Author Archives: Edi

Death and sepulcher – facing the inevitable

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Benjamin Franklin famously wrote, “in this world nothing can be said to be certain, except death and taxes.” In all the years that I’ve worked with clients to create a financial path for their long-term wishes in life and after they are gone, I’ve covered a huge spectrum of topics. Until now, I’ve never asked clients about their “right of sepulcher” (the right of sepulcher means the right to choose and control the burial, cremation, or other final disposition of a deceased person). I recognize that, for some, this topic may seem a tad morbid. The cautionary tales of contentious and messy celebrity funerals that follow (suggested by Amy F. Altman, an associate at Meltzer, Lippe, Goldstein and Breitstone) may provide you with some perspective and may help you consider how you and your loved ones feel about your right of sepulcher.

  • Litigation surrounding the 2007 death of actor, model and TV personality Anna Nicole Smith made headline news for weeks as her mother and the guardian of her infant daughter battled for the right of sepulcher. Ultimately, the daughter’s guardian prevailed and Anna was buried in the Bahamas next to her late (and recently deceased) son.
  • Boston Red Sox Hall of Famer Ted Williams’ death in 2002 resulted in a spectacular rift between his children over the disposition of his remains. His eldest daughter argued that Williams’ will clearly stipulated cremation, BUT his son had been given power of attorney and his father’s health proxy and he wanted his father cryogenically preserved. Eventually, the son won out, largely because the daughter could not afford the cost of litigation.
  • Legendary actor Mickey Rooney died in 2014. His estranged wife wanted him buried in a shared plot purchased before they had separated. Rooney’s conservator (court appointed guardian) had other ideas and a costly tug-of-war ensued. In the end, his wife capitulated, recognizing that burial in a Hollywood cemetery befitting Rooney’s status was appropriate.

These cases, regardless of age, underscore the importance and value of discussing with loved ones your preferences for disposition. The laws regarding rights of sepulcher vary widely by state. If permitted under state law, completing a “disposition of remains form” together with advanced directives seems an appropriate start. This will create clarity with respect to the sensitive issues surrounding burial.

As with all legal documents you need to first understand what it is that you really want, which can take a long time to fully grasp and may require delicate discussions with loved ones and personal introspection. Leaving aside what I consider the more important question regarding life support for now, you can first deal with the question, do you want to be cremated, or perhaps cryogenically preserved? Do you want to be an organ donor? Would you like your funeral to take place at home or at a funeral parlor? Do you want a formal service or commemorative event? Though you’ll be gone, these are all options that may well prove to be important (and costly if mishandled) to those you leave behind.

At times, I think that there is so much to do while we are alive that taking time to consider what will happen after we’re gone seems inconsequential and entirely unimportant, but this may not be the case for loved ones. Let me offer an example.

Recently, a client shared that over the course of a dinner conversation with his parents they casually revealed their preference to be cremated. This came as an enormous shock. “Never in a million years,” he said, “would I have predicted that this was my parents actual wish.” This is a man who has made every effort to ensure he is in touch with the real wishes of his aging parents. “I would have got it wrong,” he said, adding “a split second’s worth of conversation set me straight.” He felt like a huge weight was lifted from his shoulders.

The person to whom you give the right of sepulcher may gain much by having even a short conversation about your wishes, regardless of your age.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Your Credit History – wealth and identity

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Our recorded credit history is tracked by the three national credit bureaus (Equifax, TransUnion, and Experian) and each calculates a credit score. Though the credit score is a required component for loans it is NOT based on our entire financial history and it may not represent us correctly. It is up to us to ensure that it does. Why is this important? For your wealth and your identity.

Each credit bureau uses an algorithm (model) to generate a number (FICO score) based on your recorded credit history that is, imperfectly, a measure of the risk the system associates to someone with your recorded history. Lenders who depend on credit bureau reports for assessing whether or not to lend, use this score as one measure of your “credit worthiness”. Those with no financial history or less than sterling repayment records are likely to face higher cost loans IF they are able to obtain a loan at all. It is true that loans are available for those with lower credit scores but additional requirements will be imposed, including a low debt-to-income ratio. Even then, the loan will be at a higher rate.

Couples can sometimes be surprised when one partner lowers the expected family credit score. These couples may be effectively managing their financial life and yet obtain a low combined credit score that will raise their cost of borrowing. In most cases, the partner with the higher credit score applies for the loan singly to obtain the best rates (‘excellent’ rates are generally available with a FICO of 780 or higher), while the other partner must rebuild their history.

As time goes on, more and more of our interactions are managed electronically. Hand-in-glove with electronic transactions come ways for us to be identified and verified electronically. It is now more common for our financial identity to be confirmed by using facts found in one of our three credit bureau history records. It is crucial that you know and can recognize all information in each of these reports.

