EagleStone Tax & Wealth Newsletter – June 2016

Life insurance can serve many valuable purposes during your life. However, once you’ve retired, you may no longer feel the need to keep your life insurance, or the cost of maintaining the policy may have become too expensive. In these cases, you might be tempted to abandon the policy or surrender your life insurance coverage. But there are other alternatives to consider as well.

Lapse or surrender

If you have term life insurance, you generally will receive nothing in return if you surrender the policy or let it lapse by not paying premiums. On the other hand, if you own permanent life insurance, the policy may have a cash surrender value (CSV), which you can receive upon surrendering the insurance. If you surrender your cash value life insurance policy, any gain (generally, the excess of your CSV over the cumulative amount of premium paid) resulting from the surrender will be subject to federal (and possibly state) income tax. Also, surrendering your policy prematurely may result in surrender charges, which can reduce your CSV.

Exchange the old policy

Another option is to exchange your existing life insurance policy for either a new life insurance policy or another type of insurance product. The federal tax code allows you to exchange one life insurance policy for another life insurance policy, an endowment policy, an annuity, or a qualified long-term care policy without triggering current tax liability. This is known as an IRC Section 1035 exchange. You must follow IRS rules when making the exchange, particularly the requirement that the exchange must be made directly between the insurance company that issued the old policy and the company issuing the new policy or contract. Also, the rules governing 1035 exchanges are complex, and you may incur surrender charges from your current life insurance policy. In addition, you may be subject to new sales, mortality, expense, and surrender charges for the new policy, which can be very substantial and may last for many years afterward.

Lower the premium

If the premium cost of your current life insurance policy is an issue, you may be able to reduce the death benefit, lowering the premium cost in the process. Or you can try to exchange your current policy for a policy with a lower premium cost. But you may not qualify for a new policy because of your age, health problems, or other reasons.

Stream of income

You may be able to exchange the CSV of a permanent life insurance policy for an immediate annuity, which can provide a stream of income for a predetermined period of time or for the rest of your life. Each annuity payment will be apportioned between taxable gain and nontaxable return of capital. You should be aware that by exchanging the CSV for an annuity, you will be giving up the death benefit, and annuity contracts generally have fees and expenses, limitations, exclusions, and termination provisions. Also, any annuity guarantees are contingent on the claims-paying ability and financial strength of the issuing insurance company.

Long-term care

Another potential option is to exchange your life insurance policy for a tax-qualified long-term care insurance (LTCI) policy, provided that the exchange meets IRC Section 1035 requirements. Any taxable gain in the CSV is deferred in the long-term care policy, and benefits paid from the tax-qualified LTCI policy are received tax free. But you may not be able to find a LTCI policy that accepts lump-sum premium payments, in which case you’d have to make several partial exchanges from the CSV of your existing life insurance policy to the long-term care policy provider to cover the annual premium cost.

A complete statement of coverage, including exclusions, exceptions, and limitations, is found only in the policy. It should be noted that carriers have the discretion to raise their rates and remove their products from the marketplace.

You understand the basic financial concepts of budgeting, saving, and monitoring your money. But this doesn’t necessarily mean that you’re in control of your spending. The following reasons might help explain why you sometimes break your budget.

1. Failing to think about the future

It can be difficult to adequately predict future expenses, but thinking about the future is a key component of financial responsibility. If you have a tendency to focus on the “here and now” without taking the future into account, then you might find that this leads you to overspend.
Maybe you feel that you’re acting responsibly simply because you’ve started an emergency savings account. You might feel that it will help you cover future expenses, but in reality it may create a false sense of security that leads you to spend more than you can afford at a given moment in time.
Remember that the purpose of your emergency savings account is to be a safety net in times of financial crisis. If you’re constantly tapping it for unnecessary purchases, you aren’t using it correctly.
Change this behavior by keeping the big picture in perspective. Create room in your budget that allows you to spend discretionary money and use your emergency savings only for true emergencies. By having a carefully thought-out plan in place, you’ll be less likely to overspend without realizing it.

