners that they work closely with.

To assist in your search, we have provided the following links to make finding a financial planner easier.

Find a CERTIFIED FINANCIAL PLANNER (CFP®) (800) 487-1497
Certified Divorce Financial Analyst (CDFA) (800) 875-1760
National Association of Personal Financial Advisors (NAPFA) (888) 333-6659
Society of Financial Service Professionals (ChFC® and CLU®) (800) 392-6900
Find a CPA Personal Financial Specialist (CPA/PFS)

When you call each planner, here are ten questions to ask:

1. What are your credentials?

While there are no formal requirements to practice as a financial planner, there are several financial planning designations that will assure you of a minimum level of education and experience. A person holding the CERTIFIED FINANCIAL PLANNER™ (CFP®) designation must pass five college-level courses that cover topics such as retirement planning, estate planning, tax planning, investment analysis, and employee benefits. Then they must pass a rigorous certification exam. Planners also must have a bachelor’s degree and meet experience requirements set by the CFP Board.

Another credential is the Certified Public Accountant/Personal Financial Specialist (CPA/PFS). These are CPAs who are members of the American Institute of Certified Public Accountants (AICPA), have at least 3 years of experience in financial planning, and pass a comprehensive and rigorous personal financial planning exam.

For a more complete description of different financial planning designations, check out: www.investopedia.com/articles/01/101001.asp

2. Can you tell me about your experience?

It’s important to know how long the planner has been in practice, and with what companies. And you’ll want to know if they have experience working with clients who have financial issues like yours. If they have been with a number of different firms in a short period of time, ask why.

3. What services do you offer?

Find out what financial planning services they offer, as well as other services they provide. Some stockbrokers or insurance agents may earn a financial planning designation to appeal to more clients. Other planners may be fee-only, providing advice that may be limited to your planning needs, but they may not be able to provide specific investment options. Make sure you choose a planner that will meet all of your needs.

4. Do you specialize in a particular area?

Some planners work only with a particular type of client. Others focus on one or two planning areas, such as retirement or education planning. Because planners offer different services and have various fee structures, it’s a good idea to know what type of services you want so you can find out if the planner is a match.

5. Will others in your office be working with me?

Depending on the size of the planner’s practice, there may be other planners, paraplanners or other professionals you will also work with. Be sure to find out who will handle the maintenance of your account and who else will be involved in your financial planning relationship.

6. How are you compensated?

There is a wide variety of ways that planners get paid. It’s important to ask this question upfront, so there are no misunderstandings. A financial planning agreement, or engagement letter, should clearly spell out the compensation arrangement. Planners can be paid as fee-only, commission-only or fee-based, which is a combination of fees and commissions. Fee only arrangements can include a flat fee, hourly billing, or a fee based on a percentage of assets under management.

7. Do you recommend specific investments?

There is no right or wrong answer to this question, but you need to know if you will get this type of advice. Whether the planner receives a fee or commission for recommending a specific investment is less important than the quality of the advice. Ask what criteria they use to screen investments and if most of their clients hold the same stocks or investments.

8. Have you ever been disciplined for unprofessional behavior?

A number of regulatory agencies keep records on disciplinary actions of financial planners. These include the Financial Industry Regulatory Authority (FINRA), CFP Board of Standards (if the planner has a CFP® designation) and your state securities and insurance departments.

9. Can you give me references to some of your clients?

Many planners are happy to let you speak with a few of their clients to find out how their experience has been working with that planner. Other planners do not provide client references due to confidentiality issues. If you are able to check references, find out how often their planner calls them, how easy is it to get an appointment, and whether or not they would recommend their planner.

10. What questions do you have for me?

A good planner wants to know what your needs are, your work and family situation, and what kind of advice you are seeking. If a planner does NOT ask you a lot of questions when you call to interview them, it could be a red flag. You want a financial planner that focuses on your goals, not theirs.

After asking these questions of three or more planners, you may find one that clearly fits the bill. If not, don’t be afraid to keep looking for more referrals. As you talk to these planners, get a feel for their style – you want to make sure you’ll be comfortable revealing personal information to your planner.

4 Steps To Perform Your Own Investment Analysis

January 21, 2021

Two of the most common questions that I get as a financial coach are, “Do my investments make sense for me?” and, “Am I paying too much?” Generally, those are questions that I can’t answer in one minute, but with the right tools and a few minutes anyone can figure out the answer.

When I was a financial advisor trying to convince a potential client that I could do better than their existing advisor, here are the steps I would take – anyone can do them with the right knowledge.

How to do a self-analysis of your investments

Step 1 – Take a Risk Tolerance Assessment

You must know what amount of risk makes sense for you. I don’t care about your friends, relatives or co-workers. Does your mix of investments make sense for you?

To find out, this Risk Tolerance Assessment takes about 2 minutes or less, and will then offer you general guidelines as to how much money you should have in stocks, bonds and cash (aka money markets or stable value funds). If you have two entirely separate goals, such as a college fund that you need in 10 years and retirement in 25 years, then take the assessment more than once, each time with that specific goal in mind.

