Financial Planning To Do's For A Family

My wife and I just added our first child to the family so this is a topic that has been weighing on my mind over the last 40 weeks. I will share just one non-financial takeaway from the entire experience.  The global population may be much lower if men had to go through what women do.  That being said, this article is meant to be a guideline for some of the important financial items to consider with children.  Worrying about your children will never end and being comfortable with the financial aspects of parenthood may allow you to worry a little less and be able to enjoy the time you have with them.

There is a lot of information to take into consideration when putting together a financial plan and the larger your family the more pieces to the puzzle. It is important to set goals and celebrate them when they are met.  Everything cannot be done in a day, a week, or a month, so creating a task list to knock off one by one is usually an effective approach.  Using relatives, friends, and professionals as resources is important to know what should be on that list for topics you aren’t familiar with.

Create a Budget

It may seem tedious but this is one of the most important pieces of a family’s financial plan. You don’t have to track every dollar coming in and out but having a detailed breakdown on where your money is being spent is necessary in putting together a plan.  This simple Expense Planner can serve as a guideline in starting your budget. If you don’t have an accurate idea of where your money is being spent then you can’t know where you can cut back or afford to spend more if needed.  Also, the budget is a great topic during a romantic dinner.

You will always want to have 4-6 months expenses saved up and accessible in case a job is lost or someone becomes disabled and cannot work. Having an accurate budget will help you determine how much money you should have liquid.

Insurance

You want to be sure you are sufficiently covered if anything ever happened. One terrible event could leave your family in a situation that may have been avoidable.  Insurance is also something you want to take care of as soon as possible so you know the coverage is there if needed.

Health Insurance

Research the policies that are available to you and determine which option may be the most appropriate in your situation. It is important to know the medical needs of your family when making this decision.

Turning one spouse’s single coverage into family coverage is one of the more common ways people obtain coverage for a family. Insurance companies will usually only allow changes to policies through open enrollment or when a “qualifying event” occurs.  Having a child is usually a qualifying event but this may only allow the child to be added to one’s coverage, not the spouse.  If that is the case, the spouse will want to make sure they have their own coverage until they can be added to the family plan.

It is important to use the resources available to you and consult with your health insurance provider on the ins and outs. If neither spouse has coverage through work, the exchange can be a resource for information and an option to obtain coverage (https://www.healthcare.gov/).

Life Insurance

The majority of people will obtain Term Life Insurance as it is a cost effective way to cover the needs of your family. Life insurance policies have an extensive underwriting process so the sooner you start the sooner you will be covered if anything ever happened.  How Much Life Insurance Do I Need?, is an article that may help answer the question regarding the amount of life insurance sufficient for you.

Disability Insurance

The probability of using disability insurance is likely more than that of life insurance. Like life insurance, there is usually a long underwriting process to obtain coverage.  Disability insurance is important as it will provide income for your family if you were unable to work.  Below are some terms that may be helpful when inquiring about these policies.

Own Occupation – means that insurance will turn on if you are unable to perform YOUR occupation.  “Any Occupation” is usually cheaper but means that insurance will only turn on if you can prove you can’t do ANY job.

60% Monthly Income – this represents the amount of the benefit.  In this example, you will receive 60% of your current income.  It is likely not taxable so the net pay to you may be similar to your paycheck. You can obtain more or less but 60% monthly income is a common benefit amount.

90 Day Elimination Period – this means the benefit won’t start until 90 days of being disabled. This period can usually be longer or shorter.

Cost of Living or Inflation Rider – means the benefit amount will increase after a certain time period or as your salary increases.

Wills, POA’s, Health Proxies

These are important documents to have in place to avoid putting the weight of making difficult decisions on your loved ones. There are generic templates that will suffice for most people but it is starting the process that is usually the most difficult.  “What Is The Process Of Setting Up A Will?, is an article that may help you start.

College Savings

The cost of higher education is increasing at a rapid rate and has become a financial burden on a lot of parents looking to pick up the tab for their kids. 529 accounts are a great way to start saving early.  There are state tax benefits to parents in some states (including NYS) and if the money is spent on tuition, books, or room and board, the gain from the investments is tax free.  Roth IRA’s are another investment vehicle that can be used for college but for someone to contribute to a Roth IRA they must have earned income.  Therefore, a newborn wouldn’t be able to open a Roth IRA.  Since the gain in 529’s is tax free if used for college, the earlier the dollars go into the account the longer they have to potentially earn income from the market.

529’s can also be opened by anyone, not just the parents. So if the child has a grandparent that likes buying savings bonds or a relative that keeps purchasing clothes the child will wear once, maybe have them contribute to a 529.  The contribution would then be eligible for the tax deduction to the contributor if available in the state.

Below is a chart of the increasing college costs along with links to information on college planning.

FAFSA and College Savings Strategies

Need to Know College Savings Strategies

About Rob……...

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.

Should I Buy Or Lease A Car?

This is one of the most common questions asked by our clients when they are looking for a new car.  The answer depends on a number of factors:

• How long do you typically keep your cars?

• How many miles do you typically drive each year?

• What do you want your down payment and monthly payment to be?

We typically start off by asking how long clients usually keep their cars. If you are the type of person that trades in their car every 2 or 3 year for the new model, leasing a car is probably a better fit.  If you typically keep your cars for 5 plus years, then buying a car outright is most likely the better option.

“How many miles do you drive each year?”

This is often times the trump card for deciding to buy instead of lease. Most leases allow you to drive about 12,000 miles per year but this varies from dealer to dealer. If you go over the mileage allowance there are typically sever penalties and it becomes very costly when you go to trade in the car at the end of the lease.  We see younger individuals get caught in this trap because they tend to change jobs more frequently.   They lease a car when they live 10 miles away from work but then they get a job offer from an employer that is 40 miles away from their house and the extra miles start piling on.   When they go to trade in the car at the end of the lease they owe thousands of dollars due to the excess mileage.

We also ask clients how much they plan to put down on the car and what they want their monthly payments to be.  If you think you can stay within the mileage allowance, a lease will more often require a lower down payment and have a lower monthly payment.  Why? Because you are not “buying” the car.  You are simply “borrowing” it from the dealership and your payments are based on the amount that the dealership expects the car to depreciate in value during the duration of the lease.  When you buy a car……you own it……and at the end of the car loan you can sell it or continue to drive the car with no car payments.

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.

NY Free Tuition - Facts and Myths

On April 9th New York State became the first state to adopt a free tuition program for public schools.  The program was named the “Excelsior Scholarship” and it will take effect the 2017 – 2018 school year.  It has left people with a lot of unanswered questions

• Do I qualify?

• How much does it cover?

• What’s the catch?

• Can I move my finances around to qualify for the program?

This article was written to help people better understand some of the facts and myths surrounding the NY Free Tuition Program.

Who qualifies for free tuition?

It’s based on the student’s household income and it phases in over a three year period:

• 2017: $100,000

• 2018: $110,000

• 2019: $125,000

MYTH #1: “If I reduce my household income in 2017 to get under the $100,000 threshold, it will help my child qualify for the free tuition program for the 2017 – 2018 school year.”  WRONG.   The income “determination year” is the same determination year that is used for FASFA filing.  FASFA changed the rules in 2016 to look back two years instead of one for purposes of qualifying for financial aid. Those same rules will apply to the NY Free Tuition Program.  So for the 2017 – 2018 school year, the $100,000 free tuition threshold will apply to your income in 2015.