Once you have checked your history thoroughly, you’ll find an annual check-up to be quick and sufficient. Obtaining your credit history and checking it for errors can be completed on your own or with our assistance. If you need to make corrections, let us know or contact the specific credit bureau directly.

Finally, when you are getting ready to take out a loan for a large purchase be sure to first check your credit history (more than three months ahead) – you don’t want surprises.

So how might you be able to improve or maintain your credit score? Here are a few essentials to keep in mind:

  • don’t miss payment due dates – set up automatic minimum payments even if you pay your accounts in full (this will protect against the unexpected)
  • monitor your cash flow – don’t over extend yourself – try not to use more than 30% (better at less than 10%) of available credit (credit used compared to total credit available is called the ‘utilization rate’)
  • don’t apply for a lot of credit from different sources all at once – it can set off major alarm bells and may impede new financial loans for several months
  • if consolidation is indicated, try to keep your total credit the same and never close your oldest credit card
  • installment loans (i.e. car, mortgage) can have a positive impact on your score – be sure your lender actually reports to at least one bureau (some don’t)
  • your credit history can include a lot more than just a car loan or credit card – utility, cable, rent, and cell phone payment history can all be tracked and used either to boost the score or knock it down
  • if retirement is on the horizon, make extra effort while you are still earning to maximize all aspects of your credit history and bolster your credit score
  • if retired, disabled or unemployed restrain your credit card purchases and instead find ways to reduce expenses – it is more difficult to recover from credit card debt when income is limited
  • verify your credit history on a regular basis and correct errors promptly

Credit history is not a statement about you personally but a less than perfect measure to determine ‘credit worthiness’. It is best to capitalize on the rules to obtain the best score possible. Moreover, since credit history is now used to verify identity, it is incumbent on us to ensure the records have captured our information accurately.

Feel free to give us a call if you need help with the process.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

A business owner quandary: cash or accrual?

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Financial statements are one of the most powerful and least utilized business tools. Small business owners need to master financial statements if they hope to work not just in their business, but on their business. And yet, I see all too often just how little time business owners spend exploring them. In my experience the bookkeeping burden doesn’t excite us into spending time on financials beyond tax preparation. In this discussion, basic features of cash and accrual financial accounting are presented with the goal of demystifying them and providing an opportunity for exploration.

One of the first decisions when starting a business is to determine the most appropriate accounting method for the business and for tax filings (the two most common are cash and accrual).

The cash method accounts for revenue when the money is received and for expenses when the money is paid out. It is useful for tracking monthly cash flow since it works just like a checkbook and the balance sheet appears like a checkbook register. Unfortunately, it can convey the wrong message regarding the long-term well-being of a company.

The accrual method of accounting provides a better picture of company profits during an accounting period by recording revenues when they are earned and expenses when incurred but it is not intuitive since the financials do not represent day-to-day accounts. Accrual accounting instead provides a view on long-term financial well-being.

So, what does the IRS require?

The IRS in 2001 relaxed prior requirements that forced many small businesses to use accrual accounting. To reduce the accounting burden on small businesses the current rules allow firms with under $5M in revenue to use cash basis accounting, unless they are an inventory based business.

For tax purposes, the accounting method is locked-in with the first business tax filing. After the initial year, a business uses the same accounting method unless it receives prior approval from the IRS.

It has been my experience that cash and accrual accounting are often misunderstood. It is important that small business owners address with their accountant, bookkeeper, and tax preparer how these two accounting methods will be implemented. The key is to be consistent in applying the rules.

What are some of the problems that may surprise you?

To cite an unusual example, a client sent you a check (on December 30, 2016) for interior decorating services you provided to her and you received the check on January 2, 2017.  Small businesses using cash accounting might be surprised that the IRS expects you to apply this check as income received in 2016. Strictly speaking, the rules require you to observe ‘constructive receipt’. Meaning, the money is available to you and under your control, whether or not you have taken actual possession of it. The fact that you haven’t deposited the check is strictly speaking a moot point as far as the IRS is concerned. Adhering to this ideal is a burden on small businesses. It’s our observation that accountants for small businesses operating on a cash basis consequently define constructive receipt as earnings and expenses in the register by December 31.

Constructive receipt argues against some commonly employed practices, such as delaying the deposit of income or the acceleration of expenses for the sole purpose of avoiding taxes. On the other hand, delaying invoicing does seem to be a more acceptable practice. It is generally more common for cash basis businesses to delay invoicing rather than delay cashing a check received so as not to run “afoul” of the constructive receipt rule.

To be clear, there is a large difference between the unintended receipt of a delayed payment (typically due to a tardy customer payment or a receivable that is in the mail) and deliberate manipulation. Here’s an example of a practice that is clearly not allowed. A small business owner is entitled to receive $20,000 on a contract completed in 2016. The owner contacts the client requesting that the payment not be made until January 2017. That’s not acceptable per published IRS rules.