Step 2 – Figure out exactly what investments are held in your funds

Just because your fund says one thing in their objective doesn’t mean that it’s clear what your fund actually owns. If you really want to know, you can actually find out using a tool on Morningstar. Here’s how:

  1. Get a copy of your statement, then look for your account holdings. You are looking for fund names such as ABC Growth Fund Class R5. Even better, see if you can find the “ticker symbol” for each fund, which is a multi-letter code such as “ABCDE.”
  2. Go to Morningstar.com and enter the name or ticker symbol.
  3. Once you’ve found the Morningstar page for your fund, click on the tab labeled “Portfolio.”
  4. This tab will break down the mix in the fund by stocks, bonds and cash – keep in mind that Stocks include both US and non-US stocks, while bonds will simply be labeled as Bonds, and cash or money market will be listed as Cash.
  5. You can really geek out if you want by digging into how much is in large company stocks compared to mid and small sized companies or look at what sector of the economy your fund focuses on (such as technology or manufacturing, etc.) You may even find some fun in looking at the Top 10 holdings in each fund to see if you have an overload in a certain company.

The most important thing is that when you add up all the money in stocks based on this analysis it is close to what your risk tolerance suggests. The other key thing to check is that everything doesn’t look exactly the same. So if all of your funds are mostly large companies or all of them are US Stocks, then you may be out of balance.

Step 3 – Analyze fees

Once you have determined that your investments are or are not matching up with your risk, the next step is determining how much you are actually paying the mutual fund companies through fees, which are also called “expense ratios.”

While Morningstar has good info on that, the FINRA Fund Analyzer is a more helpful tool for this purpose. Here’s how:

  1. Again, enter the fund name or the ticker symbol into the analyzer, and when you’ve found your fund, click on “View Fund Details.”
  2. Scroll down to “Annual Operating Expenses” to see how the expenses for your fund stack up against its peers.
  3. Also look to see if you must pay a fee to get into or out of that fund.

Obviously, the ideal is to invest in funds where the fees built into the fund are at or below the average fee for that peer group.

Step 4 – Compare your advisor fees to benchmarks (if you have an advisor)

If you are a do-it-yourself investor, you can skip this last step, but if you have an investment advisor who is helping you with your investments then the last step is figuring out if you are paying them more than average.

Commission-based advisor

If you are investing in funds that showed a lot of up-front commissions or “Contingent Deferred Sales Charges” or “CDSCs” in Step 3, then that means your advisor is paid by commission. If so, then the key here is to make sure that the commissions are comparable to industry averages and that you are holding onto the funds – or at least staying in the same mutual fund company options – for about 7 years or longer in order to realize the value of the up front fees. This allows you to minimize the overall fees paid and avoids paying commissions too frequently.

“Fee-only” advisor

If your advisor is “fee-only,” then they don’t charge commissions, and instead they charge a management fee based on the total value of your investments. Generally, this is a fee that is collected quarterly, so in that case each quarter the fee is applied to your balance and then divided by 4. So, if you have a 1% fee on your $100,000 account, your fee would be $1,000 per year or $250 per quarter. Keep in mind that this is in addition to the fees you explored in Step 3, and will show up as a separate fee on your statement.

How much is too much?

As for what your fee should look like, in 2018, the average advisory fee was 0.95% and many people use 1.0% as an industry standard. A good rule of thumb is that if you are paying close to or above the average, then you should be receiving value for that in the form of other services such as financial planning, tax planning, etc. to justify the higher fee.

That said, it can vary quite a bit depending on the size of your account. For accounts between $0 – $250,000, the average advisory fee was 1.1% and over $5 million that dropped to 0.7%. In other words, the more money you have, the lower the percentage, but probably higher the dollar amount of your advisory fee.

Ultimately, it’s up to you to determine if you’re receiving proper value for any advisor-based fees. If you don’t think you are, then consider shopping around.

What about robo-advisors?

Today, there are lots of robo-advisors out there that will do most of the same things when it comes to managing your investments that a typical advisor would do, but the fees tend to be lower, ranging from 0.25 – 0.35%. Does that mean everyone should be using robo? Like anything else, some people are very comfortable with using technology as a tool and getting planning or guidance somewhere else. If that is you, then a lower-cost robo advisor may make sense.

If, however, you are like many folks and prefer someone you can call when you have questions who is intimately familiar with you and your situation, then paying up to that industry average may be worthwhile. Lastly, if you like your advisor but their fees are above average then you can always try to negotiate with them for lower fees and/or additional services like financial planning, retirement or college planning, etc.

Should You Let A Robo-Advisor Pick Your Investments?

January 21, 2021

Technology has revolutionized everything from choosing a restaurant to getting directions or even a ride to that restaurant, but is it time for technology to get you to your investment destination as well? While this may sound like science fiction, the rise of “robo-advisors” over the last few years has made this into a plausible option.

These online automated investment services can provide investment advice or management for typically a lot less than a human advisor. But should you really entrust your nest egg to a computer and if so, which of the many options would make the most sense for you?

Pros of robo-advisors

  • It’s convenient. You don’t have to have a large amount to invest or go to a fancy office and talk to a pushy salesperson. Most robo-advisors have very low minimums and allow you to set up and fund the account from the comfort of your smartphone or at least, your computer.
  • You get a customized asset allocation. “Asset allocation” is a fancy term for dividing your money into various types of investments (called “asset classes”) like stocks, bonds, and cash. Rather than having to make this decision on your own, robo-advisors generally do this for you based on your responses to questions that are designed to determine your time frame and comfort with risk. All you need to do is then fund the account.
  • The costs are relatively low. You could get asset allocation advice from a human advisor, but that typically costs about 1% of your assets. They may also put you into funds with high fees. Robo-advisors generally charge a lot less and use low cost index funds.

