How Much Emergency Fund Should You Have And How To Get There

How Much Emergency Fund Should You Have And How To Get There

If you watched the nightly news during the latest government shutdown you would have seen stories about how people struggle when they aren’t getting a paycheck.  Most Americans are not immune to having a set back at a job and it is a scary feeling to not know when the next paycheck will come.  The emergency fund is what will help you bridge the gap in these hard times.  This article should help determine how much emergency fund you should have and strategies on how you can get there.

We make a point of this in every financial plan we put together because of its importance.  A lot of people will say their job is secure so they don’t need to worry about having an emergency fund.  This may be true, nevertheless the emergency fund is not only for the most extreme circumstances but any unexpected expense.  Anyone can have an unforeseen cost of $1,000 to $5,000 and most people would have to pay for this expense on a credit card that will accrue interest and take time to payoff.

Another common thought is, “I have disability insurance, so I don’t need an emergency fund”.  Most disability insurance will not start until a 90-day elimination period has been met.  This means you will be out of a check for that period but still have all the expenses you normally would.

Current Savings In The United States

“Smartasset” came out with a study in November 2018 that stated; of those Americans with savings accounts, the average savings account balance was $33,766.49.  This seems like an amount that would be enough for most people to have in a “rainy day fund”.  But that is the average.  Super Savers with very large balances will skew this calculation so we use the median which more accurately reflects the state of most Americans.  The median balance is only approximately $5,200 per “Smartasset”.

With a median balance of only $5,200, it doesn’t take much misfortune for that to be spent down to $0.  At $5,200, it is safe to assume that most Americans are living paycheck to paycheck.

If your income only meets your normal expenses, you need to ask yourself the question “where am I coming up with the money for an unexpected cost?”.  For a lot of people, it is a credit card, another type of loan, or dipping into their retirement assets.  By taking care of the immediate need, you shift the burden to another part of your financial wellbeing.

Emergency Fund Calculator

There is no exact dollar amount but a consensus in the planning industry is between 4-6 months of living expenses.  This is usually enough to cover expenses while you are searching for the next paycheck or to have other assistance kick in.

It is important for everyone to put together a budget.  How do you know what 4-6 months of living expenses is if you don’t know what you spend?  Putting together a budget takes time but you need to know where your money is going in order to make the adjustments necessary to save.  If you are in a position that you don’t see your savings account increasing, or at least remaining the same, you are likely just meeting expenses with your current income.

Resource:  EXPENSE PLANNER to help you focus on your spending.

I Know My Number, How Do I get There?

Determining the amount is the easy part, now it is getting there.  The less likely option would be going to your boss asking, “I need to replenish my emergency fund, can you increase my pay?”.  Winning the lottery would also be nice but not something you can count on.Changing spending habits is an extremely difficult thing to do.  Especially if you don’t know what you’re spending money on.  Once you have an accurate budget, you should take a hard look at it and make cuts to some of the discretionary items on the list.  It will likely take a combination of savings strategies that will get you to an appropriate emergency fund level.  Below is a list of some ideas;

• Skip a vacation one year

• Put any potential tax refund in savings

• Put a bonus check into savings

• Increase the amount of your paycheck that goes to savings when you get a raise

• Side work

• Don’t upgrade a phone every time your due

• Downgrade a vehicle or use the vehicle longer once paid off

Reward Yourself

There is no doubt some pain will be felt if you are trying to save more and it also takes time.  Set a goal and stick to it but work in some rewards to yourself.  If you are making good progress after say 3 months, splurge on something to keep your sanity but won’t impact the main objective. 

Where To Keep Your Emergency Fund?

This account is meant to be liquid and accessible.  So locking it up in some sort of long term investment that may have penalties for early withdrawal would not be ideal.  We typically suggest using an institution you are familiar with and putting it in a savings account that can earn some interest. 

About Rob……...

Hi, I’m Rob Mangold. I’m the Chief Operating Officer at Greenbush Financial Group and a contributor to the Money Smart Board blog. We created the blog to provide strategies that will help our readers personally, professionally, and financially. Our blog is meant to be a resource. If there are questions that you need answered, please feel free to join in on the discussion or contact me directly.

What Happened The Last Time The Dow Dropped By More Than 4% In A Day?

Yesterday was an “ouch”.  The Dow Jones Industrial average dropped by more than 1000 points resulting in a 4.60% drop in the value of the index.  While yesterday marked the largest “point” decline in the history of the Dow Jones Index, it was not anywhere near the largest percentage decline which is the metric that we care about.

Below is a chart that shows the largest daily “point” losses in the history of the Dow Jones Industrial Index:

You will find yesterday at the top of the chart. Now look at the column all the way to the right labelled “% change”.  You will notice that while yesterday topped the chart from a point decline, it does not come anywhere near the largest percentage decline that we have seen.  In fact, it does not even make it in the top 20 worse days for the Dow.  See the chart below that shows the largest daily percentage declines in the Dow’s history:

What Happened Last Time?

Whenever there is a big drop in the stock market, I immediately start looking back in history to find market events that are similar to the current one.  So when was the last time the market dropped by more than 4% in a single day?

The answer:  August 8, 2011

If you remember, 2011 was the start of the European Sovereign Debt Crisis.  That was when Greece, Portugal, Spain, and Ireland announced that they were unable to repay their government debt and needed a bailout package from the European Union to survive.  There were two single day declines in the month of August that rivaled what we saw yesterday.

How Long Did It Take The Market To Come Back?

If we are looking to history as a guide, how long did it take for the market to recoup the losses after these large single day declines?  On July 31, 2011 the Dow Jones Industrial closed at 11,444, the Europe debt crisis hit, and the market experienced those two 4%+ decline days on August 4th and August 8th.   By September 11, 2011, the Dow Jones closed at 11,509, recouping all of its losses from the beginning of August. Thus making the answer to the question: 38 days.  The market took 38 days to recoup all of the losses from not one but two 4%+ decline days in 2011. 

We Don’t Have A Crisis

The main difference between 2011 and now is we don’t have a global economic crisis.  In my opinion, the market correction in 2011 was warranted.  There was a real problem in Europe.  We were not sure how and if those struggling Eurozone countries could be saved so the market dropped.