On the other hand, IRS rules can sometimes be too onerous for a small business. For example, if you pay $2,000 in 2016 for an insurance policy effective for one year beginning July 1, you should deduct $1,000 in 2016 and $1,000 in 2017. It is my experience that this is seldom the practice for small business owners who without intending to avoid payment of tax, will register payment in the year paid without an evaluation of when the benefit will be derived.

Though few use the accrual method of accounting, its purpose is to match income and expenses in the same year. It is therefore critical to choose the year well – when there is any doubt on which year to choose, the decision is made on when ‘economic benefit’ was attained. This can be burdensome to small business owners since the assessment of ‘economic benefit’ is sometimes quite difficult to ascertain.

Under an accrual method, you generally include an amount in your gross income for the tax year in which all events that fix your right to receive the income have occurred and you can determine the amount with reasonable accuracy. As an example, you sold a computer on December 28, 2016 and billed the customer the first week of January 2017, but did not receive payment until February 2017. Using the accrual method, you must include the amount received for the computer with your 2016 income because ‘economic benefit’ was obtained when the computer was sold. Obviously, tracking and attribution requires a lot more work on the part of the small business owner using the accrual accounting method.

As part of learning to work on your business, not just in your business, it is important that you first develop confidence that your financial statements (Profit & Loss, Balance Sheet, and Cash Flow statements) accurately represent your financial activity. It can take time to develop a reliable and consistent system. Once you have confidence in your financial statements you should address deriving more from them than just how to handle business tax liability.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

 

Understanding Longevity Risk and Your Retirement

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The oldest person alive today is Emma Morano of Vercelli, Italy who turned 117 this November. She was born in 1899! Queen Victoria was still on the throne of England and William McKinley was president of the United States. If you’d asked Emma in 1917 if she could imagine living long enough to see 2017, would she have imagined such a long life? Most Americans do not live as long as Emma, but in general we are living longer and healthier lives. The number of centenarians is on the rise. Longevity – long life – can have obvious perks, but also poses a conundrum in terms of finances. To help us plan for longevity we use “longevity risk” to measure the likelihood that you’ll run out of wealth before you’ll run out of life. In our planning we like to ensure that we mindfully set longevity at the right level for each person.

Few, if any of us, have advance knowledge of precisely when our time will come, so questions like this often boil down to statistics. You’ll sometimes hear that the average life expectancy for females is age 83 and age 81 for males, BUT are these appropriate target-end dates for your retirement plan? The truly important challenge is coming up with the best end-dates for retirement that will allow you to enjoy your wealth early while leaving enough assets to comfortably support you later in life.

In retirement planning, the variation in life expectancy can range quite dramatically and yet we find that client expectations generally fall into two categories, (1) those who want to make absolutely sure they don’t outlive their wealth, and (2) those who have a definite expiration date in mind, say 80 years of age, and believe that planning for life beyond that age is simply not relevant or realistic. The latter are often operating on some assumption based on, for example, both parents dying in their late 70s or not long after retirement.

At the risk of sounding morbid, but with the goal of having your retirement plan more fully represent your expected end of life target date, I want you to consider three facts that most often cause people to underestimate their longevity (in turn, this may help you understand why we sometimes encourage you to increase your target-end date):

Life expectancies that are often quoted may not be relevant since they are often calculated at birth. Life expectancy on reaching age 60 or 65 should be much higher than those quoted at birth since some will die before they reach this age. In fact, life expectancy for a 65-year-old, non-smoker is much higher. As an example, a 65-year-old female of average health has a 50% chance of reaching age 88 (see the table below) but once she reaches age 88 she has a much higher chance of reaching age 95.

longetvity_table

  1. Life expectancy is often calculated using mortality rates from a fixed year instead of projected to future expected mortality rates. Social Security Administration (SSA)’s period life tables are based on real mortalities in any given year. Though valuable, since they are real, they underestimate the observed trend for increased survival. As mentioned above, we perceive our survival based on our own anecdotal experiences. The question to ask ourselves, is this correct or is this an underestimation?
  2. Finally, we find that the population on which longevity risk calculations are based may not be appropriate. If we work with an aggregate US population life expectancy (as does the SSA period life tables) we must include a correction for socioeconomic and other factors that are known to impact mortality rates and could underestimate our lifespans. To-date there is evidence to indicate a positive link between income, education, long-term planning, and health. Yes, someone who plans and prepares appears (statistically) to live longer.