Cons of robo-advisors

  • The “advice” is very limited. Robo-advisors generally only help you with your investments. You typically won’t get help with other financial planning issues like how much you should be saving, what type of accounts to invest in, and whether you have adequate insurance coverage and estate planning. The investment advice you do get may also not incorporate taxes or how your money is invested elsewhere.
  • There’s no “hand holding.” One of the most valuable services of an advisor is to talk you out of doing something stupid – whether that’s putting too much in an aggressive tech stock or bailing out when the market takes a downturn. To the extent that robo-advisors do this, they still lack the emotional connection and persuasive/motivational ability of a trusted human advisor.
  • There are generally still advisory fees. Even a small advisory fee can add up over time. You could do a lot of what robo-advisors do without paying their fees by simply investing in an asset allocation fund that matches your risk level or taking a risk tolerance questionnaire and following the asset allocation guidelines.

How to get started if a robo-advisor is what you need

  • Know what you’re looking for. If you’re investing in a taxable account, you might want to look for a robo-advisor that offers tax-efficient investing and/or tax loss harvesting. A few offer access to a human advisor by phone. Make sure you’re also comfortable with the program’s investment strategy.
  • Know your options. Your employer’s retirement plan may offer a robo-advisor program. Some are also offered by particular brokerage firms for their clients. You can find a good comparison of options here.
  • Know what you’re paying. Look at both the fees that the robo-advisor charges and the expenses of the funds it recommends. “Free” robo-advisors typically put you in their own bank accounts and mutual funds, which may be more expensive than another program’s fees.

For investors who are looking for investment management or advice but are unwilling or unable to hire a financial advisor, robo-advisors can offer a simple and relatively low cost solution. (Just be aware of their limitations.) At the very least, they will make human advisors work that much harder to earn the fees they charge.

How To Become A Millionaire In Just 15 Minutes

January 21, 2021

I was recently speaking with my colleague Doug Spencer about how many people joke about winning the lottery and he asked me: “What are your odds of winning a lottery?” I know the odds are always outrageous, so I’ve never played the lottery, but I decided to look up those odds and give Mr. Spencer a smart answer. I searched the Internet and found that, according to the lottery mathematics page in Wikipedia, the odds of winning a standard lottery (picking six numbers correct numbers out of 49) are 1 in 13.98 million. It doesn’t matter how many people play. Those are just the odds of picking those numbers. By comparison, you have better odds of becoming an astronaut, giving birth to identical quadruplets, or winning a gold medal in the Olympic Games.

The point Doug wanted to make to me is that the odds of collecting a massive amount of wealth by chance are slim, and the odds of doing so on purpose, however, are actually very certain. His method is simply to add 1% to your annual savings rate every year from now until you retire. It can even be done automatically in most cases through your employer’s auto-escalation feature in a 401(k) or other retirement savings plan. This got me to thinking about those numbers more seriously, and that’s when I discovered just how true his secret is – and how I can become a millionaire in just 15 minutes with incredibly little effort.

The first five minutes of your day = 1%

The standard American work week is 40 hours or eight hours per day. It just so happens that 1% of that eight hours is 4.8 minutes. I’m going to round that off to 5 minutes here. That means that in the first five minutes of every day, I’ve earned 1% of my income, and that’s what I’m going to add to my savings.

It takes four minutes to calculate how this might work

I used an auto-escalation calculator to learn what would happen if, starting at age 25, I contributed 1% of my income to my 401(k) and used moderately aggressive funds, and increased that contribution by 1% each year until I was contributing 20% (45 years old). According to a Tower’s Watson survey of employers, the average pay raise per year is 3% for American workers, so by adding just 1% each year to my savings rate, I’m still getting the advantage of my pay increases and not missing that 1%. If my company matching contribution is 6%, and I start off making $48,000 a year, then by the time I retire at 65, I will have amassed over one-million dollars in my 401(k) account! It took me four minutes to open up and run this calculator with a few different scenarios. Your time may be quicker.

In just three minutes I can sign up

Actually signing up for an auto-escalator in most 401(k)s is a breeze. Just log in and find it as an option under contributions. In some plans, it happens automatically when you sign up for the 401(k) or when you are auto-enrolled at the beginning of employment. When I walked through the process with a participant in a plan with whom I recently spoke, the whole process took less than three minutes!

Two minutes to check your investments

While you’re accessing your 401(k), take just a couple of minutes to review your investments and re-balance to fit your investment plan, if necessary.

Take a minute to think of future you

Write yourself a quick thank you note from the future.

Should You Be In An Asset Allocation Fund?

January 21, 2021

One of the most common questions we get on the Financial Helpline is how to choose investments in your employer’s retirement plan. Investing can be complex and intimidating so it doesn’t surprise me that people are looking for help with their decision. What does surprise me is how few of them understand and use an option that was created to help simplify their decision.

Target date or target risk funds

Depending on your plan, you may have a target date or a target risk fund available to you. Both are “asset allocation funds” that are designed to be fully-diversified “one stop shops.” All you need to do is pick one fund that most closely matches your target retirement date or your risk level. (Target date funds can also be “set it and forget it” because the funds automatically become more conservative as you get closer to the target retirement date.)