MYTH #2:  “If I make contributions to my retirement plan it will help reduce my household income to qualify for the free tuition program.” WRONG.  Again, the free tuition program will use the same income calculation that is used in the FASFA process so it is not as simple as just looking at the bottom line of your tax return.  For FASFA, any contributions that are made to retirement plans are ADDED back into your income for purposes of determining your income for that “determination year”.    So making big contributions to a retirement plan will not help you qualify for free tuition.

What does it cover?

MYTH #3:  “As long as my income is below the income threshold my kids (or I) will go to college for free.”  DEFINE “FREE”.  The Excelsior Scholarship covers JUST tuition.   It does not cover books, room and board, transportation, or other costs associated with going to college. Annual tuition at a four-year SUNY college is currently $6,470.   Here are the total fees obtained directly from the SUNY.edu website:

Tuition:                       $6,470             Covered

Student Fee:               $1,640             Not Covered

Room & Board:          $12,590           Not Covered

Books & Supplies:      $1,340             Not Covered

Personal Expenses:    $1,560             Not Covered

Transportation:          $1,080             Not Covered

Total Costs                 $24,680

When you do the math for a student living on campus, the “Free” tuition program only covers 26% of the total cost of attending college.

What’s the catch?

There are actually a few:

CATCH #1:  After the student graduates from college they have to LIVE and WORK in NYS for at least the number of years that the free tuition was awarded to the student OTHERWISE the “free tuition” turns into a LOAN that will be required to be paid back.  Example: A student receives the free tuition for four years, works in New York for two years, and then moves to Massachusetts for a new job.  That student will have to pay back two years of the free tuition.

CATCH #2:  The student must maintain a specified GPA or higher otherwise the “free tuition” turns into a LOAN.  However, the GPA threshold has yet to be released.

CATCH #3:  It’s only for FULL TIME students earning at least 30 credit hours every academic year.  This could be a challenge for students that have to work in order to put themselves through college.

CATCH #4:  This is a “Last Dollar Program” meaning that students have to go through the FASFA process and apply for all other types of financial aid and grants that are available before the Free Tuition Program kicks in.

CATCH #5:  The free tuition program is only available for two and four year degrees obtained within that two or four year period of time.  If it take the student five years to obtain their four year bachelor’s degree, only four of the five years is covered under the free tuition program.

Summary

There are many common misunderstandings associated with the NYS Free Tuition Program.  In general, it’s our view that this new program is only going to make college “more affordable”  for a small sliver of students were not previously covered under the traditional FASFA based financial aid.   Given the rising cost of college and the complexity of the financial aid process it has never been more important than it is now for individuals to work with a professional that have an in depth knowledge of the financial aid process and college savings strategies to help better prepare your household for the expenses associated with paying for college. 

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.

Strategies to Save for Retirement with No Company Retirement Plan

The question, “How much do I need to retire?” has become a concern across generations rather than something that only those approaching retirement focus on.  We wrote the article, How Much Money Do I Need To Save To Retire?, to help individuals answer this question.  This article is meant to help create a strategy to reach that number.  More specifically, for those who work at a company that does not offer a company sponsored plan.

Over the past 20 years, 401(k) plans have become the most well-known investment vehicle for individuals saving for retirement.  This type of plan, along with other company sponsored plans, are excellent ways to save for people who are offered them.  Company sponsored plans are set up by the company and money comes directly from the employees paycheck to fund their retirement.  This means less effort on the side of the individual.  It is up to the employee to be educated on how the plan operates and use the resources available to them to help in their savings strategy and goals but the vehicle is there for them to take advantage of.

We also wrote the article, Comparing Different Types of Employer Sponsored Retirement Plans, to help business owners choose a retirement plan that is most beneficial to them in their retirement savings.

Now back to our main focus on savings strategies for people that do not have access to an employer sponsored plan.  We will discuss options based on a few different scenarios because matters such as marital status and how much you’d like to save may impact which strategy makes the most sense for you.

Married Filing Jointly - One Spouse Covered by Employer Sponsored Plan and is Not Maxing Out

A common strategy we use for clients when a covered spouse is not maxing out their deferrals is to increase the deferrals in the retirement plan and supplement income with the non-covered spouse’s salary.  The limits for 401(k) deferrals in 2021 is $19,500 for individuals under 50 and $26,000 for individuals 50+.  For example, if I am covered and only contribute $8,000 per year to my account and my spouse is not covered but has additional money to save for retirement, I could increase my deferrals up to the plan limits using the amount of additional money we have to save.  This strategy is helpful as it allows for easier tracking of retirement accounts and the money is automatically deducted from payroll.  Also, if you are contributing pre-tax dollars, this will decrease your tax liability.

Note:  Payroll deferrals must be withheld from payroll by 12/31.  If you owe money when you file your taxes in April, you would not be able to go back and increase your deferrals in your company plan for that tax year.

Married Filing Jointly - One Spouse Covered by Employer Sponsored Plan and is Maxing Out

If the covered spouse is maxing out at the high limits already, you may be able to save additional pre-tax dollars depending on your Adjusted Gross Income (AGI).

Below is the Traditional IRA Deductibility Table for 2021.  This table shows how much individuals or married couples can earn and still deduct IRA contributions from their taxable income.

As shown in the chart, if you are married filing jointly and one spouse is covered, the couple can fully deduct IRA contributions to an account in the covered spouses name if AGI is less than $99,000 and can fully deduct IRA contributions to an account in the non-covered spouses name if AGI is less than $184,000.  The Traditional IRA limits for 2017 are $5,500 if under 50 and $6,500 if 50+.  These lower limits and income thresholds make contributing to company sponsor plans more attractive in most cases.

Single or Married Filing Jointly and Neither Spouse is Covered

If you (and your spouse if married filing joint) are not covered by an employer sponsored plan, you do not have an income threshold for contributing pre-tax dollars to a Traditional IRA.  The only limitations you have relate to the amount you can contribute.  These contribution limits for both Traditional and Roth IRA’s are $5,500 if under 50 and $6,500 if 50+.  If married filing joint, each spouse can contribute up to these limits.

Unlike employer sponsored plans, your contributions to IRA’s can be made after 12/31 of that tax year as long as the contributions are in before you file your tax return.

Please feel free to e-mail or call with any questions on this article or any other financial planning questions you may have.

Below are related articles that may help answer additional questions you have after reading this.

Traditional vs. Roth IRA’s: Differences, Pros, and Cons

A New Year: Should I Make Changes To My Retirement Account?

Backdoor Roth IRA Contribution Strategy

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, pleas feel free to join in on the discussion or contact me directly.

A New Year: Should I Make Changes To My Retirement Account?

A simple and easy answer to this question would be…..Maybe?  Not only would that answer make this article extremely short, it wouldn’t explain some important items that participants should take into consideration when making decisions about their retirement plan.Every time the calendar adds a year we get a sense of reset.  A lot of the same tasks on the to do list get added each January and hopefully this article helps you focus on matters to consider regarding your retirement plan.

Should I Consult With The Advisor On My Plan?

