Home In Trust

Keeping our homes is a prominent financial priority. This is the third and final installment in a series of articles on strategies that may  protect the family home in the face of expensive long-term care services. The first, looked at creative uses of life estates. The second, long-term care insurance and family members. This column will examine the use of trusts. 

First a bit of background. The average net worth of Americans ages 65 to 74 is $190,000. Nearly seven in ten own a house, the average value of which is $150,000. (Source: Federal Reserve Board, Survey of Consumer Finances, 2004) 

The American dream starts at home. The threat is nursing home care. We are living longer. A married couple that celebrates each other’s 65 birthday has a 60 percent chance that one will be blowing out 90 candles on a cake. (U.S. Census Bureau) When we live this long, we often need help. And help is expensive. In Connecticut, average home care costs $25 an hour.  Assisted Living is at least $3,500 a month. Nursing home care tops $300 a day. (Source: MetLife Mature Market Institute 2007)

The nursing home bill is often first paid from income, then bank accounts, then other countable assets may have to be liquidated, and finally the state, if needed. In Connecticut, the average nursing home resident is a single woman at least 85 years-old on state support. (Source: State of Connecticut Annual Nursing Facility Census, September 30, 2007) This means she has $1,600 or less to her name. 

Of all the strategies discussed, transferring a home to a trust is probably the most complex to execute and cumbersome to maintain. Trusts can only be used with the assistance of a qualified attorney. 

Trusts can either be revocable or irrevocable. A revocable trust will do nothing to protect the value of a home, as the trust’s contents are easily accessible. Therefore, an irrevocable trust is required. In this case, the irrevocable trust would provide the grantor with the right to remain in the house and receive any income benefits there from.  This would allow the property to be included in the grantor’s gross estate and achieve the step-up in basis discussed in the life estate article while at the same time removing the property from the grantor’s probate estate and thereby avoiding estate recovery.   (Caution – While under current state law many states, including Connecticut, would exclude a house held in such an income only trust from estate recovery, federal law does authorize these states to expand their definition of available assets to include any asset in which the decedent has any interest 

Here’s how it works. 

A grantor places the house in a trust. This is a transfer for Medicaid purposes. It may or may not be a gift for estate tax purposes, depending on how the trust is drafted. The grantor has given up control of the house, but the trust is drafted in such a way that the grantor is responsible for paying the income tax on any income generated by the trust. 

The ultimate beneficiaries of the trust will be of the grantor’s choosing. In some cases, it will be rigidly established at the time the trust is established. In others, the grantors may retain a special power of appointment that allows them to change beneficiaries. The grantors can live in the house. They are responsible for its upkeep, but they no longer own it. 

This strategy provides for some flexibility. The transfer will always count as a Medicaid transfer, but the estate tax outcomes are entirely up to the grantors and their qualified attorneys. 

First the Medicaid transfer. Under federal law, when one applies for Medicaid assistance, the state will “look back” five years to determine if the applicant or the applicant’s spouse transferred assets to another person. If there was a transfer in this five year period, and a transfer to this trust would count, the value of that transfer would make the person ineligible for state assistance for the period of time that the monetary value of the transfer would have paid. This is marked from the date of application for Medicaid, not from the date of the transfer.  It is therefore important to transfer the house to the trust at least five years before any assistance is required.  In Connecticut, the average monthly cost of care penalty for 2008 is $9,464. So if a $500,000 house was transferred in the five year period preceding a need for Medicaid, it would make the person ineligible for state aid for 52 months. 

Now for estate tax. If the grantors are worried about estate size and ultimate taxation, they can make the transfer a completed gift, deal with the gift tax consequences and remove the asset from the taxable estate. If estate tax is not a concern, they can keep the house in the estate and enjoy a step up in the house’s cost basis to fair market value at the time the house transfers from the trust to the beneficiary. 

It’s entirely possible for a person to protect the entire value of their home even in the face of catastrophic medical or long-term care expenses. There are basically two sets of rules. One set is established by default. These are the rules that most people end up with. They require all assets to either be spent down or in some case be subject to recovery at death, including the value of the house for a single person. The other set of rules potentially allows for the protection of our houses and significant financial assets. It’s available to everyone in theory, but in practice only those who take the time to financially plan their lives actually enjoy them. They require a bit of effort, some time and working with professionals . In recent years the Medicaid laws have undergone a number of changes. Certain planning vehicles have been eliminated and most rules have been tightened. It is reasonable to expect that further changes will occur. It is vital that you speak with a local attorney with much experience in Medicaid planning.

Identity Struggle

A colleague of mine often jokes that he recently had his identity stolen and his credit score increased. If you wouldn’t expect this to be the result for you, you may want to take steps to protect yourself. 

Identity theft is a serious problem. In 2007, more than 8 million Americans were affected at a total estimated cost of $49 billion, according to the Privacy Rights Clearinghouse. The effects are most often financial—the average incident sets a person back $5,720. It is hugely disruptive of one’s life, taking, on average 25 hours to resolve. But the effects can be even more dire. Criminals have been known to assume someone else’s identity when arrested. They then skip bail and the bench warrant is issued on the unsuspecting innocent. Spending the night in jail, I’m told, is no fun. 

Fortunately, taking a few prudent steps can reduce most of the risk of ever being a victim of identity theft.

One key way to avoid the financial effects of identity theft is to never pay with your money—at least not initially. This tip was shared with our firm by no less than Frank Abagnale, the once con-man now FBI consultant on whose life the movie “Catch Me If You Can” was based. Mr. Abagnale, who in his criminal days forged more than $2.5 million worth of checks, told us to pay for everything on a credit card. This puts the bank’s money at risk, not yours, should someone get a hold of your account. When the bill arrives, you can dispute the charges and the bank takes it from there. 

I know from experience that this works, as I once went on a shopping spree in Brazil with a Citibank Visa Card, even though I’ve never been to the country. The bank held me harmless. In another instance, my house was burglarized when I lived in San Francisco. The thieves got my wife’s jewelry, were able to spend my $50 but I never paid for the gas they put on my stolen credit card.

An added benefit: The card issuer may reward you in cash back or gift-card like credits  for using their card. 

Other prudent steps to take to guard one’s identity include an annual check of your credit report. This will allow you to see if anyone is doing business in your name. You can log on to annualcreditreport.com for a free copy of your report.

It is important to guard your Social Security number. It’s a good idea  not to have it on your checks. Provide it only to trusted institutions and individuals for legitimate purposes, such as opening an investment or bank account. 

Don’t discard your junk mail and old bank and investment statements—shred them. And don’t just shred them with any shredder, make sure to use a cross-cut shredder. Anyone dumpster diving for your information will only come up with confetti, not useful information. 

Moving from the physical world to cyberspace, it’s critical to protect yourself from predators. Install firewalls and keep them updated. Don’t respond to solicitations that can’t be confirmed to be from reputable sources. When you discard your old computer, make sure you wipe the hard drive clean with dedicated software. The delete function does not get the job done.

Finally, or perhaps even initially, consider purchasing home and auto insurance that provides for identity theft protection. An insurance company can’t prevent the theft any more than it can prevent the car accident or tree falling on the house. What it can do, however, is to assume the financial risk of the event for a set premium and provide skilled help in fixing the mess should it occur.

It is a bit sobering to think that in my relatively short lifetime I have gone from living in a community in which we not only didn’t lock the house but also left keys in car ignitions to a world in which we have to guard our Social Security numbers. But that is simply how it is. We just have to deal with it.

Your Financial Plan

It’s a new year, a new beginning, and I’m pleased to introduce a new regular column focused on the importance of personal finance and the latest tools and techniques to make your money work as hard as you do.

I’ll use this space to address finance issues impact your daily lives. Don’t expect to find stock tips here—the only tip I ever provide is to align investment vehicles to your life’s great goals and your ability to weather volatility, and then get invested, keep investing, and stay invested. 

What you will find is practical guidance for your journey towards life’s great destinations: enjoying a worry-free retirement, educating the next generation, and even enjoying a luxury or two in the process. 

I’ll address the best way to hedge your bets—that is, manage life’s risks so that when bad things happen, you and your loved ones aren’t wiped out financially.

This column will not worship money, acclaim accumulation for accumulation’s sake, or celebrate conspicuous consumption. I will use this space to assist you in addressing the unavoidable reality of today’s world: If we want to prosper, it is up to us to make smart choices and put programs in place to ensure success.  

The government will not do it. 

Our employers will not do it. 

We must do it for ourselves. 

A great trend of recent decades is the shift of financial responsibility from governments and employers back to individuals. We’ve seen it in education—the day of the free public University is long gone. We’ve seen it in retirement—the traditional monthly pension check is being replaced by 401(k)-style accumulation accounts. We’re seeing it in health care—first dollar coverage for all things medical is giving way to increased cost sharing and IRA-style accumulation accounts. 

This shift is scary at times—but it’s not all bad. The shift in responsibility has come with new tools, tools that were not available to our parents and grandparents. 

The pension has given way to 401(k)s and now Roth 401(k)s. 

