Q&A: Fully Funded 529 Plan But Kids Aren’t Going to College

Ric Edelman is a co-founder of Edelman Financial Engines. The following is taken from his weekly radio call-in show.

3 alternative ways to use the funds in your 529 plan.

Question: When I received my two 529 account statements at the end of the last calendar year, I was stunned at how much they had grown — and then I realized I have a problem. My son has decided he wants to be a plumber, and my daughter has decided she really doesn’t want to go to college. I have about $160,000 sitting in the two 529 accounts. What should I do?

Ric: Your situation illustrates why we get concerned about people overfunding 529 plans. Who knew when your children were 5 years old that they would grow up not wanting to attend college? Or they might win a scholarship and not need the money? Now you find yourself having to pay taxes plus a 10% penalty when you make withdrawals.

I have three possible solutions for you:
First, you could transfer these accounts to benefit your nieces or nephews. You might strike a deal with your brothers and sisters: You’ll retitle your two 529 accounts (with $80,000 in each of them), and they will give you $80,000 over the next few years in exchange (to avoid gift taxes).

A second option is for you to go back to college — not necessarily for a degree, but for something like an archaeological expedition to Egypt. Many universities offer trips with an educational component, and you can use 529 accounts tax-free to fund some of them. You could even transfer the accounts to your parents if they are able and would like to go on such an expedition. You’ll need to change the beneficiary designations before making any withdrawals.

A third option would be to leave the money where it is, wait until you have grandchildren and then retitle the beneficiary designations into their names. There’s no expiration date on when the funds have to be used, so this can give you two more decades or so of potential growth.

Of course, by then college might be entirely free, thanks to exponential technologies affecting the delivery of higher education — but that’s a conversation for another day!

This material was prepared for informational and/or educational purposes only. Neither Financial Engines Advisors L.L.C (also referred to as Edelman Financial Engines) nor its affiliates offer tax or legal advice. Be sure to consult with a qualified tax or legal professional regarding the best options for your particular circumstances.

Q&A: Advice for a 20-Something

Ric Edelman is a co-founder of Edelman Financial Engines. The following is taken from his weekly radio call-in show.

It’s never too early to prepare for retirement.

Question: My 26-year-old nephew lives with his parents and is working at his first serious job since graduating from college. He grosses about $50,000 a year and has $15,000 in the bank. He pays about $2,500 a year in interest on student loan debt of about $82,000. His loans are made up of components with interest rates that vary from 3.25% to 8%. I pointed out to him that if he makes a traditional IRA contribution he will increase his tax refund by about $1,100. Or he could contribute the maximum to a Roth IRA and let it grow 40 or 50 years tax-free. The third option would be to apply that money toward the student debt. His parents and I would like your opinion on which is his best option.

Ric: None of the ideas you mention is a bad one.
I would recommend that he contribute to a Deductible IRA. I question whether the Roth IRA will be tax-free by the time he’s in his 70s. That’s 50 years from now — 25 Congresses and maybe six presidents into the future.

Can we really predict how they will treat the Roth IRA? You don’t have to worry or wonder with the Deductible IRA, because he gets the tax break this year (instead of merely the promise of getting a break some 50 years from now).

However, even after making that contribution, he still has extra money. So I would use it to pay down the 8% college debt. He should not be in a hurry to pay down the portion of the debt that’s costing him only 3.25%. (That rate is so low he can likely earn more through a diversified portfolio over the next few decades.)

If he is not permitted to apply his payments only to the higher interest portion of the debt but is instead required to apply the extra payments across all the loans, then I wouldn’t prepay at all. Instead, he should place all his savings into a diversified investment portfolio.

This material was prepared for informational and/or educational purposes only. Neither Financial Engines Advisors L.L.C (also referred to as Edelman Financial Engines) nor its affiliates offer tax or legal advice. Be sure to consult with a qualified tax or legal professional regarding the best options for your particular circumstances.

Q&A: A Look at Market Behavior

Should you worry when “experts” say a crash is coming?