If you think of investing as getting you from point A to point B, asset allocation funds are like the commercial jets of investing. They’re much cheaper than a private jet (a financial advisor) and much simpler than piloting your own plane (picking your own investments). That’s why when I first heard about these funds early in my financial career, I assumed they would take over much of the mutual fund industry and even replace the need for a lot of financial advisors. While they have seen a meteoric rise, especially as the default option in retirement plans, they still aren’t utilized as much as I thought they would be. I think there are 3 main myths responsible for this:

1. Putting everything in one asset allocation fund is having all my eggs in one basket. What you don’t see is that an asset allocation fund is actually a basket of baskets. Each fund is composed of several other funds. In fact, one asset allocation fund is usually more diversified then the typical mix of funds that I see people in.

So why not have other funds in addition to it? Isn’t that making your portfolio even more diversified? The problem here is that these funds were professionally designed to hold a certain proportion of investments so adding others will throw the balance off. It’s like adding extra ingredients to a chef-prepared meal. Only do it if you really know what you’re doing (in which case, you probably don’t need an asset allocation fund anyway).

2. I can probably do better on my own. Remember that these funds were put together by professional money managers who’ve been trained in investment management and do this for a living. What’s the chance that you’ll create a better portfolio? One study of 401(k) participants showed that investors who chose their own funds did worse on average than those who just went with a target date fund.

Part of that is due to lack of knowledge. However, a lot is also likely due to the temptation to buy investments that are performing well and then sell them when they eventually underperform, which is a recipe for buying high and selling low. If nothing else, asset allocation funds provide discipline… assuming you don’t trade these funds too of course.

3. Asset allocation funds are always more expensive. You would think that this professional management would come at a steep price. After all, paying for investment management typically costs .5-1% of your portfolio. However, asset allocation funds are generally only slightly more expensive than other funds and if they’re composed of index funds, they can actually cost much less than most actively managed funds. Check the fund’s expense ratio before making assumptions as to their cost.

That all being said, there are reasons not to use an asset allocation fund. You may not have one available in your plan or the one you have may be too expensive. Sophisticated investors or those with an advisor may want to create a more personalized portfolio that better matches their risk level or complements outside investments to maximize tax-efficiency. But if those situations don’t apply to you, consider an asset allocation fund. Flying commercial may not be a perfect experience, but it’s better than the alternatives for most people.

How to Be Financially Independent in 5 Years

January 21, 2021

One of the things that makes the lives of financial planners so difficult is that we usually have to get people to do what they don’t want to do, so that they can get what they want. In other businesses and professions, you’re generally either providing a good or service that will provide some immediate pleasure or alleviate some immediate pain.

Financial planning is more like dieting and exercise. Almost all the pain (saving money, taking a little more investment risk, diversifying out of your favorite stock, or taking the time to draft boring estate planning documents) is upfront for a gain (being debt free, having enough money to retire, or making sure your family is taken care of in case something happens to you) that seems so distant and far away.

Find one goal that really motivates you

Most of us know that financial planning is something that we need to do, but it’s easy to procrastinate because it’s rarely urgent (and by then it’s often too late to do much). So how can we overcome the challenge of our own inertia? I think it begins with finding at least one goal that really motivates you.

Becoming financially free in just 5 years

One of the things that has inspired me is a blog called earlyretirementextreme.com, which shares stories and tips from people who were able to retire in their early 30s, not through get rich quick schemes, but by “extreme” saving. The math works out so that if you save 75% of your after-tax income, and earn about 8% a year on those savings for 5 years, you’d have enough to maintain that standard of living indefinitely by withdrawing a sustainable income of 4% a year from those savings. Imagine being financially independent 5 years from now and being able to do whatever you’d like to do for the rest of your life?

I also know this is possible firsthand because I have a very good friend who will be financially independent, and essentially able to retire, this year at the ripe old age of 32. He did this without ever earning a six-figure income or making any noticeable sacrifices (he doesn’t make his own clothes or go dumpster diving). In fact, you wouldn’t notice much different about his lifestyle at all.

Why aren’t more people doing this?

So why don’t more people do this? Obviously, it’s quite difficult to live on only 25% of your after-tax income but the blog is full of more real-life examples of individuals who’ve been able to do just that with middle-class incomes of $30-70k. The most important thing is changing your perspective on money and how much you really need to live a happy and fulfilling life.

As an example, I read an article about how many wealthy technology executives and entrepreneurs live incredibly modest lifestyles. Warren Buffett, the second richest man in the country, is also notorious for his frugality. When you really think about it, you may discover that you need a lot less than our consumer society would lead you to believe.

Just try some of the ideas

That all being said, saving the full 75% may not be realistic for most people, especially if you’re used to a certain standard of living or have a lot of financial obligations that are hard to get out of. But, if you could apply just a few of these ideas to your life and save, say 30% of your income, it could still make quite a big difference, whether your goal is to pay off debt faster or retire a few years earlier.

I’ve actually been able to save and invest about 75% of my income. Does that mean I’m planning to retire in 5 years? Not necessarily. I enjoy my job and can’t imagine not working at all, even when I’m well into my golden years. To me, it’s more about the security, freedom, and peace of mind that comes from not being dependent on anyone else for my livelihood.

Where you are in life matters

A final point is that the younger you are, the easier, more necessary, and more beneficial these changes will be. It will be easier because young people tend to have fewer financial obligations. For example, recent graduates often just need to maintain the lifestyle they’re already used to in college (and have enjoyed quite a bit) instead of automatically increasing their spending to match their higher incomes once they start working.

At the same time, it will be more necessary because younger generations won’t be able to count as much on government entitlement programs that are going bankrupt and defined benefit pension plans that are going the way of the dinosaur. The good news though, is that they will benefit more from having a longer time for their savings to grow and compound and for them to enjoy the freedom that comes with financial independence.

