July 2010
FLA Blog
Jim Oliver & Associates, P.C.
FB Bancorp Building
17300 Henderson Pass
Suite 240
San Antonio, TX 78232
p:210.344.0205
f:210.344.4362
cpa@teamoliver.com
www.teamoliver.com
Financial Life Advisors
FB Bancorp Building
17300 Henderson Pass
Suite 290
San Antonio, TX 78232
p:210.918.8998
f:210.344.4362
advisor@teamoliver.com
www.fladvisors.com
This firm is not a CPA firm.
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Articles in this Month's Issue
The 4 Percent Rule -- What is the Right Amount to Withdraw from Your Retirement fund each year?
With stagnant incomes and roller-coaster investment returns over the past decade, individuals on the brink of retirement might wonder what became of all those “rules of thumb” affecting how they handle their nest egg once they walk away from their jobs.
They’re still there. But the question of how well they work comes down to the individual.
Chief among them is the “Four Percent Drawdown Rule” first revealed by CERTIFIED FINANCIAL PLANNER™ professional William Bengen in the October 1994 issue of the Financial Planning Association’s Journal of Financial Planning. Bengen wrote that retirees who took out no more than 4.2 percent of their mostly stock-based portfolio in the initial year and adjusted their remaining portfolio toward a 60/40 split in stocks and bonds each year, that money could last an average of 30 years. That approach made Bengen’s work a gospel in the financial planning industry.
But after this decade, which ended with the worst recession in 70 years, some experts are taking a new look at the 4 percent rule.
1990 Nobel Laureate William Sharpe of the Stanford Graduate School of Business reported last month that this particular rule can be harmful to many simply because of its level of risk tied to stocks and other assumptions including lifespan. He suggests that planners and investors need to do a better job of assessing client risk tolerance and consider more stable investment choices like TIPS (treasury inflation protected securities) among other low-risk options as a foundation for post-retirement drawdowns.
In other words, consider client risk tolerance and the content of the portfolio more, a standard percentage of drawdown less. In fact, Sharpe points out that investors actually risk wasting money by adhering to a percentage drawdown that actually could leave more money behind after a few good investment years – in essence, the annual strict drawdown concept could lower a retiree’s standard of life unnecessarily.
So what do you do? You work on the big questions first, not the numbers, and the best time to do this is as far in advance of your retirement date as possible. Here are some conversation starters for key discussions you should have with your financial planner as well as your tax and estate experts:
Set a vision of retirement and revisit it every year before and after you’re retired: If you’ve already been working with a good investment manager or financial planner, you might have already done this. But retirement goals change as most life goals do, so treat the subject organically. Talk about the fun stuff, but state your objectives for a post-retirement work picture if you want to create a new career or simply want healthier finances. Set your lifestyle expectations now and revisit them as necessary.
Track your working-life expenses for 3-6 months and examine how well your current retirement nest egg and other resources could support that spending: This is where your imagined vision of retirement becomes real -- or falls apart. A thorough examination of your current spending habits is a great first step in determining how realistic your preparation for retirement has actually been. It will also provide a picture of what else has to be done.
Consider worst-case scenarios: For many retirees, increasing healthcare expenses and the cost of end-of-life-care account for significant spending. As a result, many retirees may pay for expensive experimental treatments to fight disease or long-term home or nursing home care. Current statistics from AARP show that the average home health care aide makes $18 an hour and a private nursing home room costs $78,000 a year. While public aid picks up medical expenses for those who exhaust their assets in most states, most of us desire more than minimal standards of care. Health care reform is not even close to solving this problem, so it’s time to plan.
Build a phased-in retirement: Many companies are becoming more open-minded about keeping older workers on the payroll or actually hiring more workers over age 60. Keep apprised of such opportunities and the skills it will take to take advantage of them – a successful phased-in or post-retirement work plan will require more than sensible financial planning. It may also require training and other personal investments, so keep your ear to the ground and always be ready to consider a fresh perspective on your value in the workplace.
July 2010 — This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Jim Oliver, a local member of FPA.