At our firm we make an effort to meet with participants at least annually.  Saving in company retirement plans is about longevity so many times the individual meetings are brief and no allocation changes are made.  Even if this is the result, an overview of your account, at least annually, is a good way to keep retirement savings fresh in your mind and add a sense of comfort that you’re investing appropriately based on your time horizon and risk tolerance.

These individual meetings are also a good time to discuss other financial questions you may have.  Your retirement plan is only a piece of your financial plan and we encourage participants to use the resources available to them.  Often times these meetings start off as a simple account overview but turn into lengthy conversations about various financial decisions the participant has been weighing.

How Much Should I Be Contributing This Year?

This answer is not the same for everyone because, among other things, people have different retirement goals, financial situations, and time horizon.  That being said, if the  company has a match component in their plan, the first milestone would be to contribute enough to receive the most the company is willing to give you.  For example, if the company will match 100% of your contributions up to 3% of pay, any amount you contribute less than 3% will leave you missing out on retirement savings the company is willing to provide you.

Again, the amount that should be saved is dependent on the individual but saving anywhere from 10% to 15% of your compensation is a good benchmark.  In the previous example, if the company will match 3%, that means you would have to contribute 7% to achieve the lower end of that benchmark.  This may seem like a difficult task so starting at an amount you are comfortable with and working your way to your ultimate goal is important.

Should You Be Making Allocation Changes?

The initial allocation you choose for your retirement account is important.  Selecting the   appropriate portfolio from the start based on your risk tolerance and time until retirement can satisfy your investment needs for a number of years.  The chart below shows that over longer periods of time historical annual returns tend to be less volatile.

When you have over 10 years until retirement, reviewing the account at least annually is   important as there are a number of reasons you would want to change your allocation.  Lifestyle changes, different retirement goals, or specific investment performance to name a few. Participants tend to lose out on investment return when they try to time the market and are forced to sell low and buy high.  This chart shows that even though there may be volatility in the short term, as long as you have time and an appropriate allocation from the start, you should see returns that will help you achieve your retirement goals. 

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, pleas feel free to join in on the discussion or contact me directly.

Market Alert - UK Votes To Exit EU

We have been working through the night to monitor the UK exit vote in Europe and wanted to get this information out as soon as possible.Today is a historic day.  Last night the UK voted whether or not to leave the European Union.  The polls closed at 10 p.m. last night, the votes were counted, and at 2 a.m. this morning it was announced that the UK had voted 51.9% in favor of leaving the EU.  To put this situation in context, this would be similar to New York deciding to leave the United States to form its own country.

This was not the expected outcome and is largely an unprecedented event. Going into the vote yesterday most polls expected the UK “stay” vote to prevail given the economic headwinds that the UK would  face if the “leave” vote were to win.  David Cameron, the prime minister of the UK, was largely in favor of the UK staying in the EU.  Today at 3:30 a.m., Cameron announced that he would step down as the prime minister since new leadership, that is in favor of the exit, should be in place to negotiate Britain’s exit from the EU.

The European Union (EU) is made up of 28 countries.  It was originally formed back in 1957 with the goal of preventing wars and strengthening the economic bond between the European countries in its membership.  The UK joined the EU in 1973.  Members of the EU benefit from:

• Freedom of movement between countries

• Freedom of trade for goods, services, and capital

• EU human rights protection

• Euro currency (the UK does not participate in the euro currency)

The Argument To Stay In The EU

Supporters of the UK to stay in the EU believe that the Union is better for the British economy and that concerns about migration and other issues stemming from EU membership are not important enough to outweigh the economic consequences of leaving.  Many economists agree with this claim.  Europe is Britain’s most important export market and its greatest source of foreign direct investment.  An exit of the EU could jeopardize its financial status in the world and the high paying jobs that come with that status.

Those who voted to stay were not necessarily defending the EU but were basically arguing that the UK is stronger with the EU than without.

Argument To Leave The EU

Those in favor of the UK leaving the EU believe that leaving the European Union is necessary for the UK to restore the country’s identity.  Immigration has been one of the largest issue on the agenda with refugees entering the UK under the EU’s permission and “taking jobs” in the place of UK citizens.  Voters in the middle to lower income classes are viewed as more likely to support leaving the Union due to a feeling of being “abandoned by their country” in lieu of the EU policies.

In a way Britain feels like they used to matter to the world as an independent country but over the years have lost their identity now that they are lumped into the EU.  This group of individuals wants to be able to have full control over the country’s economic policy, culture, political system, and judicial system.

What Happens Next?

Now that the UK has voted to leave the EU, it has become clear that there needs to be new leadership in government that supports the UK exit since most of the current leaders, including the prime minister, were in favor of the UK staying in the EU.  We would expect this to happen in a fairly short period of time.

Once the new leadership is in place, the negotiation will begin between the UK and the EU for the exit.  There is not a precedence for this process which leaves a lot of unknowns.  Immediately, nothing changes.  Most likely while the negotiations are taking place over the course of next few months, or more likely years since the UK is still technically an EU member, UK citizens will still be able to move about the Eurozone countries freely, trade will continue, etc.

However, there will most likely be an immediate negative impact on the UK economy given the expectation of the exit.  The British pound (currency) will most likely drop significantly.  The profitability of the multinational companies and banks that are headquartered in the UK will come into question since they will eventually lose the benefits of free trade and capital movements with other EU countries.

Overall we are entering a period of increased uncertainty. Unfortunately, in our view, there is a larger issue at hand.  Yes, the UK exiting the EU is a significant event but the larger issue is for the first time they are laying the ground work that will allow a country to exit the EU.  There are other countries in the EU that may take up similar votes to leave the European Union since a precedence is now being set for the UK to exit.  If the entire EU were to further destabilize it would most likely cause further disruption across the global economy. 

Michael Ruger

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 Process Of Buying A House

Buying a house can be a fun and exciting experience but it’s also one of the most important financial decisions that you are going to make during your lifetime.  This article is designed to help home buyer’s understand:

• The home buying process from start to finish

• The parties involved in the process (real estate agent, attorney, bank, etc.)

• Common pitfalls to avoid

• What to expect when applying for a mortgage

• How to calculate the amount of your down payment

Owning Versus Renting

You first have to determine if owning a house is the right financial decision for you.  Society wires us to think that owning a house is automatically better than renting but that is not necessarily true in all situations.  From a pure dollar and cents standpoint, it may make sense to keep renting given your personal situation.  We typically tell clients if there is a fair chance that they may need to sell their house within the next 5 years, in many cases it may make sense to keep renting as opposed to buying a house given all of the upfront costs associated with purchasing a house.  It takes a while to recoup closing costs and when you go to sell your house you will most like have to pay your real estate agent 5% - 6% of the selling price.

Determine How Much You Can Afford

Before you even start looking at houses you have to determine two things:

• The down payment and closing costs

• The amount of the monthly mortgage payment that fits into your budget

There is no point in looking at $300,000 houses if you cannot afford the down payment or the monthly mortgage payment so the initial step involves determining what you can afford.

Calculating Your Closing Costs

Closing costs are in addition to your required “down payment”.  First time home buyers often make the mistake of just using the 5% down or 10% down as a rule of thumb for their total upfront cost for buying a house. They often forget about closing costs which can add an additional 2% - 5% of the purchase price of the house to the amount due at closing.  Closing costs include:

Discount Points:  An up-front fee that you can choose to pay if you want to reduce the interest rate on your loan.