Is It The Right Time To Convert To Roth?

January 21, 2021

Are you wondering if you should convert your retirement account to a Roth by the end of the year? After all, there’s no income limit on IRA conversions. Many employers are now allowing employees to convert their company retirement plan balances to Roth while they’re still working there. At first glance, it may sound appealing. Earnings in a Roth can grow tax-free, and who doesn’t like tax-free? However, here are some reasons why now might not be the time for a Roth conversion:

3 reasons you might not convert to Roth this year

1) You have to withdraw money from the retirement account to pay the taxes. If you have to pay the taxes from money you withdraw from the account, it usually doesn’t make financial sense as that money will no longer be growing for your retirement. This is even more of a tax concern if the withdrawal is subject to a 10% early withdrawal penalty.

2) You’ll pay a lower tax rate in retirement. This can be a tricky one because the tendency is to compare your current tax bracket with what you expect it to be in retirement. There are a couple of things to keep in mind though. One is that the conversion itself can push you into a higher tax bracket. The second is that when you eventually withdraw the money from your non-Roth retirement account, it won’t all be taxed at that rate.

You can calculate your marginal tax bracket and effective average tax rate here for current and projected retirement income. (Don’t factor in inflation for your future retirement income since the tax brackets are adjusted for inflation too.) The tax you pay on the conversion is your current marginal tax bracket. However, the tax you avoid on the Roth IRA withdrawals is your future effective average tax rate.

3) You have a child applying for financial aid. A Roth conversion would increase your reported income on financial aid forms and potentially reduce your child’s financial aid eligibility. You can estimate your expected family contribution to college bills based on your taxable income here.

Of course, there are also situations where a Roth conversion makes sense:

6 reasons to consider converting to Roth this year

1) Your investments are down in value. This could be an opportunity to pay taxes while they’re low and then a long-term investment time horizon allows them to grow tax-free. When the markets give you a temporary investment lemon, a Roth conversion lets you turn it into tax lemonade.

2) You think the tax rate could be higher upon withdrawal. You may not have worked at least part of the year (in school, taking time off to care for a child, or just in between jobs), have larger than usual deductions, or have other reasons to be in a lower tax bracket this year. In that case, this could be a good time to pay the tax on a Roth conversion.

You may also rather pay taxes on the money now since you expect the money to be taxed at a higher rate in the future. Perhaps you’re getting a large pension or have other income that will fill in the lower tax brackets in retirement. Maybe you’re worried about tax rates going higher by the time you retire. You may also intend to pass the account on to heirs that could be in a higher tax bracket.

3) You have money to pay the taxes outside of the retirement account.  By using the money to pay the tax on the conversion, it’s like you’re making a “contribution” to the account. Let’s say you have $24k sitting in a savings account and you’re going to convert a $100k pre-tax IRA to a Roth IRA. At a 24% tax rate, the $100k pre-tax IRA is equivalent to a $76k Roth IRA. By converting and using money outside of the account to pay the taxes, the $100k pre-tax IRA balance becomes a $100k Roth IRA balance, which is equivalent to a $24k “contribution” to the Roth IRA.

Had you simply invested the $24k in a taxable account, you’d have to pay taxes on the earnings. By transferring the value into the Roth IRA, the earnings grow tax free. This calculator helps you crunch your own numbers.

4) You want to use the money for a non-qualified expense in 5 years or more. After you convert and wait 5 years, you can withdraw the amount you converted at any time and for any reason, without tax or penalty. Just be aware that if you withdraw any post-conversion earnings before age 59½, you may have to pay income taxes plus a 10% penalty tax.

5) You might retire before age 65. 65 is the earliest you’re eligible for Medicare so if you retire before that, you might need to purchase health insurance through the Affordable Care Act. The subsidies in that program are based on your taxable income, so tax-free withdrawals from a Roth account wouldn’t count against you.

6) You want to avoid required minimum distributions (RMDs). Unlike traditional IRAs, 401ks, and other retirement accounts that require distributions starting at age 72 (or 70½, depending on your age), Roth IRAs are not subject to RMDs so more of your money grows tax free for longer. If this is your motivation, remember that you can always wait to convert until you retire, when you might pay a lower tax rate. Also keep in mind, Roth conversions are not a one-time-only event. You can do multiple conversions and spread the tax impact over different tax years if you are concerned about pushing your income into a higher tax bracket in any particular year.

There are good reasons to convert and not to convert to a Roth. Don’t just do what sounds good or blindly follow what other people are doing. Ask yourself if it’s a good time for you based on your situation or consult an unbiased financial planner for guidance. If now is not the right time, you can always convert when the timing is right.

How To Contribute To A Roth IRA If You Make Too Much

January 21, 2021

There are multiple reasons to contribute to a Roth IRA, but if you make too much money, the Roth may not seem to be an option. However, there are a few things to keep in mind before completely writing off the Roth IRA.

The limit is based on MAGI, not total income

One is that the income limits are based on MAGI (modified adjusted gross income). That means if you contribute enough to a pre-tax 401(k) or similar qualified retirement plan, you may be able to bring your MAGI below the income limits. (Here is a little more on MAGI.)

Income limits apply to contributions, but not to conversions

The bigger point here for people whose MAGI far exceeds the income limits is the fact that there is no income limit to converting a traditional IRA into a Roth IRA. This is the key that allows people who make too much money to put money directly into a Roth IRA to still participate.

