What Happens To My Pension If The Company Goes Bankrupt?

Given the downward spiral that GE has been in over the past year, we have received the same question over and over again from a number of GE employees and retirees: “If GE goes bankrupt, what happens to my pension?”  While it's anyone’s guess what the future holds for GE, this is an important question that any employee with a pension should know the answer to.  While some employees are aware of the PBGC (Pension Benefit Guarantee Corporation) which is an organization that exists to step in and provide pension benefits to employees if the employer becomes insolvent, very few are aware that the PBGC itself may face insolvency within the next ten years.  So if the company can’t make the pension payments and the PBGC is out of money, are employees left out in the cold?

Pension shortfall

When a company sponsors a pension plan, they are supposed to make contributions to the plan each year to properly fund the plan to meet the future pension payments that are due to the employees.  However, if the company is unable to make those contributions or the underlying investments that the pension plan is invested in underperform, it can lead to shortfalls in the funding.

We have seen instances where a company files for bankruptcy and the total dollar amount owed to the pension plan is larger than the total assets of the company.   When this happens, the bankruptcy courts may allow the company to terminate the plan and the PBGC is then forced to step in and continue the pension payments to the employees.  While this seems like a great system since up until now that system has worked as an effective safety net for these failed pension plans, the PBGC in its most recent annual report is waiving a red flag that it faces insolvency if Congress does not make changes to the laws that govern the premium payments to the PBGC.

What is the PBGC?

The PBGC is a federal agency that was established in 1974 to protect the pension benefits of employees in the private sector should their employer become insolvent.  The PBGC does not cover state or government sponsored pension plans.  The number of employees that were plan participants in an insolvent pension plan that now receive their pension payments from the PBGC is daunting.  According to the 2017 PBGC annual report, the PBGC “currently provides pension payments to 840,000 participants in 4,845 failed single-employer plans and an additional 63,000 participants across 72 multi-employer plans.”

Wait until you hear the dollar amounts associate with those numbers.  The PBGC paid out $5.7 Billion dollars in pension payments to the 840,000 participants in the single-employer plans and $141 Million to the 63,000 participants in the multi-employer plans in 2017.

Where Does The PBGC Get The Money To Pay Benefits?

So where does the PBGC get all of the money needed to make billions of dollars in pension payments to these plan participants?  You might have guessed “the taxpayers” but for once that’s incorrect.   The PBGC’s operations are financed by premiums payments made by companies in the private sector that sponsor pension plans.  The PBGC receive no taxpayer dollars.  The corporations that sponsor these pension plans pay premiums to the PBGC each year and the premium amounts are set by Congress.

Single-Employer vs Multi-Employer Plans

The PBGC runs two separate insurance programs: “Single-Employer Program” and “Multi-Employer Program”.  It’s important to understand the difference between the two.  While both programs are designed to protect the pension benefits of the employees, they differ greatly in the level of benefits guaranteed.  The assets of the two programs are also kept separate. If one programs starts to fail, the PBGC is not allowed to shift assets over from the other program to save it.

The single-employer program protects plans that are sponsored by single employers.  The PBGC steps in when the employer goes bankrupt or can no longer afford to sponsor the plan.  The Single-Employer Program is the larger of the two programs. About 75% of the annual pension payments from the PBGC come from this program.  Some examples of single-employer companies that the PBGC has had to step into to make pension payments are United Airlines, Lehman Brothers, and Circuit City.

The Multi-Employer program covers pension plans created and funded through collective bargaining agreements between groups of employers, usually in related industries, and a union.  These pension plans are most commonly found in construction, transportation, retail food, manufacturing, and services industries.  When a plan runs out of money, the PBGC does not step in and takeover the plan like it does for single-employer plans.  Instead, it provides “financial assistance” and the guaranteed amounts of that financial assistants are much lower than the guaranteed amounts offered under the single-employer program.  For example, in 2017, the PBGC began providing financial assistance to the United Furniture Workers Pension Fund A (UFW Plan), which covers 10,000 participants.

Maximum Guaranteed Amounts

The million dollar question.  What is the maximum monthly pension amount that the PBGC will guarantee if the company or organization goes bankrupt?  There are maximum dollar amounts for both the single-employer and multi-employer program.  The maximum amounts are indexed for inflation each year and are listed on the PBGC website.  To illustrate the dramatic difference between the guarantees associated with the pension pensions in a single-employer plan versus a multi-employer plan; here is an example from the PBGC website based on the 2018 rates.

“PBGC’s guarantee for a 65-year-old in a failed single-employer plan can be up to $60,136 annually, while a participant with 30 years of service in a failed multi-employer plan caps out at $12,870 per year.  The multi-employer program guarantee for a participant with only 10 years of service caps out at $4,290 per year.”

It’s a dramatic difference.

For the single-employer program the PBGC provides participants with a nice straight forward benefits table based on your age.  Below is a sample of the 2018 chart.  However, the full chart with all  ages can be found on the PBGC website.

PBGC

Unfortunately, the lower guaranteed amounts for the multi-employer plans are not provided by the PBGC in a nice easy to read table. Instead they provide participant with a formula that is a headache for even a financial planner to sort through.  Here is a link to the formula for 2018 on the PBGC website.

PBGC Facing Insolvency In 2025

If the organization guaranteeing your pension plan runs out of money, how much is that guarantee really worth?  Not much.  If you read the 138 page 2017 annual report issued by the PBGC (which was painful), at least 20 times throughout the report you will read the phase:

“The Multi-employer Program faces very serious challenges and is likely to run out of money by the end of fiscal year 2025.”

