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After you have filed your tax return, try to avoid just tossing a copy of it into your filing cabinet. According to financial experts, it could play a key role in terms of financial planning.
According to a recently released survey from the American Institute of CPAs, about 55% of American taxpayers have altered their financial plan based on information in their annual tax return, and about 27% make this a yearly practice. On the flip side, a survey by The Harris Poll in late 2020 found that 23% of Americans have no financial plan at all.
Regardless of which category you fall into, your tax return is a valuable tool in building or revising a financial plan, as it provides a succinct overview of your current financial situation.
“One of the biggest challenges with doing a financial plan is probably why so few do it: it requires a lot of information,” said Matt Rosenberg, who is a member of the AICPA National CPA Financial Literacy Commission. “You might as well turn and use that information from your taxes for planning.”
Here are a few ways that your tax return can help you in regards to financial planning.
Consider Changes to Your Family Structure
A good place to start is with the first lines of your 1040 form, which provides the basic information about your filing status. Are you married and filing jointly? Are you the head of your household? How many dependents do you claim? Consider any changes in the past year to your family structure, such as whether a child has gone to college or you have adopted a child.
This information is an excellent starting point for a conversation with your financial planning expert. Each family member who is part of your tax filing could have an impact in terms of estate planning and saving for college tuition, as well as spending for health and life insurance. Your financial planner can talk with you about your goals for each member of your family, as well as important documents you need to have updated and in place, such as durable financial power of attorney and a health care proxy.
Categorize Your Income
Your tax return will provide a concentrated, up-to-date snapshot of your income sources, including your wages or salary, your returns from investments, and Social Security income. With this information, you can categorize income as recurring, sporadic, or one-time, giving you a good foundation for establishing or revising your budget. When this data is combined with your expenses, you’ll know how much money you have left to apply toward your financial goals.
Reconsider Your Withholdings
Many financial planners advise that your withholdings don’t create a situation where you owe or receive a lot of money from the government. Rules governing withholdings have changed, and many Americans haven’t updated their withholdings accordingly. Your tax return will show how the amount withheld over the year aligned with the taxes you owe.
If you received a large return from the government, that means according to some financial experts that you have essentially given the government an interest-free loan for the past year. Conversely, if you owe money at tax time because you withheld too much, you will be charged a penalty.
While you will still pay the same amount of taxes in the end, adjusting your withholding ensures that you will keep the money in the interim.
Adjust Your Retirement Plan
As you refine your retirement plan, your tax return can help you make adjustments to keep your plan current and focused on financial security. Tax returns will show you the impact of your tax-deductible contributions to your retirement plan on your taxable income and help you make decisions such as how to best transition to Medicare or other insurance after you retire without severely impacting your income.
It’s also wise to annually review your beneficiaries, as circumstances can change from one year to the next. For example, in the unfortunate event that your spouse or child dies or you divorce, you’ll need to update your retirement accounts, insurance policies, and beneficiary designations, as these assets will be given to their designees, not through stipulations in a will.
Assess Your Charitable Giving
Rules have changed for charitable giving in recent years regarding itemized deductions, and the result has been that taxpayers are less likely to itemize their charitable giving and reap the tax benefits. Your financial professional can help you make decisions about how and where to direct charitable giving to maximize the tax benefits under changing laws. For example, you may want to condense several years’ worth of charitable giving into one year (rather than giving the same amount each year) so that itemizing these deductions will have more of an impact on your taxable income.
Regardless of your financial goals, examining your tax returns each year will allow you to assess your situation and make changes accordingly to protect and build your personal portfolio.
Recently introduced legislation suggests that the US Congress is interested in increasing taxes on high-wealth individuals. While none of these bills have made significant advancements in the legislative process yet, individuals whose wealth could be impacted should pay attention to potential changes, particularly to estate law. Significant revisions to tax rules could require you to rethink your estate plans.
Here are two recently introduced bills to keep track of and how they could impact you.
The 99.5 Percent Act
Sen. Bernie Sanders introduced this bill on March 25, and if passed, changes to estate and gift tax law would take effect on December 31. According to Jonathan Blattmachr, principal in ILS Management, LLC, this bill and others like it could “rock the world of every estate planner.”
In a nutshell, this bill, which is aimed at the top .5 percent of wealthy Americans, would expand the number of estates eligible to pay estate tax and would increase the amount of taxes each estate would pay.
Here are the primary changes the bill would enact.
- Reduce the US federal estate tax exemption from $11.7 million to $3.5 million (although the current limit will sunset to just less than $6 million in 2026).
- Reduce the US federal gift tax exemption from $11.7 million to $1 million.
- Increase the progressive federal gift and estate tax rate from 40 percent to 65 percent. To break it down, the rate will increase to 45 percent for excess value over $3.5 million, 50 percent for excess value over $10 million, 55 percent for excess value over $50 million, and 65 percent for excess value over $1 billion.
- Institute a limit of 50 years on generation-skipping trusts, also known as GSTs or dynastic trusts.
- Allow a $10,000 annual gift tax exclusion per recipient with a cap of $20,000 per donor.
- Limit minority-interest discounts when valuing some non-business assets for transfer for gifts and estate taxes.
- Require a 10-year minimum and 25 percent minimum value for remainder interest for grantor retained annuity trusts.
The proposed changes also would add Code 16 to the law, a new section outlining rules for transferring taxation of grantor trusts in the cases of gift and estate transfers and transfers that skip a generation.
Earlier this year, Sanders along with Sens. Cory Booker and Elizabeth Warren introduced the Sensible Tax and Equity Promotion Act. More commonly called the STEP Act, the overall goal of this legislation is to get rid of a loophole that allows people who inherit property not to pay capital gains tax on the property’s increase in value.
Currently, when someone inherits property, its value is “stepped up” to the current market value. Beneficiaries can take advantage of this loophole by immediately selling the property at market value without paying capital gains tax on the increase in valuation. However, if someone keeps the property for several years before selling it, they will be required to pay capital gains on any value the property has added since it was inherited.
This system will change if the STEP Act is enacted. If the property had increased in value, the new law would require the estate to pay capital gains taxes on that increase over the first $1 million in appreciated assets (increases in value less than $1 million would not be taxed). Beneficiaries who inherit a farm or business could spread their estate tax payments under the STEP Act over 15 years. All taxes paid on an asset’s increase in value would be deducted from the estate tax.
Impact on Estate Planning
The Joint Committee on Taxation estimates that the untaxed step-up will cost the US almost $42 billion in revenue in 2021. It also notes that for estates valued at more than $100 million, more than 55 percent of the wealth comes from untaxed capital appreciation.
If these bills are signed into law, estate planners predict they will create significant change for beneficiaries of estates and in the way estates are managed. Many predict it will make the paperwork and administration of estates much more complex, primarily because the historical tax basis for assets will have to be determined. With this anticipated increase in work, estate planners recommend making appointments now to work on your estate and enact your plan before new laws are passed. Otherwise, the demand for services may mean you’ll have to wait to meet with financial professionals.
Analysts aren’t sure yet whether these bills will make any progress in Congress, but because Democrats control Congress, some or all of these changes could become law. Passing the bills would require 50 votes in the Senate, which may be difficult given the legislating body is evenly split between Democrats and Republicans. Regardless, it’s likely that significant changes could be coming to estate tax law, and the best way to prepare is to stay in touch with your financial professional and begin discussing adjustments and changes you’ll need to make to your estate if these proposed rules become law.
With retirement decades away, many young people just entering the workforce imagine themselves to have ample time to get around to saving and planning. However, financial experts recommend that young adults consider their future now, as waiting sacrifices valuable years of saving and planning.
Here are some tips for anyone who is considering their financial future.
1. Pay Attention to Your Spending
Unfortunately, many high schools do not offer practical finance classes that teach basic skills such as budgeting and investing. As a result, many young adults may find themselves with an income but little control over their spending.
Learning how to set limits on yourself and stick to a budget are basic skills necessary for developing a solid financial foundation. That means not running up credit card debt to make purchases or spending your entire paycheck when some of it could be saved, the consequences of which could be significant and lasting. For example, if you use a credit card and don’t pay off your monthly balance, your debt could continue to grow, resulting in a potentially substantial amount of your income going toward interest payments rather than paying down the credit card’s balance.