The IRA menu is long and growing: Traditional, Roth, Non-deductible, Simple and SEP. 

We can finance junior’s education with bonds, Education Savings Accounts, and Section 529 plans, to name just three choices. 

The passbook savings account has been joined by money market bank accounts, money market mutual funds, and short term CDs. 

Tools must be used properly for the proper job. This column will help turn you from an apprentice to a journeyman. 

Our ability to finance our dreams and consumption has grown as well. Many can remember the day when getting a credit card was an achievement. Today, our credit options not only include the plastic in our wallet, but the equity in our homes, a portion of the balance in our retirement plans, and, of course, the finance department at the store or dealership where we are making our latest purchase.

Which finance tool to use for what job?  We’ll address that too.

The Long-Term Care Advantage

When people consider long-term care, they often think about nursing homes. In fact, long-term care is not just about nursing homes, and understanding that can help you protect your family and finances.

Long-term care is a continuum of care services you will likely need when you live a long life. The question is not necessarily who will take care of you, because your family will most often, but rather what providing that care will do to your family and finances.

Long-term care is defined as needing assistance with activities of daily living (toileting, bathing, dressing, eating, transferring from one point to another, and continence). It also includes care due to cognitive impairment so severe that the individual needs constant supervision.

The New England Journal of Medicine has estimated that 43 percent of people over age 65 will need nursing home care for some period of time in their lives.  Many  will also need care in their own homes, before or after nursing home stays. Those who never enter a nursing home may still need long-term care. The question is, who will pay for the at-home care?

Medicare typically pays only for skilled or rehabilitative care, not long-term custodial care. Medicaid will pay for custodial care, but most often that which is provided in nursing homes. So many people end up using retirement savings to pay for custodial care, and that can put them at risk of outliving their assets.

Long-term care insurance can pay for the expense of having experienced home health professionals to assist the family members with the toughest tasks, allowing the family to provide care better and longer at home.

Connecticut residents can benefit from the Connecticut Partnership for Long Term Care, a collaboration between the state and insurance industry that allows residents to preserve assets and still, if necessary, rely on Medicaid. If you buy a Connecticut Partnership-qualified long-term care insurance policy, you may retain a dollar of assets for every dollar the policy pays for care without that dollar being counted toward the Connecticut asset maximum permitted to become Medicaid eligible. 

When buying this insurance, look for a long-term care specialist. One consideration is whether they talk first about a plan or a product. If they are interested in developing a plan to solve your long-term care needs, you are probably on the right track. If they focus only on product and price, you’ll probably want to get another opinion.

Credit Check

An annual physical is a valuable tool to keep your body in shape, and it’s also a vital part of maintaining your financial health.

Reviewing your credit history is part of a thorough financial checkup, and under the Fair Credit Reporting Act, Valley residents may now take a close look at their credit records for free. That’s a real boon to consumers in these days of computer errors, identity theft, and an increasing reliance on credit scores for major purchases.

Your credit history determines whether you qualify for a zero percent car loan, a cut-rate credit card offer, or a rock-bottom mortgage rate. It can affect your ability to rent an apartment or house or even land a job. And it may determine whether you must pay a deposit on utility services.

Under federal regulations passed in 2005, you are entitled to an annual look at the records the three major credit bureaus keep on your finances, at no charge. This allows you to discover and correct any mistakes, to see how well you are managing credit, and to improve your record if necessary.

To request your free reports, go to www.annualcreditreport.com or call (877) 322-8228.

Study the reports, making sure the information is accurate and that all of your accounts are included. Credit can be adversely affected if your major accounts don’t show up, as a solid payment history works to boost one’s eligibility in the eyes of future suitors. Obviously, erroneous information on the ugly side – such as late or no payments to accounts that are not yours – need to be cleared up.

You may challenge any information on the credit reports and you have a right to receive a response within 30 days. Do it in writing and keep copies of correspondence. If the credit bureaus can’t verify the information with the reporting credit issuer, by law they must remove the item from your permanent record.

The free reports won’t provide your actual credit score. The most well-known of these is the FICO score, developed by Fair Isaac & Co. You may obtain this number, which ranges from 300 for the highest risks to 850 for the lowest, with a $7 payment at the time you order your credit history report. So if you want to know your score along with your history, have your credit card handy.

There’s Hope for the CD Blues

Are you retired or near retirement? Do you have more money than you need, want, or know what to do with at this point in time? Are you tired of paying unnecessary taxes? 

I ask these questions because more and more I am running into people who fit this profile. It’s not that they are Bill-Gates rich, but they’ve lived right, saved a few dollars, and are able to meet current bills with current income. Still, they have some money that not only is providing low returns but, to add insult to injury, even these low returns are being eroded by federal and state income taxes. 

If you recognize yourself or someone you know and care about in the above description, there is help. It may be beneficial for you to consider a deferred fixed annuity with a highly rated insurance company.  If structured properly, such a solution can provide competitive rates when compared to fixed bank products. 

I know I’ve used the A word, annuity.  Fixed annuities are complex flexible tools. Like any tool, they can be used correctly or incorrectly. 

The type of annuity I am discussing is a deferred fixed annuity. As a CD, it offers a fixed interest rate for a given period of time. Unlike a CD, there is no FDIC insurance.  It is guaranteed by the claims-paying ability of an insurance company, not a bank. There is, however, a state guarantee fund for insurance companies. 

Interest on bank CDs is taxable at your highest rate. This means that a person in the very common combined state and federal tax bracket of 30 percent, ends up with only a 2.1 percent return on a 3 percent CD. 

Interest in a deferred fixed annuity accumulates tax-deferred. It will be taxed when it is withdrawn, but that may be years in the future. In the meantime, you are able to compound the entire interest rate. In the above example, 3 percent would be 3 percent. 

Fixed annuities are designed for retirement. One reason the IRS allows for tax deferral is that the government wants to encourage us to save for our future. As a result, the IRS imposes a 10 percent penalty on any earnings withdrawn before a contract owner reaches the age of 59 and a half. This is not an issue for anyone over this age.

Deferred fixed annuities contain a few other flexible features that make them attractive to many people. If held until death, like a IRA or life insurance, they transfer outside of probate. . 

I do not know if a deferred fixed annuity would meet your needs. I do know that it’s a good fit for many. You just might be among them. 

Flow Control

The leading cause of bankruptcy in America, you may be surprised to learn, I believe is a smaller than expected raise.  This may not be entirely correct, but it employs humor to make an important point. Americans are optimistic. I feel our future has always been better than our past. And expecting this to apply to us, we often spend money, or commit to spending money today that we expect to have in the future.

Don’t worry. This isn’t another column on the subprime mortgage crisis and housing hangover. It will introduce two important concepts that, if heeded, I believe will keep you out of financial trouble.

The key to financial success is not complicated to understand, it’s just difficult to execute. One has to break the law, Parkinson’s law. In 1955, British civil servant Cyril Northcote Parkinson postulated that work expands to fill the time available for it. The monetary corollary is that expenses expand to consume all available income, and then some. The key is to break the law, drive a wedge between income and expenses and save that wedge, preferably at least 10 percent, over a long working lifetime. 

It’s easier said than done. Here are two enemies.

The first is a phenomenon known as buying up. One buys up when, upon receiving news of an increase in salary, they immediately devote it to new consumption, rather than spending. A $1,200 a year salary increase, for example may immediately turn into a lawn furniture set, the payments for which are $100 a month. Since or desires are as expansive as the possibilities for consumption, and since there is always something a little nicer that we could enjoy, a propensity to buy up keeps us from saving for the future. We’ll increase the 401k with next years increase, we tell ourselves, but then next year comes and we find another enhancement our life would not be complete without.

The cost is not just the $100 a month in new consumption, but what the $100 a month could have compounded to if invested for a reasonable rate of return. At a hypothetical 6 percent rate of return, $100 a month grows to $16,388 over ten years and continues on to a hypothetical $46,204 over 20. 

The second is the phenomenon is known as the invisible commitment. If buying up is out in the open, invisible commitment is its deadly cousin. Invisible commitment refers to the hidden expenses that come with a purchase. Move from a Camry to a Lexus, for example, and it’s not just the monthly payment that’s larger. Insurance may increase, maintenance may be more expensive and the premium gas certainly will be.  Purchase a larger house and you certainly make some visible commitments: larger mortgage and increased taxes. There will be some less visible ones as well: higher utilities, more landscaping costs, and perhaps other expenses like the need to upgrade the Camry to the Lexus is keeping up with the Jones become important. 

Neither of these concepts should is shocking, nor can or should we strive to completely avoid them. We work hard to earn well to provide an enjoyable lifestyle for ourselves and our loved ones. There is nothing wrong with enjoying a raise or, to quote George Jefferson, moving on up. Providing for our future and the financial security of ourselves and those who depend on us is also important. And if we understand the natural urges to buy up and make visible as many invisible commitments as possible, we can buy up to a secure financial future and a worry-free retirement. 

