Floods and Your Insurance

Posted On September 3, 2017 By Scott Stratton, CFP(R), CFA In Financial Planning /

In the aftermath of Hurricane Harvey, many Texans are discovering that SURPRISE, homeowners insurance doesn’t cover flooding. The damage from Harvey was from torrential rains, not wind, and in most cases will not be covered by insurance. Only those with Federal Flood Insurance will be covered, but most people do not have flood insurance unless you live in a flood zone that requires it.

If you have a mortgage and thought that you’d be covered by your homeowner’s insurance or that the bank would forgive your loan, sorry, but even if your house is a total loss you still owe every penny of your mortgage balance. What can you do? For counties which are declared a disaster area by FEMA, you may be eligible for Federal Assistance.

FEMA’s Individuals and Households Program (IHP) provides grants to those in disaster counties. You can apply online at disasterassistance.gov or by phone at 800-621-FEMA (3362). To apply, you must have already filed a claim with your insurance and been denied. The IHP will not pay for your deductible, if the damage is covered. For those who receive a grant, you must agree to purchase and maintain Federal Flood Insurance on your property going forward.

The IHP offers two types of assistance:

1. Housing Assistance, including lodging expense reimbursement, rental assistance, and repair or replacement of your primary residence. The IHP only covers a primary residence and not a vacation home, rental property, or other type of property.

2. Other Needs Assistance, such as damage to household goods, vehicles, cleanup costs, medical expenses, child care, or funeral expenses.

The IHP is a terrific program to help cover disaster costs which are uninsured, however, the limit is only $33,000 and many homeowners will easily exceed this amount if their home has been sitting in three feet of water. A grant through the IHP is non-taxable and does not have to be repaid.

The Small Business Administration (SBA) offers Home and Property Disaster Loans of up to $200,000 to homeowners – and you do not need to be a small business owner. The loan must be used to repair or rebuild your home after it was damaged.

While homeowner’s insurance does not cover losses from flooding, most auto insurance policies do. Current estimates are that 500,000 cars will be total losses from Hurricane Harvey and most are covered by insurance. Rental companies, insurers, and car makers are already shipping significant numbers of vehicles to Texas to help people get back on the road.

If you’ve been impacted by Hurricane Harvey and have questions, please feel free to call or email me. And if you haven’t been impacted, it might be a good time to actually look at your insurance policies in some detail and figure out what is covered and what is not covered. No one likes surprises when it comes to insurance.

Income Planning by Retirement Age

Posted On August 19, 2017 By Scott Stratton, CFP(R), CFA In Financial Planning /

What is often missing in most academic articles about retirement is a consideration of age at retirement. Most articles just assume that someone retires at 65 and has a 30 year time horizon. We know that is not always the case! If you retire early or later, how does that impact your retirement income strategy?

Let’s consider three age bands: early retirement, full retirement age, and longevity planning.

Early Retirement (age 50-64)

Fewer and fewer people are retiring early today. In fact, more than 70% of pre-retirees are planning to continue to work in retirement. Kind of makes you wonder what “retirement” even means today? However, I can see a lot of appeal to retiring early and there are plenty of people who could pull this off. Here are four considerations if you are thinking of retiring early:

Healthcare. Most people who want to retire before 65 abandon their plans once they realize how much it will cost to fund health insurance without Medicare. Let’s say you have a monthly premium of $1250 and a $5000 deductible. That means you have $20,000 a year in potential medical expenses, before your insurance even pays a penny! If you want to retire at 55, you might need to set aside an additional $200,000 just to cover your expenses to get you to Medicare at 65. It’s a huge hurdle.
If you have substantial assets, you will need to have both sufficient cash on hand for short-term needs (1-3 years), and equity investments for long-term growth. This is why time-segmentation strategies are popular with early retirees: setting aside buckets for short, medium, and long-term goals. While time segmentation does not actually protect you from market volatility or sequence of returns, there may be some benefit to a rising equity glide path, and it may be more realistic to recognize that spending in future decades will depend on equity performance, rather than assuming at 55 that your spending will be linear and tied to inflation.
For those who do retire early, taking withdrawals often makes them very nervous, especially after you realize that you must invest aggressively (see #2) to meet your needs that are decades away. If you have $1 million and want to take a 4% withdrawal, that works out to $3333 a month. Taking that much out of your account each month is more nerve wracking than having $3333 in guaranteed income, which leads us to…
A Pension. Most people I have met who retired in their fifties have a Pension. They worked for 20 or 30 years for a company, school district, municipality, branch of the military, etc. At 55 or so they realize they could collect 50% of their income for not working, which means that – in opportunity cost – if they continue to work it will only be for half the pay! It’s kind of a convoluted way of thinking, but the fact remains that a pension, combined with Social Security and Investments, is the strongest way to retire early.

