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An Example of Using the New Reverse Mortgage

Imagine you have a retirement account valued at $1 million, where you take a monthly distribution of $3,000.  If the market (and your account) declined 30%, that monthly distribution will become a real strain on your account.  What was originally a 3.5% rate of withdrawal would increase to a risky 5.1% rate of withdrawal.

Now imagine the same situation, but that you had a reverse mortgage.  Instead of tapping your retirements account when it is down for the year, you took your monthly distribution out of the equity in your home, thus preserving the value in the 401(k).  Because the income received through the reverse mortgage is tax free, you could take out less than you would have from your retirement account (subject to any required minimum distributions).

In some of the research we are monitoring from the Journal of Financial Planning, we are seeing these coordinated withdrawal strategies as a significant tool to improve the probability of maintaining one’s current lifestyle through retirement. Research is showing that it can extend retirement spending out another 10 years or even more.

(Some readers may think about using a reverse mortgage to take equity out of their home to invest it in the stock market.  We strongly discourage that kind of thinking.)

Reverse Mortgages, like social security, annuities, life insurance, retirement accounts, and brokerage accounts, are all tools with good and bad features.  The ideas and research being done by the academics around reverse mortgages used in coordination with other tools are very promising.  In the next 5 years, I wouldn’t be surprised if the reverse mortgage concept became a common tool used in most retirement plans.

 

Five Creative Uses for a 529 Plan

What should you do if you have extra money in a 529 College Savings Plan? Perhaps it’s left over funds used to pay for a child’s education or perhaps the child has opted not to go to college.

The common options are to change the beneficiary (to a different child or relative). But that may not be practical. Below are a few interesting ideas I’ve stumbled across over the years:

Outward Bound (Website)– This outdoor educational institution teaches people of all ages about wilderness expeditions and training. Many of their courses accept payment from 529 plans. (Details)

Study Abroad – There are examples of some people taking an educational trip abroad through a university. If set up correctly, funds from 529 can be used. (Details)

The Culinary Institute of America (Website) – One of the most respected cooking institutes in the world allows most of their college course programs to be paid for using money from a 529 plan.

Pursue a hobby – An example in this article references an individual who started a small maple-syrup farm. He wanted to learn a lot more about the science behind what he was doing and ended up taking horticulture classes at his local community college. (Details)

Go to graduate school – Maybe the children are done with undergrad. In that case, maybe they will eventually go for a master’s degree. The 529 can be used for that too.

The New Reverse Mortgage Strategy

In a recent post, I tried to dispel some of the common myths surrounding reverse mortgages that have been written since April 2015.  In this post, I will explore how the Reverse Mortgage could be used.

Instead of thinking about a reverse mortgage as a last resort after all other assets have been depleted, think about it in conjunction with your other investments and working in tandem with your 401(k) or IRA and your other investments.

The basic premise behind a reverse mortgage is that it’s a product designed to tap an illiquid investment – your home.  For many Americans, it is still one of the biggest assets they own.  When it comes to using a reverse mortgage to tap the value of the home, there are four options:

1)      Lump sum payment

2)      Annuity-like stream of income guaranteed for as long as a borrower lives in the home.

3)      Fixed payment over a fixed number of years

4)      Line of Credit (that grows at a variable rate) that is accessible as needed

It’s option four, the line of credit, that has become most intriguing. The idea is to apply for a reverse mortgage in the early years of retirement and leave it alone for the most part.  You take on the line of credit long before you actually need it because the line of credit will grow over time.  If held long enough, the line of credit could exceed the value of the home.  The line of credit grows, even if the value of the home does not. But the homeowner or the estate would only be on the hook for at most 95% of the value of the home because a reverse mortgage is a “non-recourse” loan.

On top of the flexibility it brings, there are tax benefits too – draws from a reverse mortgage are not taxable.

(Some readers may think about using a reverse mortgage to take equity out of their home to invest it in the stock market.  We strongly discourage that kind of thinking.)

This is a compelling new tool that could provide innovative solutions for many retirees.  Research is showing that it can extend retirement spending out another 10 years or even more.