A better approach is to be more mindful of your spending and potentially delay purchase-related gratification. Do you really need a $7 coffee daily, or could you save that money for a special treat? Is that pair of shoes worth the interest you’ll have to pay on a growing credit card balance?
Making a budget and tracking your spending will force you to pay attention to your spending habits and consider the impact of purchases on your finances.
2. Save Now
The more you save for retirement now, the bigger the payoff will be when you retire. Plus, it’s never too early to establish a lifelong habit of saving.
Numerous options are available to help you save for retirement. Your employer may offer a 401(k) and provide matching contributions. If that’s not the case, check into a Roth IRA, which offers tax-free withdrawals (contributions are taxed) starting at age 59 1/2. Although that may seem like a lifetime away, the sum you accumulate over a lifetime of saving will be worth it once you retire.
3. Save for Emergencies
In addition to retirement savings, it’s important to begin building an emergency fund. Ideally, this fund would be enough to cover your expenses for six months if you lost your job. It could also be used to cover unexpected medical expenses, car repairs, or other large, unexpected expenses that don’t fit into your budget.
While traditional savings accounts are easy to use, they don’t generate a lot of interest. Better choices for emergency funds include high-interest savings and money market accounts, as well as short-term certificates of deposit. When you set up an account, make sure that you can withdraw money easily in an emergency.
When making a budget, savings for an emergency fund should be a priority, even if you can only save a small amount. In addition to building your savings over time, this practice should confer some peace of mind since you will be financially prepared for unexpected expenses.
4. Learn about Taxes
It’s important to understand how taxes work, as they can have a significant impact on your income and financial planning. For example, when you get your first job offer, you’ll need to know whether the salary is enough – after taxes – to cover your budget and savings goals. Likewise, if you receive a promotion or otherwise change jobs, you could secure a higher salary that moves you into a higher tax bracket that cuts into your raise. You can calculate your taxes with an online tax calculator.
5. Invest in the Market
Investing in the stock market can be intimidating, and many don’t invest because they’re afraid. However, following a set of easy rules for investing wisely in the stock market can reap significant advantages.
When purchasing stocks, which offer you partial ownership in a company, buy when they are priced low and sell when their value is higher than what you paid for your shares. Stocks can be purchased individually or in mutual funds, which means that you buy pieces of multiple stocks in the same purchase. New investors should choose mutual funds, as they spread your investment across numerous stocks and are less risky.
6. Enlist a Financial Planner
While managing your own money doesn’t require a finance background, once you move beyond the basics, it can be helpful to bring in a financial adviser. These professionals can assist you with creating an overall financial strategy, including plans for budgeting, saving, and investing. Be sure to hire a financial professional that only charges a fee and is concerned with your best interests rather than a financial adviser who receives a commission when you buy into investments their company supports.
Estate planning is a vital step in not only ensuring that your assets are distributed according to your wishes upon your death, but it also prevents conflict that could arise among your survivors if they are left to make decisions about your estate themselves.
If the cost of estate planning has you thinking twice, consider the possible issues that could arise without it. Young children could be left without guardians, and irreparable rifts could develop between adult children trying to split assets themselves. You would leave a lifetime of assets in the hands of others with no say in where they go next. But if you have an estate plan, your survivors will not have to worry about making decisions about your estate while they are grieving.
Here’s a breakdown of fees associated with estate planning.
Online vs. In-person
While the Internet can be a great source of information, it’s not where you want to spend your money on estate planning. You’ll find plenty of do-it-yourself estate planning kits online (for a fee) that will allow you to create a simple will online, but don’t fall for their easy approach and low costs. This type of planning may work for someone with no beneficiaries and few assets, but everyone else should hire a professional.
The best use of the Internet in estate planning? Using it to do initial research into the field and come up with smart questions for your professional estate planner.
The costs of estate planning will vary according to the professional’s fee and how complex your property is. The cost for a simple, straightforward will could be a low as $150, while a complicated estate may require thousands of dollars.
Estate planning professionals, who can include attorneys and financial planners, typically will charge flat fees or an hourly rate.
Estate planning professionals using this pricing system will charge a set price, often based on their experience and the work that they offer. If you are offered a flat fee, it’s important to ask the attorney or finance professional what that fee covers, as it may not include extras such as a notary fee, and how they expect payment. Some professionals require the entire flat fee up front, while others may ask for only part of the fee before they start on your plan.
Other professionals charge an hourly rate; this will cover all the time that the lawyer or planner spends working on your estate. In some cases, the professional also may ask for an initial retainer fee, which you will pay before work begins.
This fee schedule often applies to more complex estates that will require additional work.
Your first meeting with the professional, which can take place in-person or virtually, typically won’t include a consultation fee. During this meeting, which can last up to an hour, you’ll talk to them about your situation and figure out the extent of estate planning you will need. While this meeting may be free, expect to pay for future consultations.
As you meet with estate planning professionals to determine which one you will work with, be sure to ask each how much they charge, what fee schedule they use, and what services they provide for that cost. This information will help you choose both an affordable service and one that can handle your estate.
Can My Bill Increase?
Yes. Even if your financial professional has given you a rate and detailed list of services that rate covers, it’s still possible they will run into work outside of that scope once they delve into your estate. To offset any surprises, talk to them up front to understand when and how much they charge in extra fees.
Managing Your Estate Planning Costs
To keep your estate planning in your budget, you can take steps in advance to minimize the costs.
- Prepare your questions: Before you start shopping for an estate planner, know what you need. Read up on basic estate plans, which documents are required, and what you need to know more about.
- Shop around: Don’t work with the first person you talk to. Take time to learn about various firms, read their reviews, and compare what they offer. You also can schedule consultations with each one to gain more points of comparison.
- Ask about costs: To avoid unexpected fees and costs, talk frankly about money during your consultation. Ask questions about their fees, rates, and scope of work so that you’ll know what you’re paying for and what could become an extra cost.
- Sign a contract: This is not the time to take a business on its word. Have the firm draft a work agreement, including costs, that both of you sign.
The COVID-19 pandemic has caused many people take financial actions like postponing retirement and to re-evaluating their estate plans. When it comes to the latter, an issue many grapple with is how—and whether—to equally allocate their assets to their children.
While dividing one’s estate into equal parts seems fair, often children have made different life choices, have different characters, and aren’t in equal life circumstances. A survey conducted by Merrill Lynch Wealth Management and Age Wave in 2018 found that many Americans don’t want to distribute inheritances to their adult children equally.
For example, 25 percent of respondents said they believed an adult child with their own children should receive more of an inheritance than an adult child with no children. About two-thirds said they believed an adult child who provided care for them should get more that those who did not provide care.
“How do you define equity?” Lisa Hanks, a California-based estate planning lawyer, recently told the New York Times. “It is different for different families.” For many, equity and equally are two different things.
As you consider how you will divide your own estate, you may find that issues of equity are complex and sensitive. For example, you may have one child who you believe will always need extra help, while your other child has a high-paying job in a stable industry. Or, you may have an adult child with special needs who will need expensive care after your death.
However, even in cases where one child may clearly benefit from extra inheritance, other siblings may not always be on board. Unequal inheritances can lead to conflict between siblings when the estate is divided. Some fights become so unmanageable that siblings take each other to court. In some cases, siblings who receive less believe that siblings with a larger share of the inheritance must have manipulated or influenced the parent to leave them more. This can lead to bitterness, distrust, and broken relationships after a parent dies.
Estate planners suggest that when parents create unequal inheritances, they should have a conversation with each child to explain their reasoning. Families also can hire mediators to facilitate discussions about inheritances to help siblings understand their parents’ decisions.
For example, one mediator described to the New York Times a situation where she helped a father and two of his sons, who were financially successful, discuss the father’s desire to leave more money to his third son, who had issues with his finances and health. In the end, the two financially successful sons decided they would prefer for their brother to receive a larger inheritance because they wanted to have a good relationship with him and were concerned that they might otherwise become financially responsible for him later in life.
Navigating an Unequal Inheritance
Here are several situations a financial planner can help you work through if you are considering an unequal distribution of your estate between your children.
- Factoring in an “Early Inheritance”
Some parents provide one child with extra financial support early on, such as paying for graduate school or helping a child with a down payment on a house. To balance out their gifts, parents often want to factor in this type of “early inheritance” into their will.