Full Retirement Age (65-84)

The primary approach for retirees is to combine Social Security with a systematic withdrawal strategy from their retirement and investments accounts. We choose a target asset allocation and withdraw maybe 4% or so each year. We often set this up as monthly automatic distributions. We increase our cash target to 4% (from 1%) and reduce our investment grade bonds by the same amount. Dividends and Interest are not reinvested, and at the end of the year, we rebalance and replenish cash as needed. That’s the plan.
Depending on when you start retirement, I think you can adjust the withdrawal rate. The 4% rule assumes that you increase your withdrawals every year for inflation. It also assumes that you will never decrease your withdrawals in response to a bear market. What if we get rid of those two assumptions? In that case, I believe a 65 year old could aim for 5% withdrawals and a 75 year old for 6% withdrawals. This can work if you do not increase withdrawals unless the portfolio has increased. Also, a 75 year old will have a shorter withdrawal period, say 20 years versus 30 years for a 65 year old retiree.
Although retirement accounts are available after age 59 1/2, most clients don’t want to touch their IRAs – and create taxable distributions – until age 70 1/2 when they must begin Required Minimum Distributions (RMDs). Investors who are limiting their withdrawals to RMDs are following an “actuarial method”, which ties your income level to a life expectancy. This is a good alternative to a systematic withdrawal plan.

Longevity Planning (85+)

Many retirees today will live to age 90, 95, or longer. It is certainly prudent to start with this assumption, especially for couples.
Social Security is the best friend of longevity planning. It’s a guaranteed source of lifetime income and unlike most Pensions or Annuities, Social Security adjusts for inflation through Cost of Living Adjustments. Without COLAs, what may have seemed like a generous pension at age 60 will lose half of its purchasing power by age 84 with just 3% inflation. If you want to help put yourself in the best possible position for longevity, do not take early Social Security at age 62. Do not take benefits at Full Retirement Age. Wait for as long as possible – to age 70. Delaying from 62 to 70 results in a 76% increase in monthly benefits.
If you are concerned about living past 85 and would also like to reduce your Required Minimum Distributions at age 70 1/2, consider a Qualified Longevity Annuity Contract (QLAC). A QLAC will provide a guaranteed income stream that you cannot outlive. Details on a QLAC here.
While equities are probably the best investment for a 60 year old to get to 85 years old, once you are 85, you may want to make things much more simple. There is, unfortunately, a significant amount of Elder abuse and fraud, and frankly, many people over age 85 will have a cognitive decline to where managing their money, paying bills, or trying to manage an investment portfolio will be overwhelming. Professionals can help.

There is no one-size-fits-all approach to retirement income. We have spent a lot of time helping people like you evaluate your choices, weigh the pros and cons of each strategy, and implement the best solution for you.

Tracking Home Improvements

Posted On August 6, 2017 By Scott Stratton, CFP(R), CFA In Financial Planning /

When you eventually sell your home, it may be helpful to have a record of your home improvement expenses. Because people often own their homes for decades, this is an area where a lot of records and receipts are lost. Here is what you need to know about tracking home improvements.

Primary Residence Exclusion

At the time of a home sale, the difference between your purchase price and your sale price is a taxable capital gain. Luckily for most people, there is a significant capital gains exclusion from the IRS: $250,000 (single) or $500,000 (married), for your primary residence. If your gain falls below this amount, you will not owe any taxes. In order to qualify, the property must have been your primary residence for at least two of the previous five years, and you must not have taken this exclusion for another property for two years.

If you make a capital improvement (described below), that expense increases your cost basis in the home. But because of the large exclusion ($250,000 or $500,000), many people don’t even bother to keep track of their home improvement expenses. That may be a mistake. Here are a number of scenarios which could be a problem:

If you get divorced or your spouse passes away, your exclusion will decrease from $500,000 to $250,000.
Should you move and make another property your primary residence for four years, you will lose the tax exclusion on the previous property.
If you own your property for the next 30 years, it is possible your capital gain ends up being higher than the $250/$500k limits. These amounts are not indexed for inflation.
Congress could reduce this tax break, although it would be very unpopular to do so. They are not likely to change the definition of cost basis and capital gains.

Capital Improvements

What constitutes a Capital Improvement which would increase your cost basis? In general, the improvement must be permanent (lasting more than one year), attached to the property (not removable or decorative), and add to the value, use, or function of the property. Maintenance and repairs are generally not capital improvements unless they prolong your home’s useful life. The IRS provides the following specific examples of expenses that are Capital Improvements:

Additions, such as a new bathroom, bedroom, deck, garage, porch, or patio.
Permanent outdoor improvements, including paved driveways, fences, retaining walls, landscaping, or a swimming pool.
Exterior features, such as new windows, doors, siding, or a roof.
Insulation for your attic, walls, floors, or plumbing.
Home systems, including heat/central air, wiring, sprinkler, or alarm systems.
Plumbing upgrades such as septic systems, hot water heaters, filtration systems, etc.
Interior improvements, including built-in appliances, flooring, carpet, kitchen remodeling, or a new fireplace.