Origination Charge:  Fee for processing your mortgage application, pulling credit reports, verifying financial information, and creating the loan

Rate-lock Fee:  If you choose to lock in your interest rate beyond a certain period of time

Other Lender Fees:  Document preparation fee, processing fee, application fee, and underwriting fees

Appraisal & Inspection Fees:  Fees for the lender to inspect and appraise the value of the house

Title Services:  Fee charged by the title agent to determine the rightful ownership of the house you are buying and some lenders require title insurance.

Government Recording Charges:  Every home buyer must pay these charges for the state and local agencies to record the loans and title documents

Transfer Taxes:  Depending on where you live, your state, county or city may charge a tax when the ownership of a home is transferred

Escrow Deposit:  At the closing of your home loan, if you decide to escrow or if an escrow is required, there will be an initial deposit in your escrow account to pay for future recurring charges associated with your home, such as property taxes, school taxes, and insurance.  You will typically need to pay for the first year of your homeowner’s insurance in full before your home loan closes.

Daily Interest Rate Charge:  This charge covers the amount of interest that you will owe on your home loan from the time your loan closes to the first day of your regular mortgage billing cycle.

Flood Insurance:  This is a form of hazard insurance that is required by lenders to cover properties in flood zones.

Attorney Fees:  Fees typically vary from $300 - $1,000.  Most individuals will work with a real estate attorney to review and negotiate the purchase agreement on their behalf. These fees are sometimes paid to the attorney prior to the closing.

As you can see there are a number of fees that you have to be prepared to pay in addition to the down payment required by the lender.  Lenders are required by law to give you a “good faith estimate” (GFE) of what the closing costs on your home will be within three days of when you apply for a loan.  However, these are just estimates and many of the fees listing on the GFE can legally change by up to 10%, potentially adding thousands of dollars to your final closing cost bill.   A day before your closing the lender should provide you with a copy of your HUD-1 settlement statement, which outlines all of the closing fees.

Calculating Your Down Payment

The amount of your down payment will vary based on the type of loan that you received to purchase your house.  The three main types of home loans are:

• FHA Loan

• Conventional Mortgage

• VA Loan (Veterans Affairs)

FHA Loan: FHA stands for Federal Housing Administration.  The loans are made by banks but they are guaranteed by the FHA which added additional protection for the lender.  FHA loans come with a minimum down payment of 3.5% which make them very popular.  With these loans borrowers pay PMI (private mortgage insurance) premiums both upfront and each year until the loan is paid down to a specified level.  Loan limits vary by housing type and county.  These loans tend to favor low to middle income borrowers who do not have a means to make the traditional 10% - 20% down payment at closing.

Conventional Mortgage:  Minimum down payment varies from 5% - 20%.  Borrowers that put down less than 20% will have to pay PMI (private mortgage insurance).  Conventional mortgages typically require a higher FICO score than FHA loans.  These loans tend to favor borrowers with higher credit scores and have enough cash on hand to make a sizable down payment.

VA Loan:  VA loans are available only to veterans.  The greatest benefit of these loans is they require no down payment and they allow qualified borrowers to purchase a home without the need for mortgage insurance.   VA loans also tend to have more flexible and forgiving requirements.  The VA charges a mandatory Fund Fee of 2.15% for regular military and 2.40% for Reserve/Guard on purchase loans.Let’s bring it all together in an example.  If you anticipate on buying a house for $200,000 and you plan on taking an FHA loan, the amount that you will need to save for the closing will be in the range of $11,000 - $17,000 (3.5% for the down payment and 2% - 5% for the closing costs).  This calculation will obviously vary based on the type of loan you plan on taking to purchase your house.

Determine what your monthly mortgage payment

After you have determined how much you need to save to meet the upfront cost of purchasing a house, the next step is to determine the monthly mortgage payment that fits into your budget.

Step 1:  Establish your current monthly and annual budget.  There is no way to determine what you can afford if you have no idea where you are now from an income and expense standpoint.  Tip: Be brutally honest with yourself when listing your expenses.  The last thing you want to do is underestimate your expenses, buy a house you cannot afford, and then go through a foreclosure.   You will also have to factor in additional expenses into your budget as if you owned the house today such as lawn care, snow removal, appliances, and maintenance expense.  As a renter you may not have any of these expenses now but as soon as you own a house, now when something breaks you have to pay to fix it.  Homeownership is often times more expensive than most individuals anticipate.

Step 2:  Based on your current monthly income and expenses, how much is left over to satisfy a monthly mortgage payment?  The general rule is your monthly mortgage payment (including property taxes, PMI, and association fees) should not exceed 32% of your monthly gross income.  Tip: Leave some extra room in your budget for life’s unexpected surprises. For example, furnace need to be replaced, dishwasher brakes, spouse loses a job, plumbing issues, etc.

Step 3:  Use an online mortgage calculator to determine the loan amount that meets your estimated monthly mortgage payment.  Do not forget to take into account property taxes, school taxes, association fees, PMI, and homeowners insurance when reaching your estimated monthly payment.

The parties involved in the home buying process 

There are a lot of different professionals that you will interact with during the process of purchasing your house.   It’s important to understand who is involved, what their role is in the process, and how they are compensated.

Buyer & Seller: This is pretty self-explanatory.  Most buyers and sellers work through realtors and attorneys to complete the real estate transaction so there is typically little or no direct interaction between the buyer and the seller.  However, in a “for sale by owner”, the buyer or the buyer’s realtor/attorney will be in direct communication with the seller since there is no real estate agent on the sellers side.

Real Estate Agent (Realtor):  Real estate agents are important partners when you are buying a house.  They can provide you with helpful information on homes and neighborhoods that isn’t easily accessible to the public.  Their knowledge of the home buying process, negotiation skills, and familiarity with the area you want to live in can be very valuable.  In most cases, as the buyer, it does not typically cost you anything to use a realtor because they are compensated from the commission paid by the seller of the house.

Real Estate Attorney:  Remember, buying a home is a legally binding transaction.  A real estate attorney can help you avoid some common pitfalls when purchasing your home.  The home buying process eventually results in a formal purchase agreement between the buyer and seller.  The purchase agreement is the single most important document in the transaction.  Although standard printed forms may be used, a lawyer can explain the forms and make changes and additions to reflect the buyer’s wishes. Examples are:

• What are the legal consequences if the closing does not take place?

• What happens if the inspection reveals termites, radon, or lead based paint?

• Will money be held in escrow from the seller’s proceeds to replace certain items?

How much does a real estate attorney cost?  It varies, but expect to pay somewhere in the range of $350 - $1,000.  Often times you have to pay the attorney a retainer or pay them in advance of the closing.  The amount an attorney charges is usually dependent on the level of services that they are provided to you.  Some attorneys may just be preparing the deed while other attorney’s may provide you with a more complete package which can include deed preparation, title examination, purchase agreement review, and lender work.   Make sure you fully understand how the attorney’s fee structure works and it often helps to ask your professional network or friends for attorney’s that they have worked with and would recommend.

