A few key tips

Along with the excitement of a new baby comes a new financial reality.   CNN Money reported last year that the average cost for a middle-income American family to raise a child from birth to age 18 is $226,920.  And that doesn’t include the cost of a college education!

Below are some key issues to think about while you are waiting for baby’s arrival:

Life Insurance

Your first order of business should be to assess the amount of life insurance you and your spouse currently have.  Once you start a family, your need for life insurance becomes more dramatic.   If your spouse dies prematurely (or vice versa), you want to be sure you are covered for your salary, the mortgage, child care, and your child’s college education. 

Term insurance is typically less expensive and will provide coverage for a set number of years.  There is no cash value, however, at the end of the term.  Some parents keep their term policies in force until their children are out of college.  Other options include universal life and whole life.  Universal life is a hybrid of term and whole life insurance which provides flexibility in terms of premium payments and death benefits.   Whole life is generally the most expensive and can be used as a retirement asset or for estate-planning purposes.  There are pros and cons to each—your financial advisor can provide counsel.

Saving for College

529 plans are a great choice for saving toward your child’s college education.  Although your contributions are not deductible on your federal tax return, your investment grows tax-deferred, and distributions from the plan for educational purposes are federally tax-free.   Check to see if your state provides tax breaks as well—not all do.  When the time comes, the money can be used for qualified education expenses including tuition and mandatory fees, supplies and equipment, and room and board.  Assets in a 529 plan are controlled by you, the account owner, so if your child decides not to go to college, he or she does not have access to the account.  Also, 529 plan funds can be transferred from one beneficiary to another which adds a lot of flexibility to the plan.

Child Care

If both you and your spouse work, child care could take a chunk out of your monthly budget.  Most important, you and your partner must feel comfortable with the type of child care situation you select.  You can opt for so-called “family care,” where a child care provider cares for a number of children in her home; a day-care center; or a nanny.   If you decide to hire a nanny to care for your child at home, be sure that you pay your nanny “on the books” by completing the necessary paperwork and remitting the appropriate taxes for her.  Read our recent blog on the subject and consult your financial advisor.  You may want to consider enrolling in a Dependent Care Flexible Savings Account, if your employer offers one, to offset some childcare expenses.

Essentials for Baby

Let’s not forget the everyday expenses for baby supplies like formula, diapers, and clothes they seem to grow out of instantly.  These add up quickly.  Consider purchasing baby products in bulk from warehouse stores or via the Internet.  Some websites offer next-day delivery, free shipping, and rewards programs. 

Starting a family is one of life’s great joys, but is, by all accounts, a very expensive proposition!  By considering the financial implications beforehand, the inevitable costs involved—now and in the future—can become more manageable.

Decumulate Stuff; Accumulate Assets

This exercise helps you to create more space and peace in your home and enables you to make some money at the same time.  Spring is a perfect time to do this.

Decide what—and how—to dispose of what you don’t want.  Ask yourself:

• Do I need it?
• Will I use it?
• Do I love it?
• Do I have a place for it?

Ask yourself these same questions when you are evaluating a purchase. It will help focus your spending on things you truly do need and save you from having to declutter again in the future.

Selling Your Stuff

A garage sale can be a lot of work, but it is a good way to sell your things.  An advertisement in your local paper will typically attract potential buyers to your place from miles around.  If you are looking to sell the entire contents of your home or someone else’s, hold an estate sale.   In this case, you may want to hire a company to help you manage and coordinate the sale.  This will, however, eat into your profits.   Posting items for sale online to such sites as Ebay, Craig’s List, and Etsy, a lesser-known online marketplace for handmade items and vintage clothing, is another option. 

Giving to Charity

If you donate items to a qualified charity, you get a tax deduction in return, typically for the fair market value (FMV) of the item(s), which the IRS defines as “the price a willing, knowledgeable buyer would pay a willing, knowledgeable seller when neither has to buy or sell.”  In the case of household items, this is generally thrift shop value.  Any item you give away should be in good condition or better; anything broken, stained, or ripped should be discarded. 