While there are many expenses which count as improvements, repairs and upkeep do not. Painting, replacing broken fixtures, patching a roof, or fixing plumbing leaks are not improvements. Also, if you install something and later remove it, that expense may not be counted. For example, if you install new carpet and then later replace the carpet with wood floors, you cannot include the carpet expense in your cost basis.

Gain or Loss?

For full information on calculating your gain or loss on a home, see IRS Publication 523. While most homeowners are focused on mitigating taxable gains, I should add that if your capital improvements are significant enough to make your home sale into a loss, that loss would be a valuable tax benefit as it could offset other income. Here’s an example:

Purchase Price: $240,000
Capital Improvements: $37,400
Cost Basis: $277,400

Sale Price: $279,000
Minus 6% Realtor Commission: -$16,740
Closing Costs: -$1,250
Net Proceeds: $261,010

LOSS = $16,390

If you just looked at your purchase price and sales price, you might think that you would have a small gain (under the exclusion amount), and there was no need to keep track of your improvements. However, in this example, you don’t have any gain at all.

Unlike other receipts, which you only need to keep for seven years, you do need to keep records of your capital improvements for as long as you own the home, and then seven years after you file your tax return after the sale. Even if you think you are going to be under the $500,000 tax exclusion, I’d highly recommend you keep track of these capital improvements which increase your cost basis.

What Are Today’s Projected Returns?

Posted On June 18, 2017 By Scott Stratton, CFP(R), CFA In Financial Planning, Portfolio Management /

One of the reasons I selected the financial planning software we use, MoneyGuidePro, is because it offers the ability to make projections based on historical OR projected returns. Most programs only use historical returns in their calculations, which I think is a grave error today. Historical returns were outstanding, but I fear that portfolio returns going forward will be lower for several reasons, including:

Above-average equity valuations today. Lower dividend yields than in the past.
Slower growth of GDP, labor supply, inflation, and other measures of economic development.
Higher levels of government debt in developed economies will crowd out spending.
Very low interest rates on bonds and cash mean lower returns from those segments.

By using projected returns, we are considering these factors in our financial plans. While no one has a crystal ball to predict the future, we can at least use all available information to try to make a smarter estimate. The projected returns used by MoneyGuidePro were calculated by Harold Evensky, a highly respected financial planner and faculty member at Texas Tech University.

We are going to compare historical and projected returns by asset class and then look at what those differences mean for portfolio returns. Keep in mind that projected returns are still long-term estimates, and not a belief of what will happen in 2017 or any given year. Rather, projected returns are a calculation of average returns that we think might occur over a period of very many years.

Asset Class	Historical Returns	Projected Returns
Cash	4.84%	2.50%
Intermediate Bonds	7.25%	3.50%
Large Cap Value	10.12%	7.20%
Small Cap	12.58%	7.70%
International	9.27%	8.00%
Emerging Markets	8.85%	9.30%

You will notice that most of the expected returns are much lower than historical, with the sole exception of Emerging Markets. For cash and bonds, the projected returns are about half of what was achieved since 1970, and even that reduced cash return of 2.50% is not possible as of 2017.

In order to estimate portfolio returns, we want two other pieces of data: the standard deviation of each asset class (its volatility) and the correlation between each asset class. In those areas, we are seeing that the trend of recent decades has been worse for portfolio construction: volatility is projected to be higher and assets are more correlated. It used to be that International Stocks behaved differently that US Stocks, but in today’s global economy, that difference is shrinking.

This means that our projected portfolios not only have lower returns, but also higher volatility, and that diversification is less beneficial as a defense than it used to be. Let’s consider the historical returns and risks of two portfolios, a Balanced Allocation (54% equities, 46% fixed income), and a Total Return Allocation (72% equities, 28% fixed income)

Portfolio	Historical Return	Standard Deviation	Projected Return	Standard Deviation
Balanced	8.53%	9.34%	5.46%	10.59%
Total Return	9.18%	12.20%	6.27%	14.23%

That’s pretty sobering. If you are planning for a 30-year retirement under the assumption that you will achieve historical returns, but only obtain these projected returns, it is certainly going to have a big impact on your ability to meet your retirement withdrawal needs. This calculation is something we don’t want to get wrong and figure out 10 years into retirement that we have been spending too much and are now projected to run out of money.