Whatever You Thought You Knew About A Reverse Mortgage You Should Forget

Whatever you thought you knew about a reverse mortgage you should forget.  Here’s why:

1)            The common strategy of using a reverse mortgage after all other retirement income options have been exhausted is a recipe for disaster. Dangling a carrot in front of an elderly couple or a widow saying “You can live in your home and we’ll even pay you” has misled many people who were shocked to learn that they still needed to pay their property taxes and maintain the house, even though they didn’t have the resources to do so.  In some cases, it resulted in the elderly couple being forced out of their home.  Bottom line, the timing strategy failed the client, not the mortgage itself.

2)            In 2013, the federal government enacted the Reverse Mortgage Stabilization Act which refined regulations around these products to make them better for the retirees.  The government stepped in to make sure the products are being used responsibly.  The provisions of “the act” were fully implemented by April of 2015. Reverse Mortgages written after that date are much different than the ones written earlier.

Reverse mortgages shouldn’t be thought of as a last resort.  Rather, it should be treated as a tool and component of an overall financial plan, which we will address in future posts.  Lot’s of academic research about how these products could actually enhance overall returns regardless of your financial situation, is happening as we speak.

How To Save, When You Can’t Save Today

“ I want to save for retirement, but I can’t afford to do so right now.”

This is a common complaint we hear, especially with our younger clients. They are dealing with debts, saving for their children’s education, and even helping to take care of their aging parents. These younger clients want to save for retirement but just don’t know what to do.

So, what should they do?

Over the last few months I have written about this concept extensively:
Is a Creative Saving Strategy Right For Me?
The Most overlooked Saving Strategy: The Serial Payment
The Three Flaws With The Most Popular Saving Strategy

The strategy that I outline is to come up with a plan to consistently save more and more every year. Perhaps you save an extra 1% of your paycheck each year, or every year allocate a portion of your raise to retirement. This concept is also referred to as Saving For Tomorrow, Tomorrow and there is a great Ted Talk about it here.

If you’re on board with this concept, visit this New York Times calculator to see how this could work for you: One Percent More Calculator

Einstein is claimed to have said that “Compounding interest is the eighth wonder of the world”. And by combining the benefits of compounding interest and compounding savings into a retirement plan, it would make for a much, much more powerful strategy.

We Don’t Pay Much In Taxes?

We like to complain about high taxes. We all do. The thought of the government taking “our” money drives us crazy. With the election right around the corner, we may be thinking about the effects on our pay checks due to a new president.

Most of what I read about income tax rates deals with the ultra-rich and the highest tax brackets. For example, I’ve read about top tax brackets in the 1940’s and 1950’s where the top earners had a 90% tax on the income in that highest bracket. To be clear, to reach that bracket, they would have needed to earn about $20 million per year. While interesting, it doesn’t apply to most Americans.

But what if we went back in time? Would we be paying more or less in taxes assuming our income was adjusted for inflation? I spent some time researching the details.

I have bad news for many of you: Your tax rate is among the lowest rate ever!

If you earn $100,000 today, you pay an effective tax rate of about 17%. But looking back between the 1940s and the 2000s, that effective tax rate was around 25%. You would have to go all the way back to the 1930’s to find an effective tax rate lower than what you pay now. Before 1940, there were many cases where the tax rate was between 2-5%.

See for yourself:
This calculator can highlight how much your income would have been taxed over the last 100 years

Republican or Democrat: Historically, Which Party Does a Better Job Growing Your Investments?

Republicans and Democrats each make strong and compelling arguments as to why their approach and strategy will be better than their opponent. The media, think tanks, and experts are constantly making solid arguments for one candidate or the other. And in many cases these arguments and research findings conflict with each other.

Conventional wisdom suggests that a Republican President will do a better job helping businesses grow, which will in turn increase the return on your investments. Yet, the Democrats have released some interesting information that suggest otherwise.

Lots of research supports the idea that the stock market (and your investments) do better when the incumbent party keeps the office. And yet, there seems to be many exceptions to that statistic when one factors in market volatility or look at a wider time frame.

So how do we as investors and voters determine if it’s better to have a Democrat or Republican in the White House when everything appears to be shades of grey?

If there’s no clear research showing that one party is better for the stock market than the other, chances are there is no statistically significant correlation. In other words: The presidential election itself has little bearing on investment performance. And all of these headlines, articles and research we read pushing one candidate over the other may just be marketing fodder.