Double Dip

Seniors looking for an out-of-the-box financial idea to increase income may want to consider paying back their Social Security. That’s right. I’m not talking about a take-it-for the team somebody else needs the money more than I do move. Quite the contrary; this strategy may produce an increased return for the client. 

It’s sort of like taking a do-over, a mulligan on the government’s pension program. The strategy has been covered in Forbes magazine and was popularized in a newspaper column by financial writer Scott Burns. It’s based on a case study from Economic professor and financial planning software entrepreneur Lawrence J. Kotlikoff. 

Here’s the deal. Americans vested in the Social Security system have a primary insurance amount. This is the amount that we get at our full retirement age, which varies depending on our year of birth. We can take benefits as early as 62, but in exchange for the steady check, we get a reduced benefit. On the other end, if we wait until 70, we get extra. Like good red wine, the inflation-adjusted annuity provided by Social Security gets better with age. 

Here’s how it works, according to a case study from Kotlikoff available on his website http://www.esplanner.com/Case%20Studies/double_dip.pdf and the article by Burns. A person born between 1943 and 1954 would face this landscape. At 62, they would be eligible for 75 percent of their full benefit. At 70, they would be eligible for 132 percent. 

As an example, assume a person’s benefit would be $1,000 a month at age 62. If they’d waited until age 70, it would have been $1,760 a month. The trick is that at 70, this person can indeed claim the higher benefit. The catch: they have to pay back all the money they received. A person files a request for Withdrawal of Application, SSA form 521, and it’s as if one never took the benefit. 

The math is compelling. In the example above, the person would have to pay back $96,000. In return, they would receive $9,120 a year more in income. And that income is inflation-adjusted. This is an initial pay-out rate of 9.5 percent, far higher than one could get if they handed this $96,000 to anyone except Uncle Sam. They don’t have to pay back any interest on the Social Security they receive and they can reclaim the taxes they paid on the previous Social Security benefits. (See IRS Publication 915, pg. 15) 

This strategy is not for everyone. In fact, it’s not appropriate for most people. One must actually have the money. Most people don’t simply save their Social Security and many don’t have this kind of excess savings. There is always the mortality risk. As with any annuity stream, if one dies before recouping the $96,000, their heirs may have been better off if they stuck with the original program. A spouse, however, may be better off in this case, and he or she might enjoy a higher survivor benefit for the rest of their lives. A final note of caution for those who may elect to take Social Security at 62 with the intent to exercise this option is in order. Although this is available today, the government could change the rules. It might not be available in the future. 

Still, if at 70 one finds themselves with some assets and in need of increased income after having elected Social Security, this is one option to consider. It may be the best deal in town. 

Facts of Life

It’s time to discuss the facts of life, a sometimes controversial and often uncomfortable discussion. This column will always cut to the core of issues—explaining the facts and, hopefully, providing readers a framework to make intelligent decisions. This week’s column is the first of two that will address life insurance. 

It’s always good to begin at the beginning, to quote Lewis Carroll.  Life insurance, most importantly, provides an income-tax free benefit, predetermined at time of purchase, should an insured die while the contract is in force.  In short, it creates a pile of tax-free money to pay mortgages, fund educations, and provide income. 

So before we even get into which flavor might be appropriate for an individual or family, we must first answer the question: Would it be important to have a pile of tax-free money for someone or some institution when we die? More to the point ask: I’m dead, what does my family do now?

Keeping in mind that the no one gets out alive, it’s a matter of when we die, not if we die. Therefore we have to answer this question if we were gone tomorrow, five years, ten years, or at ten years past our life expectancy. 

If the answer is yes for any one of the time frames, then a person has a need for life insurance.  

Some situations are obvious: A young family dependent on one or two incomes to pay a mortgage, educate children, and amass money for retirement. A couple in the ten-year dash to retirement, with one or two people in peak earning years that are necessary to catch up on retirement contributions. A family with a special needs child who will need expensive support long-after mom and dad are gone. 

Others might be less so, but careful consideration reveals a need.  A soon-to-be retired couple whose income is tied to a pension and social security benefit that will be significantly reduced should one person die will need life insurance. A family with significant assets that, if no planning is completed, will see a distressingly large portion sent to Uncle Sam in estate taxes.

Others still might decide that none is needed. Income sources are secure and able to cover expenses regardless of life or death, no taxes will be owed to the government, and no one will be left holding a bag of bills should one pass. 

Once a need is determined, the question arises: how much?  The number one reason people purchase life insurance is to replace income. There are many legitimate ways to determine how much insurance is needed to provide sufficient income for loved ones. 

The human life value places a dollar amount on the value of one’s life. It asks the question, how much is a person worth, in dollar terms, to their family should they survive to life expectancy. In technical terms, it is the net present value of one’s future earnings. Believe it or not, we can put a dollar figure on each of our lives. This is what courts do for legal purposes. It provided the basis for the 9/11 compensation fund, which paid an average death benefit in excess of $2 million, according to the ABA Law Journal (Jill Schachner Chanen and Margaret Graham Tebo, “Accounting for Lives: The 9/11 victim compensation fund worked. But what about next time?” ABA Law Journal, August 2007).

The virtue of this method is that it requires relatively simple calculations and no need to understand an expense or debt structure. It merely asks, how long is one planning to be dead, answers forever, and replaces the necessary amount of money.

Another method is a basic needs analysis. It asks, what would I want for my family should I not come home or wake up? This method demands that we pull out a piece of paper and put dollar figures to goals: How much will we need to fund college, retirement, and income for survivors. This analysis requires combining desired income streams and lump sums into a single number. It’s the dollar amount that is needed to keep a family in its own world, should nothing else change.

For young families, the human life value and basic needs approach will produce very similar results, since most of their great life goals—paying off a mortgage, educating their children, and amassing money for retirement—are dependent on future earnings. In later years, human life value may produce a larger number. In both cases, the numbers are usually larger than people expect—we undervalue ourselves—and much larger than most group policies cover at work, creating a need for privately owned insurance. 

One method is not right and the other is not wrong, they are simply different paths to the same goal—protecting our loved ones. The important point is to take action, ask the sometimes uncomfortable questions posed in this column, and then do something to protect the people you love.  

Fundamental Finance

We Americans, as a collective, under perform in our financial lives. Don’t get me wrong, I’m not saying we’re bums. Quite the contrary. We’ve created the world’s most dynamic economy; we produce life-enhancing innovations at a pace that has never been matched. We work hard, we work smart, we work creatively, and we are, in general, well rewarded for it.  From 1967 to 2006, average incomes have jumped from $36,502 to $48,223 in constant 2006 dollars, according to the U.S. Census Bureau. (U.S. Census Bureau, Current Population Survey, Annual Social and Economic Supplements, 2006).

Yet I can’t help wondering, for all of the wealth that is produced, for all the income that flows through our checking accounts, why isn’t more retained by the average American household? In 2004, the average net worth was $93,100, according to the Federal Reserve Board’s 2004 Survey of Consumer Finances. The average 401K balance, net of loans, was $58,328 in 2005, according to a the Investment Company Institute and the Employee Benefits Research Institute, large enough to produce $243 a month in income at a 5 percent rate of withdrawal. ( Sarah Holden and Jack VanDerhei, “401K Plan Asset Allocation, Account Balances, and Loan Activity in 2004,” Investment Company Institute Perspective, Vol. 11/No.4, September 2005). 

I am convinced that our under accumulation of wealth stems from a fundamental confusion about what constitutes sound financial management, a confusion of good business finance with good personal finance. 

We’ve all heard the phrase; it takes money to make money. In business and investment this is certainly the case.  We must spend money before any will come back to us. The basic paradigm is the agricultural model, which provided humans with our first movement into stable, self-sustaining societies. In order to earn money farming, a person must acquire money, either through savings or loans, purchase land and seed, then work the land, rely on a bit of luck that no aberrant or other catastrophe wipes out the crop, then work to harvest, sell the produce, pay off the loans. It is only then that the farmer earns a profit and starts the cycle again. 

The bottom line: In business, we must spend money before we have it so that we can have it to spend it. Failure to spend will doom any business to stagnation and ultimate failure. Being too cheap will end an enterprise. 

The fundamentals of personal finance, however, are the opposite. In personal finance we should wait until we have the money to spend it. We must earn, set aside 10 to 20 percent, and let the pile grow. It is only after the pile has grown that the prudent person indulges in spending to upgrade one’s lifestyle. 

This pay yourself first rule is not new and certainly not revolutionary. It was first put to print in 1926 by George S. Clason in his classic parable, “The Richest Man in Babylon.”  Yet far too few Americans accept Clason’s advice. 

Instead, we tend to justify today’s consumption with expectations of future earning increases. Many of us actually use the business paradigm to rationalize spending on the personal side.  We categorize personal consumption as an investment in business. 

I may, for example, have a Toyota Camry that, while a decade old, is paid off, running fine and inexpensive to maintain. Not having a car payment of $500 enables me to invest an equivalent amount in a taxable account or far more in a retirement account, as I don’t have to pay taxes. 