They have placed a 50% probability that the multi-employer program runs out of money by 2025 and a 99% probability that it runs out of money by 2036.  Not good. The PBGC has urged Congress to take action to fix the problem by raising the premiums charged to sponsors of these multi-employer pension plans.  While it seems like a logical move, it’s a double edged sword. While raising the premiums may fix some of the insolvency issues for the PBGC in the short term, the premium increase could push more of the companies that sponsor these plans into bankruptcy.

There is better news for the Single-Employer Program.  As of 2017, even though the Single-Employer Program ran a cumulative deficit of $10.9 billion dollars, over the next 10 years, the PBGC is expected to erase that deficit and run a surplus.  By comparison the multi-employer program had accumulated a deficit of $65.1 billion dollars by the end of 2017..

Difficult Decision For Employees

While participants in Single-Employer plans may be breathing a little easier after reading this article,  if the next recession results in a number of large companies defaulting on their pension obligations, the financial health of the PBGC could change quickly without help from Congress. Employees are faced with a one-time difficult decision when they retire.  Option one, take the pension payments and hope that the company and PBGC are still around long enough to honor the pension payments.  Or option two, elect the lump sum, and rollover then present value of your pension benefit to your IRA while the company still has the money.  The right answer will vary on a case by case basis but the projected insolvency of the PBGC’s Multi-employer Program makes that decision even more difficult for employees.

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.

Volatility, Market Timing, and Long-Term Investing

Volatility, Market Timing, and Long-Term Investing

For many savers, the objective of a retirement account is to accumulate assets while you are working and use those assets to pay for your expenses during retirement.  While you are in the accumulation phase, assets are usually invested and hopefully earn a sufficient rate of return to meet your retirement goal.  For the majority, these accounts are long-term investments and there are certain investing ideas that should be taken into consideration when managing portfolios.  This article will discuss volatility, market timing and their role in long-term retirement accounts.

“Market timing is the act of moving in and out of the market or switching between asset classes based on using predictive methods such as technical indicators or economic data” (Investopedia).  In other words, trying to sell investments when they are near their highest and buy investments when they are near their lowest.  It is difficult, some argue impossible, to time the market successfully enough to generate higher returns.  Especially over longer periods.  That being said, by reallocating portfolios and not experiencing the full loss during market downturns, investors could see higher returns.  When managing portfolios over longer periods, this should be done without the emotion of day to day volatility but by analyzing greater economic trends.

So far, the stock market in 2018 has been volatile; particularly when compared to 2017.  Below are charts of the S&P 500 from 1/1/2018 – 10/21/2018 and the same period for 2017.

Source: Yahoo Finance. Information has been obtained from sources believed to be reliable and are subject to change without notification.

Based on the two charts above, one could conclude the majority of investors would prefer 2017 100% of the time.  In reality, the market averages a correction of over 10% each year and there are years the market goes up and there are years the market goes down.  Currently, the volatility in the market has a lot of investors on edge, but when comparing 2018 to the market historically, one could argue this year is more typical than a year like 2017 where the market had very little to no volatility.

Another note from the charts above are the red and green bars on the bottom of each year.  The red represent down days in the market and the green represent up days.  You can see that even though there is more volatility in 2018 compared to 2017 when the market just kept climbing, both years have a mixture of down days and up days.

A lot of investors become emotional when the market is volatile but even in the midst of volatility and downturns, there are days the market is up.  The chart below shows what happens to long-term portfolio performance if investors miss the best days in the market during that period.

Source: JP Morgan. Information has been obtained from sources believed to be reliable and are subject to change without notification.

Two main takeaways from the illustration above are; 1) missing the best days over a period in the market could have a significant impact on a portfolios performance, and 2) some of the best days in the market over the period analyzed came shortly after the worst days.  This means that if people reacted on the worst days and took their money from the market then they likely missed some of the best days.

Market timing is difficult over long periods of time and making drastic moves in asset allocation because of emotional reactions to volatility isn’t always the best strategy for long-term investing.  Investors should align their portfolios taking both risk tolerance and time horizon into consideration and make sure the portfolio is updated as each of these change multiple times over longer periods.

When risk tolerance or time horizon do not change, most investors should focus on macro-economic trends rather than daily/weekly/monthly volatility of the market.  Not experiencing the full weight of stock market declines could generate higher returns and if data shows the economy may be slowing, it could be a good time to take some “chips off the table”.  That being said, looking at past down markets, some of the best days occur shortly after the worst days and staying invested enough to keep in line with your risk tolerance and time horizon could be the best strategy.

It is difficult to take the emotion out of investing when the money is meant to fund your future needs so speaking with your financial consultant to review your situation may be beneficial.

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.

The Stock Market Dropped 800 Points Today. Is This A Warning Sign?

There was a large sell off in the stock market today. The Dow, S&P 500, and Nasdaq all dropped by over 3% in today’s trading session.  After a long bull rally, big drops in the stock market often lead investors to the question: “Is this big drop in the market the beginning of something worse to come?”  To answer that question, you have to identify what changed and more importantly what did not change in the economy and the markets over the past two weeks. 

Interest Rates Have Spiked

If there is a single indicator or event that we can point to that has triggered the recent sell-off, it would be the dramatic rise in interest rates.  Between September 17th and October 10th, the yield on a 10 year government bond went from 3% to 3.23%.  Now that may not sound like a big move but interest rates on a 10 year bond moving by 0.23% in less than a month is a big move.

When interest rates go higher, it increases the cost associated with borrowing money.  Mortgage News Daily reported yesterday that the average interest rate on a 30-year fixed mortgage is currently at 5% compared to just below 4% a year ago.   As interest rates move higher, it may prevent some individuals from being able to finance a mortgage, get a car loan, or it may cause a business to forgo taking that loan to expand their business.