The only trigger that I hear analysts pointing to in an effort to explain the selloff yesterday is the 2.9% wage growth number that we got on Friday.  This in turn has sparked inflation fears and in reaction, the Fed may decide to hike rates four times this year instead of three.  Hardly a “crisis”.   Outside of that nothing else meaningful has happened to trigger the volatility that we are seeing in the stock market.   OK……so what should you do in reaction to this?  Sometimes the right answer is “nothing”.   It’s difficult to hear that because emotionally you want to pull money out of the market and run to cash or bonds but absent a sound economic reason for making that move, at this point, the best investment decision may be to just stay the course.

We Have Forgotten What Volatility Feels Like

When you are in a market environment like 2017, you very quickly forget what normal market volatility feels like.  In 2017, the stock market just gradually climbed throughout the year without any hiccups.  That’s not normal.  Below is a chart that shows the magnitude of market corrections each year going back to 1990. As you will see, on average, when the economy is not in a recession, the market averages an 11.56% correction at some point during the year.  In 2017, we only experienced a 3% correction.

intra year drops in the S&P 500 Index

Now the next chart shows you the big picture. Not only does it illustrate the amount of the largest market correction during the year but it also shows the return of the S&P 500 for the year.

Look at 2016.  In 2016, at some point in the year the S&P 500 Index dropped by 11%.  If you just held through it, the S&P 500 returned 10% for the year.

In 2011, the S&P 500 dropped by 19% during the year!!  If you didn’t sell and just held through the volatility, you would have had a breakeven year.

Easier Said Than Done

Every big market correction feels like a new world ending crisis.  It’s not.  We have been fortunate enough to have a nice easy ride for the past 12 months but it seems like we are returning to more historical levels of volatility.  Days like February 5, 2018 will test your patience and make you feel compelled to react.  It’s easy to look back and confess that “yes, I should have just held through it” but it’s easier said than done.

It’s important to understand the catalysts that are driving the volatility in the markets.  Sometimes the markets are dropping for a good reason and other times it’s just plain old fashion volatility.  Based on what we have seen over the past few days and absent the emergence of a new economic, political, or global crisis, we expect it to be the later of the two.

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

How Rental Income Will Be Taxed In Years 2019+

Tax reform will change the way rental income is taxed to landlords beginning in 2018. Under current law, rental income is classified as "passive income" and that income simply passes through to the owner's personal tax return and they pay ordinary income tax on it. Beginning in 2018, rental income will be eligible to receive the same preferential tax treatment as the "qualified business income" (QBI) for small business owners.

20% Deduction

Starting in 2018, taxpayers with qualified business income (including rental income), may be eligible to take a tax deduction up to 20% of their QBI. Determining whether or not you will be eligible to capture the full 20% deduction on your rental income will be based on your total taxable income for year. The taxable income thresholds are as follows:Single filers: $157,500Married filing joint: $315,000"Total taxable income" is not your AGI (adjusted gross income) and it's not just income from your real estate business or self-employment activities. It's your total taxable income less some deductions. The IRS has yet to provide us with full guidance on the definition of "total taxable income". For example, let's assume you have three rental properties owned by an LLC and you net $50,000 in income from the LLC each year. But your wife is a lawyer that makes $350,000 per year. Your total taxable income for the year would be $400,000 landing you above the $315,000 threshold.

Below The Income Threshold

If your total taxable income is below the income thresholds listed above, the calculation is very easy. Take your total QBI and multiply it by 20% and that's your tax deduction.

Above The Income Threshold

If your total taxable income is above the thresholds, the calculation gets more complex. If you exceed the income thresholds, your deduction is the LESSER of:

1. 20% of QBI

1. The GREATER OF:

• 50% of W-2 wages paid to employees

• 25% of W-2 wages paid to employees PLUS 2.5% of the unadjusted asset basis

The best way to explain the calculation is by using an example. Assume the following:

• I bought a commercial building 3 years ago for $1,000,000

• I have already captured $100,000 in depreciation on the building

• After expenses, I net $150,000 in income each year

• The LLC that owns the property has no employees

• I'm married

• I own a separate small business that makes $400,000 in income

Since I'm over the $315,000 total taxable income threshold for a married couple filing joint, I will calculate my deduction as follows:The LESSER of:

1. 20% of QBI = $30,000 ($150,000 x 20%)

1. The GREATER of:

• 50% of W-2 wage paid to employees = $0 (no employees)

• 25% of W-2 wages page to employees plus 2.5% of unadjusted basis

(25% of wages = $0) + (2.5% of unadjusted basis = $25,000) = $25KIn this example, my deduction would be limited to $25,000. Here are a few special notes about the calculation listed above. In the 11th hour, Congress added the "2.5% of unadjusted basis" to the calculation. Without it, it would have left most landlords with a $0 deduction. Why? Real estate owners typically do not have W-2 employees, so 50% of W-2 wages would equal $0. Some larger real estate investors have "property management companies" but they are usually set up as a separate entity. In which case, the W-2 income of the property management company would not be included in the calculation for the QBI deduction. If you are someone who owns a property or properties and is need of a Property management company to help you with organizing and operating your property, then doing research in your general area to find a real estate company that can help you with that is important.Another special note, 2.5% is based on an unadjusted basis and it's not reduced by depreciation. However, the tangible property has to be subject to depreciation on the last day of the year to be eligible for the deduction. Meaning, even though the 2.5% is not reduced for the amount of depreciation already taken on the property, the property must still be in the "depreciation period" on the last day of the year to be eligible for the QBI deduction.Tony Nitti, a writer for Forbes, also makes the following key points:

• The depreciable period starts on the date the property is placed in service and ends on the LATER of:

- 10 years, or- The last day of the last full year in the asset's "regular" (not ADS) depreciation periodMeaning, if you purchase a non-residential rental building that is depreciated over 39 years, the owner can continue to capture the depreciation on the building but that will not impact the 2.5% unadjusted basis number for the full 39 years of the depreciation period.

• Any asset that was fully depreciated prior to 2018, unless it was placed in service after 2008, will not count toward the basis.

• Shareholders or partners may only take into consideration for purposes of applying the limitation 2.5% his or her allocable share of the basis of the property. So if the total basis of commercial property is $1,000,000 and you are a 20% owner, you basis limitation is $1,000,000 x 20% x 2.5% = $5,000

Phase-In Of The Threshold

The questions I usually get next is: "If I'm married and our total taxable income is $320,000 which is only $5,000 over the threshold, do I automatically have to use the more complex calculation?" The special calculation "phases in" over the following total taxable income thresholds:Single filers: $157,500 - $207,500Married filing joint: $315,000 - $415,000I won't get into the special phase-in calculation because it's more complex than the special "above the income threshold" calculation that we already walked through but just know that it will be a blend of the straight 20% deduction and the W-2 & 2.5% adjusted basis calculation.