I want a Lexus. I don’t have the money saved. I will have to take a loan. No problem. I tell myself it is important for me to have a nice car for business appearances. Just as a dentist must have teeth, a financial advisor must drive an upper-end automobile. 

I’ve rationalized personal consumption as a business expense, and diminished my future net worth--my ability to achieve real financial freedom--in the process.  I could do the same with any number of nice -to-have lifestyle items including, a larger house, a vacation home, a country club membership, a boat, season tickets for the Yankees and Red Sox’s (I have clients who are fans of both teams,) private schools for the children, expensive suits, just to name a few.  

Now some of these may in fact improve my bottom line. Dentists do need teeth and I can’t live in a tent and ride a bicycle to appointments with clients in second hand blue jeans. Some purchases, such as vacation homes, may be a great investment in family time. But each dollar must come from somewhere and I can justify almost any purchase as an investment, when, in fact, many will simply be lifestyle enhancing consumption.

Ultimately, there is no objective measure that can neatly pinpoint the optimal spot between the bicycle and the Rolls Royce or the second-hand jeans and the five figure suit where I should place my marker. The principles, however, are useful. They provide a gut check, the ability for us understand our spending habits, choices, and their consequences. Most important, they allow us to be honest with ourselves and make smart money choices. 

Homeland Security: Part II

For most Americans, our home is are largest asset. My last column focused on how people can use “life estates,” to protect either their home or its value. This column will focus on the use of family and insurance.

First a bit of background. The average net worth of Americans ages 65 to 74 is $190,000. Nearly seven in ten own a house, the average value of which is $150,000. (Source: Federal Reserve Board, Survey of Consumer Finances, 2004) 

The American dream starts at home. The threat is nursing home care. We are living longer. A married couple that celebrates each other’s 65 birthday has a 60 percent chance that one will be blowing out 90 candles on a cake. (U.S. Census Bureau) When we live this long, we often need help. And help is expensive. In Connecticut, average home care costs $25 an hour.  Assisted Living is at least $3,500 a month. Nursing home care tops $300 a day. (Source: MetLife Mature Market Institute 2007)

The bill is often first paid from bank accounts, then the home, if not protected, and then the state, if needed. In Connecticut, the average nursing home resident is a single woman at least 85 years-old on state support. (Source: State of Connecticut Annual Nursing Facility Census, September 30, 2007) This means she has $1,600 or less to her name.

One way to protect a home is through the use of long-term care insurance. In Connecticut, the state and the insurance industry have combined to offer Partnership policies. These policies provided dollar for dollar asset protection. This means that for every dollar a policy pays on a person’s behalf, that person can keep a dollar of assets over and above any limits set by Medicaid. For example, a person with a five year policy that paid $250 a day for at home, assisted living, or nursing home care would be able to protect $456,250 in assets. This is in addition to the $1,600. In many cases, this would protect the value of the home. So if the house was valued at $450,000, the entire value would be at risk of Medicaid recovery in absence of a partnership policy. With the above referenced partnership policy, the house could be protected under the $456,250 pay out from the insurance company. 

Not all policies are Partnership policies. If asset protection is an important goal, one should ensure that they at least consider this option. 

In addition to insurance, family members can play a critical role in protecting the house, provided that there is advanced planning. A house can either be considered countable asset or an excluded asset for Medicaid purposes. They key it to make it an excluded asset. This can be done with the help of family members. 

First, the value of a house is protected if a spouse lives there. There is a general rule that $750,000 of equity can be protected. But with a spouse living in the house, the sky is the limit. In addition, if a sibling with an equity ownership position has lived in the house for at least one year, the house can be protected. If an minor child or adult child with disabilities resides in the house, it can be protected. 

Finally, there is the adult child caregiver rule. If an adult child has lived in the house for at least two years and in so doing has kept a person from entering a nursing home, the house can be transferred to the child without fear of Medicaid recovery. It is important that the care be documented by a medical professional. As always, it is important to work with professionals including an attorney who understand the nuances of how the laws are applied in this area.

Some strong themes should be emerging from my last two columns. First, that there are many ways for seniors to protect the value of their homes, should they require long-term care. Second, each of these strategies requires advanced planning. Third, family is a tremendous resource. Finally, that it’s important to consult with qualified professionals who can help you and your loved ones sort through the options and pick a combination of strategies customized to your hopes, dreams, and desires. There is very little that can’t be accomplished, provided one sets the goal, takes the time to plan, and takes action.

Make the Most of Year End

We have much to be thankful for this holiday season, and for many the first item on the list is that 2008 will nearly over. It’s been an eventful year, historic in many important ways. But the history it’s made in financial markets has been on the infamy side of fame. That’s just how it is. Life is not an Irish blessing.  The road may not always rise to meet us, and, at least in investing, the wind may not always be at our backs. Yet as brutal as 2008 may have been, we can make it a little better if we take advantages of year-end moves that may just help us turn some lemons into lemonade. 

Regardless of one’s outlook, there are nearly always tax, income and investing moves to be made at year end to improve one’s financial situation. I will touch on some common examples. As always, for tax advice you need to consult with a tax professional. Legal advice requires and lawyer and you should always review your personal financial situation with a licensed professional. (If you would like a more comprehensive piece on year-end planning, contact me and my office will send it out.)

The first move is to always check on employer sponsored retirement plans. While we have until tax filing to contribute to IRAs, employer plans work on calendar years. Make sure you have put in the appropriate amount into your retirement based on your long-term financial plan. 

Individuals with taxable investment accounts will want to open the statements and check for gains and losses. It may make sense to sell some winners and losers, only losers, or only winners, and book the gains and losses. Every case is different and it will depend on one’s personal situation and one’s view of the future. 

For example, if one expects their taxes to be higher in the near future, they may want to take the gains and save the losses. If they have realized other big income gains this year and expect their income to be lower in the coming years, they may want to do the opposite. People in the two lowest tax brackets may not have to pay capital gains taxes at all this year through 2010, due to a provision of the Bush tax cuts that may disappear.  Individuals in these brackets may want to sell and reestablish a higher tax basis. 

Other opportunities involve playing with income and deductible expenses. People who expect to either be in higher tax brackets next year because of promised increases or because they expect to earn more, will want to do what they can to shift income to 2008, an option easier for the self-employed that employees. They will also want to pay all the deductible expenses as possible next year, holding off on charitable contributions and property tax payments till January. 

People who expect to be in more favorable tax situation in 2009 will want to do the opposite. Prepay deductible expenses now. Cut that check to the church and your favorite charity. Prepay property tax. Push the income back, if possible. 

Again, it is smart to consult your financial professionals before year-end to develop a strategy that meets your needs. It must be personalized to your situation. But understand that regardless of what your situation is, there are probably smart year-end moves you can make to improve it. 

Money Bliss

Money may not be able to buy happiness, as some maintain, but it can assist in structuring some pretty good illusions, allowing one rent it for spell. Certainly, the link between money and happiness is complex.

One definition of being wealthy in the United States is earning $1 more than one’s brother-in-law. This may appear flippant, but academic research actually supports the spirit of this quip. 

People who live in households that earn $90,000 or more are significantly happier than those in households earning less than $20,000, according to a study by two academics. Yet the higher income households were only slightly less happy than those living in households with total earnings ranging from $50,000 to $89,000.( “Would You be Happier if you were richer? A Focusing Illusion,” by D. Kahneman, A. Krueger, D. Schkade, N. Schwarz and A. Stone, Science June 2006.)

Once we establish an absolute level of wealth that ensures our basic needs are met, our happiness has more to do with the context of our money, than how much we have in some absolute level. 

“If you compare two people with the same income, with one living in a richer area than the other,” Harvard Economist Erzo Luttmer told Money Magazine, “the person in the richer area reports being less happy.”(Quoted in, David Futrelle, “Can Money Buy Happiness?” Money, July 18, 2006.)

This makes sense—as it’s stressful keeping up with the Jones and the Jones aren’t the superrich in the magazines and television shows, but our neighbors whose children our children play with and with whom we socialize. If all the other kids are going to summer camp without a problem but a couple is tapping credit to provide the same experience for their child, they’d be happier in an area were kids stayed local in the summer. 

A house, after all, is a house, and there’s nothing in the bonus room, granite countertop, or formal dining room that causes humans to emit endorphins. Consider that the average house in the United States jumped from 983 square feet in 1950 to 2349 square feet in 2006, according to National Association of Home Builders, “Housing Facts, Figures, and Trends 2006,” and it becomes clear that we are consuming more that just square footage when we build our literal castles.

Americans are not twice as happy with our houses in 2008 as they were in 1950. I recall many conversations from my youth with elders in which they linked two phrases without missing a step: “We didn’t have much, but we were happy.” 

So if money alone can’t make us happy, can being happy make us money? It turns out the answer is yes, as long as we are not too happy. On a happiness scale of one to ten, people who scored themselves as a 7-8 enjoyed the most career and monetary success, according to researchers at the University of Virginia, University of Illinois in Urbana-Champaign, and Michigan State University. (Shigehiro Oishi, Ed Diener, and , and Richard E. Lucas “The Optimum Level of Well-Being: Can People Be Too Happy? Perspectives on Psychological Science, December 2007.) 