When interest rates rise gradually as they have over the past three years it historically does not prompt a big sell off because those higher rates are slowly integrated into the economy.  The yield on the 10 Year Treasury bottomed in May 2016 at 1.46% and has been steadily climbing ever since.  In May 2018, the 10 Year Treasury Bond was yielding around 2.80% so it took 2 years from the yield to go up by 1.34% compared to the 0.23% jump that we experience over the past 2 weeks.

Will The Rise In Rates Continue?

We could see a further rise in rates over the next few weeks but at this point, we have probably seen the majority of the big move up.  Even though the Fed is expected to raise rates in December and possibly three to four times in 2019, there are other forces at work that are anchoring our rates to lower levels.

The first being the lower level of global interest rates.  As you will see on the chart below, as of September 30, 2018, the U.S. is issuing 10 year bonds at 3.46%.  When you look at other “credit worthy” counties like Germany, they are issuing their 10 year bonds at 0.69%.  So when foreign countries have cash to park, they will gladly take the 3.46% interest rate for 10 years as opposed to 0.69% for 10 years.  This makes the demand for US debt high around the global and we are not pressured to issue our debt at higher rates to entice buyers because our rates are already a lot higher than debt being issued by other governments around the world.

The second reason that rates are most likely to remain at lower levels over the next few months is tame inflation.  When inflation rises above the Fed’s 2% target rate, they often respond by raising the Fed Funds Rate either more frequently or by larger increments.   As you will see in the chart below, the annual year over year change in the core Consumer Price Index (CPI) as of August 2018, which is the Fed’s primary measure of inflation, was only up 2.2%.  Very close to the Fed’s target range so the Fed is not behind the inflation curve.  If inflation was roaring ahead at 3% or higher it would probably prompt the Fed to raise the Fed Funds rate faster than the market expects.

Rates Are Still At Healthy Levels

Even though interest rates are rising, they are still at historically low levels.   Which then prompts the question:   “At what level do interest rates become problematic?”   If we use history as a guide, it would seem that once the yield on the U.S. 10 year treasury bond reach 4.50%, returns from the stock market come under pressure in the two year following the breach of that threshold.  But historically, when rate are where they are now and moving higher, the stock market has traditionally moved higher as interest rates were rising.

See the chart below which illustrated the correlation between interest rates and stock prices.  Each dot on this chart represents a 2 year return from the stock market between 1963 and 2018.  If there is a positive correlation, that means interest rates are moving higher and stock prices are moving higher at the same time.  This is illustrated with a dot placed above the line in the chart. Those are favorable environments and it makes sense because in the early stages of a rising rate environment the Fed is raising rates because the economy is healthy but rates are not higher enough yet where they are harming the growth rate of the economy.

Visa versa when the dots are below the line that means that there is a negative correlation between interest rates meaning interest rates are going up and stock prices are going down.

If you look at where 3.25% would be on the x axis you will not see any dots below the line. That would imply that between 1963 – 2018 when the interest rate on the 10 year treasury bond were at the current level and moving higher, two years later stock prices were always higher. Otherwise you would see a dot below the line.  If the stock market were to be lower 2 years from now and interest rates are at their current rates and moving higher, it would be the first time that has ever happened within the last 55 years.

Could stock prices be lower 2 year from now? Sure they could but if you use history as a guide, it would suggest that such an event would have a low probability of occurrence.

Conclusion

As of right now, it would seem that the recent sell-off in the U.S. stock market was triggered by an unexpected rise in interest rates over the past two week.  While higher interest rates are often revered as an unwelcome guest to bull markets, history would suggest that interest rates have not reached levels that would prompt an end to the current economic expansion.    We would also add that there are other forces at work such as tame inflation rates and a lower global interest rate environment that may prevent a further dramatic increase in rates from the current levels. 

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 Could The Midterm Elections Impact The Stock Market?

The most common question that I have been asked over the past few weeks is: “If the Republicans lose control of either the House or the Senate in November, what impact do you think that will have on the markets?”   How much the stock market may go up or down in the days leading up to or directly after the midterm elections, regardless of the result, is anyone’s guess.  But if we use history as a guide, investors will probably realize that this situation is not uncommon, and there is probably less to worry about than investors think. 

A Shift In Power Is Not Uncommon

If we look back at every midterm election going back to 1934, on average, the president’s party has lost 30 seats in the House and 4 seats in the Senate during a midterm election year.  There are only three years in history that the president’s party actually gained seats due to a midterm election:  1934, 1998, and 2002.  So if the Republican’s lose seats in Congress in November that would really be the norm instead of the exception to the rule.  If it is in fact the norm, investors have to ask themselves, “how much of that shift in power is already priced into the market?” 

How Does The Stock Market React During Midterm Election Years?

In attempting to answer this question there are two components: volatility and return.  As many would guess, during midterm election years volatility typically rises leading up to the elections. Looking at the S&P 500 Index going all the way back to 1970, the volatility levels in the stock market are typically 10%+ more volatile when compared to the levels of volatility in the S&P 500 when there are no midterm elections.

From a return standpoint, the results speak for themselves.    Below is a bar chart that shows the return of the S&P 500 Index 12 months following the midterm elections 1950 – 2015:

stock market returns

12 months after a midterm elections the S&P 500 Index averages a 15.1% annual return.  In all other years the stock market averages a 6.8% annual return.