Here are a few strategies to keep in mind over the next few months:

  • Expect volatility as the election draws near. The markets do not like it when there are looming questions about the future direction of the country. Most likely this volatility is short term and will clear up as investors digest the implications of one president over the other. This will be especially true if the candidates target a particular industry (such as health care or defense)
  • Remember you are a long-term investor. Much of the noise and headlines will not have a long term impact on your investment future.
  • Stay the course with your investment strategy. The candidates, their respective parties, think-tanks, experts, pundits and the media will try very hard to rattle your cage to sway your opinion and to get your vote. They will use fear tactics or they will paint rosy pictures of the future. And unfortunately, many investors will make poor investment choices prior to the election. They will move to cash if they are afraid or they will move into an asset class they believe will soar if their candidate wins.
  • Any significant policy changes will take months to develop and potential a year to roll out.

How to Deal With the 2016 Presidential Election and Your Portfolio

It’s tempting to position your portfolio to take advantage of new policies being proposed by a new President before they have been elected or shortly after their election. Evidence suggests it’s better to wait instead of trying to time the market.

Here are a few strategies to keep in mind over the next few months:

  • Expect volatility as the election draws near. The markets do not like it when there are looming questions about the future direction of the country. Most likely this volatility is short term and will clear up as investors digest the implications of one president over the other. This will be especially true if the candidates target a particular industry (such as health care or defense).
  • Remember you are a long-term investor. Much of the noise and headlines will not have a long term impact on your investment future.
  • Stay the course with your investment strategy. The candidates, their respective parties, think-tanks, experts, pundits and the media will try very hard to rattle your cage to sway your opinion and to get your vote. They will use fear tactics or they will paint rosy pictures of the future. And unfortunately, many investors will make poor investment choices prior to the election. They will move to cash if they are afraid or they will move into an asset class they believe will soar if their candidate wins.
  • Any significant policy changes will take months to develop and potential a year to roll out.

Why We Shouldn’t Mix Politics and Investing?

We can’t help but hear about the election on the news. And when it comes to each candidates economic policies, we are quick to imagine how it will affect our investments. We assume that Trump’s determination to bring jobs back to the US could boost US stock prices and perhaps hurt foreign stock prices. We think that because Clinton has talked about reform on Wall Street, that financial companies would be hurt if she were elected President.

But the connection isn’t as clear as the media makes it out to be. Both politics and the markets are very complex systems with many, many moving parts. We are quick to arrive at various conclusions as to cause and effect. Or quick to identify patterns. In reality, it’s nearly impossible to predict how presidential policies will affect the stock market. We may think we see a pattern or understand cause and effect, but there could be more factors contributing to the expected outcome

All of these thoughts can be connected to a set of common investing errors that are discussed in a growing field of behavioral economics. The following article does a great job of capturing some of these elements

Why Your Instincts Are Hurting Your Investment Returns?

Imagine your reading this post in a busy coffee shop. All of a sudden you look up and see people running out of the shop. What do you do first? Chances are, you get up and follow everyone else. You might not even know what’s going on at first. Are you getting away from a dangerous situation, such as a fire in the coffee shop? Or is everyone running toward something or someone, such as a celebrity?

This is an instinctual reaction. There is perceived safety in numbers. It goes back to some of the earliest known ancestors and can be seen in many animal species today.

If we dig into this a little deeper, it’s actually a mental short-cut (technically called a “heuristic”) . In the coffee shop example, you didn’t have time to take stock of the situation to understand what’s occurring. Instead, you relied on actions of others and assumed they were making the right decision. It worked well for our ancestors and it continues to work well for us today. Except….

Except for when it comes to investing. Assume you’re watching the news and all everyone is talking about how XVZ stock is doing “great” and “everyone” is buying it. Unfortunately, the average investor will want to get in on it. They follow the hearding behavior of others and buy XYZ simply because “everyone” else is doing it.

That’s precisely the wrong time to be buying a stock, yet it’s so difficult to overcome this instinctual response. This is even more difficult when stock prices are declining and investors hear about so many people selling out of their investments. The instinctual response to follow the crowd kicks in. The investor will feel better and maybe safer knowing they are doing what everyone else is doing. But evidence clearly shows it to be a poor decision to follow the heard of other investors.

This is an example of our instincts working against us. Instead of reacting to the news, take a minute to take stock of the situation, assess what is going on, consult with your financial advisor, and understand how your decision to buy or sell an investment will affect your likelihood of reaching your financial goal.