If the FMV of your donations is more than $500, you must file Form 8283 with your federal income tax return.  If a single item has a FMV of more than $5,000, you must get a written appraisal from a qualified appraiser before you can take a tax deduction; and in certain cases, such as artwork valued at $20,000 or more, the written appraisal must be attached to Form 8283.

Going forward, consider this advice from organizational experts:

• Don’t save things “just in case”
• Don’t keep things out of obligation – a gift giver’s intent was to make you feel good about the item. If it is no longer serving that purpose, give it away
• If you are holding on to things that belonged to someone you love, keep a few items to honor them and let the rest go
• If the price is the best thing about an item, don’t buy it

Now doesn’t that feel better?  Purging yourself of excess possessions can actually be financially rewarding and refreshing.  Hopefully, it will make you think and lead to wiser, more practical buying decisions in the future.

By completing the necessary paperwork and paying the required taxes for your nanny, you are enabling her to show proof of employment.  This is key if your nanny wants to apply for a loan, show a work history to future employers, or obtain a credit card.  Keeping your nanny “on the books” also gives her the ability to collect unemployment insurance when you no longer need her to watch your children, as well as Social Security and Medicare benefits once she retires.

According to the IRS, your nanny is considered a “household employee” since you control what work she does and how she does it.  In addition to nannies, household employees can include housekeepers, maids, and gardeners.

The taxes you need to pay for your nanny are based on her income and include Social Security and Medicare as well as Federal Unemployment Tax (FUTA).   You, as the employer, must pay an “employer’s share” of Social Security and Medicare as well as FUTA on your own tax return.  You must also withhold  Social Security and Medicare tax from her paycheck or you can pay both her share and yours.   Be sure to keep a record — you’ll need it for her W-2.   

The nanny taxes you pay are counted as part of your overall taxes owed.  You may need to make quarterly estimated payments in order to avoid a penalty – your financial advisor can provide guidance.

The Necessary Paperwork

Before you withhold a dime of your nanny’s paycheck, you must file certain forms including: 

• Form SS-4 (hard copy or online).  Use this form to formally apply for an Employee Identification Number (EIN).  This EIN is your ID number, as an employer, with the IRS. 
• Forms W-2 and W-3.  If you pay Social Security and Medicare wages of $1,800 or more, complete a W-2.  Keep a copy, give one to your nanny and send a copy with the W-3 to the Social Security Administration.
• Form I-9.  This form documents your nanny’s eligibility to work in the U.S. and her Social Security number.
• According to the IRS, you are not required to withhold Federal income tax from wages you pay to a household employee.  You can, however, withhold the tax if she asks you to (and you agree).  In this case, you will need to complete Form W-4, Employee’s Withholding Allowance Certificate.  Your tax advisor can provide guidance as to whether you need to pay any state tax for your nanny.

Workers’ Compensation Insurance

Be sure that you obtain a workers’ compensation insurance policy to cover your nanny in the event of any accidents that may occur while she is working in your home.  Workers’ comp is not covered by most regular homeowner’s insurance policies.   Each state has its own requirements for workers’ compensation insurance, so be sure to check.  

Although it sounds involved, once you know the rules and implement a system for withholding and paying your nanny’s taxes, the whole process should run smoothly.  Your tax advisor can help you navigate the requirements and outline what you need to do and when.  There are also online “nanny tax” services that can assist you — for a fee.

As a refresher, tax-exempt bonds are generally free from federal income tax.  In addition, if the bond is issued by your home state, it is usually free from state tax as well.  Similarly, if the bonds are issued by a local municipality e.g., New York City, they are usually tax-free for city residents who purchase those bonds.   There are several different types of tax-exempt bonds, including General Obligation (G.O.) bonds that are backed by the credit as well as the taxing authority of a municipality; and revenue bonds, supported by the income generated by the issuing utility, service, or project. 

Tax-exempt bonds are rated by the rating agencies (Standard & Poor’s, Moody’s, or Fitch) according to their creditworthiness.  Some tax-exempt bonds are insured by a third-party insurer, which automatically boosts their rating to AAA — the highest — since the repayment of all the principal and interest is guaranteed to the bondholder, even in the event of the issuer’s default.   Insured bonds usually have a lower yield than comparable uninsured bonds.