As an investor, what can you do in light of lower projected returns? Here are five thoughts:

Use projected returns rather than historical if you want to be conservative in your retirement planning.
Emerging Markets are cheap today and are projected to have the highest total returns going forward. We feel strongly that they belong in a diversified portfolio.
We can invest in bonds for stability, but bonds will not provide the level of return going forward that they achieved in recent decades. It is very unrealistic to assume historical returns for bond holdings today!
Investors focused on long-term growth may want more equities than they needed in the past.
Although projected returns are lower than historical, there may be one bright spot. Inflation is also quite low today. So, achieving a 6% return while inflation is 2% is roughly comparable in preserving your purchasing power as getting an 8% return under 4% inflation. Inflation adjusted returns are called Real Returns, and may not be as dire as the projected returns suggest.

Robots and The Future of Work

Posted On April 3, 2017 By Scott Stratton, CFP(R), CFA In Financial Planning /

Technology will change work in ways we can only begin to imagine. Self-driving cars and trucks, for example, could eliminate 4 million transportation jobs in the next 10 or 20 years in the US alone. But it’s not just blue collar jobs which will be replaced. In medicine, we will increasingly see hospitals turning to artificial intelligence for diagnoses and incredibly precise robots for surgical procedures. It’s not that we won’t have human doctors, just that many of the tasks that they currently spend hours on every week could be done by computers with better accuracy, more consistency, and lower cost.

In finance, Blackrock, one of the world’s largest asset managers, announced last week they would be reducing the number of actively managed funds they offer, to focus more on quantitative investing using computer models. Rather than using human research and analysis, they are finding that computers may be better stock pickers, especially after costs are considered.

Jobs in manufacturing today are more likely lost to automation than to outsourcing to another country with a lower cost of labor. In almost every industry, fewer workers will be needed, and eventually we will even have robots designing, building, and repairing other robots.

With human workers being replaced by robots, Bill Gates has proposed taxing robots for the economic value of their productivity, rather than taxing humans based on their income. (Gates’ comments appeared in the Wall Street Journal, Forbes, and elsewhere this month.) This would help address the loss of tax revenue as companies employ fewer humans to create the same or higher economic output.

A frequently discussed use of a “robot tax” would be to create a universal living wage for all people, to help offset the loss of income from automation. It’s a novel idea.

It will be interesting to see what jobs will look like 25 and 50 years from now. Change is inevitable. Just as Henry Ford made horse drawn buggies obsolete, today’s technologies will inevitably cause some industries to go away. Instead of trying to save jobs in manufacturing, trucking, or coal mining, we might be smarter to not stand in the path of progress, and focus on being a leader in technology, automation, and clean energy.

Those are challenges for countries. I see two distinct challenges for individuals:

1) Are you in a profession which could be replaced by automation or new technology? If so, can you adapt while maintaining or improving your current income? Can you keep from becoming obsolete in a rapidly changing economy? Smart workers will manage their careers and proactively change jobs before it is forced upon them.

2) Your financial security will depend on your savings. Social Security is projected to be bankrupt by 2034 (when I turn 62, just my luck…), and many municipal and corporate pensions are significantly underfunded. It’s easy to bemoan that we deserve what was promised to us, but that doesn’t change the math: people are living longer, the ratio of workers to retirees has fallen dramatically, and the money simply isn’t there. What seemed feasible in 1950 or 1980 we know doesn’t work with 2017’s demographics.

There is no easy fix to just keep these programs as they are today without enormous tax increases. There will be cuts to retirement programs, whether that occurs through increasing the retirement age, reducing benefits, etc. I believe they will continue to exist, just perhaps not in their current form. People who will derive the bulk of their retirement income from Social Security are at the greatest risk of poverty.

It may seem depressing to think about how the future may displace workers, but technological progress is going to be net positive for society. We will reduce mundane and dangerous jobs, lower costs of goods and services, and increase our total wealth and consumption. And people who say that we don’t make anything anymore aren’t considering the impact and future benefits that are going to come from US leaders like Apple, Tesla, Google, and hundreds of other medical, software, and energy innovations. Work will change – for the better.

How to Help Your Millennial Children With Money

Posted On March 27, 2017 By Scott Stratton, CFP(R), CFA In Financial Planning /

Your kids are recently out of college and starting to make their way in the world. They have a mountain of student loans, an underpaying job, and are just making ends meet. How can you help them become prosperous? Should you help them financially?

Today’s recent grads face a tougher job market and a longer career path than previous generations. The cost of a college education has become staggering. Long gone are the times when you could put yourself through college by working a summer job or waiting tables on the weekends. Those jobs aren’t going to cover the $50,000 tuition bills at a private university today. Even students who work through college can finish with $40,000, $60,000, $80,000 or more in debt.

I’ve also seen parents go too far and give their children million dollar homes, creating unreasonable expectations and a total lack of drive and ambition. Why work if you’re just going to be given whatever you need? Parents risk having adult children who don’t value money and have no interest in developing their own financial success.

