Student Loan Series: Refinancing Private, Variable Rate Loans

https://www.cafecredit.com/

https://www.cafecredit.com/

I, like 44.2 million other Americans, have student loan debt. Student loans are a fact of life for 77% of graduates from a four-year institution. So if you also have student loans, you are far from alone. Now that you hopefully feel slightly better about your debt, how can we make a plan to pay it off?

Below is one of the multiple scenarios that you may find yourself in as a graduate with student loan debt.  If this situation doesn’t apply to you, stay tuned.  I’m going to be addressing several scenarios over the course of the student loan blog series.

Check out Scenario #1: Jane has the following student loans financed through Citizens Bank. So they are private, not federal like Stafford Loans, for example.

At first glance, it looks like she received a good deal from Citizens considering that her highest interest rate is 4.00%.  Let’s pause though and consider that interest rates have been historically low since 2008, and we are now in a rising rate environment. That means if and when interest rates rise, so will the variable rates on Jane’s loans. And the cap on this increase is often high. In Jane’s situation, she has a couple of options.

1. Stick with her current loans.

She needs to be relatively comfortable with uncertainty and confident that interest rates aren’t going to dramatically increase. She also needs to be able to make monthly payments that are higher than she pays now when the rates increase.

2. Refinance to a fixed rate now.

Lock in a fixed rate that will be higher than these variable rates but most likely lower than Federal Direct Loan fixed rates. This will increase her monthly payment now but will save her from paying higher monthly payments if the rates rise.

3. Stay the course for now, but refinance to a fixed rate in the future.

If rates start to rise and she becomes uncomfortable with the payment amounts, she can always refinance to a fixed rate.  This fixed rate will be higher than in option 2, but she will have benefited from the lower variable rates for the time she waited.

When trying to decide which option is best for Jane (or you), I would recommend quantifying it. How much can you afford to pay each month in student loan repayment? Enter your loan information into a student loan calculator, such as this one on Bankrate, and see how a rate increase would affect your payment amounts. If there is a rate that will no longer fit into your budget, then avoid it by locking in a lower fixed rate before you get to that point. 

If I were speaking with Jane, I would advise her to go with option 2 – lock in that low fixed rate now. It eliminates the risk and avoids having to perfectly time refinancing later.  It’s important to choose a strategy that fits your needs and risk aversion though. So factor in your budget and your personal preferences but also think beyond today. In 3 years, you may take on a new financial burden, such as a home or paying for a wedding. Your job may be in jeopardy, or you may choose a position that pays less money. Consider those possibilities, and choose an option you can stick with to pay down those private student loans.

 

This is a hypothetical example and is for illustrative purposes only. No specific investments were used in this example. Actual results will vary. Past performance does not guarantee future results.
 

Obamacare and the Penalty of Marriage

Back in my grandmother’s childhood, marriage was very important. If you were not married by a certain age you where looked down on, considered an old maid. In today’s world, many feel that marriage is a piece of paper. Not a deciding factor on how in love with a person you are. Many couples decide to live together for years before marriage even becomes a topic of discussion.

It is important that we are educated and knowledgeable about aspects of marriage before we decide to take the plunge. However, when deciding whether to get hitched or not I bet no one thought of the tax implications marriage could have. One that many people are unaware of is the Obamacare tax credits.

In the United States there is something called a “marriage penalty”, since 1971 this penalty has forced married couples to pay more in taxes than people who were not married. This means that married couples making 400,000 a year could save 27,000 annually if they decided to divorce and file separately. Who would have thought that marriage would still be costing us money after the I Do’s where done!

Even though, Obamacare insurance tax credit and subsidies are taking effect and the tax credits are not something to be taken lightly. This means that there is an even greater marriage tax as a result of the Affordable Care Act. This tax credit is not based on assets but instead taxable income. This makes it easy for even the wealthy clients to qualify for the Obamacare tax credit. 

If you are not married the subsidies range from 0 to around 7,840 per year for someone with less than 46,000 dollars in taxable income at 62 years old. For a married couple however, the subsidy is around 11,000 dollars but the couple would be disqualified if their income is more than $62,041.”

This raises an issue for the couples who are earning at or somewhere near the cutoff level. If they reduce taxable income that could help, or they could divorce and file separately. If they took the divorce path they would save 11,028 dollars per year or about 900 dollars per month. However this is  only if they make under $46,000 on an individual basis.

So how do you know which option is best for you and your family?

If you want to see for yourself CLICK HERE for the marriage bonus and penalty tax calculator.

But the best course of action is to discuss your questions and concerns with your financial advisor

5 Common IRA Misconceptions

Although some IRA planning and investment strategies appear simple, they can become expensive and time consuming if implementation errors are made. Your clients could pay unexpected taxes or penalties, their IRAs could lose tax-exempt status, or their beneficiaries could experience difficulties when inheriting IRA funds. To help your clients avoid these issues, here are five common IRA misconceptions to keep in mind.