Ric Edelman is a co-founder of Edelman Financial Engines. The following is taken from his weekly radio call-in show.

Question: Some “experts” are predicting a bigger-than-ever market crash in the near future. I’m retired and probably wouldn’t have time to recover from that. Is someone in your firm watching carefully the IRAs of persons like me who can’t afford a large reduction in funds to live on?

Ric: There are always “experts” predicting a market crash. They are usually hawking a book, seminar or newsletter — or worse, some crazy investment scheme.

That said, of course there will be another market crash! They occur from time to time. Big ones are called depressions, panics and crashes; smaller ones are called corrections and bear markets. Regardless, it’s not important that prices will drop. What’s important is what happens after. And this is where those pundits always get it wrong: they ignore the “after.”

Market declines are not in the shape of the letter L — that is, prices don’t stay down forever. Instead, markets look more like a U or V — and that’s what’s important. Over time, it all looks like a W tilted upward to the right.

Yes, you can expect that prices will fall at some point — and you can expect that prices will rise thereafter. As an investor, you need to do only three things: diversify, so some of your money doesn’t fall in value when the markets decline; rebalance, so you can buy while prices are down; and maintain a long-term focus, so you are able to participate in the eventual recovery (with the understanding that past performance isn’t indicative of future results).

Investing strategies, such as asset allocation, diversification, or rebalancing, do not assure or guarantee better performance and cannot eliminate the risk of investment losses. There are no guarantees that a portfolio employing these or any other strategy will outperform a portfolio that does not engage in such strategies. Funds and ETFs are subject to risk, including loss of principal. All investments have inherent risks. There can be no assurance that the investment strategy proposed will obtain its goal. Past performance does not guarantee future results.

Know the Difference Between a Stock and Bond?

Take the Quiz

Our firm has always promoted financial education and literacy. The need for improvement is displayed by the results of a LIMRA survey asking 2,000 Americans 10 questions about basic financial and retirement topics.

The study found that only one in eight scored 90% correct. More than a third (36%) answered five or fewer questions correctly — with some not even knowing the difference between a stock and a bond. Men scored a little better than women (31% vs. 23% correct responses), but both groups failed miserably. Ditto for older consumers vs. younger ones (40% vs. 21%, with age 55 the separator).

And the most revealing factor? Those who have a financial advisor scored highest on the quiz. So if you want to become smarter about personal finance, get a financial advisor!

Test your knowledge of basic personal-finance issues. Here is LIMRA’s quiz:

1. Suppose you had $100 in a savings account and the interest rate was 2% per year. After five years, how much would you have if you allowed the money to grow?
a) $100.10
b) $102
c) $110
d) $110.41

2. If the interest rate on your savings account were 1% per year and inflation were 2% per year, after one year your money would be able to buy:
a) more than it does today
b) exactly the same as it does today
c) less than it does today

3. Over the last 50 years, which option has provided the highest average growth per year?
a) savings account
b) certificate of deposit
c) insurance policy
d) stock mutual fund

4. A stock fund’s beta rating can best be described as:
a) a measure of relative volatility of the fund vs. the S&P 500 index
b) a measure of relative growth vs. the S&P 500
c) a measure of relative capital outflow of the fund vs. the S&P 500
True or False

5. Buying a single company stock usually provides a safer return than a stock mutual fund.
a) True
b) False

6. Annuities are financial products that can provide a series of payments to a person that will last as long as he or she lives.
a) True
b) False

7. If you were to invest $1,000 in a stock mutual fund, it would be possible to have less than $1,000 when you withdrew the money.
a) True
b) False

8. Roth IRA earnings accumulate tax-free.
a) True
b) False

9. A person who is 55 in 2019 will be able to collect full Social Security benefits at age 65. (See Editor’s Note below)
a) True
b) False

10. The IRS currently limits contributions to 401(k) plans for those under age 50 to $19,000 per year. (See Editor’s Note below)
a) True
b) False

Answers to LIMRA Quiz:
1. D 2. C 3. D 4. A 5. False 6. True 7. True 8. True 9. False* 10. True*
*Editor’s Note:
• #9: A person who is 55 in 2019 will be able to collect full Social Security benefits at age 67.
• #10: In 2019 the IRS limits contributions to 401(k) plans for those under 50 to $19,000 per year.