Affordable Care Act Tax Provisions
The Affordable Care Act was enacted on March 23, 2010. It contains some tax provisions that take effect this year and more that will be implemented during the next several years. The following is a list of provisions now in effect; more provisions are expected.
Health Coverage for Older Children
Health coverage for an employee's children under 27 years of age is now generally tax-free to the employee. This expanded health care tax benefit applies to various workplace and retiree health plans. These changes immediately allow employers with cafeteria plans (plans that allow employees to choose from a menu of tax-free benefit options and cash or taxable benefits) to permit employees to make pre-tax contributions to pay for this expanded benefit. This also applies to self-employed individuals who qualify for the self-employed health insurance deduction on their federal income tax return.
Small Business Health Care Tax Credit
This new credit helps small businesses and small tax-exempt organizations afford the cost of covering their employees and is specifically targeted for those with low- and moderate-income workers. The credit is designed to encourage small employers to offer health insurance coverage for the first time or maintain coverage they already have. In general, the credit is available to small employers that pay at least half the cost of single coverage for their employees.
Contact us for more information on the small business health care tax credit.
Medicare Part D Coverage Gap "donut hole" Rebate
The Affordable Care Act provides a one-time $250 rebate in 2010 to assist Medicare Part D recipients who have reached their Medicare drug plan's coverage gap. This payment is not taxable, and it is not made by the IRS. Call us for more information.
Therapeutic Discovery Project Program
This program is designed to provide tax credits and grants to small firms that show significant potential to produce new and cost-saving therapies, support jobs, and increase U.S. competitiveness. IRS guidance describes the process by which firms can apply to have their research projects certified as eligible for the credit or grant. Companies could submit applications for certification beginning on June 21, 2010, and they have until July 21, 2010 to apply (postmark date). Give us a call if you have questions about eligibility or how to apply.
Keeping Your Credit Score Healthy
It doesn’t take much these days to damage a credit score. Before the recession, late payments and blasting through credit limits would take its toll. But in the past year, Fair Isaac, the company that developed the algorithm that is the leading determinant of our scores, made an important change in its formula.
It’s now putting much more emphasis on the size of your balances and how close they are to your total credit limit. It’s a behavior trigger that creditors see as a bigger worry than ever. So the best thing you can do for your credit score is to get your balances down to under half of your credit limit.
Even better, pay them off entirely and use them only when you know you can pay them off at the end of the month. Inactive accounts will ding your credit score, but quick payments can only help.
The latest revision in the FICO system will actually allow a bit of lenience on late payment – something that might affect more than a few consumers with the downturn in the economy. Obviously, this won’t mean that someone can chronically pay late, but once or twice won’t make the same impact as in earlier FICO versions.
Yet credit utilization – the amount of credit you’re actually using relative to your credit limit – is a much bigger deal simply because high balances are still prevalent among consumers. From the lender’s perspective, high balances mixed with a tough economy means a higher risk of default among customers.
So, one more time. What’s a good target utilization rate for all your revolving credit accounts? No more than 50 percent of your credit limit, and if you can get it significantly lower than that over time, that’s a good plan. The lower your credit utilization, the better your score.
What does that mean for ordinary Americans who don’t meet that under-50 percent goal? It means you shouldn’t be applying for new credit or refinancing for awhile, and that includes something as innocuous as a department store charge.
So maybe that means deferring gratification for awhile until you get things under control. But look at it this way – you can use this time as a way to develop more knowledge about credit and be in a better position long-term. Here are some things you need to know:
You’ll need at least a 740 score for the best rates: You’ll often hear that credit scores of 700 and up will get you best customer status with lenders. That’s true, but you need to aim significantly higher. For the lowest rates and best terms, you need to get your credit score above 740 (the top credit score, by the way, is 850), so keep that target in mind.
Budget: If you’ve never reviewed your spending and picked out areas where you can cut, you’ve never done a budget. Start tracking your spending either on paper or with financial planning software and start pinpointing what spending you can shift over to paying off debt.