Misconception #1: Naming an IRA Beneficiary Is Simple

It’s true that naming a beneficiary is among the easiest tasks when opening an IRA. But if your client fails to review beneficiary information regularly or plan ahead, it can lead to problems.

Spouse named as the IRA’s primary beneficiary. This provides many options when the beneficiary inherits the funds. But when a client divorces or a spouse dies, the client must update the beneficiary information. Otherwise, if the client passes away, a former spouse could be entitled to the decedent’s assets, causing legal headaches for the intended IRA beneficiaries.

Estate named as the primary beneficiary. Generally, the intention here is to let the will or trust document decide how assets will be distributed, but it can prove costly. An estate beneficiary has no age or life expectancy, leading to fewer distribution options. For example, beneficiaries determined by the estate could be forced to deplete IRA assets within five years or take distributions over the decedent’s life expectancy because they couldn’t use their own. This would result in larger distributions and potentially higher taxes. Plus, if your client leaves assets to the estate, the probate court would include the estate in the decedent’s total assets—opening the door to creditors’ claims.

The informed choice. Help your clients understand the pros and cons of their options, and reconfirm beneficiary information in their annual reviews. In addition, whenever there is a major life event, remind clients to make any necessary changes to beneficiary designations.

Misconception #2: You Can Borrow from Your IRA

Loans are not permitted from IRAs, although clients may take advantage of the 60-day rollover rule.

Under IRS regulations, clients may withdraw assets from an IRA and roll over all or a portion of that withdrawal back into the IRA within 60 days. This is allowed once during a 12-month period. Straightforward, right? In reality, the 60-day rule has caused issues for countless clients who didn’t execute the rollover properly:

  • Clients complete the rollover after the deadline. The rollover into the IRA must be completed 60 calendar days after clients receive the distribution. Holidays and weekends count among the 60 days, a fact overlooked by many who consequently miss their deadline.
  • Clients violate the once-per-year rule. The IRS counts the number of distributions taken within the 12-month period, not the number of contributions into the IRA. Sometimes, clients take two separate distributions and roll over both into the IRA as one payment, thinking the IRS will count this as one 60-day rollover.
  • Clients break the same-property rule. When a client takes the distribution of a stock or bond, for example, he or she must roll the same asset back into the IRA. It’s not uncommon for clients to withdraw a bond, sell it, and roll over the proceeds from the sale of the bond into the IRA instead of the bond itself.

The informed choice. Clients should exhaust all external options before borrowing from an IRA. If they decide on a 60-day rollover, be sure that they understand the process, including the taxes and penalties on failed rollovers.

Misconception #3: Backdoor Roth Conversions Are Always a Good Idea

To contribute to a Roth IRA, a client’s modified adjusted gross income cannot exceed specific income thresholds. To work around this, advisors sometimes recommend that clients fund a Roth with a backdoor conversation. This involves making a nondeductible, post-tax contribution to a traditional IRA and immediately converting the amount to a Roth IRA because there are no income limits for this conversion. If your client has no other IRAs, this strategy is worth considering.

But what if your client has an IRA rolled over from a previous employer? Can he or she isolate the contribution to the traditional IRA and convert it to a Roth? No! When assessing Roth conversions, the IRS requires all IRA assets to be aggregated and treated as one account. This means that your client’s pre- and post-tax IRA assets will be lumped together, and only a certain percentage of the recent conversion would be tax-free.

The informed choice. Clients should review all aggregate IRA assets before considering the backdoor option. If your client is in a high tax bracket, this strategy may not be the best option.

Misconception #4: Funding a Start-Up with an IRA Makes Sense

Another commonly considered strategy is the “rollover as business start-up” (ROBS), which invests IRA assets to back a new venture.

To fund a start-up, an individual establishes a C corporation. The corporation then sets up a retirement plan, which offers employees the option to purchase company stock. The owner rolls his or her IRA or 401(k) from a previous employer into the new retirement plan and uses these assets to purchase the start-up’s stock. The business now has the capital to operate.

Although each step is generally acceptable, ROBS has been garnering increased IRS scrutiny and may potentially be viewed as a prohibited activity. Why? 

  • The business owner pays him- or herself a salary, even though he or she is among the disqualified persons whom the IRS says cannot benefit from ROBS in specific ways. The IRS may see the salary as a transfer of plan assets for the employer’s benefit, which is prohibited.
  • The purchase of company stock is available only to the employer. With a C corporation, the option to purchase company stock must be available to all employees.
  • The valuation of the employer’s IRA assets at the time of purchase is inaccurate. This could affect clients who are taking required minimum distributions (RMDs). An inaccurate valuation of the purchase could lead to taking less than the correct RMD amount.
  • Promoter fees are part of the deal. Some franchisors hire promoters to reel in potential ROBS candidates, such as your client. If the promoter is a fiduciary, the payment of promoter fees from plan assets could be considered a prohibited transaction.

