Q: I’m 64 and retired. My wife is 54 and still working, but I’m asking her to join me in retirement. We have about $1 million in savings, with about half in an IRA and the rest in CDs. How can try I try to preserve the principal, generate about $2,000 in monthly income until I collect Social Security at age 70, and somehow double my investment? — Rajen in Iowa
A: The first thing you need to ask yourself is what’s really more important: Growth, income, or safety? You say you want to preserve your principal – and your large cash position suggests that you are risk averse – but you also say you want to double your investment.
“Why do you need to double your investment?” asks Larry Rosenthal, a certified financial planner and president of Rosenthal Wealth Management Group in Manassas, VA. “Everybody likes the idea of doubling their investment, but there’s a high cost if it doesn’t work out.”
Given that you’re already retired, doubling your investment is a tall order. You probably don’t have that kind of time. At a 5% annual return, it would take you more than 14 years, and that’s without tapping your funds for income along the way. Nor can you afford to take on too much additional risk.
Either way, you do need to rethink how you have your assets allocated.
A 50% cash position is likely far too much, especially with interest rates as low as they are. “You’re effectively earning a negative return,” factoring in inflation, says Rosenthal.
And while cash is a great buffer for down markets, the value is lost in the extreme: The portion of your portfolio that is invested in longer-term assets such as stocks and bonds needs to do double duty to earn the same overall return.
If generating growth and income are both priorities, “look at shifting some of that cash into dividend paying stocks, a bond ladder, an annuity, or possibly a combination of the three,” says Rosenthal, who gives the critical caveat that the decision of how to invest some of this cash will depend on how your IRA money is invested.
Meanwhile, you should take a closer look at the pros and cons of claiming Social Security at full retirement age, which is 66 in your case, or waiting until you’re 70 years old.
The current conventional wisdom is to hold off taking Social Security as long as possible in order to maximize the monthly benefit. While that advice still holds true for many people, you need to look at the specifics of your situation – as well as that of your wife. The best way to know is to run the numbers, which you can do at Social Security Timing or AARP.
The tradeoff of waiting to claim your benefit, says Rosenthal, is spending down more of your savings for six years. You may in fact do better by keeping that money invested.
What’s more, “if you die, you can pass along your savings,” adds Rosenthal. But you don’t have that type of flexibility with Social Security benefits.
Q. I am covered by my employer’s health plan, but I’m not happy with it. My son is 21 and currently covered under my plan. While I realize that I am not eligible for Obamacare, I am curious if I can terminate my son’s policy so that he might be eligible.
A. Since the open enrollment period to sign up for coverage on the state marketplaces ended Feb. 15, in general people can’t enroll in a marketplace plan until next year’s open enrollment period rolls around.
If you drop your son from your employer plan, however, his loss of coverage could trigger a special enrollment period that allows him to sign up for a marketplace plan. Whether he’s entitled to a special enrollment period depends on whether his loss of coverage is considered voluntary, say officials at the Centers for Medicare & Medicaid Services.
In general, voluntarily dropping employer-sponsored coverage doesn’t trigger a special enrollment period for individuals or their family members. But if you drop your son’s coverage on his behalf without his consent, his loss of coverage wouldn’t be considered voluntary and your son could qualify, according to CMS.
Whether he’ll be eligible for premium tax credits to make marketplace coverage more affordable is another matter, says Judith Solomon, vice president for health policy at the Center on Budget and Policy Priorities.
If you claim him as your dependent, he generally won’t be eligible. If you don’t claim him as your dependent, he would have to qualify for subsidies based on his own income.
Q: I’ve followed your advice and gotten three bids from different contractors who want to do my project. Now what? Do I just hire the one with the best price?
A: Those bids can tell you a lot about the contractors who wrote them—but they may not be very accurate measures of the total price each one would wind up charging for your project. Here’s why.
Unless you’ve given the bidders the exact specifications for your job—in other words, drawings, materials lists, and product names put together by an architect or designer—the bids are at best educated guesses, says Cambridge, Mass., Realtor and renovation consultant Bruce Irving.