But What About A Flip In Control

It’s one things to lose seats in Congress but do we have to worry more because it’s not just about losing seats this year, it’s about a shift in power within Congress?  Again, using history as a guide, let’s look at what has happened in the past.  The House majority switched parties as a result of midterm elections in 1994, 2006, and 2010.  In all three of those years where a shift in power was in the cards, the stock market was either down or flat leading up the midterm elections in November.   However, in all three of those years the stock market was significantly higher 12 months after the midterm elections. See the chart below: 

past returns of S&P 500 Index

The Stock Market Cares More About The Economy

If you asked me which environment I would choose to invest in:

A)  Stable political environment and bad economy

B)  Unstable political environment and good economy

I would probably choose “B” because at the end of the day the stock market is historically driven by the economy.    While politics have the power to influence the economy, if we end up in a gridlock situation after the November elections, that is also the norm.  Going back to 1948, we have had a “divided government” 61% of the time.  As we get closer to the elections, there is a very good chance that the level of volatility in the markets will increase because the stock market doesn’t like uncertainty.  But if we use history as our guide, the 12 months following the midterm elections may reward investors that stay the course.

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.

Target Date Funds: A Public Service Announcement

Target Date Funds:  A Public Service Announcement

Before getting into the main objective of this article, let me briefly explain a Target Date Fund.  Investopedia defines a target date fund as “a fund offered by an investment company that seeks to grow assets over a specified period of time for a targeted goal”.  The specified period of time is typically the period until the date you “target” for retirement or to start withdrawing assets.  For this article, I will refer to the target date as the “retirement date” because that is how Target Date Funds are typically used.

Target Date Funds are continuing to grow in popularity as Defined Contribution Plans (i.e. 401(k)’s) become the primary savings vehicle for retirement.  Per the Investment Company Institute, as of March 31, 2018, there was $1.1 trillion invested in Target Date Mutual Funds.  Defined Contribution Plans made up 67 percent of that total.

Target Date Funds are often coined as the “set it and forget it” of investments for participants in retirement plans.  Target Date Funds that are farther from the retirement date will be invested more aggressively than target date funds closer to the retirement date.  Below is a chart showing the “Glide Path” of the Vanguard Target Date Funds.  The horizontal access shows how far someone is from retirement and the vertical access shows the percentage of stocks in the investment.  In general, more stock means more aggressive.  The “40” in the bottom left indicates someone that is 40 years from their retirement date.  A common investment strategy in retirement accounts is to be more aggressive when you’re younger and become more conservative as you approach your retirement age.  Following this strategy, someone with 40 years until retirement is more aggressive which is why at this point the Glide Path shows an allocation of approximately 90% stocks and 10% fixed income.  When the fund is at “0”, this is the retirement date and the fund is more conservative with an allocation of approximately 50% stocks and 50% fixed income.  Using a Target Date Fund, a person can become more conservative over time without manually making any changes.

Note:  Not every fund family (i.e. Vanguard, American Funds, T. Rowe Price, etc.) has the same strategy on how they manage the investments inside the Target Date Funds, but each of them follows a Glide Path like the one shown below.

The Public Service Announcement

The public service announcement is to remind investors they should take both time horizon and risk tolerance into consideration when creating a portfolio for themselves.  The Target Date Fund solution focuses on time horizon but how does it factor in risk tolerance?Target Date Funds combine time horizon and risk tolerance as if they are the same for each investor with the same amount of time before retirement.  In other words, each person 30 years from retirement that is using the Target Date strategy as it was intended will have the same stock to bond allocation.This is one of the ways the Target Date Fund solution can fall short as it is likely not possible to truly know somebody’s risk tolerance without knowing them.  In my experience, not every investor 30 years from retirement is comfortable with their biggest retirement asset being allocated to 90% stock.  For various reasons, some people are more conservative, and the Target Date Fund solution may not be appropriate for their risk tolerance.The “set it and forget it” phrase is often used because Target Date Funds automatically become more conservative for investors as they approach their Target Date.  This is a strategy that does work and is appropriate for a lot of investors which is why the strategy is continuing to increase in popularity.  The takeaway from this article is to think about your risk tolerance and to be educated on the way Target Date Funds work as it is important to make sure both are in line with each other.For a more information on Target Date Funds please visit https://www.greenbushfinancial.com/target-date-funds-and-their-role-in-the-401k-space/

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.

New York May Deviate From The New 529 Rules

When the new tax rules were implemented on January 1, 2018, a popular college savings vehicle that goes by the name of a “529 plan” received a boost.  Prior to the new tax rules, 529 plans could only be used to pay for college.  The new tax rules allow account owners to withdraw up to $10,000 per year per child for K – 12 public school, private school, religious school, or homeschooling expenses. These distributions would be considered “qualified” which means distributions are made tax free.

Initially we expected this new benefit to be a huge tax advantage for our clients that have children that attend private school.  They could fully fund a 529 plan up to $10,000 per year, capture a New York State tax deduction for the $10,000 contribution, and then turn around and distribute the $10,000 from the account to make the tuition payment for their kids.

New York May Deviate

States are not required to adhere to the income tax rules set forth by the federal government. In other words, states may choose to adopt the new tax rules set forth by the federal government or they can choose to ignore them.  The new tax laws that went into effect in 2018 will impact states differently.  More specifically, tax payers in states that have both income taxes and high property taxes, like New York and California, may be adversely affected due to the new $10,000 cap on the ability to fully deduct those expenses on their federal tax return.

As of June 30, 2018, New York has yet to provide guidance as to whether or not they will recognize the K -12 distributions from 529 plans as “qualified”.   More than 30 states have already announced that they will adhere to the new federal tax rules.  On the opposite side of that coin, California has announced that they will not adhere to the new 529 tax rules and they will tax distribution made for K – 12 expenses.  Oregon has gone one step further and will not only tax the distributions but they will also recapture state tax deductions taken for distributions made for K – 12 expenses.