In case it is still not clear – let me explain. When planning retirement projections, the length of retirement greatly impacts planning choices (planning for 20 versus 45 years may require different strategies given the same wealth). Considering your specific longevity risk necessitates that we prepare for the contingencies that apply to you. There may be good reasons to target a lower longevity, but for most we will likely need to include, at the very least, a reasonable adjustment for expected increased longevity. This often means distribution of existing assets and thinking about end-of-life questions (a topic most prefer not to address too closely). If you are expecting a longer life, consider accumulating a pool of longevity assets (like some are doing to cover for potential Long-Term Care contingency) or purchasing a longevity annuity (this asset would only be used if you live past a certain age and, therefore, accumulate what are called mortality credits that can provide a good income late in life, but would be lost if you wind up passing sooner).

Obviously, estimations are just that, estimations. Still, a thoughtful scientific approach ought to be the foundation for retirement projections, never speculation or conjecture. Like Emma, some of us will be blessed with a long life, even inadvertently. One way or the other, I want all of us to feel that we’ve had a life well spent, and that will depend largely on how well we’ve planned for possible contingencies in your life.

This educational piece was drawn from my work with clients, www.longevityillustrator.org, the Social Security Administration period life tables, and a recent academic publication by Wade D. Pfau, Ph.D., published in The Journal of Financial Planning, November 2016, vol 29, issue 11, pp 40.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

2016 Presidential Election and the Markets

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No matter the results, this is certainly turning out to be an “interesting” election. One of the things I find intriguing, is the willingness of financial “experts” and pundits to make predictions about the economic and financial ramifications of electing either candidate. Predicting the markets is fraught with difficulties at the best of times. Predicting lasting market behavior based on campaign promises and fluid party platforms is impossible.

The summary of pundit prognostications below does NOT reflect my views, but it does reflect the sort of noise I hear daily from market timers and day traders (a high proportion traditionally lean toward the Republican Party).

On a Clinton Victory
What reaction can we expect: Mild relief, to include a rally in stocks and bonds, but nothing particularly bullish though we expect to regain at least our September 30th gains. Expect little change in oil/gold and, similarly, little change in the value of the US dollar by year-end.

Perceived winners: Hospitals (no Obamacare repeal or replacement, maybe some small tweaks); small businesses (new tax breaks); alternative energy (continued investment in alternative energy programs).

Perceived losers: Biotech/pharma (fears of regulation/price ceilings); energy & coal (increased environmental regulation reducing coal and fossil fuel production); private prisons (Clinton wants to shut them down).

On a Trump Victory
What reaction can we expect: Stocks: a selloff lasting into the New Year. Bonds: Treasuries lower in the near term, but not a large change. Dollar: lower as markets take in the cancellation or renegotiation of major trade deals. Gold/Oil: both up on uncertainty.

Perceived winners: Coal (anticipating reduced regulation on coal production and sales); overall energy sector (in a relaxed regulatory environment); pharma/biotech (little or no risk of price controls or ceilings); banks (potentially higher rates, rollback of certain Dodd-Frank regulations).

Perceived losers: Hospitals (changes to healthcare law, including repeal of Obamacare); alternative energy (less funding and support for alternative programs and a return to energy reliance on oil/coal).

For what it’s worth, at the time this goes to press [October 31] online betting sites show a 70% probability that the Democrats will win the Senate and Hillary Clinton a 75% chance of winning the presidency. The media, on the other hand, suggests that there are ways for Donald Trump to garner enough Electoral College votes for an upset victory. This additional uncertainty will have potential market consequences until the end of election day.

As investors, as Americans simply trying to decide how to manage our finances, what do we surmise from all this prognostication? Basically, don’t lose perspective. Our thinking should change very little since our long-term goals have not changed. In 2012, the S&P 500 dropped 7% ahead of and after the election. The level of fear so far indicates that in 2016 we may see a similar drop which will provide another buying opportunity. Personally, though I understand why these predictions are being made I do not believe it is possible to predict market direction in the long-term. Storms come and go and staying the course is safest until the facts are in. Throughout, we remain true to our goals – rebalance as necessary and stick to a well-diversified portfolio.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Retirement Income Planning – Spend early or make it last?

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During our working years we plan for retirement or financial independence in part by saving maximally and investing in assets that are likely to appreciate.  While we are working and saving for retirement we are in the accumulation phase. As we approach retirement (within about 5 years) we continue accumulating assets and begin the process of distributing those assets to sustain our chosen lifestyle throughout retirement. When we use an income stream from our assets we have entered the distribution phase.

During the accumulation phase we all focus on portfolio returns and tolerate some volatility. We can weather market fluctuations and lack of liquidity since we are not dependent on the portfolio and have our earnings to support our lifestyle. The main objective is to pay required taxes, support our lifestyle, save, and establish a life that encourages us to flourish.

As we approach the time when our assets alone will be used to support our lives, it becomes essential that we address the nuances of how the assets will be deployed – this is termed Retirement Income Planning.