Qualified Trade or Business Requirement

In August 2018, the IRS came out with further clarification of how the QBI deduction would apply to real estate. In order to qualify for the QBI deduction for real estate income, your real estate holdings have to qualify as a "trade or business". The definition of a trade or business for QBI purposes deviates slightly from the traditional IRS definition. There is a safe harbor that states if you spend more than 250 hours a year working on that business it will qualify for the deduction.There are a few items to consider in the 250 hour calculation. So called "drive bys" where the owner is spending time driving by their properties to check on them does not count toward the 250 hours. If you have a property management company, the hours that they spend managing your propoerty can be credited toward your 250 hour requirement. However, the property management company has to provide you with proper documentation to qualify for those credited hours.

Consult Your Accountant

I'm a Certified Financial Planner®, not an accountant. I wrote this article to give real estate investors a broad view of what tax reform may have instore for them in 2018. If you own rental property, you should be actively consulting with our accountant through the year. As the IRS continues to release guidance regarding the QBI deduction throughout 2018, you will want to make sure that your real estate holdings are positioned properly to take full advantage of the new tax rules.

About Michael.........

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Tax Reform: Changes To 529 Accounts & Coverdell IRA's

Included in the new tab bill were some changes to the tax treatment of 529 accounts and Coverdell IRA's. Traditionally, if you used the balance in the 529 account to pay for a "qualified expense", the earnings portion of the account was tax and penalty free which is the largest benefit to using a 529 account as a savings vehicle for college.So what's the change? Prior to the Tax Cuts and Jobs Act (tax reform), qualified distributions were only allowed for certain expenses associated with the account beneficiary's college education. Starting in 2018, 529 plans can also be used to pay for qualified expenses for elementary, middle school, and high school.

Kindergarten – 12th Grade Expenses

Tax reform included a provision that will allow owners of 529 account to take tax-free distributions from 529 accounts for K – 12 expenses for the beneficiary named on the account. This is new for 529 accounts. Prior to this provision, 529 accounts could only be used for college expenses. Now 529 account holders can distribute up to $10,000 per student per year for K – 12 qualified expenses. Another important note, this is not limited to expenses associated with private schools. K – 12 qualified expense will be allowed for:

• Private School

• Public School

• Religious Schools

• Homeschooling

529 Accounts Will Largely Replace Coverdell IRA's

Prior to this rule change, the only option that parents had to save and accumulate money tax-free to K – 12 expenses for their children were Coverdell IRA's. But Coverdell IRA's had a lot of hang ups

• Contributions were limited to $2,000 per year

• You could only contribute to a Coverdell IRA if your income was below certain limits

• You could not contribution to the Coverdell IRA after your child turned 18

• Account balance had to be spend by the time the student was age 30

By contrast, 529 accounts offer a lot more flexibility and higher contributions limits. For example, 529 accounts have no contribution limits. The only limits that account owners need to be aware of are the "gifting limits" since contributions to 529 accounts are considered a "gift" to the beneficiary listed on the account. In 2018, the annual gift exclusion will be $15,000. However, 529 accounts have a provision that allow account owners to make a "5 year election". This election allows account owners to make an upfront contribution of up to 5 times the annual gift exclusion for each beneficiary without trigger the need to file a gift tax return. In 2018, a married couple could contribution up to $150,000 for each child to a 529 account without trigger a gift tax return.If I have a child in private school, they are in 6th grade, and I'm paying $20,000 in tuition each year, that means I have $140,000 that I'm going to spend in tuition between 6th grade – 12th grade and then I have college tuition to pile on top of that amount. Instead of saving that money in an after-tax investment account which is not tax sheltered and I pay capital gains tax when I liquidate the account to pay those expenses, why not setup a 529 account and shelter that huge dollar amount from income tax? It will probably saves me thousands, if not tens of thousands of dollars in taxes, in taxes over the long run. Plus, if I live in a state that allows tax deductions for 529 contributions, I get that benefit as well.

Income Limits and Tax Deductions

Unlike Coverdell IRA's, 529 accounts do not have income restrictions for making contributions. Plus, some states have a state tax deduction for contributions to 529 account. In New York, a married couple filing joint, receive a state tax deduction for up to $10,000 for contribution to 529 account. A quick note, that is $10,000 in aggregate, not $10,000 per child or per account.

Rollovers Count Toward State Tax Deductions

Here is a fun fact. If you live in New York and you have a 529 account established in another state for your child, if you rollover the balance into a NYS 529 account, the rollover balance counts toward your $10,000 annual NYS state tax deduction. Also, you can rollover balances in Coverdell IRA's into 529 accounts and my guess is many people will elect to do so now that 529 account can be used for K – 12 expenses.

Contributions Beyond Age 18

Unlike Coverdell IRA's which restrict contributions once the child reaches age 18, 529 accounts have no age restriction for contributions. We will often encourage clients to continue to contribute their child's 529 account while they are attending college for the sole purpose of continuing to capture the state tax deduction. If you receive the tuition bill in the mail today for $10,000, you can send in a $10,000 check to your 529 account provider as a current year contribution, as soon as the check clears the account you can turn around and request a qualified withdrawal from the account for the tuition bill, and pay the bill with the cash that was distributed from the 529 account. A little extra work but if you live in NYS and you are in a high tax bracket that $10,000 deduction could save you $600 - $700 in state taxes.

What Happens If There Is Money Left In The 529 Account?

If there is money left over in a 529 account after the child has graduated from college, there are a number of options available. For more on this, see our article "5 Options For Money Left Over In College 529 Plans"

Qualified Expenses

The most frequent question that I get is "what is considered a qualified expense for purposes of tax-free withdrawals from a 529 account?" Here is a list of the most common:

• Tuition

• Room & Board

• Technology Items: Computers, Printers, Required Software

• Supplies: Books, Notebooks, Pens, Etc.

Just as important, here are a list of expense that are NOT considered a "qualified expense" for purposes of tax free withdrawals from a 529 account:

• Transportation & Travel: Expense of going back and forth from school / college

• Student Loan Repayment

• General Electronics and Cell Phone Plans

• Sports and Fitness Club Memberships

• Insurance

If there is ever a question as to where or not an expense is a qualified expense or not, I would recommend that you contact the provider of your 529 account before making the withdrawal form your 529 account. If you take a withdrawal for an expense that is not a "qualified expenses" you will pay income taxes and a 10% penalty on the earnings portion of the withdrawal.