Get some advice: Remember that debt is just one part of your overall financial picture. It might not be a bad time to sit down with a financial planner to talk about your debt issues, planning for retirement, your kids’ college education and any other key financial goals.
Monitor your credit reports: Remember that you have the right to get all three of your credit reports -- from Experian, TransUnion and Equifax -- once a year for free. You can do so by ordering them at www.annualcreditreport.com. Order them individually at different points in the year. That means you’ll get an extended picture of how your credit picture looks because the three bureaus feed each other the latest information. You’ll also be able to clean up errors as you find them -- errors can drag down a credit score – and you’ll also keep an eye on identity theft. Oh, and make sure you use the site above and avoid the businesses that use “free credit report” in their title. It’s easy. If they ask for your credit card number, don’t do business with them.
Make electronic payments: Electronic bill payment will allow you to save on postage while guaranteeing on-time payment, and the budgeting advice mentioned above will allow you to put a few more bucks toward getting that loan or credit card bill paid off. It’s important to always pay more than the minimum payment on your bill – otherwise your balance will barely move.
July 2010 — This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Jim Oliver, a local member of FPA.
Saving for College with 529 Plans
As another school year ends, college tuition payments are a year closer. Parents often wonder when they should start saving and how much.
College tuition and fees are costly and on the rise. But even with 4-year private schools running on average $36,000 per year, the cost is well worth it. According to the US Census Bureau, individuals with a bachelor's degree earn more than double those with just a high school diploma.
How much to save depends on how much you think your child's education will cost. The best way is to start saving before they are born. The sooner you begin, the less money you will have to put away each year.
Example: Suppose you have one child, age six months, and you estimate that you'll need $120,000 to finance his college education 18 years from now. If you start putting away money immediately, you'll need to save $3,500 per year for 18 years (assuming an after-tax return of 7%). On the other hand, if you put off saving until the child is six years old, you'll have to save almost double that amount every year for twelve years.
Another advantage of starting early is that you'll have more flexibility when it comes to the type of investment you can use. You'll be able to put at least part of your money in equities, which, although riskier in the short run, are better able to outpace inflation than other investments in the long run.
Financial Calculator: College Savings Planner
Use this calculator to help develop and fine-tune your child's college education savings plan. How Much Will a College Education Cost?
Based on the survey completed for the 2009 Trends in College Pricing, the average cost for tuition, fees, and room and board for 2009-2010 was:
$15,200 per year for 4-year public (in state) colleges and universities.
This is an increase of 6.3% from 2008-2009 findings.
$35,600 per year for 4-year private colleges and universities.
This is an increase of 4.4% from 2008-2009 findings.
It should be noted that on average, full-time students receive $14,400 of financial aid per year in the form of grants and tax benefits for private 4-year institutions, $5,400/yr for public 4-year institutions, and $3,000/yr for public 2-year institutions. Section 529 Qualified Tuition Plans
Many parents are looking at ways to save for college. Section 529 plans, also known as Qualified Tuition Programs (QTP), are a popular college savings vehicle for parents.
Every state now has a program allowing persons to prepay for future higher education, with tax relief. There are two basic plan types, with many variations: - The Prepaid Education Arrangement. You essentially buy future education at today's costs, by buying education credits or certificates. This is the older type of program, and it tends to limit the student's choice of schools within the state.
- Education Savings Accounts. You contribute to an account earmarked for future higher education.
Tip: When approaching state programs, one must distinguish between what the federal tax law allows and what an individual state's program may impose.
You may open a Section 529 plan in any state. But when buying prepaid tuition credits (less popular than savings accounts), you often need to apply the credits to a specific college or group of colleges.
Unlike certain other tax-favored higher education programs, such as the Hope and lifetime learning tax credits, federal tax law doesn't limit the benefit only to tuition. Room, board, lab fees, books, and supplies can be purchased with funds from your 529 Savings Account. (Individual state programs could be narrower.)
The key parties to the program are the Designated Beneficiary, the student-to-be, and the Account Owner, who is entitled to choose and change the beneficiary and who is normally the principal contributor to the program.