2. Rewarding yourself

Are you a savvy shopper who rarely splurges, or do you spend too frequently because you want to reward yourself? If you fall in the latter category, your sense of willpower may be to blame. People who see willpower as a limited resource often trick themselves into thinking that they deserve a reward when they are able to demonstrate a degree of willpower. As a result, they may develop the unhealthy habit of overspending on random, unnecessary purchases in order to fulfill the desire for a reward.
This doesn’t mean that you’re never allowed to reward yourself–you just might need to think of other ways that won’t lead to spending too much money. Develop healthier habits by rewarding yourself in ways that don’t cost money, such as spending time outdoors, reading, or meditating. Both your body and your wallet will thank you.

If you do decide to splurge on a reward from time to time, do yourself a favor and plan your purchase. Figure out how much it will cost ahead of time so you can save accordingly instead of tapping your savings. Make sure that your reward, whether it’s small or big, has a purpose and is meaningful to you. Try scaling back. For example, instead of dining out every weekend, limit this expense to once or twice a month. Chances are that you’ll enjoy going out more than you did before, and you’ll feel good about the money you save from dining out less frequently.

3. Mixing mood with money

Your emotional state can be an integral part of your ability to make sensible financial decisions. When you’re unhappy, you might not be thinking clearly, and saving is probably not your first priority. Boredom or stress also makes it easy to overspend because shopping serves as a fast and easy distraction from your feelings. This narrow focus on short-term happiness might be a reason why you’re spending more than normal.
Waiting to spend when you’re happy and thinking more positively could help shift your focus back to your long-term financial goals. Avoid temptations and stay clear of stores if you feel that you’ll spend needlessly after having an emotionally challenging day. Staying on track financially (and emotionally) will benefit you in the long run.

4. Getting caught up in home equity habits

Do you tend to spend more money when the value of your assets–particularly your property–increases? You might think that appreciating assets add to your spending power, thus making you feel both wealthier and more financially secure. You may be tempted to tap into your home equity, but make sure you’re using it wisely.

Instead of thinking of your home as a piggy bank, remember it’s where you live. Be smart with your home equity loan or line of credit–don’t borrow more than what is absolutely necessary. For example, you may need to borrow to pay for emergency home repairs or health expenses, but you want to avoid borrowing to pay for gratuitous luxuries that could put you and your family’s financial security at risk. After all, the lender could foreclose if you fail to repay the debt, and there may be closing costs and other charges associated with the loan.

If you’re within 10 years of retirement, you’ve probably spent some time thinking about this major life change. The transition to retirement can seem a bit daunting, even overwhelming. If you find yourself wondering where to begin, the following points may help you focus.

Reassess your living expenses

A step you will probably take several times between now and retirement–and maybe several more times thereafter–is thinking about how your living expenses could or should change. For example, while commuting and dry cleaning costs may decrease, other budget items such as travel and health care may rise. Try to estimate what your monthly expense budget will look like in the first few years after you stop working. And then continue to reassess this budget as your vision of retirement becomes reality.

Consider all your income sources

Next, review all your possible sources of income. Chances are you have an employer-sponsored retirement plan and maybe an IRA or two. Try to estimate how much they could provide on a monthly basis. If you are married, be sure to include your spouse’s retirement accounts as well. If your employer provides a traditional pension plan, contact the plan administrator for an estimate of your monthly benefit amount.

Do you have rental income? Be sure to include that in your calculations. Is there a chance you may continue working in some capacity? Often retirees find that they are able to consult, turn a hobby into an income source, or work part-time. Such income can provide a valuable cushion that helps retirees postpone tapping their investment accounts, giving them more time to potentially grow.

Finally, don’t forget Social Security. You can get an estimate of your retirement benefit at the Social Security Administration’s website, ssa.gov. You can also sign up for a my Social Security account to view your online Social Security Statement, which contains a detailed record of your earnings and estimates of retirement, survivor, and disability benefits.

Manage taxes

As you think about your income strategy, also consider ways to help minimize taxes in retirement. Would it be better to tap taxable or tax-deferred accounts first? Would part-time work result in taxable Social Security benefits? What about state and local taxes? A qualified tax professional can help you develop an appropriate strategy.