Retirement Income Planning addresses in a pro-active manner how to create a stream of income for our remaining days (using accumulated assets) once our income from work no longer fully supports our lifestyle. Since the retirement time horizon is unknown, we must marry wishes for early retirement or plans for having larger income distributions with having assets last through an unknowable lifespan.

Running out of money is never an option in retirement but leaving money behind is also not acceptable, if it limits your lifestyle. This balance becomes a challenge as lifespans extend and health preservation becomes more successful and expensive. The latest survey shows that couples aged 65 have more than half probability (56%) of at least one spouse living to age 92. Despite these findings many feel they will not live past 80 and yet, if healthy and productive, they might feel very differently once they reach 90. Planning effectively for longevity is essential and must be weighed against the benefits of early spending.

For Retirement Income Planning, we also need to manage tax liability since we want to be sure that assets last as long as possible, particularly tax-deferred assets that are taxed at ordinary tax rates on withdrawal.

A market downturn can more greatly impact a portfolio early in retirement or just before the distribution phase. In retirement, unlike in the accumulation phase, it is much more difficult for the portfolio to recover from a market downturn. A robust retirement income plan must include ways to deliver the needed income regardless of market behavior.

The new reverse mortgages are income distribution tools that retirees can use to access home equity as part of a retirement income plan. For some, they provide at least three advantages early in retirement: reduced tax liability, longer investment time for the portfolio, and enjoyment of their home until retirees are ready to downsize.

For all retirees preserving their purchasing power (not just preserving the dollar amount) is an essential part of an income plan. Failure to include inflation protection is evident when retirees hold little to no significant equity portfolio and the consequences are dire. Though annuity and pensions are useful income distribution tools they fail unless combined with a strategy that protects against inflation. Sustaining purchasing power is even more significant when considering healthcare expenses. Keep in mind that healthcare costs grow due to inflation and also as a percent of annual spending as we age.

Scenarios that use all available tools to address how to best deploy retirement income will provide each retiring person with confidence to spend early and throughout retirement without fear of outlasting their assets.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

What makes a portfolio “good”

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What are the ingredients of a good portfolio?

If you do a little research, you will likely discover the three characteristics or criteria of a ‘good’ portfolio: (1) it should be diversified, (2) uses indexes, and (3) keeps costs low. All valid characteristics, to a point. In reality, this amounts to an over simplification that tells only part of the story. Applied to a poorly constructed portfolio, these characteristics will not help you create a good portfolio and you will not feel the confidence you need to see you through a market downturn. So, what is the best recipe for a ‘good’ portfolio—one that doesn’t cause you anxiety and keeps you up at night while generating long-term reasonable returns?

Here is my list of five ingredients for an effective long-term portfolio:

1.      HAS A STRATEGY. First and foremost, your portfolio should follow a strategy that you believe will be effective. You need to understand and believe in it enough that you can allow it to capture value over time (while others are off chasing the latest trend). At AIKAPA we use a global investment strategy that leans towards value (rather than growth) allocations.

2.      IS DIVERSIFIED. Select a diversification that represents your strategy and provides exposure to asset classes that behave significantly different from each other. In AIKAPA’s portfolio we are diversified across equities (that include large and small US and non-US equities) and across bonds, each global asset class providing opportunities to capture value. Using the chart below, you can compare global asset classes and how their volatility and returns differ from each other.

august_nibbles_asset-class-return-risk-for-2000-2005

3.      IS LOW-COST/HIGH-QUALITY (i.e., often an index fund). Implementing your diversified strategy needs to be completed using low cost, high quality securities. Use of baskets of securities (such as proven index funds) to represent chosen asset classes in your portfolio will permit the needed diversification while eliminating the risk associated with the failure of any one company (mutual funds or exchange traded funds are the baskets we use for your portfolio).

4.      IS LOCATION SENSITIVE and TAX MINDFUL.  Being mindful and “tax sensitive” when purchasing securities and locating them in the appropriate type of account can result in higher NET gains. Tax free, tax deferred, and taxable accounts should hold securities that will provide needed diversification, but will also yield the best AFTER tax returns. This approach is termed asset LOCATION selection. Taxable accounts are particularly valuable in the short and long-term but should hold assets that will not dramatically increase personal tax liability (particularly for those already in the higher tax brackets). As an example, two similar US Small capitalization funds can create very different tax liability simply by the level of “turnover” inside the fund. This turnover is often caused by frequent trading by the fund managers and can significantly reduce after tax net returns.

5.      IS REGULARLY REBALANCED. Finally, we have rebalancing of a portfolio. Rebalancing by conventional wisdom is what enhances your long-term returns by periodically selling what is overpriced (over-valued) and buying those that are underpriced (under-valued). The reality is not quite that simple. Automatic rebalancing software, for example, is tempting owing to its simplicity, BUT can lead to high turnover and reduced gains. Keep in mind, rebalancing has at least two different purposes. Rebalancing across unlike return assets (for example between equities and bonds) will result in a decrease in long-term returns, while reducing volatility (or risk). Yes, you trade some upside to reduce the downside. On the other hand, rebalancing between similar return assets (such as, between equity funds of large and small capitalized companies) will capture gains and lead to enhanced long-term returns as long as you don’t trade too often.