Taxable bonds, on the other hand, are subject to federal and state tax and are typically backed by the issuing company’s future income.   Similar to tax-exempt bonds, the credit quality of corporates is rated  by the rating agencies and generally speaking, their yields are most often higher than tax-exempt bonds.    However, in order to do an ‘apples to apples’ comparison on the yields of taxable vs. tax-exempt bonds, you must factor in the effect of income taxes.

Use This Mathematical Calculation

There is a longstanding formula that has been used by advisors and investors to determine the taxable equivalent yield of a tax-exempt bond:

Taxable Equivalent Yield = Tax-exempt yield / 1 – [tax bracket] 

For example, if the tax-exempt yield of the municipal bond you are looking at is 4% and you are in the 25% tax bracket, this is how the formula would work:

4%/1-0.25 = 5.33%                                    

So a comparable taxable bond would have to yield 5.3% to equal the return of a 4% tax-exempt bond.

In general, tax-exempt bonds will be beneficial for investors in higher tax brackets.  There’s more than meets the eye, however, than the underlying yield of a bond.  Your financial advisor can provide guidance about which bonds are best for your portfolio considering your specific situation and goals and your income.  

Life insurance can be used for many purposes –wage replacement, your mortgage, children’s college educations, and estate planning. 

To briefly review, group insurance is typically provided by your employer.  It could be a multiple of your salary – whatever multiple your employer deems appropriate.  If you purchase additional insurance on your own in the form of whole life, you keep making premium payments and have coverage for life (usually defined as age 95).  The proceeds, upon your death, pass to your beneficiary and can be used for any purpose.  Term insurance is generally less expensive than whole life and provides coverage over a certain time period.   In the event of your death, a death benefit is paid, but once the contract period expires, the policy must be renewed (if still needed), usually with a new, higher premium.

If You Lose Your Job, You May Lose Valuable Insurance Benefits

Some employees, most notably, senior executives, are given group insurance as part of their overall benefits package.   For example, you may have a total of $3.5 million in insurance coverage, with $2 million of that total coming through your employer and the remaining $1.5 through an external policy that you have purchased.  If you lose your job, however, you may also lose that group insurance policy.  In order to ensure adequate, ongoing coverage, be sure to check with your Human Resources representative to see if your firm offers either portability of that coverage, or some kind of opportunity, similar to COBRA, to finance your policy once your tenure is over.  If not, you may have to bridge the gap with term insurance.  Consider purchasing a short-term policy, say 10 years, to provide coverage while you are looking for another position.  Once you obtain another job, depending on your employer’s insurance benefit, you can cancel the policy.     

During the course of performing a cash flow analysis for you, your financial advisor can help you determine what amount of life insurance is right for you and whether your current policies fit the bill.  He or she can help you decide on the coverage you need to ensure your family’s future financial security.     

During the height of the recession, we saw many people putting up to a year’s worth of living expenses in their cash savings accounts.  In speaking with clients during this time, we found that people were comfortable with this level of security as it was taking longer to find jobs and the market was especially volatile.  But lately, we’ve seen consumers putting their cash back to work and keeping lower levels of cash on hand.  This is most likely due to several factors, including general fears of another 2008 subsiding; small, positive signs in the U.S. economy; and as always, the need to stay ahead of inflation. 

Of course, this more optimistic attitude about the state of the markets and the economy varies from person to person.  Nevertheless, as fears of prolonged recession generally seem to be receding, it’s not a bad idea to revisit some budgeting and investment basics: 