Do I Have To Close My Coverdell IRA?

While 529 accounts have a number of advantages compared to Coverdell IRA's, current owners of Coverdell IRAs will not be required to close their accounts. They will continue to operate as they were intended. Like 529 accounts, Coverdell IRA withdrawals will also qualify for the tax-free distributions for K – 12 expenses including the provision for expenses associated with homeschooling.

About Michael.........

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

How Pass-Through Income Will Be Taxed For Small Business Owners

While one of the most significant changes incorporated in the new legislation was reducing the corporate tax rate from the current 35% rate to a 21% rate in 2018, the tax bill also contains a big tax break for small business owners. Unlike large corporations that are taxed at a flat rate, most small businesses, are "pass-through" entities, meaning that the profits from the business flow through to the business owner's personal tax return and then are taxed at ordinary income tax rates.While pass-through income will continue to be taxed at ordinary income tax rates, many small business owners will be eligible to deduct 20% of their "qualified business income" (QBI) starting in 2018. In other words, some pass-through entities will only be taxes on 80% of their pass-through income.

Pass-through entities include

Sole proprietorships

Partnerships

LLCs

S-Corps

Unanswered Questions

I wanted to write this article to give our readers the framework of what we know at this point about the treatment of the pass-through income in 2018. However, as many accountants will acknowledge, there seems to be more questions at this point then there are answers. The IRS will need to begin issuing guidance at the beginning of 2018 to clear up many of the unanswered questions as to who will be eligible and not eligible for the new 20% deduction.

Above or Below "The Line"

This 20% deduction will be a below-the-line deduction which is an important piece to understand. Tax lingo makes my head spin as well, so let's pause for a second to understand the difference between an "above-the-line deduction" and a "below-the-line deduction".The "line" refers to the AGI line on your tax return which is the bottom line on the first page of your Form 1040. While both above-the-line and below-the-line deductions reduce your taxable income, it's important to understand the difference between the two.

Above-The-Line Deductions

Above-the-line deductions happen on the first page of your tax return. These deductions reduce your gross income to eventually reach your AGI (adjusted gross income) for the year. Above-the-line deductions include:

• Contributions to health savings accounts

• Contributions to retirement plans

• Deduction for one-half of the self-employment taxes

• Health insurance premiums paid

• Alimony paid, student loan interest, and a few others

The AGI is important because the AGI is used to determine your eligibility for certain tax credits and it will also have an impact on which below-the-line deductions you are eligible for. In general, the lower your AGI is, the more deductions and credits you are eligible to receive.

Below-The-Line Deductions

Below-the-line deductions are reported on lines that come after the AGI calculation. They are comprised mainly of your “standard deduction” or “itemized deductions” and “personal exemptions” (most of which will be gone starting in 2018). The 20% deduction for qualified business income will fall into this below-the-line category. It will lower the income of small business owners but it will not lower their AGI.

However, it was stated in the tax legislation that even though the 20% qualified business deduction will be a below –the-line deduction it will not be considered an “itemized deduction”. This is a huge win!!! Why? If it’s not an itemized deduction, then small business owners can claim the 20% qualified business income deduction and still claim the standard deduction. This is an important note because many small business owners may end up taking the standard deduction for the first time in 2018 due to all of the deductions and tax exemptions that were eliminated in the new tax bill. The tax bill took away a lot of big deductions:

• Capped state and local taxes at $10,000 (this includes state income taxes and property taxes)

• Eliminated personal exemptions ($4,050 for each individual) (Eliminated in 2018)

  • Family of 4 = $4,050 x 4 = $16,200 (Eliminated in 2018)

• Miscellaneous itemized deductions subject to 2% of AGI floor (Eliminated in 2018)

Restrictions On The 20% Deduction

If life were easy, you could just assume that I'm a sole proprietor, I make $100,000 all in pass-through income, so I will get a $20,000 deduction and only have to pay tax on $80,000 of my income. For many small business owners it may be that easy but what's a tax law without a list of restrictions.The restriction were put in place to prevent business owners from reclassifying their W2 wages into 100% pass-through income to take advantage of the 20% deduction . They also wanted to restrict employees from leaving their company as a W2 employee, starting a sole proprietorship, and entering into a sub-contractor relationship with their old employer just to reclassify their W2 wages into 100% pass-through income.

S-Corps

Qualified business income will specifically exclude "reasonable compensation" paid to the owner-employee of an S-corp. While it would seem like an obvious reaction by S-corp owners to reduce their W2 wages in 2018 to create more pass through income, they will still have to adhere to the "reasonable compensation" restriction that exists today.

Partnerships & LLCs

Qualified business income will specifically exclude guaranteed payments associated with partnerships and LLCs. This creates a grey area for these entities. Partnerships do not have a “reasonable compensation” requirement like S-corps since companies taxed as partnerships are not allowed to pay W2 wages to the owners. Also the owners of partnerships are not required to take guaranteed payments. My guess is, and this is only a guess, that as we get further into 2018, the IRS may require partnerships to classify a percentage of a owners total compensation as a “guaranteed payment” similar to the “reasonable compensation” restriction that S-corps currently adhere too. Otherwise, partnerships can voluntarily eliminate guaranteed payments and take the 20% deduction on 100% of the pass-through income.

This may also prompt some S-corps to look at changing their structure to a partnership or LLC. For high income earners, S-corps have an advantage over the partnership structure in that the owners do not pay self-employment tax on the pass-through income that is distribution to the owner over and above their W2 wages. However, S-corp owners will have to weigh the self-employment tax benefit against the option of changing their corporate structure to a partnership and potentially receiving a 20% deduction on 100% of their income.

Sole Proprietors

Sole proprietors do not have "reasonable compensation" requirement or "guaranteed payments" so it would seem that 100% of the income generated by sole proprietors will count as qualified business income. Unless the IRS decides to enact a "reasonable compensation" requirement for sole proprietors in 2018, similar to S-corps. Before everyone runs from a single member LLC to a sole proprietorship, remember, a sole proprietorship offers no liability barrier between the owner and liabilities that could arise from the business.