There are, I think, a number of creative ways to help your children financially without simply writing them a blank check. Parents want to prevent their children from falling on their faces, but we have to remember that challenges often teach us the most important lessons. Children often copy their parents’ money habits, and not talking about money isn’t going to help your kids become responsible adults. Here are ways to help.

1) Rent to Roth. If your kids are going to move back home after college, consider charging a nominal amount for rent, based on what they can afford. If that’s only $200 or $300 a month, fine. Then, take that money and put it into a Roth IRA in their name. Give them the account after they move out.

There is an enormous benefit to starting early for retirement saving. If they save $3,600 at age 23 and 24 ($300 a month), and earn 8%, they’d have over $175,000 at age 65 just from those two years! But they have to not touch this money – to leave it invested and not spend it on student loans, or a car, or a house, or a wedding. It’s got to be off limits!

2) Give them this book. It is a gem. It’s short and they could read it in one afternoon. If they read it, they will know more about money than 99% of their peers. (And if they don’t read it, you’re only out $12.)

3) Mom and Dad’s Matching Program. Rather than making an outright gift of cash and hoping they use those funds wisely, offer to match their funds for goals like student loans, buying a used car, or funding an investment account like a 401(k) or IRA. This at least requires that they also contribute towards their financial goals rather than making everything a free-bee. Support financial needs which will make them more self-sufficient, rather than inadvertently making them more dependent on their parents for living expenses. Ask if this support is empowering or enabling?

4) Sign them up for my Wealth Builder Program, which is specifically designed for their needs. I will work one on one with them on their financial goals, including loan repayment, risk management, savings strategies, and investing. They get advice from their own fiduciary, which they may accept more readily than advice from a parent! Your cost is $200 a month. Alternatively, if you’re working with another financial advisor, ask if they will include your adult children as part of your household, but meet with them separately.

5) Encourage Entrepreneurship. Working families think that an education is the key to financial success. And to some extent, it is. But wealthy families know that owning a business is the real path to financial independence. Consider how you can encourage, support, and invest in your children starting a business.

Just remember before sinking your whole nest egg into their yoga studio (or whatever) that 80% of new businesses disappear in less than 5 years. If you are going to commit money to an idea, then it should be a sensible investment – either equity in the business or a loan with specific terms – and not a gift. It must be in line with your own investment strategies and not represent a substantial change to your risk profile.

An estimated two-thirds of parents are financially supporting their children over the age of 21. While this may be a new reality, it is also wreaking havoc with many parents’ finances and their ability to save for retirement. In some cases, we also need to be candid about what the parents can or cannot afford and what these sacrifices may mean for the parents’ finances. This is where a financial planner can provide an independent, objective point of view to make sure that your generosity is not going to jeopardize your own goals or become a permanent need for support.

The Rate of Return of Life Insurance

Posted On March 19, 2017 By Scott Stratton, CFP(R), CFA In Financial Planning /

Life insurance is a necessity for many families to protect them from the unexpected potential loss of income that could occur with a loss of life. For young families, term insurance is an excellent vehicle to address this risk.

As we get older, we hopefully have generated some wealth and we will have fewer future expenses. At some point, your kids will be out of college, you may have paid off your house, and accumulated a nice size retirement account. Each year, your need for life insurance is reduced, and eventually, you may be able to self-insure the risk of an unexpected death.

Still, I know that many pre-retirees like the idea of having a permanent life insurance policy to leave money for their spouse, heirs, or charity. Unlike a Term policy, “permanent” life insurance may provide a specified death benefit for as long as you keep the policy in force. Obviously, a permanent policy is much more expensive than term insurance. But is it a good rate of return?

It depends on how long you live! The longer you live, the more premiums you pay, and the longer your heirs have to wait to receive a fixed payout. Therefore the return is lower. Here’s an example.

For a 60 year old male in good health, you might pay $8,000 a year for a $500,000 policy. Even if you live for another 25 years, that means your heirs would receive $500,000 and you only paid $200,000 in premiums. That must be a good return, right? Let’s take a look:

$500,000 future payout, cost is $8,000 a year.
Rate of Return

10 Years	32.1%
15 Years	16.5%
20 Years	9.9%
25 Years	6.5%
30 Years	4.4%

I would say the return is excellent if you live for 20 years or less. If you live for 30 years or more, you may have more total wealth if instead of purchasing insurance, you had simply kept your $8,000 a year invested. Historically, it has not been very difficult to beat 4.4% over 30 years. So as a long-term investment, I don’t like life insurance. Which brings us back to the primary purpose of life insurance in my mind: to protect against the danger of pre-mature death.

To be fair, the rate of return on insurance is generous because so many policies lapse. When that happens, insurers will have received years of premiums and never have to pay out a death benefit. Other policy holders will borrow from their policies, causing them to deplete and never payout. I believe the majority of people who start a permanent policy will never receive a death benefit because of their own choices.