Bank / Credit Union:  Most home buyers need a mortgage to finance the purchase of their house.  It is recommended that you contact a few banks and credit unions in your area to compare interest rates, closing costs, and fees associated with the issuance of your mortgage.  Similar to selecting a real estate attorney we strongly recommend asking your professional network (accountant, investment advisor) for lenders that they recommend working with.  You will have a lot of interaction with the lender throughout the home buying process and working with a lender that makes the underwriting process as smooth as possible will make the overall home buying experience much more enjoyable.

Home Inspector:  After your offer has been accepted by the seller you will need to hire a home inspector to visit the house.  Your real estate agent will most likely recommend a home inspector to use.  The job of the home inspector is to visit the property to make sure there are no issues with the house that may not be apparent to the untrained eye.  They look for termite damage, structural issues, mold, condition of the roof, electric, plumbing, drainage, septic, radon levels, etc.  A few days after their visit they will provide you with a formal report of their inspection.   You typically pay them at the time they conduct the inspection.  The cost of a home inspection typically ranges from $250 - $600.

Insurance Broker:   You will need to obtain a homeowners insurance policy prior to the closing date.  Since you are adding a house to your insurance coverage, often times this is a good opportunity to look at your insurance coverage as a whole because insurance companies will usually offer discounts on “bundling” your insurance coverage.  Meaning that a single provider covers your house, cars, and personal umbrella policy.  The annual cost of your homeowners insurance will vary greatly depending on the value of your house and where the house is located.  For homeowners that have an escrow account associated with their mortgage, the homeowners insurance premium is typically baked into your total monthly mortgage payment , the insurance company issues the invoice directly to the bank, and the bank pays your homeowners insurance directly out of your escrow account.

Timeline: The home buying process from start to finish

Now that we have explained how to determine what you can afford and the parties involved in the home buying process it’s time to put it all together so you know what to expect step by step through the process of purchasing your new home.

Step 1:  Get prequalified for a mortgage.  You may think you can qualify for a $250,000 mortgage but you really do not know until you actually apply.  In the preapproval process you will provide some information to the bank that will be issuing your mortgage such as tax returns, statements showing investment and savings accounts, and they will usually run a credit report.    The more intense financial due diligence happens after an offer has been accepted on your house and they are actually preparing to provide you with the loan.

Step 2:  Begin looking at houses.  Most individuals at this point will hire a real estate agent to help them find and look at houses.

Step 3:  Make an offer.  Once you find the house that you want, you will have your real estate agent present the seller with your offer.  This is where the negotiation process begins.  If the seller is listing the house for $200,000, you can make an offer for whatever amount you choose. Once an offer is presented to the seller, three things can happen:

• The seller can accept it

• The seller can reject it

• The seller will counter offer

Your real estate agent can really help you in this process to determine what may be a reasonable offer.  It is usually dependent upon how long the house has been on the market, where is the property located, is there a situation that requires selling the house quickly, and what have other similar houses sold for in the area.  After making the offer you will typically receive a response within 48 hours.  The seller will sometimes give their real estate agent a range saying that they will accept less than the asking price but only to a specific threshold. In most situations the buyer and the seller meet somewhere in the middle. If the house is listed for $200K, the buyer may put in an offer for $180K and after some back and forth they eventually meet somewhere around $190K.  But that is not always the case.  If there are multiple offers on the house you could end up in a “bidding war”.  Offers are “blind bids” meaning that you and your real estate agent have no way of knowing what other people are offering the seller for the house.  Buyers are essentially making their “best guess” that their offer will win.  You may make an offer for full price only for another buyer to come in two hours later and offer $10,000 over their asking price.  You really have to lean on your real estate agent to give you some guidance based on their knowledge of the market.

Step 4: Offer accepted……now what?  Typically, purchase offers are contingent on a home inspection of the property.  Your real estate agent will usually help you arrange to have a home inspection conducted within a few days of your offer being accepted.  There are usually contingencies in your offer agreement that provides you with the chance to renegotiate your offer or withdraw it without penalty if the inspection reveals significant material damage.  If the inspector discovers issues with the house you will have to make the decision if you want to ask the seller to fix the issue prior to the closing date.  Prior to the close you will have a walk-through of the house, which gives you a chance to confirm that any agreed-upon repairs have been made.

Step 5:  Apply for a mortgage.  Now that your offer has been accepted the mortgage underwriting process will kick into high gear.  The bank will assign you a “loan officer” or “mortgage broker” to serve as the direct contact at the bank throughout the mortgage approval process.  You will provide them with the information on the house that you intend to purchase, they will send you the mortgage application with all of financial documents that they will need to formally approve you for the mortgage. The bank will also arrange for an appraiser to visit the house and provide an independent estimate of the value of the house.  After all if they are giving you a loan for $200,000, they want to make sure that house is worth at least $200,000 in case you were to stop paying the mortgage then essentially the bank would own the house and have to sell it.  You will receive a “commitment letter” from your bank once your mortgage has been formally approved.

You will need to show the bank documentation of the account that is currently holding the cash that will be used for your down payment and closing costs.  If someone gifts you money to buy your house, the person that made the gift will most likely have to sign a letter stating that it was an outright gift and not a loan.

Step 5½ : You will simultaneous engage a real estate attorney to begin working with at this time.  Your attorney will review the purchase agreement, initiate a title search and review the results, begin prepping the deed, and communicate directly with the seller’s attorney if changes or additions need to be made to the purchasing agreement.

Step 6: Set a closing date.  The closing date is the date that you will sign a huge pile of papers and the house officially becomes yours.  There is typically an “estimated closing date” set in the purchase agreement but a firm date needs to be set by the buyer, seller, attorneys, and the bank.  The seller’s real estate agent, the buyer’s real estate agent, your mortgage broker, and the attorneys on both sides will typically communicate with each other to establish the closing date.  A special note……..a lot can happen during a real estate transaction that can delay the closing date.    Issues can arise on the seller’s side or the mortgage process could take longer than expected.  In other words, even though you have a “final closing date” be prepared for the closing date to change.  If you are renting right now and have a lease, if your closing date is May 1st it’s usually recommended that you have your current lease run until May 30th or June 30th in case the closing date gets pushed back.  Real estate transactions have a lot of moving parts and a lot of unexpected things that are out of your control can happen.

Step 7:  Contact your insurance broker to establish a homeowner’s policy.  Your bank will require you to have homeowners insurance on the property.  You must pay for the policy and have it at closing.  You are free to select your own insurance carrier but the lender will typically require the insurance company issuing the policy to be a specific rating or higher.

Your insurance broker may also help you with your title insurance policy.  Many lenders will require you to have a title insurance policy at closing.  As part of the home buying process a title search should be conducted which results in a report that shows who owns the property and if there are any liens against the property.  Title insurance protects you and the lender up to the full value of the property if fraud, a lien, or faulty title is discovered after your closing.

Step 8: The day BEFORE the closing.  It is recommended that you send a reminder email to your real estate agent, attorney, and mortgage broker to confirm that everything is a “go” for the closing the next day.  You and your real estate agent should make a final inspection of the property within 24 hours prior to the closing.  In many cases, the lender will make a similar inspection before closing.  The bank that is issuing you the loan should also be able to provide you with a copy of your HUD-1, which is a long, one page document that details all of the financial activity associated with the purchase of your house.  You should review this document with your mortgage broker and/or attorney prior to the closing to make sure everything is accurate.