How it works

You can simply contribute to a traditional IRA and then convert your traditional IRA into a Roth IRA. Anyone can contribute, regardless of income levels, but many people don’t because it’s not tax-deductible if you earn too much to contribute to an IRA and are covered by a retirement plan at work.

This is called a “backdoor” Roth IRA contribution. Since it’s really a conversion rather than a contribution, you may have to wait 5 years before you can withdraw the amount you converted penalty-free before age 59 1/2. You’ll have to file IRS Form 8606 to document the non-deducted contribution to the traditional IRA, which will offset the 1099-R form you’ll receive for the conversion.

If you already have a traditional IRA, beware the pro-rata rule

There is a potentially huge caveat to this strategy though. If you have other funds in a traditional (pre-tax) IRA already that you aren’t converting, you have to pay taxes on the same percentage of the conversion amount as you have in total IRA dollars that are pre-tax. That means you could end up owing taxes on the conversion even if all the money you convert was nondeductible and thus after-tax.

Here’s what I mean

For example, let’s say that you have an existing IRA with $95k of pre-tax money and you contribute $5k to a new IRA after-tax. Since 95% of your total IRA money is pre-tax (because it was already there before and presumably contributed pre-tax), 95% of any money you convert to a Roth IRA is taxable even if you convert the new IRA with all after-tax money.

In other words, the IRS looks at all of your IRAs as if they were one account and taxes your conversions on a pro-rata basis. In this case, you would owe taxes on 95% of the $5k you convert — basically you’d have $4,750 of taxable income. So you can still do it, and $250 would be converted without causing a tax effect. It’s just not a tax-free transaction.

One way to avoid the pro-rata rule

The good news is that there may be a way to avoid this. If your current job’s retirement plan will allow you to roll your existing IRA money into your existing employer’s retirement plan, then you’d be eliminating the need to pro-rate by no longer having an existing pre-tax IRA. If you move your IRA into your 401(k), then complete the “backdoor” transaction, the only IRA money you would have in this example would be the $5k after-tax IRA, so you won’t pay any taxes on the conversion since 0% of your total IRA money is pre-tax.

Still not a bad deal

Even if you can’t avoid the tax on the conversion, it’s not necessarily a bad deal. After all, you or your heirs will have to pay taxes on your IRA money someday. By converting some (or all) of it into a Roth, at least future earnings can grow tax-free. It’s probably not worth it if you have to withdraw money from the IRA to pay taxes on the conversion.

So there you have it. You can contribute to a Roth IRA one way or another as long as you have some type of earned income. Otherwise, you won’t be able to contribute to a traditional IRA either.

Where Should You Save For College?

January 21, 2021

CNBC ran a series of articles about why college costs are so high. One example they use is Harvard University. In 1971-72 the cost of a year’s tuition and fees was $2,600. If Harvard’s costs were merely tracking inflation, today’s cost would be $15,189. In reality, the cost is over $50,000!!!

That is ridiculously far above inflation in the real world and it’s not just Harvard. The long term trend is that college costs have increased at nearly twice the rate of inflation. That’s astounding! I think that’s why my daughter’s class costing approximately the same as one of my semesters hit me so hard.

That rising cost factor is contributing to an enormous and ever-growing level of student loan debt. It now totals over $1.2 trillion in the U.S. That is a number that continues to grow each year and is a very disturbing trend.

What’s driving these costs? Competing for students by hiring top faculty, building and maintaining facilities and ever-nicer amenities, greatly increasing non-teaching staff positions, and a transfer of financial responsibility from government subsidies to the students and their families are all factors increasing the cost of attending college. For someone facing this burden in the future, the question of “Where should I save for college?” is a very common one. There are a lot of choices out there and I’ll walk through the pros and cons of a few.

UGMA/UTMA (Uniform Gift (or Transfer) to Minors Act):

  • This is a very common way that parents open accounts for young children to collect birthday checks and random other funds that the child receives and where my son’s paychecks from his first job are currently being deposited. The best part of this type of account is that many financial institutions in the country offer these and your investment options are almost unlimited.
  • The downside of the UGMA/UTMA is that at the child’s age of majority (between 18 and 21 depending on the state), the assets become the property of the child so if they see a shiny new car or motorcycle or guitar that they want to buy…they can do that rather than pay tuition. Also, significant assets in the child’s name have the ability to negatively impact a financial aid package.

529 savings plan

  • Typically, when I talk to people and they say they want to open a college funding account, they are talking about a 529 savings plan. (My favorite college planning website www.savingforcollege.com started out as a 529 plan review website and has built other capabilities over the course of time.) 529 plans can offer a state tax break for dollars on the way into the plan, growth that is tax deferred, and if used for education, a nice tax break on the way out. They are a GREAT way for grandparents and other relatives to contribute to the cost of education. When my daughter was very young, I set up a 529 and let all her grandparents, aunts, uncles, etc. know that it existed and suggested that rather than buy a toy that might end up at a yard sale in 18 months, throw a few dollars into the 529. Surprisingly, they listened! She isn’t going to be able to fund college with birthday/Christmas gift money, but it’s paying for books and we are happy that she has that plan in place.
  • The downside of the 529 is that investment options are quite limited, fees may not always be as low as I’d like, and while it’s technically an asset of the parent on the FAFSA form, many schools consider it an asset of the child and can alter the financial aid package accordingly. To combat this, I’ve seen grandparents or a non-custodial parent open the 529 so that it avoids being reported on the FAFSA form. Just be aware that withdrawals from non-parental 529 accounts can be considered income to the child, which has an even greater impact on financial aid eligibility, so you might want to wait until the last couple years of school to tap those savings.