I should add that getting the best price on a life insurance policy is no easy task. Underwriting for a permanent policy will be rigorous, looking at your health, weight, blood tests, family and occupational history and more. Now, if your premium was higher than $8,000 a year for this hypothetical policy, the rates of return above would obviously be much lower.

My recommendation for most people: get term to cover you until your kids are out of college. For many people, that will be the only life insurance policy they will ever need. There are some good uses for permanent insurance, such as for business succession or estate planning. But it’s not the vehicle financial planners prefer for long-term wealth accumulation.

How to Give Away Money

Posted On March 5, 2017 By Scott Stratton, CFP(R), CFA In Financial Planning /

It shouldn’t be difficult to give money away, but there are many ways we can help improve outcomes for families who have more than enough assets to last a lifetime. While estate planning is important, let’s make your money go further and have a greater impact by creating a giving plan for while you are alive.

If you are philanthropically inclined, have a favorite charity, or just want your children or grandchildren to benefit from your blessings, we can help you plan how to best distribute your money, minimize taxes, and safeguard your future. Here are seven tips to get started.

1) Put yourself first. It should go without saying that you should not give away a significant amount of your wealth if there is any question as to whether you have sufficient funds to last a lifetime. With increasing longevity and rising costs of healthcare, it is not difficult to burn through a million or two over a 25-year retirement.

We begin with a retirement analysis that includes your philanthropic goals, and evaluates the likelihood your funds will cover your lifetime. The more guaranteed sources of income you have – Social Security, Pensions, Annuities, etc. – the more we can distribute other capital without worries of loss of income. The purchase of an Annuity can give you the confidence to disburse cash during your lifetime without fear of market risk, sequence of returns, or longevity.

We generally do not recommend that retirees aim to impoverish themselves to qualify for Medicaid. States have a 60-month look-back period that determines if you have given away money. In some cases, Medicaid planning may make sense, but we prefer to plan for abundance.

2) Understand the Gift Tax Annual Exclusion. Each year, you can give $14,000 (2017) to any person under the gift tax exclusion. This is well known, but most people don’t understand that you do not necessarily have to pay a tax if you exceed this amount; rather you are required to file a gift tax return, and your gift (over $14,000) reduces your lifetime gift and estate tax exemption, currently $5.49 million per individual.

Although most estates will not exceed these levels, we do know that there are many politicians in Washington who want to lower the estate exemption. So it’s difficult to predict what the exemption will be in 10 or 20 years. The easiest approach is to stay under the $14,000 annual exclusion. Remember that a couple may, combined, give $28,000 to an individual or $56,000 to another couple, such as a daughter and son-in-law.

Additionally, there are medical and educational exceptions to the gift tax. You can pay college tuition or medical bills for anyone, and those amounts are not subject to a gift tax. The best approach is to pay those bills directly to the providers, and not write a check to the recipient, to avoid any implication of a gift.

3) Give now, rather than leave everything in your will. By making donations and gifts today, you can:

receive a tax deduction for charitable giving. If you’re in the 28% tax bracket, giving $10,000 a year now could save you $2,800 on your taxes.
see your gifts make a difference for your family, causes, and institutions immediately. Your gifts may be more helpful to your children today rather than when they are 55 or 65.
discover how those monies will be spent, and learn who will be responsible with a large sum of money. Leaving a large inheritance through a will sometimes backfires, causing reckless spending. Starting a gifting program early may identify these issues and provide planning and education, or identify the need for trustees who can help ensure money is used prudently.
avoid the fights, misunderstandings, and vastly expensive lawsuits that so frequently occur with large estates. Don’t cause future problems for your spouse or children by leaving them a mess or a distribution that creates anger and divisions. This is so common and yet most parents think it will never happen to their family.

4) Give appreciated securities to charity rather than cash. You can donate shares of stock, mutual funds, or other assets to charity and avoid paying capital gains tax on the gains on those investments. Besides avoiding capital gains, you also get to deduct the full value as a charitable donation, as eligible. The charity will sell the donated securities immediately, but not owe any taxes to Uncle Sam. It’s a great way to be more efficient in your charitable giving. It saves you taxes, which ultimately means you will have more money to donate and do good.

5) Leave money to charity through your IRA rather than through your will. If you leave a $500,000 IRA to an individual, they will owe income taxes on any distribution, which could eat up $200,000 of the account, or more, if you have state income taxes. If you leave the same IRA to a charity, they will pay no taxes on the account, and would receive the full $500,000 immediately.

Instead, leave a taxable brokerage account to your children; they will receive a step-up in cost basis on those investments and therefore will likely have little or no capital gains on the sale of those assets. Your kids will be so much better off receiving taxable assets rather than the same number of dollars from your IRA.