Experts recommend that parents discuss the early inheritance with their children and document the gifts in their estate plan. If parents have loaned a child money, the will should include a promissory note outlining the amount and terms of the loan, how much has been repaid and whether the balance should be deducted from that child’s share of the estate.
While including past gifts may complicate your estate plan, not acknowledging them in your will can create resentment in children who did not receive substantial financial help from you while you were alive.
- Repaying a Care Provider
In some cases, one adult child served as their parents’ primary caregiver at the end of their life and parents want to reward this child. However, siblings may not be on board with the inequity it could cause in their parents’ estate.
To avoid real or perceived inequities, when the estate is drawn up to compensate a caregiving child, financial planners often advise families to create a personal caregiving agreement that defines the caregiving services and the value of their contribution in the estate, such as extra money to buy a house or more of the estate. As always, parents should also talk about these decisions with their children.
- Taking Care of Stepchildren
Blended families can create added complications when drawing up an estate, as research has found that parents with no stepchildren are much more likely to treat their children equally than families with stepchildren. To ensure assets are distributed as the deceased intended, financial planners recommend being specific in how the estate is set up.
For example, a husband with children from a previous marriage may want to create a trust that provides for his spouse and bequeaths his remaining assets to his biological children after she dies. Alternatively, the husband could specify that certain amounts of his estate should go directly to his children rather than leaving everything to his spouse or name his children beneficiaries of a life insurance policy.
Regardless of careful estate planning, however, inequities can creep in. To best preserve sibling relationships, parents should always lay out detailed estate plans in advance and talk to their adult children frankly about their estate and the reasoning behind their decisions.
Two key considerations in retirement planning are ensuring that you outlive your retirement income and that your financial plan can withstand changes in the market. Pensions used to provide this assurance, but as these types of savings plans become rarer, you may have to create your own guaranteed retirement income.
Deferred income annuities (DIAs) are a sometimes-overlooked financial tool that fortify retirement portfolios and guarantee that retirees will have a cash flow, regardless of market ups and downs. While financial advisers generally will not recommend investing the majority of your portfolio in a deferred income annuity, many do advise retirees to include them in their portfolios.
Why are these financial tools such a good idea? The main reason is they provide a guaranteed income for life, whether you live to 80 or 100. While the income they generate may not be enough to cover all your living expenses, they can provide peace of mind and a reliable source of income in your retirement years.
How Deferred Income Annuities Work
Unlike other investments that produce income, deferred income annuities guarantee income as long as you are alive—no matter how long your lifespan. This works because DIAs operate on the concept of the “mortality credit,” which means that the assets from annuities whose recipients live for shorter periods of time stay in the “mortality pool” to work for recipients who live longer. DIAs are managed by insurers, who can share risk with other clients.
To build a DIA, a buyer invests a one-time amount or makes incremental payments to an insurer, who invests the money and guarantees a regular income later on. The investor can choose when to start taking payments, although most begin at age 80 or later to ensure they have an income in the last year of life.
The key to maximizing income from DIAs, which convert part of your savings into regular income, is to invest before you retire. An early start can mean a higher stream of income after you stop working. Financial advisers generally recommend DIAs for everyone except those who can’t afford to commit their money to an investment, as DIAs are not liquid.
There are several good strategies for investing in a DIA. First, make a DIA part of a diversified portfolio, since it is not impacted by market conditions. A DIA can stabilize income projections and provide assurance that your basic bills will be covered in retirement (along with other guaranteed incomes from sources such as Social Security and work pensions). Investing in a DIA incrementally long before your retirement date also is an excellent way to build your own pension fund.
You and your spouse can each buy your own DIA, or you can buy one as a couple with a joint payout that guarantees the surviving spouse will continue receiving payments. For those concerned that they will die before they receive payouts or before payouts exceed the amount of the original deposit, ask your insurer about a return-of-premium option that will give beneficiaries the original deposit back. Be aware that this option will reduce the payout amount a little.
Why DIAs Are a Good Choice
The biggest advantage of DIAs is that you don’t use them until many years after you’ve invested. For example, if you buy a DIA when you are 50 years old, but don’t withdraw income until you are 80, you’re benefiting from annuities growth after 30 years of compounding interest.
Unlike an IRA or 401(k), which also grows over time and offers tax advantages, a DIA that’s not in a retirement plan (aka a nonqualified annuity) does not require you to begin withdrawals at age 72 to defer taxes. Additionally, DIAs do not have limits on how much you can contribute each year.
DIAs also provide more flexibility in how you distribute your retirement savings. For example, if you retire at age 70 and invest part of your savings in a DIA that you won’t use until you are 85, you can use the rest of your retirement money for income during the 15 years between 70 and 85. This will allow you more freedom with your money early in retirement, because you know you have a guaranteed income planned for your later years.
When Should You Buy a DIA?
The best time to buy a DIA is five to 10 years before you plan to retire, usually between ages 55 and 65. This will lengthen the duration of your deferral period and increase the size of your payouts.
Deferring the payout also allows you to make additional investments in your DIA over a long period of time, taking advantage of potentially lower interest rates as rates fluctuate. Investing in an asset that provides guaranteed income also reduces the need to take on riskier investments or to sell your investments in a down market to generate cash flow.
Creating a last will and testament is a key part of end-of-life planning. However, to clearly articulate your wishes for your assets and dependents upon your death, you must engage in the larger process of estate planning. A will is an excellent starting point, but it’s only one piece of managing one’s estate.
The terms will and estate plan are often (incorrectly) used interchangeably. Here’s how they’re different.
What Is a Will?
A will is a legally binding document that outlines how your property should be distributed after you die. Wills can be made quickly and easily—you simply need to put your wishes in writing or dictate them to someone else. You can include everything from who will receive your assets to who will take guardianship of your children to who will manage your business. A will also can include information about who will serve as its executor and make sure all of the instructions in your will are followed.
Wills are important because detailing your wishes can avert conflicts between family members over your property and about who should make important legal decisions following your death. Without a will, your family also would have to pay a lawyer or work with a public trustee to deal with your property.
What Is an Estate Plan? The
A broader approach, estate planning is a more involved process that ensures your beneficiaries receive the maximum benefit from your estate and that taxes and other fees and expenses are minimized. Estate planning allows you to provide input into matters that go beyond a will, such as trusts and property transfer.
Estate plans also can address issues such as power of attorney, superannuation, and transfer of financial assets. As with wills, you can appoint a guardian or trustee who will make sure that your beneficiaries are protected and your assets are transferred according to your desires. An estate plan can have numerous features, outlined below.
These designations outline who will receive what from your estate, including who will receive your retirement account, your savings, your home, and your life insurance policies. This aspect of estate planning allows you to carefully and strategically appoint who will receive which pieces of your estate. Designating beneficiaries helps prevent posthumous conflicts between family and friends over your assets and ensuring that you maximize your estate among your beneficiaries.
If someone does not leave a will or designate an executor, the estate can be turned over to a probate court, which will distribute it. This can be a lengthy and costly process that also can be made public. The easiest way to avoid probate is to move your assets into a living trust, which will distribute your assets and property in the trust to your beneficiaries upon your death.
Because your property has already been distributed to the trust, you can avoid probate altogether. Owning properly jointly (it will go to the surviving co-owner) and designating beneficiaries for major assets such as bank and retirement accounts can also can help avoid the probate process.
Powers of Attorney
This important designation allows a person or people you trust to act on your behalf—including in legal matters—if you are incapacitated or if you die. You can appoint as many people as you’d like, and you can designate different powers of attorney for different situations.
Letter of Intent
Working with a financial professional to draw up an estate plan can be a timely process in which you discuss your plans—and the motivations behind them—at length. Together, you can draft a letter of intent for the executor of your estate that outlines everything from the details of your funeral to an overview of how and why you want your estate executed.
While a letter of intent is not a legally binding document, it offers an opportunity for you to share your heart and your values with your beneficiaries. As they make significant decisions about your estate, the letter will give you a guiding voice.
Where Do I Start?
The popular stereotype that wills and estate planning are for the rich is wrong. Anyone who has assets, no matter how modest or how many, can write a will or plan their estate to ensure that their property is handled how they want after their death.