You will also need to confirm with your attorney/mortgage broker the amount of the certified check that you will need to bring to the closing.  A certified check is a special type of check issued by a bank that guarantees that the funds to back that check are guaranteed by the bank issuing the check.

Step 9:  The date of your closing.  You made it!!!!!! Today is the day your new house officially becomes yours.    There are two primary things that you need to bring with you to the closing:

• Certified check

• Homeowners policy and proof of payment

The actual closing is conducted by a “closing agent” who may be an employee of the lender or title company, or it may be an attorney representing you or the lender.  The lender and seller, or their representatives, and the real estate agents may or may not be at the actual closing.  It is not unusual for the parties to the transaction to complete their roles without ever meeting face to face.

For the most part, your role at closing is to review and sign the numerous documents associated with a mortgage loan.  The closing agent should explain the nature and purpose of each one and give you and your attorney an opportunity to check them before signing.

At the conclusion of the meeting you receive the keys to the house and you are officially a new homeowner.

Step 10: Begin making your monthly mortgage payments.  One of the top questions that we get is “What is an escrow account?”  You will hear that term a lot when you are going through the mortgage process.  Think of an escrow account as a separate savings account that is attached to your mortgage.  When you make a monthly mortgage payment, it is made up of a few components:

• Principal & Interest Payments: Amount applied against your actual loan

• PMI (if applicable): Mortgage insurance

• Escrow: Cash reserve to pay taxes and homeowners insurance

If my monthly mortgage payment is $2,000, only $1,100 of that amount may actually be applied against the loan. The other $900 may be used to pay my monthly PMI and the remainder is deposited to my escrow account.

When your property taxes and school taxes are due, the county that you live in will typically send those tax bills directly to the bank holding your mortgage and then the bank in turn pays those bills out of your escrow account.  The bank will typically mail the homeowners a receipt that the tax bill has been paid.  It’s basically a forced monthly savings account for your anticipated tax bills.  The same thing is true for your homeowner insurance premium payments. The bank that is holding your mortgage forecasts how much your taxes and homeowner insurance is going to be for the next 12 months and then builds those amounts into your monthly mortgage payments. The bank does not want you to lose your house because you were unable to pay your property or school taxes.  The property and school tax bills show up once a year and depending on where you live those bills can be for thousands of dollars.

If there is additional money left in your escrow account after the taxes and homeowner insurance has been paid, the bank is usually required to send a portion of that additional cash reserve to the homeowner in the form of a check.  Those are fun checks to get in the mail. 

Michael Ruger

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 Much Money Do I Need To Save To Retire?

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This is by far the most popular question that we come across as financial planners. You may have heard some of the "rules of thumb" like “80% of your current take-home pay” or “1 million dollars”.  In reality, the answer varies greatly on an individual by individual basis.  This article will outline the procedures that we follow as financial planners to help individuals answer this very important question.

Step 1:  Estimate Your Annual Expenses In Retirement

The first step is to get a ballpark idea of what your annual expenses might look like in retirement.    The best place to start is to list your current monthly and annual expenses. Then create a separate column labeled “expenses in retirement”.  Whether you are 2 years, 10 years, or 20 years away from retirement the idea is to pretend as if you were retiring tomorrow and determining what your annual expenses might look like.  Some of your expenses in retirement will be lower, others may be higher, but most people find that a lot of their current expenses will carry over at the same level into the retirement years. This is because most people have become accustom to a certain standards of living and they intend to maintain that standard of living in retirement. Here are a few important questions that you should ask yourself when forecasting your retirement expenses:

• How much should I budget for health insurance?

• Will I have a mortgage or debt when I retire?

• Do I plan to move when I retire?

• Since I will not be working, should I budget additional expenses for vacations and hobbies?

• Will I need to keep my life insurance policies after I retire?

Step 2:  Adjust Your Retirement Expenses For Inflation

Now that you have a ballpark number of your annual expenses in retirement, you will need to adjust those expenses for inflation.  Inflation is just a fancy word for “the price of everything that we buy today will gradually go up in price over time”.  If the price of a gallon of milk today is $2 then most likely 20 years from now that same gallon of milk will cost $3.51.  A 75% increase!!   Historically inflation has grown at a rate of about 3% per year.  There are periods of time when the rate of inflation grows faster or slower but on average it grows at 3% per year.

Another way to look at inflation is $20,000 in today’s dollars will not buy the same amount of goods and services 10 years from now because inflation erodes the purchasing power of your $20,000.  If I did my annual expense planner and it tells me that I need $50,000 per year in retirement to meet all of my estimated expenses, let’s look at what adjusting that $50,000 for inflation does over different periods of time assuming a 3% rate of inflation:

Today’s Dollars 5 Years From Now 10 Years From Now 20 Years From Now

$50,000         $56,275                  $65,238                    $87,675

In the above example, if I am retiring in 10 years, and my estimated annual expenses in retirement will be $50,000 in today’s dollars, by the time I retire 10 years from now my annual expenses will increase to $65,238 per year just to stay in the same place that I am in today.  Also, inflation does not stop when you retire, it continues into the retirement years. If I am 50 today and plan to live until 90, I have to apply this inflation adjustment for 40 years.  It’s clear to see how inflation can have a significant impact on the amount that you may need to withdrawal for your account to meet you estimated expenses at a future date.

Step 3:  Gather The Information On Your Current Assets

Once you know your expenses, you now need to gather all of the information on your retirement accounts and pension plans.  You should collect the most recent statement for all of your investment accounts (401K, 403B, IRA’s, brokerage accounts, stocks, etc.), pension statements (if applicable), obtain your most recent social security statement, and gather information on the other sources of income and/or assets that may be available when you retire. Such as:

• Sale of a business

• Downsizing the primary residence

• Rental income

• Part-time employment

Step 4:  Project The Growth Of Your Retirement Assets

There are three main categories to consider when calculating the growth rate of your retirement assets:

• Annual contributions

• Withdrawals

• Investment rate of return

For annual contributions, it’s determining which accounts you plan on making deposits too each year and how much?  For most individuals, their employer sponsored retirement plan is the main source of new contributions to their retirement nest egg.   If your employer makes regular employer contributions to your retirement plan, you should factor those in as well.  For example, if I am contributing 8% of my pay into the plan and my employer is providing me with a 4% matching contributions, I would reasonably assume that I’m adding 12% of my pay to my 401(k) plan each year.

The most popular question that we get in this category is “how much should I be contributing each year to my retirement account with my employer?”  We advise employees that they should have a goal of contributing 10% of their pay each year to their retirement accounts.   This is an aggregate total between your personal contributions and the employer contributions.   Even if you cannot reach that level right now, 10%+ is the target.

Let’s move onto the next category…….withdrawals.  Pre-retirement withdrawals from retirement accounts have become much more common in recent years due largely to the rising cost of college education.  Parents will take loans from their 401K/403B plans or take early withdrawals from IRA accounts to fulfill the need for additional income during the years that their children are in college.  If part of your overall financial plan is to use your retirement accounts to pay for one-time expenses such as college, you will need to factor that into your projections.