The contractor is making assumptions about what you’ll pick as the project unfolds and pricing each component of the job based on those assumptions. So the differences in their bids could very well boil down to differences in their assumptions. And your costs are bound to escalate as the project proceeds, because you can be sure that the contractors will hit you with up-charges for any product or option you select that’s more expensive than his estimate.
If you have hired a professional designer (which Irving recommends for any significant project, because for the added 10% or 20% you’ll pay, he says, you will get you a far better result, professional oversight of the contractor, and a whole lot less stress along the way), the bids are likely much more accurate measures of what each contractor will charge, especially if their bottom lines are just a few percentage points apart. Always throw away outliers. Extreme low bidders are probably desperate for work and planning to cut corners on your job, and super high bidders are probably too busy to take on your project unless you’re willing to overpay.
Whether or not you’re not using a designer, however, bids can be quite useful as character studies about the contractors.
“Look not only at the numbers but at how they’re presented,” says Irving. “Are they clear, organized, detail-oriented, and delivered when they were promised? Do they accurately reflect the nuances of what you told him you’re looking to do?” There’s no guarantee that a quality bid equates to a quality contractor—or that a sloppy one means you’ll get sloppy work—but it increases the odds.
Look for a bid that thoroughly outlines every aspect of the job, from the cost of the porta-potty for the crew to the fee for the town building permits—and of course the contractor’s price for each and every element of the project, with a bit of detail about the options that he’s priced (not just “under-cabinet lights,” for example, but “eight under-cabinet LED light fixtures”).
That way, even without architect specs, you can see, in writing, exactly what he’s proposing to deliver—and charge you—for each part of the job. Once you sign the bid and it becomes your contract, if a question arises later about whether the price includes, say, installing stone or ceramic tiles, you’ll have his description to refer back to.
In any case, the bids should only play a supporting role in your decision about who to hire. “It’s just as important to visit a current project, see the way the jobsite is kept, and meet the crew,” says Irving. “And it’s vital that you talk to his three most recent customers to ask whether they’d use him again—and how close the final price came to his original bid.”
Q: “My husband and I have been saving for our kids’ college since they were born. They are now 4 and 6. Our initial plan was to just throw what we could into a savings account, then we moved that money to a 529. We make small monthly contributions, and also contribute some money whenever we get a bonus or they get a birthday gift from grandparents. However, we still don’t have a number in mind for what we actually need by the time they start school. How much should we be saving for them each month?” —Ryan Phelan
A: Congratulations for starting the saving process early and taking full advantage of compounding in that 529 account. That’s less money you’ll have to borrow later.
Now for the bad news: By the time your eldest child enters college, four years at an in-state public school will cost an average $130,000 and a private-school education will run $235,000 if prices continue rising at the rate they have for the last five years.
Footing the full freight will be unrealistic for most folks, especially those like you who have more than one child to put through school. Besides, you should also be saving for your own retirement—since you can’t fund that stage of life with loans as you can your kid’s education.
Mark Kantrowitz, author of Filing the FAFSA and senior vice president of the Edvisors Network, offers a more reasonable goal: Try to save a third of your kids’ expected college costs by the time they’re on campus. The next third can come from income (plus grants and scholarships) at the time tuition needs to be paid, and the final third you or your kid can borrow.
The idea is to spread the cost out over time to make that staggering price tag more manageable, says Kantrowitz. You’re putting together past income (what you’ve saved), current income (while the child is in school), and future income (yours or your child’s to pay back the loans).
So in your situation, a good goal would be to put away at least $43,000 or $78,000 for your eldest child, depending on whether you’re aiming to pay for public or private school.
You can estimate a savings number for your younger child—and anyone else can figure it out for their own kid—by figuring out the full cost of an average college education the year the child was born, since college costs increase by about a factor of three over any 17-year period, says Kantrowitz.
For help translating the big number into what you need to save each month—based on your state, income, children’s ages, and current 529 savings—use this 529 college savings planner tool from Savingforcollege.com.