Fall into the blues, and it carries over in negative ways. But more strikingly, blissed out individuals underperformed the merely content. The reason, researchers think, is that they are out of touch with life’s often harsh realities.  

So if being above average makes us happy, and being above average happy makes us successful, it might come as a surprise that being down, blue, depressed can put us in the poorhouse. It’s called retail therapy and in a study to be published in the June 2008 issue of Psychological Science, researchers from Carnegie Mellon, Stanford and the University of Pittsburgh found that people who viewed a video clip designed to produce melancholy spent up to four time as much on an item as individuals who were showed emotionally neutral clips. The rationale is that being sad produces self-centered focus that causes people to treat themselves.  

So what’s the lesson? One obvious one is that we are a wealthy society and offer plenty of money to pay people to study happiness.  But beyond that, the lessons seem the sort that we all need to be reminded of periodically. Money is a tool that helps us achieve things we want for ourselves and our families. It can provide security, options, and, to some extent, freedom.  But in and of itself, it does not produce happiness and can, in fact, produce strife, discord and tension.  In the worst cases, money merely buys a cage with golden bars. I often liken it to the plumbing in one’s house: Well adjusted people don’t want to spend a lot of time thinking about it but if it malfunctions or worse, didn’t exist, they’d be in a world of hurt.  

So, in terms of happiness, the best money advice is often that if you want to feel rich, count your blessings. Better yet, do so in the company of friends and loved ones. And if you want to feel like a baron, just make sure you earn $1 more than your brother-in-law.

Retiring Possibilities

This year’s financial markets have been brutal, with nearly every asset class posting double-digit declines. For the young investor, they provide a reality check that what goes up indeed can, and must, at some point go down. For the optimistic, they might consider this a giant sale with deep discounts. It’s a different story for those close to, at, or already in retirement. Their buying days are mostly in the past. The movie is certainly not a comedy. It’s not even a drama, but pure horror.  Yet if one has a proper plan, they comfortably watch the film to the end, knowing that they will be okay. 

The first thing to understand that the recent decline, although steep, quick, and volatile, is not without precedent. In the 63 years since World War II, there have been 13 market declines of 20 percent or more, the official definition of a bear market.   (“The Four Essential Characteristics of All Bear Markets, Nick Murray Interactive, Vol 8, Issue 10, October 2008.) Many can recall the malaise of the early 1970s. We can all recall the horror of 9/11, the technology bubble bursting and the last round of corporate scandals that nearly cut the broad U.S. stock market marked by the S&P 500 by half.  In every case in the past, the decline proved temporary, the increase proved sustainable and those that stayed broadly invested in diversified portfolios were rewarded. 

We must also recall why people are invested in publicly traded securities, and equities. The challenge of retirement is generating an income that maintains one’s standard of living. The good news is that Americans are living longer. A married couple retiring at 65 has a better than even chance that one person will be alive at 88. (Society of Actuaries, 2000 Male and Female Mortality Tables) That 88 year-old person will need income. That income will need to have doubled since the day they retired just to keep up with a modest inflation rate of 3 percent. 

That’s the bad news. Living is indeed expensive. Most corporate pensions do not adjust for inflation. Social Security does, but then the inflation is often the Medicare payment that is removed from the check. One of the best bulwarks against the relentless increase in prices is owning common stock of the companies that sell the stuff that is increasing in price. 

If one puts equity investing in the proper perspective of an overall plan for retirement, they will be okay if this or some other decline coincides with their desired retirement date. The reason is that such a plan would have contingencies built in, such as two to five years of expenses that are required from investments to be in cash or near cash investments. That is, if  $500 a month is needed from investments, a person may have as much as $30,000 in a safe cash account. Other components include products, often from insurance companies, that can provide for guarantees on income streams and sometimes principal. Guarantees always come with restrictions, fees, and charges. Yet just as a car payment gets one a car, a fee for a guarantee is a great value in the right situation. 

 A properly diversified income plan is flexible enough to not have to sell too much, too quickly in a down market. It can help provide for an umbrella in the rain, a storm cellar when the weather gets particularly mean but also the gear to enjoy the sunshine when the environment improves.  Most important, having a plan allows one to actually read the days financial news and say to themselves and their loved ones, we’ll be okay. We planned for this. 

Making Your Money Last in Retirement

We are living longer lives, and that’s a good thing. But there is a downside – your retirement savings must stretch to cover you and your spouse for a protracted period of time.

According to the latest figures from the Centers for Disease Control and Prevention, if you were 65 years of age in 2001, at that time you could expect to live an average 18.1 more years. That compared with an average 16.4 years of life expectancy at age 65 in 1980, and 13.9 years to go at age 65 in 1950.1

To keep up with inflation, you must not only preserve your nest egg’s principal but keep the income growing as well. For example, an income of $2,000 a month when you retire will be worth just $1,107 a month 20 years later, assuming a 3 percent rate of inflation.

But how do you invest your money to satisfy both of these conflicting imperatives? Preserving principal requires shorter-term fixed investments such as certificates of deposit, savings accounts, fixed annuities, and short-term bonds. In return for stability, however, investors accept returns that may not keep up with rising expenses. They lose principal slowly, overtime, to inflation.

Alternatively, if you invest for higher return potential, you are likely putting your principal at greater risk, generally subjecting yourself to the vagaries of the marketplace, short-term volatility and uncertainty. That uncertainty could translate into continued growth and robust retirement income or it could mean that you need to cut expenses as your income decreases or even face finding employment or assistance in the most dire of circumstances. 

Fortunately for Valley residents, you can take advantage of the expertise of a Financial Planner or Financial Services Representative from the Barnum Financial Group to evaluate your current circumstances and take realistic steps to help manage risks to your future retirement income. Working with a financial professional is key because not one solution is appropriate for all circumstances.  Whatever you do, be sure that you are fully informed about the pros and cons of any financial product or investment strategy. 

Keeping the Home

For most Americans, home is not only where the heart is, it’s where the money is as well.  It’s little wonder then that a leading concern of many people seeking advice from financial professionals centers on issues of housing. 

For our young clients, the issues are: How much can we afford? How soon can we buy? What’s the best kind of mortgage? 

More mature clients often focus on another pressing issue: How can we protect our home and pass it or its value to the next generation regardless of whether we get sick and need expensive long-term care services?   

Fortunately, there are ways for seniors to plan that may protect the value of their homes and ensure passage to the next generation, should that be a goal. Some are easy and obvious, and some a big more complicated. They all take a bit of effort. Nothing happens in life unless one makes it happen. Each requires time to complete, anywhere from a few months to five years. So the sooner one moves the better. They all involve using some combination of gifting, insurance, trusts, and family. 

First a bit of background. The average net worth of Americans ages 65 to 74 is $190,000. Nearly seven in ten own a house, the average value of which is $150,000. (Source: Federal Reserve Board, Survey of Consumer Finances, 2004) 

The American dream starts at home. The threat is the cost of nursing home care. We are living longer. A married couple that celebrates each other’s 65 birthday has a 60 percent chance that one will be blowing out 90 candles on a cake. (U.S. Census Bureau) When we live this long, we often need help. And help is expensive. In Connecticut, average home care costs $25 an hour.  Assisted Living is at least $3,500 a month. Nursing home care tops $300 a day. (Source: MetLife Mature Market Institute 2007)

The nursing home bill is often first paid from income, then bank accounts, then other countable assets have to be liquidated and finally the state, if needed.  In Connecticut, the average nursing home resident is a single woman at least 85 years-old on state support. (Source: State of Connecticut Annual Nursing Facility Census, September 30, 2007) This means she has $1,600 or less to her name.

So how can we protect our homes? While the home, assuming the nursing home patient states an intention to return to that home, is not a countable assets and thus will not prevent the nursing home patient from receiving Medicaid.  Upon the death of the nursing home resident, however, his or her home may be subject to a lien equal to the value of services they received through Medicaid.   So you may not only have to remove the house from your name, but you also have to keep the house out of the reach of the estate recovery rules.  This is not so simple to achieve, and any attempt to accomplish either has tax and ownership consequences that should be discussed with a qualified Medicaid planning attorney.   

This column will focus on a strategy that uses a “life estate.”  Property rights are typically a bundle of rights that can be split and divided, and the rights to a home are no different.  If a person wants to transfer their home—removing it from their ownership—but retain the ability to live in it forever, considering a life estate strategy is a good idea. 