The informed choice. Help your clients reconsider this strategy. The violations could lead to hefty IRS taxes and penalties for your client, and it could significantly deplete your client’s retirement assets.

Misconception #5: Investing in Real Estate Within an IRA Is a Good Opportunity

An IRA owner has multiple options for investing account assets, including buying mutual funds, individual stocks, and bonds. One risky investment strategy is purchasing real estate within a self-directed IRA. Although the potential to generate income from rent and capital gains on the property is attractive, numerous prohibited transactions could result. Here’s what your client should know if considering such an investment: 

  • The property cannot be used by disqualified people—including any fiduciary to the plan, the IRA owner, and direct family members.
  • Expenses directly related to the real estate must be paid with the IRA’s assets.
  • Management and maintenance of the real estate must be handled by the account’s custodian.
  • IRA assets must be valued and reported to the IRS annually. Real estate investments are generally illiquid, and their value can’t readily be assessed, which could lead to inaccurate reporting to the IRS.

 

 

 

April Is Financial Literacy Month

Did you know that April is Financial Literacy Month? This is a great time to get serious about planning for your financial future. One way to plan and keep track of your Social Security benefits is to check your Social Security statement. 

You can access your Social Security statement instantly online and get information such as estimates for your retirement, disability, and survivors benefits. You can also review the amount of Social Security and Medicare taxes you’ve already paid.

Because Social Security bases your future benefits on your recorded earnings, you should check your statement at least once a year to be sure the amounts recorded are correct. You may also want to check your statement when you have a change of employment.

Make sure you log in or create a My Social Security account today at www.socialsecurity.gov/myaccount and plan for your bright financial future!

The End of Having Your Cake and Eating It Too – Social Security Edition

by Danielle Finnerty 

We’ve all heard the old saying, “You can’t have your cake and eat it too.”  While the validity of this statement has always been questionable to me, the use of the file and suspend strategy for receiving Social Security benefits bolsters the side of the argument that says this age old phrase is false. 

First, let’s review what this strategy actually entails, and I’ll insert the cake metaphor as I go.  To put it simply, a person exercising file and suspend files for Social Security benefits at full retirement age, then immediately suspends them (has their cake).  This suspension allows the primary worker to earn an 8% delayed retirement credit each year while also making his/her spouse eligible for spousal benefits (eats it too).  The person gets to enjoy the benefits of SS via his/her spouse while still growing their own benefit until later – having your cake and eating it too.  In this case though, the cake is something that you have worked for and paid into for your entire life, so it is probably more enjoyable than your standard, frosted sheet cake.

This practice of file and suspend will no longer be allowed though due to the passing of the Bipartisan Budget Act on Nov. 2, 2015.  This means that if the primary worker decides to suspend his/her benefits, all benefits paid to others based upon the same working record will also be suspended.  Thus, switching its support for the legitimacy of the cake statement to team true.

Here’s what you need to know:

You have some time! The new rules do not start immediately. 

If you are at full retirement age or will be within six months, you can still file and suspend until Apr. 29, 2016 when the rule goes into effect.  So if you fit into this age range, don’t worry too much, you still have time to meet with a Social Security rep, consult with your financial advisor, and make a decision.  Your cake options are still open.

 

If you are already receiving benefits through file and suspend, you will not be impacted at all.

If you have already filed and suspended, then you also don’t need to be concerned.  There will be no retroactive changes made to your filing status. The same goes for those who file and suspend during this Nov. 2nd to Apr. 29th waiting period; nothing will change about your benefits on Apr. 30th due to this Act.  You can keep proving the person who invented this cake statement wrong.

 

Individuals will also no longer be able to utilize file and suspend.

Currently, individuals who intend to delay taking benefits until full retirement age can choose to file and suspend in order to build up delayed retirement credits.  This strategy is used in case the person decides to change their plans and receive benefits before full retirement.  They could then go back and collect every benefit from the date they suspended in a lump sum.  This will no longer be an option.  Individuals are in the same cake-restricted boat as married couples and will no longer be able to use this technique.

 

The new legislation does not affect your ability to postpone receipt of your own Social Security benefits.

You can still take advantage of delayed retirement credits by postponing when you start receiving benefits.  Nothing about this strategy has changed, so you can still make the most of that 8% bump.

 

While this act does eliminate a commonly used Social Security strategy, you still have options to maximize your benefits and make them available to your spouse.  If you will reach full retirement before Apr. 29th, you have even more options and should make an appointment with Social Security and your advisor as soon as you can.  In the meantime, the question still remains – can you really have your cake and eat it too?

Commonwealth Financial Network® does not provide legal or tax advice.  You should consult a legal or tax professional regarding your individual situation.