• “Pay Yourself First” – Taking a percentage of your net pay every paycheck to put into a savings account works better than itemizing all of your bills and expenses first and then determining what you can salt away.  Many people don’t do this.  It’s easier and, no matter what the percentage, you are bound to save more this way. 
• Fight inflation by investing your cash.  Investing is one of the safest ways to fight inflation, which is a much more serious threat to a person’s financial future than short-term market volatility.  This is critical in terms of consumers maintaining their current lifestyle and extending it into retirement.  Inflation is constantly at our heels.  Assuming an annual inflation rate of 3%, holding $500,000 in cash just over one year will cost you $15,000. 
• Pay down debt with the highest interest rates first, like credit cards (even before you pay yourself first).   This old adage still rings true — it doesn’t make sense to hang on to debt with double-digit rates if you are going to earn much less than that on any investment that you make. 
• In a worst-case scenario, considering borrowing against the equity in your home to fund emergency payments or to pay down a high credit card balance.  Mortgage and home equity rates are still at historic lows, so this type of debt should remain at the lower end of your payoff priority list. 
• Take advantage of employer -sponsored savings accounts. Most of you already know about the benefits of a 401(k) plan, but some employers offer additional tax deferred savings plans like Health savings accounts (HSAs) and flexible savings accounts (FSAs). These accounts allow you to save by using pre-tax dollars to pay for uncovered health expenses including deductibles.  Just make sure you perform a healthy calculation of expected expenses prior to committing dollars because you still want to be able to meet your immediate living expenses, and not forfeit the unused balance in an FSA. (HSA balances however roll over —it’s your account!  Click here for more information about HSAs.) 

Time will tell if the U.S. economy and markets will continue to stabilize and move in a positive direction.  In the meantime, your financial advisor can help you create a personalized financial and investing plan geared to your overall objectives and risk tolerance.

You may have been given the opportunity to establish and contribute to an HSA each year when you enroll for your medical, dental, and other employer benefit programs.  HSA plans are only available to individuals covered by high-deductible health insurance plans.  Although HSA plans are required to have a $1,200 individual deductible ($2,400 for families) and can increase from these required minimums, many HSA plans offer 100% coverage and often don’t require co-insurance payments.  So, if you fall within this category and have out-of-pocket medical expenses greater than your deductible, your costs will actually be less than if you had a more conventional 80/20 co-share plan.  Unlike Flexible Spending Accounts, HSAs are not a “use-it-or-lose-it” plan.  You don’t have to use the money by a certain deadline.  In addition, the funds accumulated in your HSA can be used for more than medical expenses. 

Like an IRA, contributions can be made up until April 15 following the year for which they are made.  For 2012, annual contribution limits to an HSA are as follows: 

• $3.100 – Individual
• $6.250 – Family
• $1,000 – Annual Catch-Up Contribution for those Age 55 and Older 

Your annual contributions may be invested and there are a variety of options available in which to invest them.  As with any investment, you will want to inquire as to the annual fees associated with your investment selections and determine how these fees will affect your overall investment return. 

If you incur unreimbursed medical expenses during the year, you may deduct these medical expenses on your tax return.  However, in order to do so, your unreimbursed medical expenses must exceed 7.5% of your adjusted gross income.  For many of us, these unreimbursed medical expenses must be quite sizable before we will be able to see any income-tax benefit.  Your HSA contributions are deductible irrespective of the amount of your unreimbursed medical bills.  Additionally, the amount of your annual salary is not a factor — there is no income limit phase-out for the deduction.  It’s important to note, however, that reimbursed expenses from an HSA cannot be deducted on Schedule A of your Form 1040. 

If you choose to open an HSA, it is important for you to maintain accurate records and receipts for out-of-pocket medical expenses.   This is especially important in retirement.  As I mentioned earlier, with HSAs there is no requirement that reimbursements be made in a “timely” manner, so it is possible to accumulate years of out-of-pocket medical expenses and request reimbursement of these expenses after you retire.    If you have not been using your HSA account to reimburse yourself for out-of-pocket medical expenses throughout the years, your HSA investment account may have increased significantly and you may consider using the HSA as a dedicated set-aside for health care expenses.  You could, for example, use the money to pay for long-term care insurance premiums. 

Once you reach age 65 and are enrolled in Medicare, however, you may no longer make contributions to your HSA and withdrawals may be made for any purpose.  Withdrawals made to cover medical costs not covered by Medicare will be tax-free.  However, withdrawals made for purposes other than medical expenses will be taxed as ordinary income in the year of withdrawal. 

Upon your death, your HSA investment account is passed via beneficiary designation.  If the beneficiary of your HSA is your spouse, the account is treated as if it is your spouse’s HSA.  If the beneficiary of your HSA is someone other than your spouse, the HSA is not treated as an HSA account and the fair market value becomes taxable to the beneficiary in the year of your death.