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Q: With interest rates predicted to rise in 2015, what should I consider doing with my mutual fund bond holdings now? About 35% of my retirement portfolio is in bonds as part of a target date retirement fund. — Alan in Orland Park, Ill.
A: No doubt this is a common concern for many investors today. Economists have for years been saying that interest rates can only go higher from here, and yet interest rates are still near historic lows. The yield on the 10-year Treasury note has been hovering around just 2% — and that’s down from 3% at the start of last year.
Why the worry? Market interest rates and bond prices move in the opposite direction. So a rise in interest rates would likely translate to a drop in the value of older bonds held by your bond funds. Trouble is, exactly when rates will rise and to what degree is still anyone’s guess.
“We all know the elephant in the room is that rates will go up,” says Jason Jenkins, an investment advisor and CEO of portfolio monitoring software company AssetLock. “But I don’t think they will respond as violently as everyone thinks.”
Jenkins isn’t alone in that view that interest rates won’t shoot up over night. While it’s true that the end of the Federal Reserve’s stimulative bond-buying program reduces domestic demand for Treasuries — which lowers prices and in turn raises rates — foreign investors have been flocking to U.S. bonds of late amid worries of another global slowdown.
Regardless of what happens in the big picture, it’s important to view this in the context of what role bonds play in your overall portfolio.
If you’re in or near retirement, odds are that you’re looking to bonds for steady income. In that case, rising rates will ultimately be to your benefit. “Investors need to remember there are two sides to the coin,” says Jenkins. “If rates go up, prices go down but payments go up.” In 1999, for example, the Barclays U.S. Aggregate index fell 7%, but the yield was 6.7%. Investors, adds Jenkins, need to think not just about price and yield but total return.
Meanwhile, bonds bring something else to the table – diversification. Historically, when stocks are at their worst, bonds have still managed a positive return. In one study, Vanguard looked at periods of bottom-decile returns for U.S. stocks from 1988 through 2012. During those times, the median monthly return bonds — including Treasuries, U.S. corporate bonds and international corporate bonds — was still positive.
That said, Jenkins and bond strategists aren’t advocating investing in bonds indiscriminately. Because long-term bonds are most vulnerable to rising rates, he recommends sticking with short-term and intermediate-term bonds.
Now, your question of what to do with bond holdings raises a couple of other points: Should you be in a target date fund, and if so, are you in the right target date fund?
Target-date funds are a handy solution for investors who would otherwise make poor investment decisions, try to time the market, or not invest at all. In theory, you could choose such a fund pegged to the year you think you’ll retire and never worry about where to invest or when to rebalance. The managers of these funds will make those decisions for you.
Yet as many investors in these funds learned after the financial crisis, one-stop-shopping isn’t a perfect solution. Two funds with the same target date may take two very different approaches — one risky, one conservative. Moreover, your own propensity for risk is as much of a factor as the date you expect to retire.
If you’re concerned, at the very least do look under the hood (sounds like you have) and see what percent of your portfolio is in bonds and the maturity of those bonds. You can use some of the free tools at Morningstar.com to see how your fund did relative to similar portfolios in 2008 and get a closer look at where it’s invested today.
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Q: Should I refinance my mortgage? I can drop my current rate by half a point.
A: Mortgage rates, though still close to the 19-month low set in mid-January, have recently started inching up. The national average for a 30-year fixed mortgage was 3.9% as of Feb. 11, according to Bankrate. That’s up from 3.8% the week before, but well below the 5%-plus rates of 2011.
So if you’re a homeowner with good credit and a solid income, now might be an opportune time to refinance.
As a general rule, refinancing—that is, paying off your current mortgage and taking out a new loan at a lower interest rate—may be worthwhile if you can drop your rate by at least half a percent, says Marilyn Capelli Dimitroff, a certified financial planner in Bloomfield Hills, Mich., and former chair of the CFP board of directors. For example, if you have $390,000 remaining on an original $400,000 loan at 4.25%, refinancing the balance into a new loan at 3.75% would save you $162 a month.