Essentially, this strategy divides the value of a home into two parts. The use value of the right to live in the house for a number of years, demarcated by a person’s life expectancy, and the remainder value after the person has passed on. The remainder value is transferred to a person, while the owner of the house retains the life estate. For Medicaid purposes, this is considered a transfer of assets, and is therefore subject to a 60 month look back rule. As a result, the sooner one takes action the better, as in so many things financial.  For Medicaid recovery purposes, many states, including Connecticut, currently limited the assets available for recovery to probate assets.  That is assets that pass through the probate process.  A life estate passes by operation of law (outside of probate) to the remainder beneficiary.  Thus in many cases the home that is subject to a life estate will not be available for estate recovery.  (Caution - federal law does authorize these states to expand their definition of available assets to include any asset in which the decedent has any interest.  Several states have expanded their definition of available assets to include property subject to a life estate.) 

Here’s some real numbers. An 85 year old woman with a house valued at $250,000. The value of her life estate is $43,524. The remainder value is $206,476. If she puts a life estate on the deed, she effectively transfers $206,476 of value for Medicaid purposes, while retaining the right to live in the house for the rest of her life. For estate tax purposes, the entire value of the house will be included in the woman’s estate. This means that although values over $1 million are subject to Connecticut estate tax and over $2 million are subject to federal estate tax, the house receives a step up in basis at death. For modest sized estates in which the house is the major asset, this is a great advantage. 

As you can see, there are real actions middle class people can take to protect the value of the home they have spent their lives building, improving, and paying off. This requires a bit of vision, planning, time, and the use of qualified professionals.  In recent years the Medicaid laws have undergone a number of changes.  Certain planning vehicles have been eliminated and most rules have been tightened.  It is reasonable to expect that further changes will occur.  It is vital that you speak with a local attorney with much experience in Medicaid planning. The first step in all things financial is to dream big dreams and set clear goals, in this case protecting the value of the family home. Then contact a professional, explore your options and get the process started. 

Working Retirement

“It ain’t what you don’t know that gets you into trouble,” quipped Mark Twain. “It’s what you know for sure that just ain’t so.” 

The spirit of this quote recently hit me like a bag of cement. I was reading a policy briefing put out by the Washington DC based think tank, The American Enterprise Institute. (Andrew G. Biggs, “The Social Security Earnings Test: The Tax That Wasn’t,” AEI Press, July 2008) The topic was Social Security and the author was Andrew G. Biggs, a former deputy commissioner at the Social Security Administration. In particular, the focus was on Bigg’s beef with financial advisors and the SSA’s bureaucrat’s around our pontification on the earnings test for early retirees. 

You see, we financial planners have been taught and we in turn teach the public and our clients to avoid the early retirement earnings penalty should they elect to take benefits prior to their full retirement age.  In 2008, if one earns more than $13,560, the Social Security Administration will reduce one’s check $1 for every $2 earned over this amount. We treat this like a harsh tax and often suggest that people who semi-retire prior to full retirement age carefully calibrate their earnings to avoid this reduction. (At full retirement age, there is no test and no penalty.)

This is true as far as it goes.  The problem is that it neglects what a famous radio personality Paul Harvey dubbed, The Rest of the Story.  Although the Administration may reduce a person’s social security check while they are working, Biggs points out that their benefits beginning at full retirement age will be recalculated to take into account the months where the check was reduced The benefit will be higher forever, compounding from the higher base. 

“At full retirement age,” writes Biggs, “Social Security not only stops withholding benefits but increases monthly benefits to replace those taken by the earnings test.”  This amount will not exceed the amount that the individual would have received had they waited until full retirement age to begin taking social security.

This is hugely important. For many Americans, Social Security is their largest check in retirement. It is a lifelong annuity that arrives with a cost of living inflator. We know that the longer a person delays taking benefits, the larger the check. The problem: most people want the money as soon as possible or simply need it. They may cut back on work they would otherwise enjoy or undertake, not wanting to have their social security checked reduced because they work. 

There are certainly many financial planning and tax factors that must be considered—and you should consult with a qualified tax advisor to run the cost benefit analysis on any scenarios that you may consider. 

The tradeoffs include both leisure and mortality risk.  By leisure risk I mean that if one elects to continue working they must, well, work, which means giving up time that could have been spent doing something else. If one wants to quit and do something else—and can afford to do so—working for more money now and more money later may not make sense. 

There is also mortality risk. If one expects that their life expectancy will be truncated due to health factors, it may make financial and lifestyle sense to take the money as soon as possible. Again, a qualified professional can assist with breakeven calculation. MetLife has created such a calculator—its Social Security Decision Tool. (http://www.metlife.com/Applications/Corporate/WPS/CDA/PageGenerator/0,4773,P17259,00.html)

For many people I think knowing that they are not actually losing benefits if they earn more than the threshold will provide peace of mind and flexibility. A person, for example, can turn on the benefits they need or want starting at age 62. If they earn less than the threshold, they keep all the money. If they earn more, they will be trading earned income today for Social Security income, knowing that the Social Security will recalculate benefits at the later retirement date. 

The flipside of mortality risk, after all, is longevity risk—that is, living longer than our life expectancy. With our lives extending well into our 90s for many people, retirees simply can’t have too much money. One’s paycheck can never be too large. Understanding the earnings test and the recalculation of benefits at full retirement  may just help some people make that check larger.  

Behind the Book “Keep It Simple, Make it Big: Money Management for a Meaningful Life”

Behind the Book “Keep It Simple, Make it Big: Money Management for a Meaningful Life”

Q: Why did you write this book?

A: My mission is to bring top-tier financial advice and attention typically enjoyed by America’s wealthiest families to America’s middle-class.  Too often financial advice is thinly veiled sales pitches for a sponsoring company’s products that may or may not benefit the consumer.  I’ve been educating consumers for nearly two decades in seminars and a radio show and I wanted to create an accessible book that would provide basic, unbiased information that would empower people to take control of their finances.  It’s my strong view, born out by experience, that in these United States of America each of us can make smart choices and enjoy financial success.

Q: What inspired the title, Keep It Simple, Make It Big?

A: I’ve always been an adherent to the KISS principal, first explained to me by Mr Vermasin, my baseball coach in 7th grade.  He said Keep It Simple Stupid.  There is an inherent complexity to personal finance in America, due to our progressive tax code, self-reliant culture, and diversity of both public and private benefit and insurance systems.  So there will always be some complexity that must be embraced, understood, and dominated.  Hence the book is nearly 200 pages.  That said, if people bring it back to the basics—spend less than you earn, invest in diversified investments that put the power of compounding on your side, minimize taxes, insure those things that you can’t afford to lose, mostly your income through disability and life insurance—they will create financial independence in America. 

The direct quote comes from Jerry Garcia, the legendary leader of the Grateful Dead.  It comes to me from a client and I found it very insightful. Growing up in Northern California in the 1980s, I spent some time at Dead shows.

Q:  In one of the simple steps at the end of Chapter One, you write, “Big goals motivate.  Don’t’ ask ‘Why?’ Ask, ‘Why not?”  What do you mean by this?

A: I’ve noticed many people live lives constrained by what is expected and normal and what others might think.  If someone said they wanted to retire to Mexico, for example, and start a fishing charter, they would think why would they do this?  I like to flip the question and ask, Why Not? Getting one’s finances right early in life allows for a lot of “why nots?” I personally was able to change careers, with a brand-new baby, in my early 30s for this reason.  Most regrets in life come from things people regret not doing not for the things they do.  Ask why not, go hard at it, and minimize regrets.

Q:  One of your roadblocks is taxes.  With all the options for accounts, pre-tax, Roth, pay as you go, are there any general rules to which accounts people should use to select accounts to minimize taxes?

A: One of the great ironies of pre-tax retirement plans is people love them while working but find them frustrating in retirement, when taxes are owed with each withdrawal.  The solution is tax diversification, best accomplished by funding Roth accounts in early earning years when income and income taxes are lower, moving to pre-tax accounts in peak earning years, and supplementing both with taxable accounts that allow for liquidity and access.  The key is to have low-tax options when it’s time to use the money.

Q: What is the greatest risk you see facing retirees?

A: The first is underestimating inflation and, correspondingly, misunderstanding which types of investments are conservative and which are aggressive.  Inflation is the carbon monoxide of personal finance: it creeps up undetected until it’s too late, prices have doubled, income has not increased, and the only option people face is to cut living standards or consume principal.  Bank assets and government bonds are obviously safe for short term needs, as they are backed by the U.S. government.  But for financing a 30-year retirement, diversified baskets of equities, i.e stock mutual funds and exchange traded funds, provide far more safety.  I like to say termites do more damage than hurricanes, even though the latter get all the press.  Inflation is the financial version of termites. 

The second, and it’s a close second, is what I call paying rent in the wrong kind of hotel.  Long-term custodial care is extremely expensive in the United States, at least $10,000 a month in the Northeast where most of my clients reside, and I see this turning middle class Americans into wards of the state.  It’s frustrating. Years ago, we had affordable insurance to address this risk.  That is no longer the case, so we deploy a variety of other strategies.

Q: What’s the largest conceptual mistake you see people making?