If you are considering opening and contributing to an HSA, seek the advice of a financial advisor to determine how best to use the funds in the account over the years, and to discuss and select your investment options and the amount of your deductible.

One school of thought rejects the notion of a fixed withdrawal percentage throughout retirement.  Typically, the formula for withdrawing a set amount of your assets each year is based on a fixed set of assumptions, e.g., how long your retirement will last, good health, an investment return of ___%, for example.  These straight line calculations are not always realistic and don’t account for all of the variables that can and will affect your finances in retirement.  Life is not static — each year’s expenses and priorities won’t be the same. 

Consider this approach — schedule a meeting with your financial advisor to develop a cash flow projection for your retirement years.  The purpose of this is to assess what you anticipate your retirement lifestyle to be and whether these plans
match up well with your projected assets. Overall, there are many factors to bake into the plan.

Some financial advisors can run Monte Carlo simulations within your cash flow projections to help estimate the probability of financial well-being based on a set of variables that could include tax rates, market fluctuations, investment management fees, your asset allocation ( including your risk tolerance), an average investment return spanning several years, travel costs, projected life span, health care bills, etc., and your pension (if applicable). 

Running Out of Money is Not an Option

This cash flow analysis can help you determine whether you will outlive your assets—which is great news in terms of your longevity, but kryptonite as far as retirement planning goes.  Withdrawing too much too early in your retirement could ultimately leave you with a goose egg rather than a nest egg.

Realistically assessing how much you are spending now and plan to spend in retirement is key to a successful plan.  It’s also a good idea to review your plan a year or two after retirement and readdress each internal and external category.
You should plan on updating your plan at least every two years while in retirement.  As a general rule, try to save as much as you can while you are working. Remember that if you spend $200k/year but only save $17,000 per year maxing out your 401(k) that you are relying on one heck of a return on that $17,000 to allow you to continue to spend $200k in retirement.  Also, age 60 is not a good time for you to start talking to your financial advisor about retirement
planning.  Working together, it’s never too early to devise a cash flow – and a savings withdrawal plan— that makes sense.

While it’s beneficial to have a benchmark with which to start planning, the reality is that any fixed annual withdrawal is going to be different for each person, depending on their particular situation.  Your financial advisor can outline your
options, perform an analysis, and determine what course of action is likely to be best for you.      

Here’s how it works:  There are three main credit reporting firms in the U.S. — Experian, Equifax, and TransUnion.  These firms sell the information in your report to lenders, insurers, employers, and other organizations that have a vested interest in your prompt repayment. These entities use the credit information to evaluate your applications for loans, credit cards, insurance, employment, or a lease. According to the Federal Trade Commission, credit reporting companies collect and sell four basic types of information:

• Identification and employment information:  Your name, birth date, Social Security number, employer, and spouse’s name.  The company may also provide information about your employment history, home
  ownership, income, and previous addresses.
  Payment history: Your accounts with different creditors are listed, showing how much credit has been extended and whether you’ve paid on time.  Related events, such as the referral of an overdue account to a collection agency may
  also be noted.
  Inquiries: Credit reporting companies must maintain a record of all creditors who have asked for your credit history within the past year, and a record of individuals or businesses that have asked for your credit history for employment purposes for the past two years.
• Public record information: Information pertaining to bankruptcies, foreclosures, or tax liens, may appear in your report.  

How Your Credit Score Fits In

Your credit score represents your ability to repay your debt in a timely manner, based on the information contained in your credit report.  Lenders use a number of facts to make credit decisions, including your credit score. The numerical score most often used is provided by the Fair Isaac Corporation, otherwise known as FICO®.  It is based on a complex mathematical formula and can range anywhere from 300 to 850.  In general, a FICO® score above 650 indicates that you have a very good credit history and demonstrates that you are less of a credit risk. 

FICO® score calculations use the information individually from the reporting agencies and reflect your payment history, how much of your available credit limit are you using, new debt you may have assumed, and how long you have been borrowing.  Therefore, if one agency has different information from another agency, the FICO® scores may differ.