Pay off debt, power up your savings

Once you have an idea of what your possible expenses and income look like, it’s time to bring your attention back to the here and now. Draw up a plan to pay off debt and power up your retirement savings before you retire.

• Why pay off debt? Entering retirement debt-free–including paying off your mortgage–will put you in a position to modify your monthly expenses in retirement if the need arises. On the other hand, entering retirement with mortgage, loan, and credit card balances will put you at the mercy of those monthly payments. You’ll have less of an opportunity to scale back your spending if necessary.
• Why power up your savings? In these final few years before retirement, you’re likely to be earning the highest salary of your career. Why not save and invest as much as you can in your employer-sponsored retirement savings plan and/or your IRAs? Aim for the maximum allowable contributions. And remember, if you’re 50 or older, you can take advantage of catch-up contributions, which allow you to contribute an additional $6,000 to your employer-sponsored plan and an extra $1,000 to your IRA in 2016.

Account for health care

Finally, health care should get special attention as you plan the transition to retirement. As you age, the portion of your budget consumed by health-related costs will likely increase. Although Medicare will cover a portion of your medical costs, you’ll still have deductibles, copayments, and coinsurance. Unless you’re prepared to pay for these costs out of pocket, you may want to purchase a supplemental insurance policy.

In 2015, the Employee Benefit Research Institute reported that the average 65-year-old married couple would need $213,000 in savings to have at least a 75% chance of meeting their insurance premiums and out-of-pocket health care costs in retirement. And that doesn’t include the cost of long-term care, which Medicare does not cover and can vary substantially depending on where you live. For this reason, you might consider a long-term care insurance policy.

These are just some of the factors to consider as your prepare to transition into retirement. Breaking the bigger picture into smaller categories may help the process seem a little less daunting.

Starting out on one’s own in college involves many financial firsts. Opening a checking account to manage money might be just one of them.

As your daughter prepares to head off to school, she should begin to shop around and find a bank or credit union that offers the best deal. Many banks (both local and national) and credit unions offer accounts tailored specifically to young adults.

Some things she should keep in mind when shopping around include:

• Is there a monthly maintenance fee?
• Are there overdraft charges?
• Does the account pay interest?
• Does the account come with free checks?
• Is there an ATM on campus or close by?
• Are there penalties for using an out-of-network ATM?

Many colleges and universities have begun to partner with financial institutions to offer accounts to their students. In fact, 40% of college students attend schools with these types of arrangements. (Source: U.S. Government Accountability Office, College Debit Cards, February 2014)

Some colleges may use official communications, such as email, to market a particular financial institution’s products. Others may allow a financial institution’s staff on campus to promote their products. A college or university may even be paid when a student opens a sponsored account.

It’s important to note that these sponsored accounts can come with high fees. As a result, you’ll want your daughter to be aware that just because an account is sponsored by her college or university doesn’t necessarily mean it’s the best option, or even that she has to use it.

Advertisements aimed at promoting a particular financial institution’s debit and prepaid credit cards are a common sight on many college campuses today. While many financial institutions have partnerships with colleges to market these products, consumer groups argue that they sometimes come at a high cost to students. As a result, the Department of Education recently issued new rules designed to offer protections to students.

Why are the new rules so important? Once tuition and fees are paid, many students receive the remainder of their financial aid through disbursements to campus-sponsored financial products, such as debit and prepaid credit cards. In fact, it’s estimated that nearly $25 billion in federal student aid funds is disbursed to students using these types of products. (Source: U.S. Department of Education Press Release, October 2015) Students often use these funds to help pay for incidental education-related expenses such as food, housing, books, and supplies. If a debit or prepaid credit card has excessive charges and high fees, it can end up cutting significantly into a student’s financial aid funds.

The new rules are scheduled to go into effect in July and apply only to campus-sponsored financial products that are directly linked to financial aid disbursements. The rules will offer a variety of protections, such as:

• Allowing students to have a choice in how they receive their federal financial aid disbursements
• Giving students objective and neutral information about their financial aid disbursement options
• Requiring institutions to ensure that students are not charged excessive fees (e.g, overdraft and transaction-swipe fees) when they select campus-sponsored financial products
• Requiring financial institutions to publicly disclose contracts for campus-sponsored financial products