Some end-of-life documents, such as a living will, also allow you to legally establish your end-of-life wishes in the case that you are unable to make decisions yourself. Estate planning can be an involved process, but the peace of mind you will gain, for yourself and your beneficiaries, will be invaluable.
If your estate is small, you can find guidance online for making an estate plan. However, if you have a large or complicated estate, a qualified financial professional can assist with this process. They will spend time getting to know you and your wishes for your estate and then incorporate that knowledge into the plan they craft with you.
A new year is a natural time for a fresh start and a new resolve, so there’s no better time to consider new ways to approach your finances in 2021—especially in light of the unusual circumstances that 2020 wrought on our finances and lives. Instead of setting out complicated resolutions that could be hard to stick with, consider adopting some of these more straightforward approaches that still can help you create a stronger, stabler financial position.
Save More Money
This resolution is the complement of the common resolve to spend less, and experts say it’s easier to follow. Rather than solely focusing on how you budget your money, try turning your attention to saving. You’ll be surprised at how much this shift can impact your finances.
First, decide now how much of your income you’d like to save every month based on your bills and salary. You may choose a percentage, such as 15 percent of your take-home income, or a dollar amount, such as $400 each month. Then, make sure you move the money into a savings or investment account or create a savings column in your budget to avoid absorbing it elsewhere, such as overspending on your credit card to compensate for the income now going to savings.
Track Your Spending
Whether your spending goals include buying a house, paying off a car loan, or spending less on groceries, keeping track of how much you spend is a vital first step to creating a budget to help you get there. When we estimate our spending, we often underestimate, which can lead to overspending and no progress toward larger financial goals.
You can figure out exactly how much you’re spending by examining old credit card and bank statements or using budget tracking software. Then, you’ll have a realistic idea of how much you spend and can make educated decisions about budgeting and saving—including chipping away at those big spending goals.
2020 provided some unique opportunities for spending changes that you may want to make permanent. Many people saved money due to restrictions on travel, dine-in eating, and entertainment venues. If your budget benefited, you may want to consider making those spending cuts permanent.
Focus on the Future
Sadly, COVID-19 cut many lives short unexpectedly, and it often left these people isolated in hospitals and assisted living facilities unable to consult with family, friends, or planners who could help them with financial paperwork. Future financial planning, whether it’s outlining your wishes for your estate or solidifying your retirement savings plan, is vital.
One smart resolution is to create a detailed retirement plan and stay with it. Do you want to continue your current lifestyle after you retire? Downsize your home and lifestyle? A planner can help you figure out how much you need to save to achieve your retirement goals and show you how to organize your financial documents to keep your spending and savings up to date. With a retirement plan in place, make it your resolution to follow it.
Estate planning is another key factor in planning for your financial future. A financial planner can talk to you about your goals for your estate and help you put plans in place now.
Pay Off Debt
Aside from causing anxiety, debt can hold you back from living the lifestyle you’d like and reaching big goals like traveling the world or purchasing a house. If you struggle with debt, resolving to pay it down is vital.
Financial planners recommend approaching your debt strategically. That means paying off higher-interest debt, such as credit card balances, first. You could also take a wider approach and focus your payments on debts that carry a specific interest rate and above.
Whatever approach you choose, resolve to understand the amounts and interest rates of your debt and create a strategy for tackling them in 2021. And that doesn’t necessarily mean paying them off completely. If repaying 25 percent of your balances in 2021 is realistic, set that as your goal. The satisfaction of reaching it will only serve as a motivator to continue working toward debt-free finances.
Build up Your Emergency Fund
If we’ve learned anything from 2020, it’s that life can change drastically, and sometimes that comes with unexpected financial ramifications such as a job loss or hospitalization. While financial experts recommend shoring up at least six months’ pay in savings for such situations, the Financial Industry Regulatory Authority found that almost half of Americans don’t have enough in an emergency fund. Without savings set aside, you are risking financial disaster.
Savings like this doesn’t happen quickly, so plan to build it gradually by committing to a monthly contribution to your emergency fund. Additionally, set this money aside for true emergencies—don’t dip into it to pay bills or offset extra spending if you can help it.
Sometimes, we decide we’d rather not know the details of our finances. Maybe we’re worried that an in-depth look at our money would reveal spending habits we’d prefer not to acknowledge, or perhaps “ignorance is bliss” and we don’t want to think about how little money we have in the bank. Perhaps we’re embarrassed by our lack of savings and investments.
Financial planners note that these kinds of fears, whether of change or the unknown, often prevent people from seeking financial planning services. We know it’s important to save money and plan for our future, but we often don’t know how to do it, and sometimes, learning seems overwhelming. However, taking charge of your finances by working with a financial planner can help you achieve major financial goals such as buying a house or paying for your child’s college tuition.
Here are a few ways to approach your finances with confidence.
Remember: No One Is Judging You
Whether your savings are scant, you’ve taken on two large car payments, or you’ve made a poor investment, a financial advisor will not judge your decisions. Finance professionals are there to help you manage your money—they aren’t concerned with how much you earn, what your assets are, or what financial mistakes you’ve made. Their job is to help you get into a better financial situation. And remember, you will not be the first client they’ve worked with who’s made a financial mistake!
Don’t Believe It’s Only for the Wealthy
One common misconception is that financial advisors are only for the ultra-wealthy. Many people worry that their money doesn’t warrant advice or that they don’t have enough to invest. This may have been true in decades past, when most financial advisors required clients to have a minimum amount of assets, but today, financial advisors are increasingly offering services catering to people who have less money to invest. These services focus on helping people manage their money, often through online financial planning investment services. Financial advice benefits everyone, even those who haven’t accumulated a lot yet.
While the details of financial planning can be intimidating at first, once you delve in, you will likely find rewards in managing your money well. There’s a certain satisfaction that comes with paying off credit card debt, retiring student loans, and building your savings and retirement accounts. The best part is that once you get a taste of the personal benefits of financial planning, you’ll want more.
Know You Can Afford It
While the perception is that financial planning is expensive, it’s simply not the case. Working with a traditional financial planner can indeed cost thousands of dollars, but there are less-customized options for financial planning that are much more affordable. While you may have to trade in-person, personalized attention for an online financial management service, these cheaper alternatives are still excellent options for helping you invest and manage your money.
Also, these services typically don’t require cash up front. Instead, they’ll take a percentage of the money you invest through them. They usually charge around 1 percent, so if you invest $10,000, your financial advisor’s fee will be $100, which likely will be deducted directly from your investment account.
Computer-based services, also called robo-advisors, are another affordable way to manage your investments. They likely won’t require a minimum account balance (or if they do, it’s low), and their fees are based on your assets under management (AUM). The AUM fee will range from .25 percent to .5 percent, which calculates to between $12.50 and $25 for a $5,000 account balance. While you won’t get personalized financial advice for your fee, computer algorithms will create and monitor your portfolio for you.
Online financial planning services, a step up from robo-advisors, offer investment management along with personalized financial planning. Some services don’t require a minimum account balance, and their customized services can range from a dedicated Certified Financial Planner to a team of financial planners. Typical AUM fees for these services range from .30 percent to about .9 percent or a flat annual fee starting at several hundred dollars based on the level of services you need.
Take the First Step
While finance professionals have sometimes gotten a bad rap as predatory, self-serving people, that’s not reality. Financial advisors care about their clients, work with their best interests in mind, and don’t judge clients’ situations or choices. They are focused on finances and helping you make the best decisions with your money.
When you find the financial planning service that best matches your needs and goals, you’ll be glad you did. The peace of mind you’ll get from having and sticking with a financial plan will be well worth the discomfort you may feel when you first reach out to a professional for help.
Due to the pandemic, colleges across the United States are starting to rethink their approach to how to provide an education. In response, many families are wondering whether paying for a college education is worthwhile right now.
Recent statistics bear out this trend. In October, the National Student Clearinghouse Research Center reported that undergraduate enrollment is down 4%. Experts attribute the decrease to concerns about contracting COVID-19, a dislike of online learning, and issues with families not being able to afford tuition. Some students are opting to take a gap year or to postpone college.
While reconsidering your college plans may be an option for some, financial planners advise families to continue saving—at least in some form—for their children’s college education. The following is some information and advice on how to manage your 529 college savings plan as the educational system navigates COVID-19.