Prepaid 529 plan

  • The prepaid plans are far less common than the traditional 529 above, but where they are available, they can be very attractive options. The way these usually work is that you buy a number of credit hours today at current prices and when the child goes to college, those credit hours are already paid for. The rate of return on the investment equals the rate of tuition increase, which has been staggering over the last 20-30 years. If the child goes to school in another state or at a private university, the funds on deposit cover the average cost of attendance that year at a state public school so there is a nice “bang for the buck” historically since the costs have risen so quickly.
  • The primary downside of prepaid plans is that since they’ve been so good for the investor, many states have frozen or terminated their plans. At a time when many states are struggling to pay the bills (trying not to go on a rant about budgetary restraint here), giving investors a very hefty return on their money puts added strain on a budget.

Taxable account in parent’s name

  • Opening an account in a parent’s name is one of my favorite ways to see education funded. It has a far less harmful effect on financial aid and if the funds aren’t used for education, they are there for retirement or debt reduction or a really awesome vacation! The universe of investments is unlimited and the control of the assets remains with the parent. If there was one place I wish I had spent more time focusing on for my kids’ education, it would be here.

Retirement account

  • Retirement accounts are an area that people are widely using to fund education costs now. From a FAFSA standpoint, these are favored assets since they don’t cause the EFC (expected family contribution) to rise (although withdrawals generally do have an impact since they are counted as income). But the funds are available, either through a loan or a hardship withdrawal from a 401(k) or a penalty-free withdrawal from an IRA, to fund a portion of education expenses. It’s a ready pool of assets that can be tapped when other resources might not be available.
  • The downside of using a retirement account as an education funding vehicle is that every dollar removed is a dollar that isn’t available for retirement. Are you willing to risk having fewer retirement dollars, especially in an era where downsizing, layoffs and an uncertain future (gone are the 40 years and a gold watch at retirement employment situations) are the new normal. This seems like a good short term option for many, but the risks are high. This is a “tread with caution” type of way to fund college costs.

Equity in your home

  • During the housing boom that ended in ‘07/’08, a lot of people used the quickly building equity in their homes to fund college. Today, post-housing bust, that isn’t as common but for those who have been in their homes for a long time and have significant equity, this is still a “go-to” strategy. As someone who is wired to be debt-averse, I’d like to point out that if you pay your mortgage down with additional principal payments and your child gets a full scholarship, I’ve never heard anyone complain about owning their home free and clear. It sure makes retirement easier since cash outflows are easily handled.
  • Much like the downside of using your 401(k), using equity in your home to pay for college could have you paying a mortgage well into retirement, which could mean a reduced standard of living post-retirement or working a few extra years to pay down that debt.

If you are looking for “the best way” to invest for future education expenses, sadly I can’t say that any one of these options is the absolute best in every situation. What can you afford to do today? Do you want to factor in the financial aid impact of your investment strategy or is your income high enough—generally over $100,000—to make financial aid a moot point? Do you want an investment that can be used for your goals should your child get scholarships or opt for a non-college career path? Look at the pros and cons of each option to determine the choice that is most suitable for your family.

How To Invest For Education Expenses

January 21, 2021

Today, I conclude my investing series with how to invest in an education savings account. The first question is whether you even should at all. Before investing for education, make sure you have adequate emergency savings, no high interest debt, and are on track for retirement. This may sound selfish but there’s no financial aid for your retirement. If you’re ready to save and invest for education, here are some things to consider:

How good is your state’s 529 plan?

529 plans are state-based education savings plans in which the earnings can be used tax-free for post-secondary education expenses (but otherwise subject to taxes and possibly a 10% penalty) and you’re not limited to the state in which you live or the state in which your child goes to school.  There are a couple of things to consider in deciding whether to use your state’s plan. The first is whether your state offers a state income tax deduction or lower expenses for residents contributing to the plan. The second is the fees charged by the mutual funds in the plan.

One good resource to consider is financial expert Clark Howard’s guide to 529 plans. The site has an “Honor Roll” of plans to contribute to if you live in one of those states and a “Dean’s List” of the overall best plans if you don’t. It also includes some suggestions on which specific investments in the plan are low cost, including “age-based portfolios” that are like target date retirement funds in that they are fully-diversified and automatically become more conservative as your child approaches college age.

Want more flexibility?

If your state isn’t on the “Honor Roll,” you may also want to consider contributing the first $2k per year (the contribution limit) to a Coverdell Education Savings Account (ESA), which also allows tax-free earnings for education (and otherwise subject to taxes and  a 10% penalty as well). You can also use an ESA for tuition, books, and computers at K-12 schools if needed while 529 plans are eligible to use only up to $10,000/year for tuition at K-12 schools. Here is a list of low-cost Coverdell ESA providers. (Coverdell ESAs have income limits on the contributors but you can easily avoid this by gifting the money to your child and having them contribute it to the account.)

Another option is to open a custodial account in your child’s name. This allows you to invest it in anything and use the money in any way penalty-free for the child’s benefit (not just qualified education expenses). The first $1,100 of earnings each year would be nontaxable and the next $1,100 would be taxed at your child’s rate. Be aware that any earnings over that would be taxed at your rate though. Money in your child’s name can also reduce their financial aid eligibility more than other savings and they can legally use it for any purpose once they reach your state’s age of majority.