Income Restrictions

There are limits that are imposed on the 20% deduction based on how much the owner makes in “taxable income”. The thresholds are set at the following amounts:

Individual: $157,500

Married: $315,000

The thresholds are based on each business owner’s income level, not on the total taxable income of the business. We need help from the IRS to better define what is considered “taxable income” for purposes of this phase out threshold. As of right now, it seems that “taxable income” will be defined as the taxpayer’s own taxable income (not AGI) less deductions.

If the owner’s taxable income is below this threshold, then the calculation is a simple 20% deduction of the pass-through income. If the owner’s taxable income exceeds the threshold, the qualified business deduction is calculated as follows:

The LESSER of:

20% of its business income OR 50% of the total wages paid by the business to its employees

Let’s look at this in a real life situation. A manufacturing company has a net profit of $2M in 2018 and pays $500,000 in wages to its employees during the year. That company would only be able to take the qualified business income deduction for $250,000 since 50% of the total employee wages ($500,000 x 50% = $250,000) are less than 20% of the net income of the business ($2M x 20% = $400,000).

This creates another grey area because it seems that the additional calculation is triggered by the taxable income of each individual owner but the calculation is based on the total profitability and wages paid by the company. For the owners that required this special calculation for exceeding the threshold, how is their portion of the lower deduction amount allocated? Multiplying the lower total deduction amount by the percent of their ownership? Just more unanswered questions.:

Restrictions For "Service Business"

There will be restrictions on the 20% deduction for pass-through entities that are considered a "service business" under IRC Section 1202(e)(3)(A). The businesses specifically included in this definition as a services business are:

• Health

• Law

• Accounting

• Actuarial Sciences

• Performing Arts

• Consulting

• Athletics

• Financial Services

• Any other trade or business where the principal asset of the business is the reputation or skill of 1 or more of its employees

In a last minute change to the regulations, to their favor, engineers and architects were excluded from the definition of “service businesses”.

This is another grey area. Many small businesses that fall outside of the categories listed above will undoubtedly be asking the question: “Am I considered a service business or not?” Outside of the industries specifically listed in the tax bill, we really need more guidance from the IRS.

If you are a “services business”, when the tax reform was being negotiated it looked like service businesses were going to be completely excluded from the 20% deduction. However, the final regulations were more kind and instead implemented a phase out of the 20% deduction for owners of service businesses over a specified income threshold. The restriction will only apply to those whose “taxable income” exceeds the following thresholds:

Individual: $157,500

Married: $315,000

If you are a consultant or owner of a services business and your taxable income is below these thresholds, it would seem at this point that you will be able to capture the 20% deduction for your pass-through income. As mentioned above, we need help from the IRS to clarify the definition of “taxable income”.

Phase Out For Service Businesses

The amounts listed above: $157,500 for individual and $315,000 for a married couple filing joint, are where the thresholds for the phase out begins. The service business owners whose income rises above those thresholds will phase out of the 20% deduction over the next $50,000 of taxable income for individual filers and $100,000 of taxable income for married filing joint. This means that the 20% pass-through deduction is completely gone by the following income levels:

Individual: $207,500

Married: $415,000

Any taxpayer’s falling in between the threshold and the phase out limit will receive a portion of the 20% deduction.

Since the thresholds are assessed based on the taxpayer’s own taxable income and not the total income of the business, a service business could be in a situation, like in an accounting firm, where the partners with the largest ownership percentage may not qualify for 20% deduction but the younger partners may qualify for the deduction because their income is lower.

Tax Planning For 2018

It's an understatement to say that most small business owners will need to spend a lot of time with their accountant in the first quarter of 2018 to determine the best of course of action for their company and their personal tax situation.While we are still waiting for clarification on a number of very important items associated with the 20% deduction for qualified business income, hopefully this article has provided our small business owners with a preview of things to come in 2018.

Disclosure: I'm a Certified Financial Planner® but not an accountant. The information contained in this article was generated from hours and hours of personal research on the topic. I advise each of our readers to consult with your personal tax advisor for tax advice.

About Michael.........

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Divorce: Make Sure You Address The College Savings Accounts

The most common types of college savings accounts are 529 accounts, UGMA, and UTMA accounts. When getting divorce it’s very important to understand who the actual owner is of these accounts and who has legal rights to access the money in those accounts.  Not addressing these accounts in the divorce agreement can lead to dire consequences for your children if your ex-spouse drains the college savings accounts for their own personal expenses. 

UGMA or UTMA Accounts

The owner of these types of accounts is the child. However, since a child is a minor there is a custodian assigned to the account, typically a parent, that oversees the assets until the child reaches age 21.  The custodian has control over when withdraws are made as long as it could be proven that the withdrawals being made a directly benefiting the child.   This can include school clothes, buying them a car at age 16, or buying them a computer. It’s important to understand that withdraws can be made for purposes other than paying for college which might be what the account was intended for.  You typically want to have your attorney include language in the divorce agreement that addresses what these account can and can not be used for.  Once the child reaches the age of majority, age 21, the custodian is removed, and the child has full control over the account.

529 accounts

When it comes to divorce, pay close attention to 529 accounts. Unlike a UGMA or UTMA accounts that are required to be used for the benefit of the child, a 529 account does not have this requirement. The owner of the account has complete control over the 529 account even though the child is listed as the beneficiary. We have seen instances where a couple gets divorced and they wrongly assume that the 529 account owned by one of the spouses has to be used for college.  As soon as the divorce is finalized, the ex-spouse that owns the account then drains the 529 account and uses the cash in the account to pay legal fees or other personal expenses.  If the divorce agreement did not speak to the use of the 529 account, there’s very little you can do since it’s technically considered an asset of the parent.

Divorce agreements can address these college saving accounts in a number of way.   For example, it could state that the full balance has to be used for college before out-of-pocket expenses are incurred by either parent. It could state a fixed dollar amount that has to be withdrawn out of the 529 account each year with any additional expenses being split between the parents.  There is no single correct way to address the withdraw strategies for these college savings accounts. It is really dependent on the financial circumstances of you and your ex spouse and the plan for paying for college for your children.

With 529 accounts there is also the additional issue of “what if the child decides not to go to college?” The divorce agreement should address what happens to that 529 account. Is the account balance move to a younger sibling?  Is the balance distributed to the child at a certain age?  Or will the assets be distributed 50-50 between the two parents?