Community College An Option
One popular option for students who don’t want to virtually attend a pricey university is to enroll in community college, which is generally a less expensive choice. Some financial advisors recommend that parents pay the lower tuition for community college out-of-pocket rather than draw on their student’s 529 plan, a popular education savings plan that allows families to invest money that has already been taxed into several investment options. Your earnings grow tax-free, and withdrawals for qualified expenses are not taxed.
This approach offers several benefits. Parents can continue contributing to their child’s 529 account and increase its long-term growth potential. In addition, they will not be withdrawing money from their student’s college savings account and taking a loss during an economic downturn. Students can also take out separate loans for community college and use the 529 proceeds later to repay up to $10,000 of those loans (principal and interest), a one-time option now available under the recently passed SECURE Act. As an added bonus, up to $10,000 in 529 plan distributions can be put toward the educational debt of each of the beneficiary’s siblings, including stepsisters and stepbrothers.
Continue to Contribute
The market ups and downs over the last year may set off warning alarms for your 529 college savings plan. Your account balance may drop, which may make the plan seem less valuable. The statistics back this up. According to data from the College Savings Plans Network, the average account reached a high of $26,054 in 2019, but now it is down to an average of $25,657.
Even with so much uncertainty, advisors recommend that families continue contributing to their 529 college savings plans as much as they can. Recent research finds that many are doing just that—total investments in 529 plans have risen to nearly $374 billion, a record. Investors value the savings plans’ tax-free deductions when the funds are used for qualified educational expenses such as tuition and books.
“When it comes to 529 college savings, staying the course is an essential component of a successful long-term savings strategy,” stated Michael Frerichs, the chairman of the College Savings Plans Network, in a recent interview with CNBC.
Other Ways to Use the Money
COVID relief legislation that was passed earlier this year allowed families who had paid for tuition from their 529 plans—before classes were moved online due to the pandemic—to receive refunds from the colleges. As long as the money was deposited back into the 529 plan within 60 days, the withdrawal was not taxed.
While families have the option to leave the money untouched, there are other ways they could use it because the law allows for 529 funds to be used to pay for a variety of qualified educational expenses. Up to $10,000 per year can be spent on private school tuition for each younger child per year (private, public, or religious education for students in kindergarten through 12th grade), and in many states that amount can be applied to reduce the taxable income of the parent or grandparent who started the fund.
The money also can be used to pay for apprenticeship programs, vocational school, and other post-secondary institutions that participate in the U.S. Department of Education student aid program. Qualified expenses also include computer software, textbooks, and supplies.
The Long-Term Outlook
For families with younger children, now may be a good time to think about what higher education will look like in a decade. Some experts predict that post-COVID, the cost of a college education will become even more expensive. In order to compensate, you can change the asset allocation of your 529 plan portfolio, making it more aggressive or conservative based on your feelings about the market.
Parents may want to explore other savings options, as well, so that they can work around the restrictions on the 529 plan. Other good investment choices include U.S. Treasury bonds, one of the safest—and slowest—investments, or stocks, which will be more volatile but could provide a much larger payoff. Parents also could consider a Roth IRA savings account, which offers the tax savings of a 529 account without the restrictions.
If your target retirement age is less than 10 years away, it may be tempting to glide into your post-work life and hope for the best. However, without proper retirement planning, you may find yourself making a bumpy landing.
Here are seven steps to ensure that you’ll be financially prepared for retirement.
Consider Your Plans
As the reality of your post-work life draws closer, it can be helpful to envision what your days will look like. Will you be traveling around the world? Downsizing your house? Taking up a pricey new hobby? Will you volunteer or work part-time? All of these decisions will play into your retirement budget.
Most importantly, ask yourself if you have the money to pay for your retirement dreams. If you don’t, there’s still time to save. First, go over your current budget and look for items that can be cut. Do you need Netflix and Hulu? Could you cut out coffee runs and eating out? Any money you save can be invested in your retirement savings.
If your dreams outsize your financial reality, it may be time to reconsider what retirement will look like. Steps such as moving into a more affordable home or working a 10-hour-a-week job could positively impact your retirement budget. A downsized retirement budget, however, doesn’t mean a downsized retirement. Spending more time with grandchildren can be more rewarding than an expensive vacation to Europe.
Get a Handle on What You Have
This step can be intimidating, especially if you haven’t been on top of retirement savings. However, you need to face the truth to best prepare for the future. You need to know how much you’ve saved and how much you’ll likely receive in Social Security and pension payments so that you can calculate a reasonable retirement budget. If your retirement savings are in several different accounts, consolidating them could provide a better idea of how much savings you have.
A financial planner can help sort through your financial situation and build a strategy for retirement savings to maximize the time you have left to save. With an accurate assessment of what you’ve saved, you also can make decisions on whether you need to work more to increase income or cut back on spending to boost your savings.
Pack Your Retirement Savings Accounts
This is the time to increase your contributions to your retirement account to the maximum allowable, including making catch-up contributions permitted under IRS rules (the agency gives contributors age 50 and older extra time each year to contribute). Also, check with your employer about whether the company matches employees’ retirement account contributions.
Get a Plan
It’s easy to put off retirement savings and justifying spending what could be potential contributions to other items. However, it’s never too late to map out a retirement plan—even if retirement is just a few years away. A financial professional can help you maximize your savings, create a strategy, and chose the most advantageous options for claiming your employee pension or Social Security when the time comes.
Pay Down Debt
Retirement budgeting will be much easier with less debt, and it’s wise to pay off as many loans and outstanding balances as possible while you’re employed. That can mean making extra mortgage payments, paying off credit cards quickly, and limiting new debt. One wise move is to pay cash for larger purchases to avoid additional credit card spending. The overall benefit? Less of your retirement income will go toward debt interest payments.
Choose your location
Your retirement budget will largely depend on where you choose to live. Downsizing to a smaller house in a more affordable area could drop your mortgage payment. On the flip side, you’ll also need to consider your budget if you move to a more expensive house or location to be near grandchildren, which can increase your retirement budget.
Factor in Medical Costs
While it’s impossible to predict the state of our personal health at retirement age, it’s wise to consider how to cover potential increased medical costs without decimating your retirement savings. One option is to maximize your contributions to your health savings account now—if you don’t spend the money, it will grow tax free and be available to spend in your retirement.
Another option is to buy long-term care insurance, which will pay for home health aides and, if needed, assisted living facilities, which aren’t covered by Medicare. The earlier you buy the insurance, the lower the premiums will be. If you wait to buy, you’ll risk rejection from insurers if you are in poor health.
Finally, you can protect your retirement savings by investing in additional health insurance. When you turn 65, Medicare will pay for most of your routine health bills, but you’ll need supplemental coverage to fund non-routine medical issues.
If you want to leave your estate to beloved family members or friends upon your death, a life insurance payout can be key to helping them pay for expenses that could decrease the impact of your estate.
Dispersing an estate can take time—sometimes months or longer, particularly for complicated estates. In the meantime, beneficiaries can be left with bills for everything from funeral costs to debt payments.
To leave those you love in the best financial position possible, it’s important to include a life insurance policy in your estate planning. Here are ways that life insurance policies can be utilized when planning your estate.
Paying funeral fees
Even the most basic of funerals can cost thousands of dollars. Low-end caskets generally start at about $2,000, on top of fees for embalming, funeral home staff services, and a grave marker. Meanwhile, cremation costs can start at $4,000. A life insurance policy can provide immediate cash to pay these costs so that your beneficiary doesn’t have to spend their savings or go into debt themselves to pay for these expenses.
Paying estate taxes
A life insurance policy can be an excellent planning tool for protecting the wealth you plan to pass on. If you anticipate your estate will be subject to federal estate taxes, which heirs must pay within nine months, your life insurance policy can pay them instead. If your estate is primarily real estate, this strategy will prevent heirs from having to sell property or liquidate assets to pay estate taxes.
It’s not uncommon for decedents to leave unpaid debt and monthly payments, including credit card bills and utility bills. A recent study by credit company Experian found that 73 percent of Americans who die leave debt behind.
While creditors likely won’t try to get payments out of surviving family members, they often will from the estate. The collections process can send an estate into probate, which can stretch out for years as creditors try to collect from it. Life insurance policies, however, aren’t subject to probate laws. That means beneficiaries can receive the entirety of the policy quickly.