Wait & See

If you live in a state like New York that has yet to provide guidance with regard to the new 529 rules, you end up in this wait and see scenario.  There is no way to know which way New York is going to rule on this new federal tax rule.  However, if New York follows the path taken by many of the other states that were adversely affected by the new federal tax rules, they may decide to follow suit and choose to ignore the new 529 tax rules adopted by the federal government.

We also don’t have any guidance as to when NYS will rule on this issue.  They may wait until November or December to issue formal guidance. If that happens, 529 account owners looking to take advantage of the new K – 12 distribution rules will have to be on their toes because distributions from 529 accounts have to happen in the same year that the expense is incurred in order to receive the preferentially tax treatment.

Potential investors of 529 plans may get more favorable tax benefits from 529 plans sponsored by their own state. Consult your tax professional for how 529 tax treatments and account fees would apply to your particular situation. To determine which college saving option is right for you, please consult your tax and accounting advisors. Neither APFS nor its affiliates or financial professionals provide tax, legal or accounting advice. Please carefully consider investment objectives, risks, charges, and expenses before investing. For this and other information about municipal fund securities, please obtain an offering statement and read it carefully before you invest. Investments in 529 college savings plans are neither FDIC insured nor guaranteed and may lose value.

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.

After A Divorce, Who Gets To File As Head of Household For Their Taxes?

There are often issues with money and taxes when a couple separates, or even when an ex-divorcee gets married again but this is one of most common tax questions that we receive when a married couple with children are in the process of getting divorced.

With regards to divorces and taxes though, there are five different tax filing types:

Single

Married Filing Joint

Married Filing Separately

Head of Household

Qualifying widow(er) with dependent child

There are a number of advantages for the spouse that is able to use the Head of Household (“HOH”) filing status after the divorce is finalized. They include:

• Lower tax brackets

• A higher standard deduction

• The possibility of qualifying for more tax credits and deductions

Joint Custody

When parents are awarded joint custody, you would think that there is some flexibility as to who is allowed to file as HOH or at a minimum that the spouses can alternate who files as HOH each year. In a divorce, even with a joint custody arrangement, there is typically one custodial parent. The custodial parent is the parent that the children spend the greatest number of days during the year.In simple terms, it literally comes down to counting the number of days during the calendar year that the children spends with each parent. The parent that spends the most days with the children during the year is the custodial parent and has the right to file as Head of Household, to claim the children as a dependent, claim the child tax credits, and the dependent child care credit.

Form 8332

At any time after the divorce, the custodial parent has the ability to file Form 8332 with their tax return which allows the noncustodial parent to claim one or any number of the children as a dependent on their own tax return. However, even if the custodial party files Form 8332 with their return allowing their ex-spouse to claim one or more of the children as dependents for that tax year, they still retain the right to file under the Head of Household filing status. The Head of Household filing status cannot be transferred to the noncustodial parent via Form 8332.

Both Parents Claim HOH

There are a few rare cases where it could be possible for both parents to file as Head of Household in the same tax year. For example, if there are two children, one child spends 51% of the year with one parent, and the second child spends 51% of the year with the other parent, both parents may be able to file as Head of Household in the same tax year. If you feel like you and your ex-spouse qualify for this exception, you will need to keep very careful records of where the children spend their days and nights throughout the year.

You should keep a “child custody log” because there is a good chance that both parents filing as HOH post-divorce will trigger an audit by the IRS. But there is nothing guaranteeing that a child custody log by itself will satisfy the IRS in the event of an audit. The IRS could request additional information to determine that the 51% time requirement was met by each parent.

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.

Patience Should Reward Investors In 2018

Bottom line, the first half of 2018 was a tough pill to swallow for investors.  They had to fight a constant rollercoaster. Volatility was high, returns were low, and the news was dominated with fears of trade wars. This environment has left investors questioning if we are on the eve of the next recession. Well I have good news. While trade wars have driven fear into the hearts of investors, during that same time period corporate earnings have been soaring and the U.S. economy has continued its growth path. For these reasons, disciplined investors may have good things waiting for them in the second half of 2018.

Coming Off A Big Year

As of the end of the second quarter, the S&P 500 Index was up 2.6% year to date. So why does 2018 seem like such a disappointment? You have to remember that 2017 was a huge year with the added benefit of very little volatility. It was a straight march up the entire year.

First, let’s compare the performance of the various asset classes in the first half of 2017 versus to first half of 2018. Below are the returns for the various assets classes in the first half of 2017:

Here are those same asset classes in the first half of 2018.

Obviously a huge difference. At this time last year, the S&P 500 Index was already up 9.3% for the year compared to 2.6% in 2018. International and emerging market equities were up over 14% in the first half of 2017. In 2018, those same international stocks were down over 2%. One might guess that bonds would preform better in a year with muted stock returns. Well, one would be wrong because the Barclay’s US Aggregate Bond Index was down 1.6% in the first 6 months of 2018.

Volatility Is Back

Not only has the first half of 2018 been a return drought but the level of volatility in the stock market has also spiked. In the first 6 months of 2017, the S&P 500 Index only had 2 trading days where the stock market moved plus or minus by more than 1% in a day. Guess how many trading days there were in the first half of 2018 where the S&P 500 Index moved up or down by more than 1% in a day.

The answer: 25 Days

That’s a 1,250% increase over 2017. No wonder everyone’s nerves are rattled. So the up 2% YTD in the stock market feels more like a down 10% because a lot has happened in a short period of time. Plus, the only big positive month for the stock market was in January which feels like forever ago.