Is for these reason that you should make sure that your divorce agreement includes specific language that applies to the use of the college savings account for your children

For more information on college savings account, click on the hyperlink below:

Link:  More Articles On College Savings Accounts

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Tax Reform: Your Company May Voluntarily Terminate Your Retirement Plan

Make no mistake, your company retirement plan is at risk if the proposed tax reform is passed.  But wait…..didn’t Trump tweet on October 23, 2017 that “there will be NO change to your 401(k)”?  He did tweet that, however, while the tax reform might not directly alter the contribution limits to employer sponsored retirement plans, the new tax rates will produce a “disincentive” for companies to sponsor and make employer contributions to their plans.

What Are Pre-Tax Contributions Worth?

Remember, the main incentive of making contributions to employer sponsored retirement plans is moving income that would have been taxed now at a higher tax rate into the retirement years, when for most individuals, their income will be lower and that income will be taxed at a lower rate.   If you have a business owner or executive that is paying 45% in taxes on the upper end of the income, there is a large incentive for that business owner to sponsor a retirement plan.  They can take that income off of the table now and then realize that income in retirement at a lower rate.

This situation also benefits the employees of these companies.  Due to non-discrimination rules, if the owner or executives are receiving contributions from the company to their retirement accounts, the company is required to make employer contributions to the rest of the employees to pass testing. This is why safe harbor plans have become so popular in the 401(k) market.

But what happens if the tax reform is passed and the business owners tax rate drops from 45% to 25%?  You would have to make the case that when the business owner retires 5+ years from now that their tax rate will be below 25%.  That is a very difficult case to make.

An Incentive NOT To Contribute To Retirement Plans

This creates an incentive for business owners NOT to contribution to employer sponsored retirement plans.  Just doing the simple math, it would make sense for the business owner to stop contributing to their company sponsored retirement plan, pay tax on the income at a lower rate, and then accumulate those assets in a taxable account.  When they withdraw the money from that taxable account in retirement, they will realize most of that income as long term capital gains which are more favorable than ordinary income tax rates. 

If the owner is not contributing to the plan, here are the questions they are going to ask themselves: 

• Why am I paying to sponsor this plan for the company if I’m not using it?

• Why make an employer contribution to the plan if I don’t have to?

This does not just impact 401(k) plans. This impacts all employer sponsored retirement plans: Simple IRA’s, SEP IRA’s, Solo(k) Plans, Pension Plans, 457 Plans, etc.

Where Does That Leave Employees?

For these reasons, as soon as tax reform is passed, in a very short time period, you will most likely see companies terminate their retirement plans or at a minimum, lower or stop the employer contributions to the plan.  That leaves the employees in a boat, in the middle of the ocean, without a paddle.  Without a 401(k) plan, how are employees expected to save enough to retire?  They would be forced to use IRA’s which have much lower contribution limits and IRA’s don’t have employer contributions.

Employees all over the United States will become the unintended victim of tax reform.  While the tax reform may not specifically place limitations on 401(k) plans, I’m sure they are aware that just by lowering the corporate tax rate from 35% to 20% and allowing all pass through business income to be taxes at a flat 25% tax rate, the pre-tax contributions to retirement plans will automatically go down dramatically by creating an environment that deters high income earners from deferring income into retirement plans.   This is a complete bomb in the making for the middle class.

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Social Security Filing Strategies

Making the right decision of when to turn on your social security benefit is critical. The wrong decision could cost you tens of thousands of dollars over the long run.  Given all the variables surrounding this decision, what might be the right decision for one person may be the wrong decision for another. This article will cover some of the key factors to consider:

Normal Retirement Age

First, you have to determine your "Normal Retirement Age" (NRA). This is listed on your social security statement in the "Your Estimated Benefits" section. If you were born between 1955 – 1960, your NRA is between age 66 – 67. If you were born 1960 or later, your NRA is age 67. You can obtain a copy of your statement via the social security website.

Before Normal Retirement Age

You have the option to turn on social security prior to your normal retirement age. The earliest you can turn on social security is age 62. However, they reduce your social security benefit by approximately 7% per year for each year prior to your normal retirement age. See the chart below from USA Today which illustrates an individual with a normal retirement age of 66. If they turn on their social security benefit at age 62, they would only receive 75% of their full benefit. This reduction is a permanent reduction. It does not increase at a later date, outside of the small cost of living increases.

taking social security early

The big questions is: “If I start taking it age 62, at what age is the breakeven point?” Remember, if I turn on social security at 62 and my normal retirement age is 66, I have received 4 years of payments from social security. So at what age would I be kicking myself wishing that I had waited until normal retirement age to turn on my benefit. There are a few different ways to calculate this accounting for taxes, the rates of return on other retirement assets, inflations, etc. but in general it’s sometime between the ages of 78 and 82.

Since the breakeven point may be in your early 80’s, depending on your health, and the longevity in your family history, it may or may not make sense to turn on your benefit early. If we have a client that is in ok health but not great health and both of their parents passed way prior to age 85, then it may make sense to for them to turn on their social security benefit early. We also have clients that have pensions and turning on their social security benefit early makes the different between retiring now or have to work for 5+ more years. As long as the long-term projections work out ok, we may recommend that they turn on their social security benefit early so they can retire sooner.

Are You Still Working?

This is a critical question for anyone that is considering turning on their social security benefits early. Why? If you turn on your social security benefit prior to reaching normal retirement age, there is an “earned income” penalty if you earn over the threshold set by the IRS for that year. See the table listed below:

In 2016, for every $2 that you earned over the $15,720 threshold, your social security was reduced by $1. For example, let’s say I’m entitled to $1,000 per month ($12,000 per year) from social security at age 62 and in 2016 I had $25,000 in W2 income. That is $9,280 over the $15,720 threshold for 2016 so they would reduce my annual benefit by $4,640. Not only did I reduce my social security benefit permanently by taking my social security benefit prior to normal retirement age but now my $12,000 in annual social security payments they are going to reduce that by another $4,640 due to the earned income penalty. Ouch!!!

Once you reach your normal retirement age, this earned income penalty no longer applies and you can make as much as you want and they will not reduce your social security benefit.

Because of this, the general rule of thumb is if you are still working and your income is above the IRS earned income threshold for the year, you should hold off on turning on your social security benefits until you either reach your normal retirement age or your income drops below the threshold.

Should I Delay May Benefit Past Normal Retirement Age

As was illustrated in first table, if you delay your social security benefit past your normal retirement age, your benefit will increase by approximately 8% per year until you reach age 70. At age 70, your social security benefit is capped and you should elect to turn on your benefits.