Assuming you’ve got all the correct characteristics in place, a ‘good’ portfolio ensures you’ve got adequate exposure to the market while assuming a measured level of risk, tax sensitivity, and an appropriate degree of rebalancing.

At the end of the day, a good portfolio can only succeed if you believe in the strategy and, most importantly, allow it to perform as designed over the long-term. To do this you, you must be certain that it is a good portfolio for you.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Ready for College? – timing & planning finances

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All college applicants that need a loan, scholarship or a grant must complete a financial-aid application. The process isn’t solely for those who have low enough income to qualify for aid. If you would  like to be considered for the 2017 education financial process you will need to complete the “Free Application for Federal Student Aid” or FAFSA (www.fafsa.gov). The process begins again on October 1, 2016.

Ideally, you will work closely with someone that is immersed in this process and aware of the 2015 changes enacted by President Obama. These changes will sync the timing of funding with college decisions for the 2017-2018 academic year. Though this timing is for federal financial calculations, individual institutions agreed to match up with the process for the 2017 school year. Even so, always double check with the specific college that is under consideration.

The process will now be based on 2015 year-end taxes (even if extended) for the 2017-18 school-year. There will no longer be estimating and re-adjusting as in past years. Parents and working students are encouraged to file taxes by the summer and to defer income (as much as possible) during college funding years.

Controlling the recognition of income (for both parent and student) will make it easier for students to obtain loans that have reasonable terms of repayment. In some cases, it is not possible and other ways of paying for higher education will be needed. Year-end tax planning should have a high priority starting two years before the intended college start.

So how does the 529 College Savings Plan affect your ability to receive loans or aid from the FAFSA system?  If the 529 plan is owned by the parent or dependent student it is an asset in the application (FAFSA) process, BUT qualifying distributions are not counted as income (i.e., tax free). Though grandparent owned 529 are not counted as part of the FAFSA calculation, distributions to pay for a student’s education does count as child’s income (but it is tax-free). The best way to handle grandparents’ distributions from 529 plans for students is to hold back distributing from grandparents until the last two years of a student’s college education.  So, keep in mind, it is best to take 529 distributions (from parent and student owned 529s) during the first two years and grandparent funded 529 during the last two years.

Though 529 plans are useful if your child has more than three years to go before college, they are not really effective as a short-term strategy. If you’ve little money saved and your child is to attend college within 3 years you need to consider other strategies. Consider paying the tuition yourself directly – you are allowed without tax consequences (but also no tax benefit) to pay for  higher education tuition costs directly without triggering gift tax (gift tax is triggered if you gift more than $14K in 2016). These tax-free gifts will not count as a student asset or income for financial aid purposes. This strategy works well for grandparents who can pay directly for a grandchild’s tuition and/or provide annually a gift towards expenses not exceeding the limit that year (limit of $14K in 2016).

Another strategy often quoted is gifting of appreciated assets which can be a double-edged sword since it can cause a student’s income/assets to exceed the FAFSA limits and result in the loss of access to loans or aid awards. We recommend close and careful monitoring and it is best if these tactics are reserved for the last two years of college so that there is little to no impact on the FAFSA annual calculation.

Sometimes parents have purchased Uniform Gifts to Minors Act (UGMA)/ or Uniform Transfers to Minors Act (UTMA) assets since they can be used for pre and post college funding, BUT these accounts are considered part of a student’s assets in the FAFSA application and have a significant impact on the availability of loans or aid. We recommend transferring to a 529 account, BUT this is not always a good strategy since it triggers capital gains taxes. The best strategy is to spend the account two years prior to college. These accounts have a much looser definition of how they must be used. Any expense that benefits the child other than those that a parent is required to pay are permitted. Ways we’ve seen these accounts used include: summer camp, highschool tuition, an electronic device (laptop or Smartphone) and academic tutoring.

The most important take away is that you must plan for a college account distribution two years before your student will attend college. The new rules do simplify the application process but it also means that your tax planning needs to be ahead of the student’s decision on higher education.

Finally, (like any complex financial decision) college planning can frankly add a level of discomfort and conflict to the family. But, it can also provide an opportunity. The experience, if inclusive, can be part of a shared life experience, an educational moment, and an opportunity to fulfill your goals. It is a chance to learn how to make financial decisions and feel good about them.