A: Misjudging their investment time horizon.  It’s common for people five years out from retirement to say their time horizon is five years so they need to get conservative.  I ask, “when do you plan on dying?” They laugh and understand that they still have 20 to 30-year time horizon and over this time there will be many ups and down and inflation will be relentless. Therefore, they need short, intermediate and long-term money.  In fact, I think if they do it right, they may have 100-year money.  My great-grandfather still has not spent all his money, even though he’s been dead for nearly 50 years.  16 years ago, I inherited $200K from him when my grandmother, his daughter passed.  I used this money to support my special needs daughter, spending nearly $150K of it on therapists, lawyers and other necessities of a young family.  Today the account value is north of $225K.  This is only possible because it’s in equity not cash or bonds.  It’s my intent never to deplete this account and send it down to my son to do the same.  The reality is, most of us will not outlive our money and therefore we should keep a good portion of it invested. 

Q: Have you seen the Covid pandemic altering your cleint’s retirement plans?

A:  In a word, No.  Our asset management and income generation systems are designed to get clients through tough time so they can benefit in the good times.  Neither the timing nor the cause of severe market declines can be reliability predicted. That they will occur with some frequency, can be expected.  We put robust simple plans in place to generate reliable income.

Q: Can you be more specific?

A: Most people require three things in retirement. 1. Stability of principal. 2. Reliability of income. 3. Growth of that income over time.  Each of these needs’ conflicts with the others. Things such as bank accounts and government bonds that provide stability of principal, for example, provide neither reliable income nor growth of income. Things that provide reliable income, Social Security and privately owned income annuities, don’t provide safety of principal nor much growth of income.  And things that provide growth of income, equity dividends and principal growth that can be sold and turned into income, don’t provide safety of principal nor completely reliable income.  Therefore we use a combination.  When markets drop, like they did, our clients simply move their withdrawals to the safety of principal bucket and allow the market to bring back the growth bucket.  Fortunately, this time the initial rebound was quick.

Q: What’s the most unexpected result of COVID that you have seen in your practice?

A: Hands down, it’s the reduction in spending and therefore withdrawals on their accounts. Client after client is pausing systematic withdrawals, as big-ticket items such as travel and dining out are either eliminated or drastically reduced.  There are always natural buffers in recessions as people worry about the future and therefore conserve resources. But in this instance, it’s been an enforced austerity and coupled with the government waiving the Required Minimum Distributions for 2020, it’s vey noticeable. 

Q: You refer to the roadblock of the three D’s: Disability, Death and Divorce.  What’s the significance of this?

A: One of my favorite rules is do these three things and you will be financially successful: Stay employed, stay married and invest at least 10 percent of one’s income.  Most of us violate at least one of these at least once.  Financial plans work on time and money. They more time has, the less money they need to devote to the future as the power of compounding is on their side.  It’s important to use insurance to provide money if we either can’t work due to disability or we die prematurely.  The smart use of disability income insurance and life insurance is key to financial success.  When I work with people, I bring up the concept of the money machine.  I ask a couple if they had a machine in the basement printing $75,000 a year in money, how much they would insure it for? They say for as much as possible.  To that I retort, think of yourself and your spouse as that machine and get the proper insurance.  I’ve seen it make a big difference in people’s lives.  Huge. 

Q: It’s becoming common wisdom that people should wait to collect Social Security to get a larger benefit as it grows at 8 percent a year.  Do you agree?

A: Sometimes, but certainly not always.  First, it’s not a real 8 percent, as its income increase not a lump sum.  For example, if I could take $2,000 a month and wait a year, I will be entitled to $2,160 or $160 a moth more.  That is good, but I gave up $24,000 in income to get that increase.  The question is how long until I break even? It’s roughly 12 years.  So, there are many cases in which I think it’s optimal for people to collect Social Security prior to their maximum benefit.  This is an area where people need to do the math and consider a lot of factors, not just the eventual larger check.  This is the basis of most family’s retirement.  It’s important to get it right.

Q: What’s your best personal finance ‘hack?’

A: It used to be Roth IRAs, as they could be used for retirement, college financing and even emergency reserves since contributions could be withdrawn at any time tax free.  That is still a good one.  

It then moved to Back-Door Roths for high earners, a strategy that allows people to invest in Roths annually by converting after-tax IRAs to Roth IRAs.

Now I have to say it’s Health Savings Accounts, the triple tax-free vehicles.  I write it up in my book how they can be used for things other than health care if done properly.  I stress that the health insurance that accompanies the account must be right for you for this to be a smart move.

Q: It’s often asserted that there is a retirement crisis in America, do you agree?

A: Definitely not.  I wrote an article based on a study that tracked real retirees and found that most Americans die with more money than they retired with.  It’s a myth that most Americans once had a pension.  This was never the case.  There are fewer pensions now for sure.  But Americans have an amazing array of options to save and invest for retirement, options that our parents and grandparents didn’t have.  A fully funded 401k or Roth IRA will provide far more income than a corporate pension ever did.  It will transfer to the next generation rather than die with the pensioner and, if a person wants the certainty of a pension, they can always use some of the funds to purchase an immediate annuity.  That they rarely do so is telling.  The key is that they system is  self-service: just like it’s easy to be physically fit provided a person behaves in an certain way, the same is true with financial success.

Q: Do retirees need life insurance?

A:  The answer is yes more often than one’d expect.  The reason is to protect Social Security payments.  The number one reason people use life insurance is to protect against a loss of income.  In modern America, in married couples both people are collecting substantial Social Security benefits.  If one dies, it could mean a loss of $30,000 plus a shift into single tax brackets.  This is a risk that is not really on most people’s radar screens and it should be.  Life insurance is one solution.  

Q: Can retirees purchase life insurance? Isn’t it for the young?

A: The good news is that people are living longer and longer and as a result they are able to purchase life insurance well into their 60s.  It costs more of course, but that’s because the likelihood of using it is higher!

Q: Do people really need to go the trouble of getting a will?

A: Absolutely and be sure to get health care directives and durable powers of attorney—appointing someone to act on your behalf as well.  It’s important not to blow it at the end and have family fighting and lawyers getting paid with your money.  Most of our assets can be transferred with beneficiary designations so these forms must be scrutinized.  Its no fun to contemplate our dismemberment and death but alas, we must all do so as it’s inevitable. 

Q: Can people do their own financial planning, or do they need a professional?

A: Yes and yes.  People can certainly do their own, if they want to invest the time. That’s in fact how I got into this career—I am a hobbyist who did my own and helped friends turned professional.  That said, if it’s not one’s passion, they ought to consider partnering with someone who is passionate about it.  One must master the complexity to get to the simplicity and one or two good insights will pay for the entire relationship. Many people who do it themselves will also hire professionals at some point for specialized consultations. 

 CRN202209-272216

Year-End Deals

As we enter the beginning of the ending of 2020, I can only think of the Grateful Dead lyric, “what a long strange trip it’s been.” And while I couldn’t blame anyone for being Dazed and Confused these days, I want to point out a few simple year-end strategies that may have a big financial impact on you.

Given that taxes are most of my client’s largest expense, it’s no surprise that most strategies focus on tax related moves.  

Do the Bracket Bump

Move number one.  Bump your bracket.  My dad fed our family as a general contractor specializing in underground construction. He won or lost jobs at blind bids, at which he put in a price he was willing and committed to completing a job.  On bid day, I’d have two questions for him upon his return from the office.  (These would usually be asked as I racked for a game of eight ball after putting Merle Haggard on the stereo.) First, “did you get the job?”  If he said yes, I follow up: “How much did you leave on the table?” This refers to the gap between his winning bid and the next lowest, that is, the amount of money he could have earned and still secured the contract. Leaving too much green on the table turns a win into a psychological loss. 

I’ve brought this concept to my financial planning practice, in which I encourage clients not to leave anything on the table if they find themselves in low tax brackets.  The U.S. tax code is extremely progressive, which means if you can keep your “taxable” income modest, you will pay very little income tax. For retirees, this may mean they are in the 12 percent bracket in early years only to jump to the 22 percent with RMDS kick in in later years.  Don’t waste the low 12 percent bracket.  

The simple strategy is to “Bump” your income to take full advantage of it.  Options include taking a withdrawal and investing it in a non-qualified account or converting it to a Roth IRA and never paying tax again. Each of these strategies will pay off big in future years for you or your heirs.

IRMAA is Not Just a Hurricane

How to you feel about paying extra for Medicare?  You most certainly will, without any extra services, if your Modified Adjusted Gross Income (MAGI) exceeds $87,000 per person in 2020.  Earn $87,100 and you’ll pay $840 a year more for Medicare Part B and D. That’s a take rate off 740 percent! There are other income thresholds as well.

This is Income-Related Monthly Adjustment Amount (IRMAA) and she’s often triggered by unwanted RMDs once you mature to age 72. The simple solution is to plan, in advance, to lower RMDs. If the threshold is $87,000, consider withdrawing or converting pre-tax retirement assets to Roth IRA assets to approach but not exceed this threshold.  If you find yourself paying IRMAA, make sure you use the entire allotted bracket. Call it IRMAA optimization.  

It’s not driven by taxable income so traditional charitable contributions will not lower it. People who are 70.5, can send non-profits money directly from an IRA, a Qualified Charitable Contribution (QCD), which will reduce their income. 