Building financial wealth
A life insurance policy, especially one with a large payout, can change your beneficiaries’ lives and your or their family’s legacy. For example, life insurance payouts can be used to pay off a beneficiary’s mortgage or student debts. Without this costly debt, they can invest or save their money, building wealth for future generations.
Replacing family income
If you are the primary earner in your family, life insurance can replace vital income if your spouse does not work or is underemployed. A life insurance payout will provide survivors will financial stability while they reconfigure their lives in your absence. Financial experts recommend that a life insurance policy cover between seven and 10 years of your income.
Life insurance also can become very important for families with young children or children with special needs. In these cases, surviving parents or guardians may not be in a position to cover the children’s financial needs on their own. Life insurance benefits, however, can pay for everything from medical bills to education.
Protecting family real estate
Family-owned property can become an immediate financial issue for heirs, who must make decisions about who will own the property. In some situations, heirs may decide to sell the property and divide the proceeds, but preparing the property for the market and waiting for a sale can take time. In the meantime, the mortgage must be paid.
In these cases, a payout from a life insurance policy can help. Beneficiaries can use it to make mortgage payments or, if they decided to keep the property in the family, pay off the mortgage.
Giving to charity
Life insurance can be an excellent way to make a significant gift to a charity of your choosing. Any charity can be designated as the beneficiary of a life insurance policy.
As you integrate life insurance into your estate planning strategy, there are many factors to consider when deciding how much and what type to invest in. You’ll need to look at whether you are the primary income earner in your household and how many people depend on you financially. You’ll also need to factor in your debts and other financial obligations (including your mortgage), whether your estate will be subjected to federal estate taxes, and whether you’d like to leave any of your estate to charity. Life insurance will provide liquidity and readily available funds for your beneficiaries.
Estate planning professionals can help you determine how life insurance can benefit your estate, regardless of your age or income. It can be a key tool in providing peace of mind that your family will be financially protected and your estate preserved as you pass it on to your heirs.
Federal unemployment benefits prompted by pandemic job losses expired at the end of July, and a recent flurry of government activity resulted in an executive order issuing $400 a week to people who are unemployed.
The weekly benefit will help the more than 30 million Americans now claiming unemployment as well as the hundreds of thousands of new applicants each week. The details surrounding this round of benefits have not been finalized, however, and it remains unclear as to who will be eligible, exactly how much they will receive, and when the payments will begin.
Here’s what we do know.
$400 a Week Isn’t Guaranteed
While this payment program, called Lost Wages Assistance, will come on top of state unemployment benefits, it looks like not everyone eligible will receive the full $400 each week. The reason? One stipulation of this new benefit is that states must provide 25 percent, or $100 of each payment, unlike the recently expired program, which was fully federally funded.
Some states aren’t in a financial position to supplement federal unemployment and may take advantage of a loophole that will lower the payment. The federal government has noted that states can count existing benefits they pay an unemployed worker toward their share of the new supplement. That would reduce the federal payment to $300 per week.
One expert believes few states will provide the additional $100 on top of state unemployment benefits. Many states are facing budget shortfalls due to decreased tax revenue during coronavirus lockdown—the Center on Budget and Policy Priorities predicts state budget shortfalls could total $555 billion.
“They’re stretched,” Andrew Stettner, a senior fellow at the Century Foundation, recently told the New York Times. “They don’t have money for masks for the teachers in their schools. They’re probably not going to come up with an extra $100 for everyone on unemployment insurance.”
In late August, the states of Kentucky, West Virginia, and Montana announced that they would provide the $100 in matching funds so that unemployed workers will receive the full $400 weekly federal benefit. South Dakota has opted out of the program entirely, and other states have announced that they will not provide the extra money. In those states, eligible people who receive unemployment will get $300 each week.
Not Everyone Will Qualify
Unfortunately, new Labor Department guidelines for the Lost Wages Assistance program could exclude the people who need it most, including people who freelance or work part-time.
People who qualified for the Pandemic Emergency Unemployment Compensation or Pandemic Unemployment Assistance programs through the Coronavirus Aid, Relief, and Economic Security (CARES) Act and can continue to provide self-certification that they lost their job because of COVID-19 should receive the new unemployment benefits. To ensure that they receive the new benefit, however, they should be careful to state on the application that they are unemployed or underemployed due to COVID-19.
Another loophole could be problematic as well. People who receive less than $100 a week in state unemployment benefits won’t be eligible for the federal weekly $300. Experts estimate this could exclude as many as 1 million workers, including low-wage earners and people who work part-time.
When will the benefits be paid?
Right now, there’s no clear guidance on when the first Lost Wages Assistance checks will be sent. Some estimate it could take months, as states that are already managing huge loads of unemployment filings will have to administer their portion of the program. Precedent may be helpful; some states took months to send out checks under the initial pandemic federal unemployment assistance program.
One Department of Labor official who works in Hawaii recently said in a media interview that the state’s computer system will have to be reprogrammed to meet federal requirements, a problem many states with older computer systems are facing. States with updated computer systems also may not be able to get payments out quickly, according to some estimates.
State offices are busy fielding questions about the new benefits—one New Mexico government official told a news outlet that his office received thousands of calls the first workday after the initial stimulus bill was signed into law in March.
While much about the Lost Wages Assistance program remains up in the air, there is some good news. The program is retroactive to August 1, so qualified recipients will receive a large first payment at some point.
The benefits are scheduled to continue through the week of December 6, which means recipients will receive financial help for another four months. This will provide some certainty for families and individuals as they make decisions about budgeting and spending this year. While the money does have an endpoint, federal elected leaders may implement another round of unemployment benefits at that time if Americans still need additional financial help due to the pandemic.
While the pandemic has created many economic hardships, one silver lining has been a significant increase in personal savings.
According to data from the US Department of Commerce, personal savings totaled almost $4.7 trillion in the second quarter of 2020, an increase of more than $3 trillion over the first quarter. That translates into a personal saving as a percentage of disposable personal income rate of 25.7 percent in the second quarter compared to a rate of 9.5 percent in the first quarter. When the personal savings rate reached 33 percent in April, it was the highest since the US government began tracking it in the 1960s.
The jump in savings can be attributed to several factors related to the pandemic. People have been hoarding cash as an uncertain future looms. As a result, consumers are buying less, traveling less, and going out less.
The country’s financial outlook remains grim, however, as the United States continue to report record job losses and unemployment rates. Personal finance experts recommend that Americans continue to save as a financial safeguard. Indeed, a recent survey from Bankrate showed that about 55 percent of Americans regret not having enough emergency savings.
What is an emergency fund?
Contrary to common belief, a one-year emergency fund isn’t the equivalent of one year’s worth of earnings—a daunting savings goal. Instead, you can calculate a more realistic emergency fund goal by looking at your minimum expenses.
If you are in a position where you need to draw on emergency savings, you likely will only be paying vital bills such as your mortgage or rent, food, and utilities. Likewise, to figure out your desired emergency savings, consider how much money you need to survive. Add up only your necessary bills for a year—the total should be significantly less than your annual income. An emergency fund based on this calculation should be a much more attainable goal.
Buckling Down on Savings
As you grow your emergency fund, consider two primary strategies. The first is to spend less, and the second is to earn more. You may want to jumpstart your savings fund by getting a second job. In today’s gig economy, for example, you could earn extra money as a delivery driver or pick up shifts at a local essential business such as a grocery store.
Here are some other strategies that may help you to save more.
Automate your savings.
Researching which high-yield savings plan is best can be a waste of time, as slight differences in interest rates won’t result in a significantly higher yield. Instead, financial experts recommend setting up automatic withdrawals from your paycheck into your emergency savings account. This strategy guarantees a monthly contribution and removes the temptation to spend the money instead of having to remember to manually deposit it into your savings account.
Automation places systems over human willpower, which can be faulty and forgetful. Automated monthly deposits create a steady flow of savings into your emergency account.
Watch the news.
The federal government continues to make decisions about how to help Americans weather the financial crisis that could impact your savings. While no legislation has been passed yet, government officials have suggested that a second $1,200 stimulus check may be sent to all eligible Americans. The amount each family unit will receive depends on factors such as income and number of dependents.
If you don’t need the entire stimulus check amount to pay urgent bills, consider investing the check in your emergency savings account. This strategy won’t provide the immediate gratification of a shopping spree, but if you find yourself in a dire financial situation, the savings will pay off.