Change your mind? If you write a charity into your will, and later want to change the amount or name a different charity, you will have to get a whole new will. But if you use your IRA for your charitable bequests, all you have to do is update the IRA beneficiary form, which is quick and free.

6) 529 plan for Grandchildren. Want to help your grandchildren be successful in life, pursue their career goals, and not be saddled with crippling student loans? Consider 529 college savings plans, which will get assets out of your taxable estate and enable tax-free withdrawals for qualified higher educational expenses.

If one beneficiary does not need the account, you can change the beneficiary to another person. You can retain control of this money, while creating a legacy for the future success of your grandchildren, great-grandchildren, or beyond.

Given a choice of having money in a taxable account or a tax-free account, you’d probably prefer the tax-free option, so I am baffled why more wealthy grandparents are not using 529 plans. The younger your grandchildren are, the longer time you will receive tax-free growth. Start early.

7) Insurance. Retirees can protect their ability to fund their giving goals by purchasing long-term care insurance. This can help ensure they do not deplete their assets or have to choose between adequate care and fulfilling their other financial goals.

If you intend to leave $1 million to your alma mater, church, or other organization, it may make sense to purchase a permanent life insurance policy specifically for that goal. Then you can preserve your other assets for your spouse or children while guaranteeing your gift to that institution. Or you could do the reverse – give money annually to charity and leave life insurance to your children or a trust. Individuals receive life insurance proceeds tax-free.

We’ve only just scratched the surface of what is possible to enable you to most efficiently disburse your money and assets. There are a lot of pitfalls that could be avoided with rigorous planning. Many of these strategies will benefit you over a long period of time, which means you’d be smarter to start these at age 58 rather than 78. Don’t procrastinate! Living the Good Life means that abundance finds joy in seeing the benefits our giving can have on the world.

Is Your Pension Insured?

Posted On February 19, 2017 By Scott Stratton, CFP(R), CFA In Financial Planning /

Pensions offer what may be the ideal source of retirement income. If you are fortunate enough to be vested into a Pension Plan, consider yourself lucky. You should ask, though, What would happen to your pension if the plan were to terminate or fail?

If you are a participant in a private sector pension, check if your plan is covered by the Pension Benefit Guaranty Corporation here. The PBGC is a federal agency that was chartered to protect pension plan participants; it’s funded through required employer contributions and receives no tax dollars.

Even if your pension is insured, there are limits on the amount of coverage available through the PBGC. If a plan terminates and you are vested, but not yet retired and receiving benefits, you would be covered only for your currently vested benefits and would not receive any further credit for future work.

This is important: you need to understand whether your Pension Estimate is based on past contributions, or an estimate based on the assumption you are going to work to age 65 or other future date. The PBGC will only cover vested benefits and a plan termination will halt the accrual of future benefits.

If you are retired and already receiving benefits, the PBGC has limits on the monthly benefit they cover. If a plan terminates and is taken over by the PBGC, you could see your monthly benefit drop by a significant amount.

The limit of benefits available through the PBGC depends on four things:

Whether your plan was a single-employer plan or a mutliemployer plan.
Your age at retirement.
The number of years you were a participant in the plan.
Whether your benefit is a single-life annuity or a joint and survivor benefit.

For single-employer plans, the limit of the PBGC coverage is capped based on your age and the year the plan was terminated. For example, if you are 65 years old and your plan were to terminate in 2017, your PBGC benefit would be capped to $5,369.32 a month for a single-life benefit or $4,832.39 for a Joint and 50% Survivor Annuity. Link: PBGC Monthly Maximum Tables.

The PBGC benefits for single-employer plans are generally quite strong. However, if your pension benefit is above the monthly guaranty amount, and the plan were to fail, your benefit would be reduced to the PBGC maximum.

This can happen! Years ago, I met an airline pilot who retired at the mandatory age of 60 and started his six-figure pension thinking he was set for life. After 9/11, his former employer went bankrupt and his pension was slashed to around $3,000 a month. They hadn’t saved very well because they were planning on the generous pension. The reduction to his monthly pension check was devastating.

If your pension offers a lump-sum payout upon retirement, we can determine the limit of your PBGC coverage and investigate the funded status of your pension plan. If your plan is in critical status, or your company has a credit rating below investment grade, you will seriously want to consider the lump sum, if your payment exceeds the limits of PBGC coverage.

The PBGC coverage for multiemployer pension plans is unfortunately much, much lower than for single-employer plans. If you are a participant in a multiemployer plan, your maximum coverage under the PBGC is based on the number of years of service. This is regardless of how your plan may calculate benefits.

PBGC formula for multiemployer plans:
100% of the first $11 of monthly benefits,
Plus 75% of the next $33 of monthly benefits,
Times the number of years of service.