Do the Roth Conversion

Roth conversions are both a tool and a strategy. They are a tool for IRMAA optimization and bracket bumping.  They can be a strategy to take advantage of stock market dips, converting and therefore paying taxes as temporarily depressed prices. The simple strategy is to optimize tax brackets or Medicare limits and keep a keen eye for distress in financial markets. That’s the time to strike for big results.

 It’s Harvest Season

Look for year-end tax-loss or gain harvesting.   Under current tax code, you always pay lower taxes on capital gains than on your earned and ordinary income.  Better yet, if you fall into the 12 percent bracket you will pay nothing, zero percent, my favorite tax rate.  One strategy involves selling losing investments to offset other gains or even $3,000 of ordinary income.  This should be an ongoing not just a year end strategy, but year-end provides the last chance to deploy it.  Another less intuitive strategy is to only take gains.  If you are in the 12 percent tax bracket, this simple move will free up funds or just reset your tax-basis higher at no cost.  That may pay off big later.

The COVID Pull Out

2020 offers a unique year-end move: The penalty-free Coronavirus distribution from pre-tax retirement plans up to $100,000.  To be eligible, you or a member of your household must either have been diagnosed with COVID or suffered economic consequences from it.  If this is the case, you can remove up to $100,000 from an IRA or participating employer plan without the usual 10 percent penalty if you’re not 59.5.  It gets even better.  You have three years to put the money back and pay zero income tax, as if you never took it.  If you plan to spread it out over three years, the first payback will be due prior to filing your 2020 return in 2021.  

Working with my clients, an often-expressed sentiment is that 2021 cannot come to soon.  Whether or not that’s the case for you, take a few minutes to reflect on some good things in 2020 and some last-minute moves that might benefit you and your loved ones financially. 

Michael Lynch CFP is a financial planner with the Barnum Financial Group in Shelton CT and the author of Keep It Simple, Make It Big: Money Management for a Meaningful Life, October 2020. He can be
reached at mlynch@barnumfg.com or 203-513-6032.

Securities, investment advisory and financial planning services offered through qualified registered representatives of MML Investors Services,LLC. Member SIPC. 6 Corporate Drive, Shelton, CT 06484, Tel: 203-513-6000. Any discussion of taxes is for general informational purposes only,does not purport to complete or cover every situation, and should not be construed as legal, tax or accounting advise. Clients should conferwith their qualified legal, tax and accounting advisors as appropriate.

Mutual Funds 101

The following is adapted from Keep It Simple, Make It Big.

With mutual funds, for as little as $50 a month, you can own part of every publicly traded company in the US economy. For another $50 a month, you can own part of the entire world economy. And for another $50 a month, you can own a piece of nearly all the debt. 

Clearly, mutual funds are a powerful investment tool. They allow individuals to bundle together small amounts of money to form large pools of money and get professional-quality investing at a reasonable price. 

They allow every American to own a piece of the economic action. 

One of the best parts of mutual funds is how easy it is to invest in them. If you have a 401(k) or Roth IRA, you’re probably invested in mutual funds, even if you don’t realize it.

But the ease of mutual funds can backfire. Many people invest in mutual funds without having any real knowledge of what they are. As you get deeper into mutual funds, you can run into a lot of jargon that makes things difficult to understand.

To get the most out of this remarkable investing tool, you need a baseline of knowledge, so here’s a Mutual Funds 101, with an explanation of the common terminology you’ll see, as well as a breakdown of the fees and expenses you should expect.

Types of Mutual Funds

Mutual funds come in many flavors.

Open-ended funds are the most common type of mutual funds that allow individuals to purchase and redeem shares daily directly from the company at the value of the investments the company holds at the end of the trading day.

Closed-end funds are a less common type of mutual fund that trades like a stock on exchanges. Once the individual securities are purchased, the manager doesn’t change the mix of securities. The fund may trade below, at, or above the combined market values of the securities it holds.

Exchange-traded funds (ETFs), which are quite common and increasing in popularity, are closed-end mutual funds that match various investment indexes, such as the S&P 500 or the Dow Jones Industrials.

Investment Objectives

Mutual funds are commonly classified by their investment objective. Here are some popular examples.

Money Market: Funds that seek to keep the share price valued at $1 and offer short-term market rates of interest. They offer check-writing privileges.

Fixed Income or Bond: Funds that invest primarily in debt securities issued by corporations, governments, government agencies, and government-sponsored corporations. Funds will specialize as government bond funds, corporate bond funds, foreign bond funds, or global bond funds. Within each specialization subspecialties exist. For example, you can invest in a government bond fund that invests in Treasury Inflation Protected Securities or TIPS.

Growth: Funds that invest in the stocks of companies that are expected to increase in value. Asset appreciation is favored over dividends.

Equity Income: Funds that invest in stocks of companies that pay dividends. May invest in a limited number of bonds.

Foreign: Funds that invest in non-US-based companies.

Global: Funds that invest in non-US- and US-based companies.

Balanced: Funds that invest in both stocks and bonds. Often, they seek to replicate a diversified portfolio.

Sector Funds: Funds that invest in the stocks of companies in a single sector such as utilities, finance, healthcare, or natural resources.

Target Date: Funds that invest in a range of investments designed to be prudent for a person retiring in a certain date range. These are popular in company-sponsored retirement plans and are often the default option.

Mutual Funds by Asset Class

Mutual funds are also often characterized by their asset classes based on a grid. 

For equities, there are two types of investing styles, value and growth, and three generally accepted market capitalizations: large, mid, and small. Large, for example, are companies valued at over $10 billion.

Management companies will use objective, style, and market capitalization categories to describe mutual funds. For example, large-cap growth, mid-cap value, or small-cap blend. Some funds may merely call themselves growth or value.

Always read a fund’s prospectus to ascertain the exact securities in which the fund invests. Labels can be inaccurate.

Fees and Expenses

Mutual funds are tightly regulated, and as a result all the expenses associated with investing in them are disclosed to and quantified for investors every six months in prospectuses.

The expenses associated with mutual funds are management fees, sales charges, and marketing expenses. 

Management fees, which are typically less than 1 percent, compensate the management company for the tasks associated with security selection, purchase, and administrative overhead. 

Sales charges apply to mutual funds purchased through a professional. These mutual funds are often offered in two share classes, A and C. 

• A shares contain a front-end sales charge. The maximum is 6 percent. There is no deferred sales charge.

• C shares do not have a front-end charge. They typically have a 1 percent deferred sales charge if sold within twelve or eighteen months of purchase.

However, the majority of long-term mutual funds purchased—85 percent—do not have a sales charge. They are either purchased directly from the mutual fund company, thus with no need to compensate an investment professional, or they’re held in an account where the professional is paid by other means, such as a flat 1 percent fee.

Marketing expenses are typically 12b-1 fees, which are commonly used by advisor-distributed funds to compensate the advisor for service and initial sales. It can be as high as 1 percent in load funds and no higher than 0.25 percent in no load funds.

A Powerful, Popular Investment Strategy

The first mutual fund, the Massachusetts Investors Trust, was created in 1924. It is still in existence today, but it is far from the only one. There are now nearly 8,000 mutual funds in the United States. 

Mutual funds have grown to be one of the most popular investment strategies in the country, and they are a key part of the vast majority of people’s retirement portfolios.

With an understanding of the terminology and basics of this powerful, popular investment strategy, you can begin better incorporating it into your own financial plan.

For more advice on mutual funds, you can find Keep It Simple, Make It Big on Amazon.

Michael Lynch is a CERTIFIED FINANCIAL PLANNERTM professional with nearly twenty years of experience working with American families to craft plans that fund their dreams, educate their children, and finance their retirement. Michael has contributed to the Wall Street Journal and Investor’s Business Daily, and hosted Smart Money Radio for a decade. He’s served as an adjunct faculty member at Fairfield University and currently teaches financial planning to employees of corporations like Madison Square Garden and Yale New Haven Health Systems. Michael is a five-time Financial Planner of the Year for MetLife and a 2019 inductee to the Barnum Financial Group Hall of Fame. You can enjoy his latest articles and videos at www.michaelwlynch.com.

Mutual funds are sold by prospectus only, which is available from your registered representative. Please carefully consider investment objectives, risks, charges, and expenses before investing. For this and other information about any mutual fund investment please obtain a prospectus and read it carefully before you invest. Investment return and principal value will fluctuate with changes in market conditions such that shares may be worth more or less than original cost when redeemed. Diversification cannot eliminate the risk of investment losses.

Representatives do not provide tax and/or legal advice. Any discussion of taxes is for general informational purposes only, does not purport to be complete or cover every situation, and should not be construed as legal, tax or accounting advice. Clients should confer with their qualified legal, tax and accounting advisors as appropriate. Securities and investment advisory services offered through qualified registered representatives of MML Investors Services, LLC. Member SIPC.  6 Corporate Drive, Shelton, CT 06484, Tel: 203-513-6000. CRN202210-272629