If you haven’t paid your federal taxes, be sure to do that as soon as possible, since the IRS has stated that unfiled taxes could impact your stimulus check. When you do fill out your taxes, include your direct-deposit information—this ensures that the IRS can deliver the any stimulus checks straight to you.
Watch your spending.
Adapting your budget to a stay-at-home lifestyle could reveal several areas of significant savings. For example, working from home should significantly cut fuel or commuting costs. You may even be able to reduce your auto insurance coverage.
You probably won’t need as many new clothes or shoes. If you’re avoiding indoor gatherings, you’ll no longer spend money on movies, bars, concerts, theater, or other forms of out-of-the-house entertainment.
Taking a close look at your monthly subscriptions also could uncover savings. Look at every recurring bill and examine whether you really need it. Are some subscriptions redundant, such as the four streaming services you pay for? Paring down these monthly expenditures can reap significant savings.
Reducing your spending could open up hundreds of dollars in your monthly budget that can be reallocated for savings—and you may find the pandemic pushes you into a simpler, cheaper lifestyle you’ll continue even after the world reopens.
The coronavirus pandemic has wreaked havoc on many aspects of people’s financial lives. Despite this, many people report that they have not stopped contributing to their children’s 529 college savings plans.
In early May, Savingforcollege.com released survey results showing the pandemic’s economic impact on families saving for college. About two-thirds of respondents reported seeing a decrease in their 529 plan’s value since January. Approximately one fourth said that someone in their household had lost a job or was making less money. However, most also said they hadn’t changed their strategy for saving for college.
As the situation developed, though, and economic hardship continued, more families (although not a majority) did report an impact on their college savings. A CollegeBacker survey in May reached out to 1,200 American adults. About 16 percent said they had paused their college savings contributions. Additionally, 17 percent planned to withdraw money from their college savings accounts, and 13 percent had decreased the amount they were contributing.
The June 2020 State of Savings report from Ascensus, which analyzed 529 plans with fewer than 500 participants between early 2019 and May 31, found about a 21 percent decrease in the amount of one-time contributions between the end of March and the end of May. However, Ascensus’ analysis showed hardly any change in automated contributions during that time period.
“There are many families facing a tougher situation so you do see some occasional monthly reductions in their contribution rates, but overall it hasn’t been as dire as you might expect,” Jordan Lee, founder and CEO of CollegeBacker, said in a press statement. Here’s what you need to know about 529 plans during the pandemic:
This Is How 529 Plans Work
The value of a 529 plan is that it allows adults, primarily parents or grandparents, to save money for a designated beneficiary. The account will grow tax-deferred, and money can be withdrawn tax-free for qualified expenses related to education.
The money can be withdrawn for other expenses (financial planners recommend this option only be used as a last resort) if times are hard. However, the plan’s earnings would then be subject to a 10 percent penalty, and the account holder would also be charged federal income tax on the withdrawal.
Extensions Were Granted to Return Money Refunded as a Result of the Pandemic
Federal regulators offered one break, however, for 529 plans during the pandemic. In some cases, families paid for college expenses for spring 2020 out of their 529 plans and may have received a refund for tuition or room and board due to schools closing their physical campuses and going online for much of the semester.
In a typical year, account holders would be required to reinvest the refund into their 529 plan quickly or be penalized. This year, the Internal Revenue Service allowed families 60 days (the deadline was July 15) to return the money without a penalty.
529 Plans Are Good Investments
The pandemic has forced many families into tough situations, as working members of families have faced layoffs, furloughs, and other economic hardships. However, 529 plans remain an excellent investment, as rules for how the money can be used have been relaxed over the years. Qualified expenses can include everything from tuition for vocational and trade schools to paying off student loans to some costs associated with K-12 education.
Federal laws restricting gifts to $15,000 each year are less stringent for 529 accounts. This means that grandparents or other adults who want to invest in a child’s education can give as much as $75,000 in a single contribution. In addition, if the account’s recipient decides not to go to college, another family member can use the money.
Your Budget May Be More Flexible Than You Think
Experts advise families to keep making contributions to their 529 plans—and even increase them if possible—during the pandemic. Some financial planners point out that typical budget items, such as eating out and vacations, may not be spent and the money could instead be allocated to college savings.
Families also should regularly review their budget and financial planning outlook. The current economic situation is changing rapidly due to ongoing questions about employment and the market. However, college will still be an expense in most cases, and a 529 college savings plan remains an excellent way to save for college even if you find yourself in financial hardship.
Plans May Be Uncertain, but 529s Are Flexible
The pandemic has forced many to change their plans, and your student may even be considering putting college off or choosing a different route all together. Restrictions on indoor gatherings have required many American colleges to remain online, an educational format that is less appealing to many students.
The good news is that 529 plans are designed for flexibility. This means you can continue saving while your student’s educational future unfolds, and the plan likely will cover other educational expenses if your student decides to pursue a nontraditional educational opportunity. And if your student foregoes education entirely to work or travel, the 529 plan can be transferred to a qualified relative whose education can benefit from the savings.
Retirement planning advice—which is not in short supply—can linger long past its time. Advice that may have worked 20 years ago, for example, may not be as applicable today, when the economy is different and people are making different choices about their retirement. It may be time to reconsider the following common retirement advice.
You Must Pay Off Your Debts, Including Your Mortgage
In reality, this advice is unachievable for many Americans. Becoming debt-free for many may be impossible or so difficult that it pushes retirement back many years. Following this guideline, then, would mean trading enjoyment in your senior years for more years of work.
In some cases, it’s OK to carry debt into your retirement; the key is determining which debt is manageable. Paying off high-interest debt, such as credit card balances, is important—interest rates on credit card debt can be 15% or higher, which means your debt can quickly build. Growing debt and a fixed retirement income aren’t compatible, and in this case, it’s a good idea to pay off all high-interest debt before retirement.
Other debt, however, may be tolerable—and even beneficial—during retirement. If you can comfortably make the payments on low-interest debt with your retirement income, there’s no reason to postpone retirement. In other situations, your money may be better spent on investments rather than paying off low-interest debt. For example, if your mortgage interest rate is 4% and your investments are generating a 6.5% rate of return, it makes more sense to invest your money rather than use it to make additional mortgage payments.
The 4% Retirement Withdrawal Rule
This rule was developed in the 1990s. It essentially says that you’re ready to retire when your savings will last for 30 years if you plan to withdraw 4% of your retirement savings the first year and a similar amount, adjusted to inflation, over the remaining 29 years.
However, many financial planners say this formula doesn’t fit all retirement situations and doesn’t take into account a fluctuating market. Retirees also don’t spend consistently over the course of their retirement—they tend to spend more in the early years when they are traveling and marking off experiences on their “bucket list.” Spending may drop as retirees settle down or increase if health issues arise.
A better strategy is to consult with a financial planner about a safe withdrawal strategy based on your circumstances and plans for your senior years. For example, a plan could be built around your required minimum distributions, or you could calculate what you need to cover basic living expenses and then factor additional money into your budget for travel and other expenses.
You Need $1 Million in Savings
Saving $1 million has been the longtime gold standard for retirement, but more recent estimates from the Bureau of Labor Statistics have increased that estimate to $1.5 million per family. Reasons for the increase include a drop in pensions, which previously could be relied upon to supplement retirement savings; inflation; and longer lifespans. Many people are in retirement for three decades or more.
Retirees Spend Less
Retirement doesn’t necessarily cause your spending to decrease. Traditional guidelines state that retirees should plan to spend between 75% and 85% of their current budget, but that estimate doesn’t always hold true.
The best way to map out retirement spending is to make a retirement budget, estimating what you’ll spend each month when you stop working. You may delete some budget items, like commuting costs, but you may take on new expenses with more travel or new hobbies. Creating a retirement budget will help you avoid an unexpected surprise if your spending in retirement doesn’t drop.
Social Security Withdrawals Should Begin at a Certain Age
Conventional wisdom has advised everything from withdrawing benefits immediately when you become eligible at 62 to delaying until you reach 70. In reality, the ideal age to begin claiming Social Security benefits depends on your individual situation.