The third variable to consider when determining the growth of your assets is the assumed annual rate of return on your investments.  There are many items to consider when determining a reasonable annual rate of return for your accounts.  Some of those considerations include:

• Time horizon to retirement

• Allocation of your portfolio (stocks vs bonds)

• Concentrated holdings (10%+ of your portfolio allocated to a single investment)

• Accumulation phase versus distribution phase

The answer to the question: “what rate of return should I expect from my retirement accounts?”, can really only be determine on a case by case basis. Using an unreasonable rate of return assumption can create a significant disconnect between your retirement projections versus what is likely to actually occur within your investment accounts.  Be careful with this step.

Step 5:  Factor In Taxes

Don’t forget about the lovely IRS.  All assets are not treated equally from a tax standpoint.  For most individuals, the majority of their retirement savings will be in pre-tax retirement vehicles such as 401(k), 403(b), and Traditional IRA’s.  That means when you take distributions from those accounts, you will realize earned income, and have to pay tax.  For example, if you have $400,000 in your 401K account and you are in the 25% tax bracket, $100,000 of that $400,000 will be lost to taxes as withdrawals are made from the account.

If you have after tax investment accounts, it’s possible that you may owe little to no taxes on withdrawals.  However, if there are unrealized investment gains built up in your after tax investment accounts then you may owe capital gains tax when liquidating positons.

Also note, you may have to pay taxes on a portion of your social security benefit.   The amount of your social security benefit that is taxable varies based on your level of income.

Step 6:  Spend Down Your Assets

In the final step, you should run long term projections to illustrate the spend down of your assets in retirement.  Here are the steps:Example

• Start with your annual after tax expense number $60,000

• Subtract social security less taxes: ($20,000)

• Subtract pension payments less taxes (if applicable): ($10,000)

• Annual Expenses Net SS and Pensions: $30,000

In the example above, this individual would need an additional $30,000 after-tax to meet their anticipated annual expenses in Year 1 of retirement.  I stress “after-tax” because if all of the retirement assets are in a pre-tax retirement account then they would need to gross up their distributions for taxes to get to the $30,000 after tax.  If it is assumed that $40,000 has to be withdrawn from an IRA each year, the 3% inflation rate is applied to the annual expenses, and the life expectancy of this individual is 20 years from the date that they retire, this individual would need to withdrawal $1,074,814 out of their retirement accounts over the next 20 years to meet their income needs.

Step 7:  Identify Multiple Solutions

There are often times multiple roads to reach a destination and the same is true when planning for retirement. If you find that you assets are falling short of the amount that is needed to sustain your expenses in retirement, you should work with a knowledgeable financial planner to identify alternative solutions.  It may help you to answer questions like:

• If I decided to work part-time in retirement how much would I have to earn?

• If I downsize my primary residence in retirement how does this impact the overall picture?

• If I can’t retire at age 63, what age can I comfortably retire at?

• What are the pros and cons of taking social security benefits prior to normal retirement age

I also encourage clients to spend time looking at their annual expenses.  If you find that your are cutting it close on income versus expenses in retirement, it's usually easier to cut expenses than it is to create more income in the retirement year. 

Michael Ruger

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.

First Time Homebuyer Tips

home buyer tips

Buying your first home is one of life’s milestones that everyone should have the opportunity to experience if they choose.  Owning a home gives you a feeling of accomplishment and as you make payments a portion is going to your personal net worth rather than a landlord.  The process is exciting but one surefire piece of information that I wish I knew when buying my first home is that you will come across surprises.  Whether it be a delay in closing, an issue with financing, or closing costs being higher than expected, it is important to know that you can do all the preparation possible and still be hit in the face with some setbacks.

This article will not only touch on some of the important considerations when buying your first home but will give examples of possible setbacks and how to avoid them.

Know Your Number

The most important piece of information to have when purchasing your home is how much you can spend.  The purchase of your home should not be the only goal to consider.  All of your other financial objectives such as paying off debt (i.e. college and unsecured) and saving for retirement must be taken into consideration.  Also, it is recommended you have an emergency fund in place that would cover at least 4 months of your fixed expenses in case something happens with your job or some other event occurs.  Knowing your number does not only include what you can afford today but how much you can afford monthly moving forward.  If your monthly cash flow becomes dangerously low or negative with the addition of a mortgage payment (including mortgage/property taxes/homeowners), the house may be too expensive.

NOTE:  Just because you are preapproved for a certain amount does not mean you need to spend that amount.

Choose An Agent You Trust

You will be spending a lot of time with your agent so choose them wisely.  It should be someone you get along with and someone you can trust will look out for your best interests.  If your agent just cares about receiving a commission, they may push you to purchase a home before looking at all of your options or buying a home you can’t afford.  Remember, you are the client and therefore should be treated as such.

NOTE:  Just because you never physically cut a check to your real estate agent doesn’t mean you aren’t paying them.   In a typical transaction the seller will pay the commissions.  An agreed upon percentage will come out of the sales proceeds and go to both real estate agents (the buyer’s and the seller’s) and therefore the cost is built into the price you pay.

Use Your Agent As An Asset

Your agent is likely much more knowledgeable about home buying than you so use that knowledge to your benefit.  The agent should be able to help you value homes and determine whether the house is fairly priced.  Ask them as many questions as possible throughout the entire process.

On The Fence

If you are on the fence whether or not to buy a home then take your time.  If you may relocate because of your job or family don’t jump into purchasing a home.  It is not worth paying the closing costs and going through the hassle of home buying if you may move in the near future.  We typically use the “5 Year Rule” when making the determination.  If you don’t see yourself being in the house for at least 5 years you should consider whether or not you will get your money back when you sell.

Compare Lenders

The banking industry is extremely competitive and it is worth shopping around for the best offer when choosing a mortgage provider.  If you aren’t comfortable with numbers, don’t be afraid to ask for help.  A difference of 0.10% on a 30 year mortgage could be the difference of thousands of dollars wasted on interest.

Don’t Cheap Out On Homeowners

Don’t choose your homeowners policy based on price.  Of course price is one of the considerations but it is not the only one.  Make sure your policy is the most comprehensive you can comfortably afford as the cost of increased premiums is likely much less than the cost of coming out of pocket for something not covered.  Remember, insurance companies, like banks, are in a competitive industry so shop around.

Down Payment

Most lenders require a 20% down payment of the home value to avoid paying additional costs.  This means if the value of the home is $200,000, you will have to pay $40,000 out of pocket!  Most lenders offer Federal Housing Administration (FHA) loans that allow you to put down as little as 3.5%.  If you choose this type of loan you also have to purchase Private Mortgage Insurance (PMI).  This will be a cost added to your mortgage payment until the value of your home is adequate enough to remove the PMI.  It is important to factor this in as a cost similar to interest because a 5% interest rate could quickly look like 6-7% if you have to pay PMI.

Closing And Other Additional Costs

There are a lot of out of pocket costs to consider when purchasing a home.  Examples of these costs are listed below.  An important piece of knowing your number is to consider all the costs that may come up during the process.

• Loan Origination Fee

• Attorney Fees

• Property Taxes

• Home Owners Insurance

• Appraisal Fee

• Inspection Fee

• Title Insurance

• Recording Fee

• Government Recording Charges

• Credit Report Fee

• Flood Determination Fee

How To Help Avoid Certain Complications

Situation:  I bought a house at the top of my budget that I thought was move in ready but needs repairs.