Recency Bias

Investors are largely suffering for what we call in the investment industry as “recency bias”. In other words, what happened recently has now become the rule in the minds of investors. Investors are largely using 2017 as their measuring stick for 2018 performance and volatility. While it would seem that the dramatic increase in the level of volatility this year would classify 2018 as an abnormally volatile year, it’s actually 2017 that was the anomaly. Below is a chart that shows the annual return of the S&P 500 Index since 1980. The dots below each annual return are the market corrections that took place as some point during each calendar year.

Based on historical data, it’s “normal” for the market to experience on average a 10% correction at some point during the year. Now look at 2017, the stock market was up 19% for the year but the largest correction during the year was 3%. That’s abnormal. By comparison, even though we are only half way through 2018, we have already experienced a 10% correction and as of June 30th, the S&P 500 Index is up 2% for the year.

Earnings Are King

Behind the dark clouds of the media headlines and the increased level of volatility this year is the dramatic increase in corporate earnings. Corporate earnings have not only increased but they have leaped forward. Take a look at the chart below:

The market traditionally follows earnings. The earnings per share for the S&P 500 Index in 2017 was 17% which is a strong number historically. In the first quarterly of 2018, the year-over-year earnings per share growth was up 27%. That is a surge in corporate earnings. But you would have no idea looking at the meager 2% YTD return from the stock market this year. Pair that with the fact that the P/E of the S&P 500 is around 16 which is in line with its 20 year historic average. See the chart below:

Even though it has been a long expansion, the market is not “over priced” by historic terms. If the stock market is fairly valued and corporate earnings are accelerating, one could make the case that the stock market has some catching up to do in the second half of the year.

The Chances Of A Recession Are Low

With the yield curve still positively sloped and the Composite Index of Leading Indicator, not only positive, but accelerating, a recession within the next 6 to 12 months seems unlikely. It’s like wandering through a jungle. When you are on the ground, the jungle is intimidating, there are plenty of things to be afraid of, and it’s tough to know which direction you should be walking. As investment advisors it’s our job to climb the tallest tree to get above the jungle to determine which way we should be walking.

In summary, 2018 has been an emotional roller coaster for investors. But making sound investment decision is about putting your emotions and gut feelings aside and looking at the hard economic data when making investment decisions. That data is telling us that we may very well be witnessing the soon to be longest economic expansion since 1900. The U.S. economy is strong, tax reform is boosting corporate earnings, interest rates are rising but are still at benign levels, and consumer sentiment is booming. In the later stages of an economic cycle, higher levels of volatility will be here to stay which will test the patience of investors. But overall the second half of the year could prove to be beneficial for investors that choose to climb the trees.

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.

We Are Sleep Walking Into The Next Crisis

The U.S. economy is headed down a dangerous path. In our opinion it has nothing to do with the length of the current economic cycle, valuations, interest rates, or trade wars. Instead, it has everything to do with our mounting government deficits. We have been talking about the federal budget deficits for the past ten years but when does that problem really come home to roost?

A Crisis In Plain Sight

An economic crisis is often easier to spot than you think if you are looking in the right places. Most of the time it involves identifying a wide spread trend that has evolved in the financial markets and the economy, shutting out all of the noise, and then applying some common sense. Looking at the tech bubble, people were taking home equity loans to buy tech stocks that they themselves did not understand. During the housing bubble people that were making $40,000 per year were buying homes for $500,000 and banks were giving loans with no verification of income. Both of the last two recessions you could have spotted by paying attention to the trends and applying some common sense.

Government Debt

Looking at the data, we think there is a good chance that the next economic crisis may stem from reaching unsustainable levels of government debt. Up until now we have just been talking about it but my goal with this article is to put where we are now in perspective and why this "talking point" may soon become a reality.

Debt vs GDP

The primary measuring stick that we use to measure the sustainability of the U.S. debt level is the Debt vs GDP ratio. This ratio compares the total debt of the U.S. versus how much the U.S. economy produces in one year. Think of it as an individual. If I told you that someone has $100,000 in credit card debt, your initial reaction may be “wow, that’s a lot of debt”. But then what if I told you that an individual makes $1,000,000 per year in income? That level of debt is probably sustainable for that person since it’s only 10% of their gross earnings, whereas that amount of credit card debt would render someone who makes $50,000 per year bankrupt.

Our total gross federal deficit just eclipsed $21 trillion dollars. That’s Trillion with a “T”. From January through March 2018, GDP in the U.S. was running at an annual rate of $19.965 trillion dollars (Source: The Balance). Based on the 2018 Q1 data our debt vs GDP ratio is approximately 105%. That’s big number.

The Safe Zone

Before I start throwing more percentages at you let's first establish a baseline for what's sustainable and not sustainable from a debt standpoint. Two Harvard professors, Reinhart and Rogoff, conducted a massive study on this exact topic and wrote a whitepaper titled "Growth in a Time of Debt". Their study aimed to answer the question "how much debt is too much for a government to sustain?" They looked at historic data, not just for the U.S. but also for other countries around the world, to determine the correlation between various levels of Debt vs GDP and the corresponding growth or contraction rate of that economy. What they found was that in many cases, once a government's Debt vs GDP ratio exceeded 90%, it was frequently followed by a period of either muted growth or economic contraction. It makes sense. Even though the economy may still be growing, if you are paying more in interest on your debt then you are making, it puts you in a bad place.

Only One Time In History

There has only been one other time in U.S. history that the Debt vs GDP ratio has been as high as it is now and that was during World War II. Back in 1946, the Debt vs GDP ratio hit 119%. The difference between now and then is we are not currently funding a world war. I make that point because wars end and when they end the spending drops off dramatically. Between 1946 and 1952, the Debt vs GDP ratio dropped from 119% to 72%. Our Debt vs GDP ratio bottomed in 1981 at 31%. Since then it has been a straight march up to the levels that were are at now. We are not currently financing a world war and there is not a single expenditure that we can point to that will all of a sudden drop off to help us reduce our debt level.