The best time for you to claim benefits will depend on your retirement budget. For example, if you begin withdrawing at age 62, your monthly benefits will be reduced because you haven’t reached your full retirement age, which will range between 66 and 67, depending on your birth year. If you wait until your full retirement age, your monthly check will include a bonus.
Retirees with comfortable savings may choose to withdraw early for extra spending cash, while people who know they will need help with income later in retirement may want to hold off so their monthly check is larger. Your health may also be an issue—people in good health who think they will live a long time may want to delay claiming benefits, while those who are in declining health may benefit more from larger checks now.
Regardless of your situation, it’s wise to consult with a financial planner about your retirement plan to make the most of the options available.
During economic crises, it can be instinctive to change course with your finances as uncertainty and perhaps even panic set in. However, it will benefit you financially to avoid making quick decisions about your money, particularly during a recession. Financial stability, especially during the COVID-19 pandemic, will reduce stress on your family and keep you moving toward your financial goals.
Here are some sound options for managing your finances during the pandemic.
Pad your emergency savings
While the pandemic has hurt many aspects of the American economy, personal savings rates have soared. CNBC recently reported that the US Bureau of Economic Analysis showed a personal savings rate (the percentage of disposable income that people save) of 33 percent in April, the highest it’s been since the 1960s, when the agency began keeping track. Nationwide stay-at-home orders have encouraged savings, as people have drastically reduced their spending on travel, shopping, and entertainment and eating out.
If you continue to have a steady income, this is an excellent time to build an emergency fund for situations ranging from job loss to an unexpected medical bill. Financial experts recommend saving between three and six months of living expenses to make sure that you can weather unforeseen hardships, including the pandemic if it stretches out.
A good place to start would be saving any lump sum of money you receive, such as a tax refund, work bonus, or a commission. You could also decrease the amount you contribute to your 401(k) temporarily and move the difference into your emergency fund.
Adjust your budget
Millions of Americans have been affected by COVID-19 shutdowns, whether they have been furloughed, laid off, or experiencing a reduction in wages. The economic fallout is far from over, so even those who have yet to be impacted by COVID-19 could as companies examine their long-term revenue and adjust their plans in the coming months.
Regardless of your job situation, this is a good time to make adjustments to protect yourself against job loss or wage reduction. You can think through your long-term income potential and job security and consider ways to insulate your family from income loss as the impact of COVID-19 unfolds over the coming months and years. You may also want to make your budget more conservative, increase your savings, and reduce non-essential spending.
Look at payment reduction options
While your income may seem stable now, that may not be true a few months down the road as the economic crisis stretches out. To be prepared for financial difficulties, familiarize yourself now with programs that allow for payment deferment or reduction on key debts.
Mortgage payments: If a time comes when you can’t make your mortgage payment, call your bank. Many states will allow property owners to take a “holiday” from mortgage payments if their cash flow has been impacted by COVID-19. Lending institutions may allow you to postpone payments without incurring late fees, extra interest, or a negative impact on your credit score.
Credit card payments: In the wake of COVID-19 financial hardship, many credit card companies are offering relief to their clients in the form of lower interest rates, reduced fees, and delayed monthly payments. Contact your credit card company for details about their COVID-19 relief plan.
Federal student loan payments: The US Department of Education currently has reduced the interest rates on federally-backed student loans to 0 percent for a minimum of 60 days, and graduates can also take a break from payments for at least two months if they call 1-800-4FED-AID and request it.
Reconsider your real estate
Your biggest monthly budget item is likely your rent or mortgage. Financial setbacks, such as a job loss, can become severe if you can’t pay it. If you’re a renter and you’re anticipating or experiencing a financial hardship, ask your landlord for a temporary reduction in your monthly payment or if you can apply your security deposit toward rent. In a more extreme scenario, you may need to get out of your lease early and move to a more affordable rental.
If you’re a homeowner, call your bank and ask for mortgage relief, such as deferred payments or temporarily paying interest only on your mortgage. With interest rates extremely low, this may be an ideal time to refinance your mortgage to decrease your payments or shorten your loan terms so that you can pay it off more quickly.
Is it time for more investments?
While your inclination may be to save right now, you may be missing out on excellent investment opportunities. Many stock prices are low, making it a good time to enter the long-term investment market or temporarily increase contributions to your 401(k). Bear markets have rebounded above average for several years, a historic trend that could play out again when the COVID-19 recovery begins.
As with any risk, however, caution is always advised. Before you step further into the market, make sure you have a generous emergency savings fund, stable expenses, and job security.
The Coronavirus Aid, Relief, and Economic Security (CARES) Act—federal legislation that was passed in March to provide relief to Americans struggling economically due to the coronavirus pandemic—offers an enticing option for withdrawing money from employee retirement accounts.====
Here are two ways that 401(k) holders who can show that they have been impacted by the coronavirus outbreak can access these accounts due to the CARES Act:
- Account holders can withdraw as much as $100,000 from their 401(k) accounts through the end of 2020. While they will be not be assessed the 10 percent early withdrawal fee that is typically applied to account holders ages 59½ and younger, they will have to pay taxes on the withdrawal over the course of three years.
- Account holders can also borrow up to $100,000 (double the typical $50,000 allowance) from their 401(k) until September 22 with their employer’s consent.
Some Americans are taking the government up on this offer, as many live paycheck to paycheck and have felt pressure to dip into their savings. The CARES Act took effect in late March, and since then, more than 370,000 people have withdrawn money from their retirement accounts, according to Fidelity. The average withdrawal was $13,000, but as many as 8,500 have borrowed the full $100,000 from their 401(k)s.
While this may seem like an effective stopgap measure during a difficult economic time, withdrawing money from your 401(k) early is not a decision to take lightly because it could significantly impact your long-term retirement plans. Here are some issues to think through before pulling money out of your 401(k).
The Long-Term Impact
Even if you pay yourself back after your economic situation improves, taking money out of your 401(k) early, even temporarily, will negatively impact your long-term savings.
Boston College’s Center for Retirement Research has determined that withdrawing money early from your 401(k) can reduce your retirement wealth by as much as one-fourth, according to a report from MSNBC. The reality was borne out during the economic downturn in the late 2000s, when people also made early withdrawals from their 401(k)s. By 2019, people who had sold their stock in 2008 had an average balance of $275,000 in their 401(k)s, while those who had not sold stock averaged $360,000 in retirement savings, according to Fidelity.
MSNBC offered the following example: A 60-year-old who earns $60,000 annually has contributed 9 percent of her earnings to her 401(k) annually for 30 years with an annual return of 6.5 percent. When she retires, she will have a savings of $675,000.
However, if she had withdrawn $40,000 when she was 40 years old due to hardship, her savings would be reduced to $480,000 at retirement.
Additionally, 401(k) balances are down across the board due to market declines. That means withdrawing money now will lock in losses, never giving that initial investment time to recover when the market improves.
Impact on the Workplace
In a recent Forbes survey on how the pandemic is affecting retirement planning, 11 percent of respondents said that they were planning to work longer to offset financial shortfalls. The majority of these individuals were 45 to 54 years old, while respondents aged 18 to 24 were the least likely to say they planned to extend their working years.
In some cases, longer working years may be attributed to changes in how employers are contributing to their employees’ 401(k) accounts. About 4 percent of respondents said their employers had stopped matching contributions during the pandemic—a number that could grow as pandemic shutdowns continue.
A Way Forward
If possible, financial advisors recommend staying calm during a crisis and focusing on long-term savings goals. historically, the ups and downs of the market tend to balance out over time. For example, between 2007 and 2012, 401(k) account balances grew an average of 12 percent annually, according to the Employee Benefit Research Institute. Reacting to market downturns by selling investments, decreasing contributions, and making early withdrawals can result in lower balances at retirement.
It’s particularly risky to borrow from your 401(k) at times of high unemployment (currently, 40 million people are out of work) because you are much more likely to be able to repay a loan when you have a job than when you don’t.
However, if you need to borrow from your 401(k) to pay bills during the pandemic, you do get a break on repayment. The CARES Act gives some borrowers a year before they must begin repayment. However, if you don’t repay the loan in five years, it will be considered a withdrawal, complete with a 10 percent penalty plus tax.
If you can stay the course, keep making monthly contributions to your 401(k) and, if possible, make additional contributions. Since so many businesses and entertainment venues are closed, Americans are spending less and saving more, making this a great time to put some of that extra money into retirement savings.