Obtaining Your Free Report

You may have heard advertisements on the radio or on TV that promise free credit reports.  Typically, if you respond to one of the advertisements, you can obtain a free report only if you make a purchase – for example, some offer debt counseling or require you to sign up for an  identity protection service.  Your best bet is to steer clear of these ads, many of which can be misleading, and instead request a free report as outlined below. 

You can obtain a truly free credit report from each of the three nationwide credit reporting companies once every 12 months.  You have the option to request all three reports at once or to order one report at a time. By requesting the reports separately, you can monitor your credit more frequently throughout the year.

The three companies use one website to process requests:  www.annualcreditreport.com.  You can also request a free report by phone at 1-877-322-8228 or by mail by completing the “Annual Credit Report Request” form on the site,  https://www.annualcreditreport.com/cra/requestformfinal.pdf) and mail it to Annual Credit Report Request Service, P.O. Box 105281, Atlanta, GA 30348-5281.  In addition, some states offer consumers free credit reports under state law.  These include Georgia, Maine, Maryland, Massachusetts, New Jersey and Vermont.

Once you receive your report, review it to ensure that the information is up-to-date, and most importantly, is accurate.  If you see credit card accounts or loans or other credit instruments/debt that don’t look familiar, contact the credit  reporting agency—as well as the lending institution or credit card provider—immediately.

If you believe you’ve been the victim of identity theft, contact your local police or you can file a complaint with the Federal Trade Commission (FTC).  The FTC outlines the steps you should take to rectify the situation. 

Maintaining good credit and having a good credit report can help pave the way for you to achieve your financial and lifetime goals.  An excellent source of information is the Federal Trade Commission’s publication, Building a Better Credit Report.  In addition, your financial advisor can provide guidance on matters of credit and debt repayment or consolidation.

Whatever your reasons, it’s important to “interview” several different advisors in order to select the one that’s right for you, preferably face-to-face, rather than over the phone.  If it makes you feel more comfortable, bring a good friend or relative with you who can help you screen the candidates. Often, it will come down to personal chemistry and gut instinct.  But there are certain characteristics that you should look for before making your decision.  For example, it’s important at the outset of your search to understand how a particular advisor makes their money.  This way, you can determine objectivity and motivation in suggesting a particular course of action or investment.   Financial advisors generally fall into the
following categories:

Fee-Only

Fee-only advisors receive compensation only from their clients and do not receive money from third parties, including commissions, rebates, bonuses, or finder’s fees.  The fees you pay could be in the form of hourly fees, a set fee for a articular
service, or a percentage of assets under management.  Advisors who are members of the National Association of Personal Financial Planners are strictly fee-only.

Commission

Advisors that are paid by commission make a living by receiving compensation from providers of investment and/or insurance products on the sales of those products.

Fee-Based

Some financial advisors will charge a fee to analyze your financial situation and they will also receive money from the sales of certain investment and/or insurance products.  They are paid using fee-based, or fee-offset, commission, not to be confused with fee-only compensation.

Some advisors “do it all” (or claim to); others stick to a few basic services.  Some concentrate on the investment side and can buy and sell stocks, bonds, and mutual funds on your behalf.  Others focus solely on creating current and future financial plans or addressing a specific objective like retirement or funding a child’s education. Minimizing your income and estate taxes is another potential area of expertise.  Determine what you need and be sure that the candidate has experience providing it.

Many advisors have one or more acronyms after their name that indicates their particular specialty and the level of training they have received.  These may include the following:  CFP® (Certified Financial Planner^TM), CPA (Certified Public Accountant), CPA/PFS (Certified Public Accountant/Personal Financial Specialist), CFA® (Chartered Financial Analyst®), RIA (Registered Investment Advisor), and RR (Registered Representative).  Depending on the kinds of services you require, you may be interested in interviewing individuals who hold one or more of these designations.

Choosing a financial advisor is a decision with ramifications, so it’s important to take special care during the selection process.  Even if you are satisfied with your current advisor, it doesn’t hurt to get a second opinion from another professional.  Your future financial security — and that of your loved ones — could benefit significantly from it.

To read more go to Choosing An Advisor