Stay connected with your financial advisor and discuss how to best deploy your available resources to benefit both you and the student.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Money Battles and the pitfalls of financial infidelity

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Let’s face it, making important financial decisions can be stressful at the best of times. When life partners fail to see eye-to-eye on finances it can lead to discord if they don’t have a way of working through their differences. It’s no secret, when compared to other types of marital disagreements, arguments over finance are the strongest predictors of divorce.  Financial decisions get even harder to make as we grow older—the habits of the past increasingly difficult to break. Add a touch of procrastination to the mix and you’ve got the potential for real trouble. It’s no wonder then, how easily decisions affecting retirement can turn into a battle over money, when so much is at stake. The best way to avoid unpleasant (and generally unnecessary) confrontations over money is to have a process in place. Let me explain . . .

Ideally, couples will create a money decision-making process early enough in their relationship that it becomes almost second nature—ensuring financial discussions are honest, frank, frequent and cordial. Both partners must be kept up-to-date on the family’s financial dealings and how those dealings align with understood and accepted goals. From our experience, monthly or at least quarterly meetings to discuss/review finances are invaluable.

This isn’t to say, every penny must be accounted for. Each partner must feel that they have reasonable autonomy and freedom to act within an allotted budget, BUT both must be clear that there are boundaries. Some couples set a specific dollar amount above which they must check with their partner and/or reach out to their financial advisor when especially tough financial decisions arise. For example, couples are well advised to discuss in detail funding a child’s college education, their retirement budget, or when to cease working.

Fights over money can be avoided if both partners have a handle on household finances, and moreover, feel their voice is included in all financial decisions.

If one partner pays all the bills and takes care of all the investments, the other partner over the long-term will begin to feel they are not a full participant in the relationship (or at least, they ought to feel that way). To counter this possibility, some choose to exchange roles for part of the year. Others have a regular monthly meeting to be sure that both are indeed aware of the family’s finances. AT A MINIMUM, all couples should go over how to access the family’s financial information (bank accounts, retirement plans, insurance, and investment accounts, etc.) AT LEAST ONCE PER YEAR.

When one partner takes on the financial responsibility for the family the inequity can (unintendedly or not) lead to “financial infidelity.” Financial infidelity occurs when one partner hides their spending on things they feel strongly about despite a clear agreement to the contrary by the couple. As an example, one partner might secretly fund their child’s business venture. I’m aware of one case where this actually happened. The situation was not revealed until the death of the offending life partner. The surviving partner’s betrayal was made all the worse by the fact that their retirement assets were depleted without his/her knowledge. The child that benefited from the covert funding, moreover, was not in a position to repay the surviving parent.

To avoid or at least reduce the likelihood of conflict over money, here are a few helpful guidelines:

  1. Communicate on expenses early, frankly, openly and honestly
  2. Meet regularly to review finances
  3. Update goals and ensure all parties are on the same page

When speaking of goals, articulate them out loud (i.e., verbally or in writing) and be sure to include your goals for both the present and the future.

The decision-making process itself should be reviewed as part of your conversation. For example, how do you determine your life-style budget, your savings goals, and what happens when you encounter expenses that fall outside of your budget for some reason?

As large financial decisions approach (such as retirement funding), the reality will undoubtedly generate much needed discussion. This conversation can turn into conflict if one side of a partnership is not in touch with family finances and family goals. Those who opt to avoid financial conversations will invariably find themselves in “money battles” that can seriously erode trust and faith in the relationship.

Facing major financial decisions, such as when, how and where to retire, needn’t be a source of discomfort or conflict. Far from it. If there is a reasonable process in place, the experience can be part of a shared life experience, an opportunity for optimism and mutual support.

I should add, in closing, that being single and unattached, doesn’t make you less susceptible to the stress imposed by major financial decisions like those discussed above. In fact, the “internal conflict” may be worse without someone to bounce things off of. If you are on your own, the same guidelines apply, but your “partner” in this is your trusted financial advisor.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Should you be a landlord in retirement?

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As you would expect, we often think about ways to supplement client retirement income and diversify a client’s finances beyond their market portfolio.

Owning one or more rental properties (commercial real estate) can provide a steady source of income and cash flow during retirement, with the added advantage of building owner equity (owner wealth). Once established, rental properties can also be a great resource to meet both planned and unexpected life events. And since they can be depreciated on your income tax, rental properties can provide a significant tax advantage while the asset actually gains in value. All this said, owning a rental property, let alone more than one, is not for the faint of heart. Without regular attention and constant re-appraisal, they can become a major headache and a huge liability.

The path to becoming a commercial real estate investor (a fancy way of saying “landlord”) often begins, innocently enough, with owning a single family home and then, for whatever reason, deciding to convert it to a rental. In this case, the property may need to be adapted in some fashion to accommodate renters. Others will approach a real estate agent with the deliberate intention of purchasing a rental property, in which case the property may be “turn key,” requiring little, if any, alteration. Whichever way you start out, the following are just some of the things you need to take into account before you commit to becoming a landlord in your golden years.