So when does it make sense to wait? The most common situation is the one where you plan to continue working past your normal retirement age. It’s becoming more common that people are working until age 70. Not because they necessarily have too but because they want something to keep them busy and to keep their mind fresh. If you have enough income from employment to cover you expenses, in many cases, is does make sense to wait. Based on the current formula, your social security benefit will increase by 8% per year for each year you delay your benefit past normal retirement age. It’s almost like having an investment that is guaranteed to go up by 8% per year which does not exist.

Also, for high-income earners, a majority of their social security benefit will be taxable income. Why would you want to add more income to the picture during your highest tax years? It may very well make sense to delay the benefit and allow the social security benefit to increase.

Death Benefit

The social security death benefit also comes into play as well when trying to determine which strategy is the right one for you. For a married couple, when their spouse passes away they do not continue to receive both benefits. Instead, when the first spouse passes away, the surviving spouse will receive the “higher of the two” social security benefits for the rest of their life. Here is an example:

Spouse 1 SS Benefit: $2,000

Spouse 2 SS Benefit: $1,000

If Spouse 1 passes away first, Spouse 2 would bump up to the $2,000 monthly benefit and their $1,000 monthly benefit would end. Now let’s switch that around, let’s say Spouse 2 passes away first, Spouse 1 will continue to receive their $2,000 per month and the $1,000 benefit will end.

If social security is a large percentage of the income picture for a married couple, losing one of the social security payments could be detrimental to the surviving spouse. Due to this situation, it may make sense to have the spouse with the higher benefit delay receiving social security past normal retirement to further increase their permanent monthly benefit which in turn increases the death benefit for the surviving spouse.

Spousal Benefit

The “spousal benefit” can be a powerful filing strategy. If you are married, you have the option of turning on your benefit based on your earnings history or you are entitled to half of your spouse’s benefit, whichever benefit is higher. This situation is common when one spouse has a much higher income than the other spouse.

Here is an important note. To be eligible for the spousal benefit, you personally must have earned 40 social security “credits”. You receive 1 credit for each calendar quarter that you earn a specific amount. In 2016, the figure was $1,260. You can earn up to 4 credits each calendar year.

Another important note, under the new rules, you cannot elect your spousal benefit until your spouse has started receiving social security payments.

Here is where the timing of the social security benefits come into play. You can turn on your spousal benefit as early as 62 but similar to the benefit based on your own earnings history it will be reduce by approximately 7% per year for each year you start the benefit prior to normal retirement age. At your normal retirement age, you are entitled to receive your full spousal benefit.

What happens if you delay your spousal benefit past normal retirement age? Here is where the benefit calculation deviates from the norm. Typically when you delay benefits, you receive that 8% annual increase in the benefits up until age 70. The spousal benefit is based exclusively on the benefit amount due to your spouse at their normal retirement age. Even if your spouse delays their social security benefit past their normal retirement age, it does not increase the 50% spousal benefit.

Here is the strategy. If it’s determine that the spousal benefit will be elected as part of a married couple’s filing strategy, since delaying the start date of the benefits past normal retirement age will only increase the social security benefit for the higher income earning spouse and not the spousal benefit, in many cases, it does not make sense to delay the start date of the benefits past normal retirement age.

Divorce

For divorced couples, if you were married for at least 10 years, you can still elect the spousal benefit even though you are no longer married. But you must wait until your ex-spouse begins receiving their benefits before you can elect the spousal benefit.

Also, if you were married for at least 10 years, you are also entitled to the death benefit as their ex-spouse. When your ex-spouse passes away, you can notify the social security office, elect the death benefit, and you will receive their full social security benefit amount for the rest of your life instead of just 50% of their benefit resulting from the “spousal benefit” calculation.

Whether or not your ex-spouse remarries has no impact on your ability to elect the spousal benefit or death benefit based on their earnings history.

Consult A Financial Planner

Given all of the variables in the mix and the importance of this decision, we strongly recommend that you consult with a Certified Financial Planner® before making your social security benefit elections. While the interaction with a fee-based CFP® may cost you a few hundred dollars, making the wrong decision regarding your social security benefits could cost you thousands of dollars over your lifetime. You can also download a Financial Planner Budget Worksheet to give you that extra help when sorting out your finances and monthly budgeting.

About Michael.........

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

The Fiduciary Rule: Exposing Your 401(K) Advisor’s Secrets

It’s here.  On June 9, 2017, the long awaited Fiduciary Rule for 401(k) plans will arrive.  The wirehouse and broker-dealer community within the investment industry has fought this new rule every step of the way.  Why? Because their secrets are about to be exposed.  Fee gouging in these 401(k) plans has spiraled out of control and it has gone on for way too long.  While the Fiduciary Rule was designed to better protect plan participants within these employer sponsored retirement plans, the response from the broker-dealer community, in an effort to protect themselves, may actually drive the fees in 401(k) plans higher than they are now.

If your company sponsors an employer sponsored retirement plan and your investment advisor is a broker with one of the main stream wirehouse or broker dealers then they may be approaching you within the next few months regarding a “platform change” for your 401(k) plan.  Best advice, start asking questions before you sign anything!!  The brokerage community is going to try to gift wrap this change and present this as a value added service to their current 401(k) clients when the reality is this change is being forced onto the brokerage community and they are at great risk at losing their 401(k) clients to independent registered investment advisory firms that have served as co-fiduciaries to their plans along.

The Fiduciary Rule requires all investment advisors that handle 401(k) plans to act in the best interest of their clients.  Up until now may brokers were not held to this standard. As long as they delivered the appropriate disclosure documents to the client, the regulations did not require them to act in their client’s best interest. Crazy right?  Well that’s all about to change and the response of the brokerage community will shock you.

I will preface this article by stating that there have been a variety of responses by the broker-dealer community to this new regulation.  While we cannot reasonably gather information on every broker-dealers response to the Fiduciary Rule, this article will provide information on how many of the brokerage firms are responding to the new legislation given our independent research.

SECRET #1:

Many of the brokerage dealers are restricting what 401(k) platforms their brokers can use.  If the broker currently has 401(k) clients that maintain a plan with a 401(k) platform outside of their new “approved list”, they are forcing them to move the plan to a pre-approved platform or the broker will be required to resign as the advisor to the plan.  Even though your current 401(k) platform may be better than the new proposed platform, the broker may attempt to move your plan so they can keep the plan assets.  How is this remotely in your employee’s best interest? But it’s happening.  We have been told that some of these 401(k) providers end up on the “pre-approve list” because they are willing to share fees with the broker dealer. If you don’t share fees, you don’t make the list.  Really ugly stuff!!