There are no income limits on who may be an account owner. There's only one designated beneficiary per account. Thus, a parent with three college-bound children might set up three accounts. (Some state programs don't allow the same person to be both beneficiary and account owner.)
Contributions must be in cash, and they must not total more than reasonably needed for higher education (as determined initially by the state). Neither account owner nor beneficiary may direct investments, but the state may allow the owner to select a type of investment fund (e.g., fixed income securities), and to change the investment annually, and when the beneficiary is changed. The account owner decides who gets the funds (can pick and change the beneficiary) and is legally allowed to withdraw funds at any time, subject to tax and penalties (discussed later).
Funds in the account not yet distributed at the account owner's death pass as part of the probate estate under state law - though this is not the result for federal estate tax purposes (see below). What's New?
529 plan distributions are tax-free as long as they are used to pay qualified higher education expenses for a designated beneficiary. Qualified expenses include tuition, required fees, books, supplies, equipment, and special needs services. For someone who is at least a half-time student, room and board also qualify. For 2009 and 2010, the American Recovery and Reinvestment Act (ARRA) added expenses for computer technology and equipment or Internet access and related services to be used by the student while enrolled at an eligible educational institution. Software designed for sports, games, or hobbies does not qualify, unless it is predominantly educational in nature. In general, expenses for computer technology are not qualified expenses for the American opportunity credit, Hope credit, lifetime learning credit, or tuition and fees deduction. Federal Tax Rules Relating to 529 College Savings Plans
Income Tax. Contributions made by the account owner or other contributor are not deductible for federal income tax purposes. Earnings on contributions grow tax-free while in the program.
Distributions from the fund are tax-free to the extent used for qualified higher education expenses. Distributions used otherwise are taxable to the extent of the portion that represents earnings.
A Section 529 distribution can be tax-free even though the student is claiming a Hope or lifetime learning credit, or tax-free treatment for a Section 530 Coverdell distribution, if the programs aren't covering the same specific expenses.
Distribution for a purpose other than qualified education is taxed to the one receiving the distribution. In addition, a 10% penalty must be imposed on the taxable portion of the distribution, comparable to the 10% penalty in Section 530 Coverdell plans.
The account owner may change beneficiary designation from one to another in the same family. Funds in the account roll over tax-free for the benefit of the new beneficiary.
Gift Tax. For gift tax purposes, contributions are treated as completed gifts even though the account owner has the right to withdraw them - thus they qualify for the up-to-$13,000 annual gift tax exclusion. One contributing more than $13,000 may elect to treat the gift as made in equal installments over that year and the following 4 years, so that up to $65,000 can be given tax-free in the first year.
A rollover from one beneficiary to another in a younger generation is treated as a gift from the first beneficiary, an odd result for an act the "giver" may have had nothing to do with.
Estate Tax. Funds in the account at the designated beneficiary's death are included in the beneficiary's estate - another odd result, since those funds may not be available to pay the tax. Funds in the account at the account owner's death are not included in the owner's estate, except for a portion thereof where the gift tax exclusion installment election is made for gifts over $13,000. For example, if the account owner made the election for a gift of $65,000 in 2010, a part of that gift is included in the estate if he or she dies within 5 years.
Tip: A Section 529 program can be an especially attractive estate-planning move for grandparents. There are no income limits, and the account owner giving up to $65,000 avoids gift tax and estate tax by living 5 years after the gift, yet has the power to change the beneficiary.
State Tax. State tax rules are all over the map. Some reflect the federal rules, some quite different rules. For specifics of each state's program, see http://www.collegesavings.org. Professional Guidance
Considering the wide differences among state plans, the federal and state tax issues, and the dollar amounts at stake, please call us before getting started with a 529 plan.
This newsletter is intended to provide generalized information that is appropriate in certain situations. It is not intended or written to be used, and it cannot be used by the recipient, for the purpose of avoiding federal tax penalties that may be imposed on any taxpayer. The contents of this newsletter should not be acted upon without specific professional guidance. Please call us if you have questions.
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