The maximum monthly benefit under the PBGC then is $35.75 times the number of credited years of service. For example, if you were a participant for 30 years, your maximum benefit would be $1072.50 a month, or $12,870 a year. And in order to get $35.75 from the PBGC, you’d have to be receiving at least $44 from the pension. In other words, to get the PBGC benefit of $12,870 a year, your pension benefit amount would need to be at least $15,840.

The amounts for Multiemployer plans are not indexed for inflation and do not receive Cost of Living Adjustments. Link: Multiemployer Benefit Guarantees.

The PBGC only covers private sector pension plans. Participants in a federal, state, or municipal government plan do not have any separate insurance or guaranty. And there are significant problems with funding in municipal pension plans. Here in Dallas, there is a billion dollar short-fall in the Police and Fire pension plan. Recent problems have prompted a stampede for the exits, as members retire early so they can take a lump sum payment. All of which is further driving the plan over the edge.

There are lots of municipal pension plans that are ticking time-bombs. It’s not clear to me that the public has the willingness to accept increased taxes so we can cover generous employee retirement plans. It seems inevitable that there will be some plans which will be forced to reduce the benefits they have promised.

All of which means that investors need to have multiple legs on their retirement plan: pension, Social Security, investment accounts including IRAs, and other sources of income. If you try to have a plan that rests entirely on one leg, you are potentially asking for trouble.

Gifts, Rights, and Duties

Posted On January 23, 2017 By Scott Stratton, CFP(R), CFA In Financial Planning /

What does Good Life Wealth Management stand for? Financial Planning is both an Art and Science, and while we dutifully toil on numbers, it is all in service to loftier goals and ambitions. Investment strategy is the one of the outcomes of our Financial Planning process, but it is certainly not the most important part.

We want to begin with an understanding and appreciation of three things in your life: Gifts, Rights, and Duties. When these are clear in your mind, your relationship with money has purpose.

Gifts certainly include inherited wealth, but we should all recognize how fortunate we truly are to be alive in 2017. I live in a vibrant city in the fastest growing state in the most prosperous country in the world. I was blessed to be born in a good zip code and attend great schools with the support and love of a wonderful family.

I attended two private universities, institutions which did not just spring from the ground, but were gifts to the future from people who were incredibly generous, insightful, and industrious. And some 175 years later, many thousands have benefited from those university founders.

Today, we have the gift of modern medicine, technology, cars, and the internet. And our wealth is invariably derived from all these gifts. It may still take a lot of our own blood, sweat, and tears, but no one in America is 100 percent self-made.

Rights include our constitutional protections of life, liberty, and private property. The ability to achieve financial freedom is an impossible dream – still – in many parts of the world. And while it is easy for me as a white male to take these rights for granted, for many other Americans, those rights did not exist in the not so distant past.

Duty is a recognition of our moral obligations. We have a duty to protect and provide for our spouse, children, and family. We have a duty to our self to plan for retirement and a secure future. We have a duty, I think, to leave the world a better place, and to help the next generation, just as our predecessors built schools and industries and fought for the rights which we enjoy today.

My vision of financial planning does not begin with choosing the “right” mutual fund or ETF. It is rather a holistic strategy to create a roadmap to your goals, as determined by your Gifts, Rights, and Duties.

– If we are to value our money, we must begin with the humility to recognize that most of our success is a gift. We won the life lottery and that 90% of who we are was luck and 10% was through our efforts. (Even intelligence, good health, and a strong work ethic are gifts, not something we earned!)

– We should not take our rights for granted. While there are fundamental rights, financial planning is to make sure you navigate your other smaller rights, such as to tax deductions, a 401(k), a Roth IRA, or Estate Plan. We want to make sure our clients take advantage of the benefits which are available to them.

– Duty to others means that we can take care of ourselves first and foremost. But it also means that we have prepared for the unexpected. That’s why I am perplexed by young families who want my help with investments, but want to skip over estate planning, college funding, or life insurance. That’s not fulfilling your duty as a parent and spouse.

There are two types of happiness: pleasure and fulfillment. Pleasure is easy: it is going to the beach and doing nothing, enjoying a glass of wine, or celebrating with friends. It is basically hedonistic. While we all need to rest and recharge from time to time, many retirees become bored after three months of golfing every day. Pleasure is not the highest form of satisfaction.

Fulfillment is having a purpose and making a difference. In Maslov’s hierarchy of needs, the highest need is achieving self-actualization, or realizing your full potential. The Good Life, is not about seeking pleasure, but finding fulfillment and purpose. While our financial planning software can crunch the numbers, our conversations are really about How do we use our gifts? What are our rights? How can we best fulfill our duty to others and make a difference? If that is the starting point for our relationship with money, we can have a more meaningful perspective on our goals, values, and impact on the world.