SECRET #2:

Because these wirehouses and broker-dealers know that their brokers are not “experts” in 401(k) plans, many of the brokerage firms are requiring their 401(k) plans to add a third-party fiduciary service which usually results in higher plan fees.  The question to ask is “if you were so concerned about our fiduciary liability why did you wait until now to present this third party fiduciary service?”  They are doing this to protect themselves, not the client.   Also, many of these third party fiduciary services could standardize the investment menu and take the control of the investment menu away from the broker.  Which begs the question, what are you paying the broker for?

SECRET #3:

Some broker-dealers are responding to the Fiduciary Rule by forcing their brokers to move all their 401(k) plans to a “fee based platform” versus a commission based platform.  The plan participants may have paid commissions on investments when they were purchased within their 401(k) account and now could be forced out of those investments and locked into a fee based fee structure after they already paid a commission on their balance.  This situation will be common for 401(k) plans that are comprised primarily of self-directed brokerage accounts.  Make sure you ask the advisor about the impact of the fee structure change and any deferred sales charges that may be imposed due to the platform change.

SECRET #4:

The plan fees are often times buried.  The 401(k) industry has gotten very good at hiding fees.  They talk in percentages and basis points but rarely talk in hard dollars.  One percent does not sound like a lot but if you have a $2 million dollar 401(k) plan that equals $20,000 in fees coming out of the plans assets every year.  Most of the fees are buried in the mutual fund expense ratios and you basically have to be an investment expert to figure out how much you are paying.  This has continued to go on because very rarely do companies write a check for their 401(k) fees. Most plans debit plan assets for their plan fees but the fees are real.

With all of these changes taking place, now is the perfect time to take a good hard look at your company’s employer sponsored retirement plan.  If your current investment advisor approaches you with a recommended “platform change” that is a red flag.  Start asking a lot of questions and it may be a good time to put your plan out to bid to see if you can negotiate a better overall solution for you and your employees.

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Planning for Long Term Care

The number of conversations that we are having with our clients about planning for long term care is increasing exponentially.  Whether it’s planning for their parents, planning for themselves, or planning for a relative, our clients are largely initiating these conversations as a result of their own personal experiences.

The baby-boomer generation is the first generation that on a large scale is seeing the ugly aftermath of not having a plan in place to address a long term care event because they are now caring for their aging parents that are in their 80’s and 90’s.  Advances in healthcare have allowed us to live longer but the longer we live the more frail we become later in life.

Our clients typically present the following scenario to us: “I have been taking care of my parents for the past three years and we just had to move my dad into the nursing home.  What an awful process.  How can I make sure that my kids don’t have to go through that same awful experience when I’m my parents age?”

“Planning for long term care is not just about money…….it’s about having a plan”

If there are no plans, your kids or family members are now responsible for trying to figure out “what mom or dad would have wanted”.   Now tough decisions need to be made that can poison a relationship between siblings or family members.

Some individuals never create a plan because it involves tough personal decisions.  We have to face the reality that at some point in our lives we are going to get older and later in life we may reach a threshold that we may need help from someone else to care for ourselves or our spouse.  It’s a tough reality to  face but not facing this reality will most likely result in the worst possible outcome if it happens.

Ask yourself this question: “You worked hard all of your life to buy a house, accumulate assets in retirement accounts, etc. If there are assets left over upon your death, would you prefer that those assets go to your kids or to the nursing home?”  With some advance planning, you can make sure that your assets are preserved for your heirs.

The most common reason that causes individuals to avoid putting a plan in place is: “I have heard that long term care insurance is too expensive.”  I have good news.  First, there are other ways to plan for the cost of a long term care event besides using long term care insurance.  Second, there are ways to significantly reduce the cost of these policies if designed correctly.

The most common solution is to buy a long term care insurance policy.  The way these policies work is if you can no longer perform certain daily functions, the policy pays a set daily benefit.  Now a big mistake many people make is when they hear “long term care” they think “nursing home”.  In reality, about 80% of long term care is provided right in the home via home health aids and nurses.  Most LTC policies cover both types of care.   Buying a LTC policy is one of the most effective ways to address this risk but it’s not the only one.

Why does long term care insurance cost more than term life insurance or disability insurance? The answer, most insurance policies insure you against risks that have a low probability of happening but has a high financial impact.  Similar to a life insurance policy. There is a very low probability that a 25 year old will die before the age of 60.  However, the risk of long term care has a high probability of happening and a high financial impact.  According to a study conducted by the U.S Department of Human Health and Services, “more than 70% of Americans over the age of 65 will need long-term care services at some point in their lives”.  Meaning, there is a high probability that at some point that insurance policy is going to pay out and the dollars are large.  The average daily rate of a nursing home in upstate New York is around $325 per day ($118,625 per year). The cost of home health care ranges greatly but is probably around half that amount.

So what are some of the alternatives besides using long term care insurance?  The strategy here is to protect your assets from Medicaid.  If you have a long term care event you will be required to spend down all of your assets until you reach the Medicaid asset allowance threshold (approx. $13,000 in assets) before Medicaid will start picking up the tab for your care.  Often times we will advise clients to use trusts or gifting strategies to assist them in protecting their assets but this has to be done well in advance of the long term care event.  Medicaid has a 5 year look back period which looks at your full 5 year financial history which includes tax returns, bank statements, retirement accounts, etc, to determine if any assets were “given away” within the last 5 years that would need to come back on the table before Medicaid will begin picking up the cost of an individuals long term care costs.  A big myth is that Medicare covers the cost of long term care.  False, Medicare only covers 100 days following a hospitalization.  There are a lot of ins and outs associated with buildings a plan to address the risk of long term care outside of using insurance so it is strongly advised that individuals work with professionals that are well versed in this subject matter when drafting a plan.

An option that is rising in popularity is “semi self-insuring”.  Instead of buying a long term care policy that has a $325 per day benefit, an individual can obtain a policy that covers $200 per day.  This can dramatically reduce the cost of the LTC policy because it represents less financial risk to the insurance company.  You have essentially self insured for a portion of that future risk.  The policy will still payout $73,000 per year and the individual will be on the line for $45,625 out of pocket.  Versus not having a policy at all and the individual is out of pocket $118,000 in a single year to cover that $325 per day cost.

As you can see there are a number of different options when it come to planning for long term care.  It’s about understanding your options and determining which solution is right for your personal financial situation.

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.