Commercial real estate requires at least 20%-30% down payment and an ongoing source of cash flow to fund expected and unexpected expenses. This means your equity will be locked in your property and only available through the available cash flow stream.

Real estate can be a great addition to an investment strategy, but rarely prudent as a sole investment. Unlike your portfolio, which will have fixed expenses, be liquid and globally diversified, your real estate will be impacted by local conditions with unexpected expenses and periods of poor liquidity. Expenses that are predictable include mortgage, taxes, landlord-specific insurance policies (both property and liability). Less predictable expenses are maintenance and repair costs as well as tenant related expenses. For those in control of their family cash flow, it is this difference that makes rentals a good consideration as a secondary investment and as part of their financial plan.

Like all investments it takes time and due diligence to generate a stable positive cash flow from rental properties – luck alone will not suffice. The price you set for rent is all important as are the expenses you incur. You need to be sure to cover your operating expenses which can include mortgage, property tax, insurance, maintenance, bookkeeping and accounting fees, utilities and if you use a management company you must also include their fee. In addition, the rent must provide you with a reasonable return based on cash flow, not just property appreciation, since you can’t sell the property to pay for ongoing expenses. The property must remain competitive with the local rental market and your cash flow able to cover expenses that may not be deductible in the year they are spent (a roof is an example of an expense that is depreciated and not deductible).

In addition to the financial considerations cited above, you will have legal obligations that are based on local laws and regulations pertaining to rental housing. A broken water pipe, furnace or refrigerator? Round-the-clock availability for emergencies is your responsibility. You can, of course, assign or pay for someone to take care of such things, but the legal responsibility will still be yours (always have sufficient liability and property replacement insurance). You are likely to be held liable for tenant or visitor injuries if due to unsafe conditions, especially in the common areas. Safety and habitability is paramount. On a regular basis, you must make sure structural elements are safe, the electrical, potable and wastewater infrastructure is sound, that trash containers are provided, that any known or potential toxins (such as mold or asbestos) are properly managed, that rodents or other vermin are kept clear off the premises.

However you come by your rental property, you will have to choose whether you should be your own property manager (directly overseeing and paying for maintenance yourself) or to take a more arms-length approach by contracting with a property management firm. Some clients hand these tasks to a family member who wishes to work part-time while others hand it over to a professional. A property manager can help those who wish to limit their day-to-day responsibilities, especially if you aren’t the handy sort or aren’t physically up to the task, but then you will have to cover the additional expense. Property managers, in simple terms, are hired to find tenants, maintain the property, create budgets, and collect rents. You will want to hire someone who knows about advertising, marketing, tenant relationships, collecting rent, maintenance, plus local and state laws in the location that you have the property. As the property owner, you can be held liable for the acts of your manager. It’s prudent, therefore, to hold the rental property in an entity that can provide some legal protection. Costs for contracting a property manager will usually run about 8% of rental income for management and about the same for engaging new tenants—this can eliminate your profit but if properly priced will provide you with a sustainable model well into retirement.

Finding reliable tenants is always a challenge, even if you employ a property manager. Tenants need to be able to pay their monthly rent, keep the property in good condition, and follow policies in the lease or rental agreement. You’ll find it easier to find good tenants if you select a property in an area experiencing low vacancies and high demand. Unfortunately, this means the property will also cost you more.

You should be prepared to have to deal with (or have someone deal with) evictions, wear and tear on your investment, unauthorized sub-lets, termination without proper notice, smoking, illicit drugs, pet odor and damage, parking and waste management issues, advertising, noise (including sometimes difficult neighbor relations), and other eventualities. Or, you can get lucky and find perfect long-term tenants! Realistically, as you age these tasks may become too stressful, eventually requiring you to hire a property management company or engage a (younger) interested and motivated loved one to take on this role. Either way, you must put this in writing as part of your purchase plan—including when you want this to happen, who this person should be, and finally, when the property should be sold.

During retirement some will love the ability to work part-time at managing their properties (even if only in a limited manner) whereas others will find it too complicated for their ideal retirement life. Invariably a well-managed property can generate ongoing income and create owner equity that will be a godsend in retirement or as an alternative to your market portfolio. Unfortunately for some, the process can become too complicated and stressful. So much so, that they avoid the tough decisions and derail their entire retirement plan. Being a landlord is very much an individual decision.

The bottom line is that rental property cash flow can generate a stable income during retirement, and can provide needed equity to fund contingency plans (such as disability, long-term care, health care needs, legacy) but profiting requires planning and annual review. It is a business that needs your ongoing attention or it will become a major liability. Even with the help of a property management firm, you may wonder in what way you can really consider yourself “retired” owning and managing rental properties.

Like any other financial investment, do your homework, and moreover, make sure it fits with your long-term financial goals and vision for a rewarding life.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com