Spending Too Much

So what is the United States spending the money on? Below is a snapshot of the 2018 federal budget which answers that question. As illustrated by the spending bar on the left, we are estimated to spend $4.1 trillion dollars in 2018. The largest pieces coming from Social Security, Medicare, and Medicaid.

federal deficit

The bar on the right illustrates how the U.S. intends to pay for that $4.1 trillion in spending. At the top of that bar you will see “Borrowing $804 Bn”. That means the Congressional Budget Office estimates that the U.S. will have to borrow an additional $804 billion dollars just to meet the planned spending for 2018. With the introduction of tax reform and the infrastructure spending, the annual spending amount is expected to increase over the next ten years.

Whether you are for or against tax reform, it’s difficult to make the argument that it’s going to “pay for itself in the form of more tax as a result of greater economic growth.” Just run the numbers. If our annual GDP is $19.9 Trillion per year, our 3% GDP growth rate I already factored into the budget numbers, to bridge the $804B shortfall, our GDP growth rate would have to be around 7% per year to prevent further additions to the total government debt. Good luck with that. A 7% GDP growth rate is a generous rate at the beginning of an economic expansion. Given that we are currently in the second longest economic expansion of all time, it’s difficult to make the argument that we are going to see GDP growth rates that are typically associated with the beginning of an expansion period.

Apply Common Sense

Here’s where we apply common sense to the debt situation. Excluding the financing of a world war, the United State is currently at a level of debt that has never been obtained in history. Like running a business, there are only two ways to dig yourself out of debt. Cut spending or increase revenue. While tax reform may increase revenue in the form of economic growth, it does not seem likely that the U.S. economy is at this stage in the economic cycle and be able to obtain the GDP growth rate needed to prevent a further increase in the government deficits.

A cut in spending, in its simplest form, means that something has to be taken away. No one wants to hear that. The Republican and Democratic parties seem so deeply entrenched in their own camps that it will make it difficult, if not impossible, for any type of spending reform to take place before we are on the eve of what would seem to be a collision course with the debt wall. Over the past two decades, the easy solution has been to “just borrow more” which makes the landing even harder when we get there.

Answering the “when” question is probably the most difficult. We are clearly beyond what history has revered as the “comfort zone” when to comes to our Debt vs GDP ratio. However, the combination of the economic boost from tax reform and infrastructure spending in the U.S., the accelerating economic expansion that is happening outside of the U.S., and the low global interest rate environment, could continue to support growth rates even at these elevated levels of government debt.

Debt is tricky. There are times when it can be smart accept the debt, and times where it isn’t helpful. As we know from the not too distant past, it has the ability to sustain growth for an unnaturally long period of time but when the music stops it gets ugly very quickly. I’m not yelling that the sky is falling and everyone needs to go to cash tomorrow. But now is a good time to evaluate where you are risk wise within your portfolio and begin having the discussion with your investment advisor as to what an exit plan may look like if the U.S. debt levels become unsustainable and it triggers a recession within the next five years.

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 Medicaid Spend Down Process In New York

You are most likely reading this article because you had a family member that had a health event and the doctors have informed you that they are not allowed to go back home to their house and will need some form of health assistance going forward.  This article was written to help you understand from a high level the steps that you may need to take to get them the care that they need and to get a preview of the Medicaid application process and the spend down process, if that’s the path that needs to be taken.

Everyone is living longer which is a good thing but it creates more complications later in life. It is becoming much more common that people have family members that have a health event in their 80’s or 90’s that renders them unable to continue to live independently. Without advance planning, a lot of the important decisions then have to be made by family and friends so it is important for even younger individuals to understand how the process works because you may be in this situation some day for a loved one.

Do I Have To Apply For Medicaid To Pay For Their Care?

What you will find out very quickly is any type of care whether it's home health care, assisted living, or a nursing home, is very expensive. Very few individuals have the assets and the income to enable them to pay out of pocket for their care without going broke. It's not uncommon for kids or family members to have no idea what mom or dad's income and asset picture looks like. But no one is going to provide you with this information unless you have a power of attorney.

Power of Attorney, Health Proxy, and Will

A power of attorney (“POA”) is a document that allows you to step into a person’s shoes that have been incapacitated. It allows you to get information on their bank accounts, investments, insurance policies, and anything else financially. If you do not have a power of attorney, you need to get one quickly.  A lot of financial decisions will most likely need to be made in a very short period of time. You will need to contact an estate attorney to draft the power of attorney. There are some choices that you will have to make when you draft the documents as to what powers the “POA” will have. They can usually be turned around by an attorney in 48 hours if needed.

While you have the estate attorney on the phone, you also will want to make sure that they have a health proxy and a will. The health proxy allows you to make healthy decisions from a family member if they are unable to do so. While it’s difficult to think about, health proxies will typically list out the end of life decisions. For example, a health proxy may state that mom or dad refuses to have a machine breathe for them if they are no longer able to breathe on their own. The questions are tough to answer but it’s very important to have this document in place.

Home Care, Assisted Living, or Nursing Home

Prior to the health event, mom or dad may have been living by themselves at their house. Now the doctor is telling them that because of the damage done by the stroke, that they will not release them from the hospital until other arrangements are made for their care. There are three options to receive care:

• Receiving care in the home via home care by health aids

• Assisted living facility

• Nursing home facility

People that cannot pay for 100% of their care and that do not have a long term care insurance policy, typically have to spend down their personal assets and then apply for Medicaid.  Now that is said, let's jump right into what is protected and not protected as far as income and assets for Medicaid.