There are costs to refinancing, of course. You’ll have to pay bank fees, attorney fees, appraisal fees, and title insurance fees that typically total about $3,000 to $5,000. Use a refinance calculator, such as this one from Bankrate, to plug in your current mortgage details, the new loan rate, and the refinancing fees, and you’ll see how many months it would take for the savings to repay the cost. Bear in mind, though, that refinance calculators tend to underestimate the payback time. They typically don’t factor in the mortgage tax deduction, which effectively lowers the net savings from reducing your monthly interest payment, and you may not anticipate every fee you’ll have to pay, so don’t refinance unless you’re planning to stay in your house for at least five years.
Even if all the numbers look good, there’s another factor to consider, says Dimitroff. By refinancing, you’re extending the loan period to 30 years from now. If you’re in year two of the original loan and you’re 34 years old, that’s probably no big deal. But if you’re in year seven and you’re in your late 40s, you may not want to start over with a 30-year loan.
If you’re concerned about extending your loan too far into the future—or if by doing so you will wind up paying additional total interest over the life of the loan, something you can check on any good refinance calculator—consider these two options:
- Take a 15- or 20-year loan instead of a 30. This will generally earn you a still-lower interest rate, though the shortened loan period will probably result in a higher monthly payment. With the example above, refinancing for 15 years at 3% (the national average in early February was 3.06%) would increase the monthly payment by $725. If you can afford that cost, this can be an extremely beneficial move because it means you’ll be done paying off your mortgage in just 15 years and will save more than $100,000 in total interest over the course of the loan.
- If you can’t afford to do that, see whether you could take a new 30-year loan, but use some of your monthly savings to pay a bit extra each month and shorten the term of the new mortgage to match the years remaining on your old one. For example, refinancing in year five of a $400,000 mortgage at 5% into a new loan at 3.75% could save around $450 a month. Put $200 of that toward paying down the principal each month, and you can shorten the new loan to 25 years and still pocket close to $250 a month. Or just keep paying the full amount you’re already accustomed to paying each month, and shorten the new loan to just over 20 years, with the freedom to pay only the regular loan payment anytime finances get tight.
Always shop around for your mortgage because rates—and fees—vary significantly from one lender to the next. If you have excellent credit, you may find the best rates from a local savings bank rather than a national bank or a mortgage broker.
Q: I have a substantial amount of tax-loss carry forwards, but all of my net worth is now in tax-deferred accounts, such as my 401(k). I am 68 years old and don’t expect any large capital gains to offset these losses. Is there any way to recover these losses before I die?
A: The silver lining of investment losses is that you can use them to offset future capital gains—and you can carry them forward indefinitely. In other words, if you lose $10,000 on a stock in a taxable account, you can sell other stocks at a $10,000 gain and not owe taxes, even if those gains come years down the road. (Remember that to claim any loss you need to have actually sold the dud investment, and of course you’ll need to fill out the proper IRS paperwork to get that loss on record.)
Unfortunately, as you noted, these losses aren’t as useful if most of your savings is in tax-sheltered retirement vehicles, which aren’t subject to capital gains taxes. “Anything you take out of a 401(k) or other tax-deferred vehicle is taxed as ordinary income,” says Barbara Steinmetz, a certified financial planner and enrolled agent in San Mateo, Calif.
Uncle Sam does offer some consolation. Each year, you can use up to $3,000 of your losses to offset your ordinary income, says Steinmetz. But you need to first use your losses against any capital gains that year.
Moreover, upon death, your spouse effectively inherits those losses. A spouse can then use those losses to offset capital gains or, if there are no gains or excess losses, up to $3,000 a year against ordinary income. Once your spouse passes away, however, those losses are gone.
If you sell your home and make more than $250,000 on the sale ($500,000 if you’re married) you can apply your carry-forward losses toward any gains above those exclusion limits, says Steinmetz.
Likewise, you could open a taxable brokerage account knowing that you’ve banked some losses toward future appreciation and harvest your winners from there. But whatever you do, don’t let the proverbial tax tail wag the dog. Better to forgo the write off than make bad investment choices.