How soon is your child going to school?

If your state offers a state income tax deduction and your child is going to school soon, you may want to contribute to a 529 even if your state isn’t on the “Honor Roll.” That’s because the value of the tax deduction can outweigh the higher fund fees in the short term. In fact, in some states you can even contribute to the plan to get the state tax deduction and then immediately use the money for education expenses. In that case, you won’t even be investing the money at all.

If you’re still not sure which option is best for you, you might want to consult with an unbiased financial planner. If your employer offers you access to one-on-one consultations through your financial wellness program, take advantage. If not, consider hiring a fee-only advisor. Whether in time or money, the first education you invest in might be your own.

Should You Invest In A REIT Or A Rental Property Directly?

January 01, 2021

What if you want to invest in real estate without all the risks and hassles of being a landlord? Another option is to invest in a REIT (real estate investment trust), which is kind of like a mutual fund for rental properties (although there are mutual funds of REITs too).  Let’s look at some things to consider when deciding between the two:

How easily might you need access to your money?

This is one of the biggest differences. You can sell a publicly traded REIT immediately like a stock. (There are also non-traded REITs that come with their own rules.) On the other hand, a directly owned rental property can take months to sell and can cost thousands of dollars in transaction costs. The advantage here clearly goes to REITs.

How important is diversification for you?

A single REIT can invest in a range of commercial and residential properties. As if that wasn’t enough, you can also buy multiple REITs individually or through a real estate fund. You need a lot more money to buy enough individual properties to even approach that level of diversification. Otherwise, you’re taking more risk with less diversification and it’s a risk that doesn’t necessarily come with higher returns.

How involved do you want to be?

With a REIT, your only involvement is whether to buy the REIT and when to sell. With a rental property, you have a lot more control over the type of property you own and how it’s managed. If you know the real estate market well and/or are good at property management (or choosing good property managers), this can be a huge advantage.

For example, many real estate investors are able to keep their maintenance costs low by doing their own repairs or having a network of contractors who they trust to deliver value. If you don’t want to be that active, you might want to delegate those decisions to a REIT.

Which provides a better tax benefit?

REITs can easily be held in tax-advantaged accounts like a 401(k), IRA, and HSA. While rental properties can be held in a self-directed IRA, that can be quite complex. However, a rental property can allow you to write-off depreciation, potentially benefit from the new 20% pass through deduction, and have the basis stepped up at death. That could make it preferable from a tax standpoint if you’ve already maxed out your tax-advantaged accounts and are looking to invest in a taxable account.

At the end of the day, the decision is a personal one. If you’ve maxed out your tax-advantaged accounts and want to be actively involved in your investing, you might prefer owning a rental property directly. If you’re investing in a tax-advantaged account or prefer having easy access to your money and being more diversified, you might choose to invest in one or more REITs.

How Your Company Stock Plan Benefits You

September 16, 2020

It wasn’t long ago (the late `90s, actually) that workers by the hundreds were becoming enviably wealthy through dot-com stock options. While those days of fast fortunes might largely be behind us, employee stock ownership plans, which make owners of all or most of a company’s workforce, can still provide a nice boost to compensation.

Stock ownership (otherwise known as equity compensation) plans come in a variety of forms, with some companies offering more than one type of opportunity to their employees.

Types of Plans

Restricted Stock Units (RSUs):

Restricted Stock Units (RSUs) represent an employer’s promise to grant employees one share of stock per unit based on vesting requirements or performance benchmarks. An employee receives the shares when they vest. Because this is taxable income, often the employer will sell the number of shares needed to cover the income and payroll taxes, thus giving the employee a tax basis on the remaining shares equal to the value of the shares at the time of vesting (vesting date price). The employee is not deemed to own the actual shares until vesting and does not have voting rights.

Because taxes have been paid on the shares when they’re received, short or long-term capital gains tax will be owed on the difference between the selling price and the vesting date price when the shares are sold.

Employee stock purchase plans (ESPPs):

An ESPP gives employees of public companies the chance to buy their company stock (usually through payroll deductions) over a specified offering period at a discount of up to 15 percent off the market price.

As with a stock option, after acquiring the stock, the employee can sell it for a profit or hold onto it for a while. Unlike with stock options, the discounted price built into most ESPPs means that employees can profit even if the market value of the stock has gone down a little since it was purchased.

Employee stock ownership plans (ESOPs):

An ESOP is similar in some ways to a profit-sharing plan. Shares of company stock are allocated to individual employee accounts based on pay or some other measure. The shares vest over time, and employees receive their vested shares upon leaving the company.

Employee stock options (ESOs) and related plans:

A stock option gives an employee the right to purchase a specified number of shares at a fixed price for some period in the future. For example, if an employee has a vested option to buy 100 shares at $10 each and the current stock price is $20, they could exercise the option and buy those 100 shares at $10 each, sell them on the market for $20, and make $1,000 profit. If the stock price never rises above the option price, the employee would simply not exercise the option.

Early on, companies gave stock options only to “key” employees (often to just the executive team). These days, many companies that give options extend them to all or most employees.

Keep in Mind

Equity compensation may not always be a sure road to the country club life, but company equity still offers great potential for financial reward. Just be sure that any company stock you own fits into your overall financial strategy. A good rule of thumb is to avoid having more than 10% in any one individual stock, so your investments are diversified. Consider contacting your personal financial coach to further discuss how these plans can play a part in achieving your financial goals.