Different Rules For Different States

Each state has different eligibility and spends down rules when it comes to Medicaid. For purposes of this article, we will assume that the person needing the care is a resident of New York. If you live in a different state, the process will be similar but the actual amounts and the definition of "protected" assets may be different. It's usually best to work with a Medicaid planner, estate attorney, or local social services office that is located within your state/county to obtain the rules for your family member that needs care.

The Medicaid Rules In New York

There are different limits based on whether the family member needing care is married and their spouse is still alive or if they are single or widowed. In general, if a couple is married and one spouse needs care, more assets and income will be able to be protected and they will be able to qualify for Medicaid because they recognize that income and assets have to be available to support the spouse that does not need the care. But for purposes of this article, we will assume that mom passed away and dad now needs care.

Asset Limit

In 2018, to qualify for Medicaid, an individual is only allowed to keep $15,150 in assets. The next question I get is "what counts toward that number?" It's actually easier to explain what DOES NOT count toward that number. The only assets that do not count toward that threshold are as follows:

• Primary Residence

• 1 Vehicle

• Pre-Tax Retirement Accounts (if older than age 70½) - (However Required Minimum Distribution goes toward care)

• Irrevocable Trust (Funded at least 5 years ago)

• Pre-paid burial expenses

That's it. If dad has $50,000 in his checking account, $20,000 in a Roth IRA, and a RV, the RV will need to be sold and he will need to spend down the Roth IRA and the checking account until the balance reaches $15,150 in order to apply for Medicaid.

Primary Residence

Very important, while the primary residence is a protected asset for purposes of the Medicaid application, Medicaid will place a lien against dad’s estate for the money that they paid on his behalf. Meaning when he passes away, the kids do not automatically get the house. Medicaid will be first in line after the house is sold waiting to get paid. The amount depends on how much Medicaid paid out. If dad lives in a house that is worth $200,000 and Medicaid during his lifetime paid out $120,000 for his care, when the house sells, Medicaid will get $120,000 and the beneficiaries of the estate will only get the remaining $80,000.

When kids hear this they typically get upset because mom and dad worked their whole life to payoff the mortgage and maintain the house and now they are going to lose it to Medicaid. Is there anything that can be done to protect it? If the house was not put into a Medicaid Trust 5 years before needing to qualify for Medicaid then no, there is nothing that can be done. That’s why advanced planning is so important.

If dad worked with an estate attorney to establish a Medicaid trust 5 years ago, the attorney could have changed the ownership of the house to the trust, once dad makes it by 5 years without a health event, it’s no longer a countable asset for Medicaid and Medicaid cannot place a lien against the house. The question I usually ask our clients is “do you want Medicaid to get your house or do you want your kids to have it?” Most people say their kids but if advanced planning was not completed, you lose this options.

No Gifts To Kids

So what if you change the name on the house to the kids? It's considered a "gift". All gifts made within the last five years are a countable assets. It's called the "5 year look back period". When you apply for Medicaid for dad you have to provide them with a ton of information including 5 years of all statements for bank accounts and investment accounts. Also you have to provide them with copies of all checks written over the past 5 years that were in excess of $1,000. Medicaid is making sure that you did not "give" all of dad's assets away last minute so he could qualify for Medicaid and avoid the spend down.

Income Limits

We have talked about assets but what about income? It's not uncommon for a parent to be receiving a pension and/or social security. They are only allowed to keep $842 per month in 2018. The rest of their income will be applied toward their care. This can create some tough decisions if dad has to go to assisted living or a nursing home and the family has to maintain the house and meet his financial needs on $842 per month. Again, Medicaid it trying to recoup as much as it can to pay for dad's care.

Medicaid Pooled Trust

There are ways to protect income above the $842 threshold through the use of a Medicaid Pooled Trust. Unlike the Medical Irrevocable Trust to protect assets that needs to be established 5 years prior, these trusts can be establish now to protect more income. They work like a special checking account that can only be used to pay bills in dad's name. You can never withdraw cash out of the accounts. As long as dad is considered "disabled" by the social security administration or NYS he may qualify to setup this trust. There are not-for-profit entities that administer this income trust. Basically his income from social security and pension would be deposited to this trust account and then when bills show up for utilities, property taxes, car payment, etc, you submit the bill to the organization that is administering the trust and they pay the bill on behalf of that individual.

Home Care Limitation

Most individuals want to return to their home and have the care provided at their house via home health aids.  This may or may not be an option. It all depends on the level of care needed. If Medicaid will be paying for dad's care, you will need to call the social services office in the county that he lives in. They will send an "assessor" to his house to determine if the living conditions are adequate for home care and they will also determine the level of care that is needed. In general, if the estimated cost of home care is expected to be at least 90% of what it would cost for care at a facility, Medicaid will not pay for home care and will require them to go to an assisted living or nursing home facility.Home health aids typically range in price from $15 - $30 per hour. Assume it cost $25 per hour, if dad needs care 8 hours a day, 7 days a week that would cost $6,083 per month. If you need a nurse or registered nurse to administer medication at the home, you are looking at $40+ per hour for those services.

Steps From Start To Finish

We have covered a lot of ground and this is just a general overview. But here is a general list of the steps that need to be taken assuming dad had a health event and you need to apply for Medicaid on his behalf:

• Contact an estate attorney to establish a power of attorney and requirement for Medicaid application

• Using the POA, begin collecting financial information for the Medicaid process

• Contact the county social services office to request an assessment to determine if home care will be an option if it's in question

• If a spend down is required to qualify for Medicaid, work with estate attorney to develop spend down strategy

• If monthly income is above threshold, determine if a Medicaid pooled trust is an option

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.