Recommendation:  Choose an inspector that has a great reputation and knows the location.  There may be issues that are common to the area that one inspector may be more likely to identify.  Also, bring a contractor or someone of similar background for a walk through.  Repairs can be extremely costly and if you purchased a home at the top end of your budget you may not be able to afford certain fixes.  It should be known that all issues cannot be foreseen but taking the necessary steps to diminish these situations will not hurt.  Don’t purchase a home that will bankrupt you if repairs need to be done.

Situation:  I bought a home I can’t fill.

Recommendation:  Closing costs and repairs won’t be the only out of pocket expenses.  Complete a summary of items you think you may need to buy after the purchase.  This may include furniture, appliances, décor, and fixtures.  In these situations it is always better to overestimate.

Situation:  My lease is up in a month and I would like to purchase a home.

Recommendation:  Purchasing a home is something that requires time and planning.  The home will likely be the largest purchase you’ve ever made (depending on the college you choose) so it is not something to rush.  If you are thinking of moving after your lease is up or when you relocate jobs, start planning as soon as possible.  Feeling forced into purchasing something as important as a home will likely lead to regrets. 

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, pleas feel free to join in on the discussion or contact me directly.

Stock Options 101: ISO, NQSO, and Restricted Stock

types of stock options

If you are reading this article, your company has probably granted you stock options.  Stock options give you the potential share in the growth of your company’s value without any financial risk to you until you exercise the options and buy shares of your company’s stock.

Stock options give you the right to purchase a specific number of shares of the company’s stock at a fixed price.   There is typically a vesting schedule attached to option grants that specify when you have the right to exercise your stock options.  Companies can offer employees:

• Incentive Stock Options (“ISO”)

• Nonqualified Stock Options (“NQSO”)

• Restricted Stock

It is very important to understand how these different types of options and grants are taxed otherwise it could lead to unfortunate tax surprises down the road.

Non-Qualified Stock Options (NQSO)

A non-qualified stock option (NQSO) is a type of stock option that does not qualify for special favorable tax treatment under the US Internal Revenue Code. Thus the word nonqualified applies to the tax treatment (not to eligibility or any other consideration). NQSOs are the most common form of stock option and may be granted to employees, officers, directors, contractors, and consultants.

You pay taxes on these options at the time of exercise. For tax purposes, the exercise spread is compensation income and is therefore reported on your IRS Form W-2 for the calendar year of exercise.

Example: Your stock options have an exercise price of $30 per share. You exercise them when the price of your company stock is $100 per share. You have a $70 spread ($100 – 30) and thus $70 per share is included in your W2 as ordinary income.

Your company will withhold taxes—income tax, Social Security, and Medicare—when you exercise the options.

When you sell the shares, whether immediately or after a holding period, your proceeds are taxed under the rules for capital gains and losses. You report the stock sale on Form 8949 and Schedule D of your IRS Form 1040 tax return.

Incentive Stock Options (ISO)………..

Incentive stock options (ISOs) qualify for special tax treatment under the Internal Revenue Code and are not subject to Social Security, Medicare, or withholding taxes. However, to qualify they must meet rigid criteria under the tax code. ISOs can be granted only to employees, not to consultants or contractors. There is a $100,000 limit on the aggregate grant value of ISOs that may first become exercisable (i.e. vest) in any calendar year. Also, for an employee to retain the special ISO tax benefits after leaving the company, the ISOs must be exercised within three months after the date of termination.

After you exercise these options, if you hold the acquired shares for at least two years from the date of grant and one year from the date of exercise, you incur favorable long-term capital gains tax (rather than ordinary income tax) on all appreciation over the exercise price. However, the paper gains on shares acquired from ISOs and held beyond the calendar year of exercise can subject you to the alternative minimum tax (AMT). This can be problematic if you are hit with the AMT on theoretical gains but the company's stock price then plummets, leaving you with a big tax bill on income that has evaporated.

Very Important: If you have been granted ISOs, it’s important to understand how the alternative minimum tax can affect you prior to exercising your stock options.

Restricted Stock……………….

Your company may no longer be granting you stock options, or may be granting fewer than before. Instead, you may be receiving restricted stock.  While these grants don't give you the same potentially life-altering, wealth-building upside as stock options, they do have additional benefits compared to ISO’s and NQSO’s.

The value of stock options, such as ISO’s and NQSO’s, depend on how much (or whether) your company's stock price rises above the price on the grant date. By contrast, restricted stock has value at vesting even if the stock price has not moved or even dropped since grant.

Depending on your attitude toward risk and your experience with swings in your company's stock price, the certainty of your restricted stock's value can be appealing. By contrast, stock options (ISO & NQSO) have great upside potential but can be "underwater" (i.e. having a market price lower than the exercise price). This is why restricted stock is often granted to a newly hired executive. It may be awarded as a hiring bonus or to make up for compensation and benefits, including in-the-money options and nonqualified retirement benefits, forfeited by leaving a prior employer.

Of course, the very essence of restricted stock is that you must remain employed until the shares vest to receive its value. While you may have between 30 and 90 days to exercise stock options after voluntary termination, unvested grants of restricted stock are often forfeited immediately. Thus, it is an extremely effective “golden handcuff” to keep you at your company.

Fewer Decisions

Unlike a stock option, which requires you to decide when to exercise and what exercise method to use, restricted stock involves fewer decisions. When you receive the shares at vesting—which can be based simply on the passage of time or the achievement of performance goals—you may have a choice of tax-withholding methods (e.g. cash, sell shares for taxes), or your company may automatically withhold enough vested shares to cover the tax withholding.   Restricted stock is considered "supplemental" wages, following the same tax rules and W-2 reporting that apply to grants of nonqualified stock options.

Tax Decisions

The most meaningful decision with restricted stock grants is whether to make a Section 83(b) election to be taxed on the value of the shares at grant instead of at vesting. Whether to make this election, named after the section of the Internal Revenue Code that authorizes it, is up to you. (It is not available for Restricted Stock Units (RSUs), which are not "property" within the meaning of Internal Revenue Code Section 83)

If a valid 83(b) election is made within 30 days from the date of grant, you will recognize as of that date ordinary income based on the value of the stock at grant instead of recognizing income at vesting. As a result, any appreciation in the stock price above the grant date value is taxed at capital gains rates when you sell the stock after vesting.

While this can appear to provide an advantage, you face significant disadvantages should the stock never vest and you forfeit it because of job loss or other reasons.  You cannot recover the taxes you paid on the forfeited stock. For this reason, and the earlier payment date of required taxes on the grant date value, you usually do better by not making the election. However, this election does provide one of the few opportunities for compensation to be taxed at capital gains rates. In addition, if you work for a startup pre-IPO company, it can be very attractive for stock received as compensation when the stock has a very small current value and is subject to a substantial risk of forfeiture. Here, the downside risk is relatively small.

Dividends

Unlike stock options, which rarely carry dividend equivalent rights, restricted stock typically entitles you to receive dividends when they are paid to shareholders.

However, unlike actual dividends, the dividends on restricted stock are reported on your W-2 as wages (unless you made a Section 83(b) election at grant) and are not eligible for the lower tax rate on qualified dividends until after vesting.

Comparison Chart

stock option comparison chart

Disclosure:  The information listed above is for educational purposes only.  Greenbush Financial Group, LLC does not provide tax advice.  For tax advice, please consult your accountant. 

Michael Ruger

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.