Originally published in Inside Personal Finance

How Long Will You Keep That New Car?

Don’t be enticed by a loan that will last much longer

Seven years is a long time to wait for anything — but it can seem like an eternity in one situation that comes to mind:

A car loan.

A generation ago, most car loans were paid off after 36 months. But as prices rose, loans of 48 months and 60 months became more common. Then we began to hear about 72-month auto loans. Now, Experian says that 25% of new car loans are for 84 months — that’s right, seven years!

Why? Well, let’s say you want a car selling for $25,000 and you make a $1,000 down payment, leaving $24,000 to be financed at 4%. Would you prefer to pay $542 per month or $328 per month? That lower payment is sure enticing, because it leaves you with an extra $214 per month to spend on other things.

The catch, of course, is that you’d be opting for a seven-year loan instead of one that ends in just four years. One might suspect buyers are choosing seven-year loans because they otherwise can’t afford the cars they want to buy. If you can afford only $500 per month, you can buy a car that costs either $22,000 or $37,000 — depending on whether your loan is paid in 48 months or 84 months. Lots of people choose the nicer car and the longer term.

The difference between buying cars and houses.
That’s a problem, though, because cars are not houses. People tend to keep houses for decades, and houses tend to increase in value over time. Cars are the opposite: People sell them far more frequently, their values fall, and their maintenance and repair costs rise over time.

That last point is a doozy (a reference to the Duesenberg, the most luxurious automobile of the early 20th century which came to mean anything prominent or noteworthy). Automobile warranties typically expire after four years, after which you must pay for all repairs and maintenance. If you have a seven-year loan, you must pay for such repairs while you still have three years of payments remaining. And after four years of a seven-year loan, you’ll still owe about $11,000 — more than the car is likely to be worth.

If the car you’re replacing is less than seven years old, what makes you think you’ll keep this new one so long? Please buy wisely when shopping for a new car. Be sure you can afford the one you want. If you’re not sure of the amount you can afford and what loan package is best, you might want to speak with a financial advisor first.


Hard Work Pays – but Not Enough

Building wealth requires something more.

Your parents and the American education system instilled in you from an early age that hard work is a virtue. Schools are designed to impart knowledge that you can apply to a career to get a job, work hard and earn money.

That’s great — but it doesn’t go far enough. It’s doubtful that you’ll become wealthy if all you do in life is work hard. Building wealth requires you to do something else in equal measure. You must also work smart.

Here’s why: If you regularly save some of your hard-earned money in an account earning 1 percent, you won’t see much increase in value — even if you save for decades. But if you manage to earn a higher return, the compounding effect can help you produce the wealth you seek. Chapter 3 of The Truth About Money explains the principle this way:

If you save $150 a month at a 5 percent annual return, in 40 years you’d have $228,903 (ignoring taxes and fees). Such returns aren’t guaranteed, of course; this information is offered merely to illustrate the concept of compound growth.

If you double your savings to $300 per month, you will double your return — to $457,806. But to do that, you’d have to work harder — and most of us work hard enough as it is.

However, if you continued to save the same $150 per month but earned 10 percent instead of 5 percent, your account in 40 years would be worth $948,612 — four times what it would have been worth at 5 percent.

That’s a simple example of working smart (not that I’m suggesting that 10 percent returns are attainable, of course). As you can see, working smart is as important as working hard when it comes to building wealth. That’s why it’s important that you build and maintain a portfolio with the potential to help you earn the returns needed to benefit from compounding.

This is a hypothetical illustration meant to demonstrate the principle of compound interest and is not representative of past or future returns of any specific investment vehicle. They do not include consideration of the time value of money, inflation, fluctuations in principal or taxes.

Evaluating Your Advisor’s Performance

8 categories to consider when choosing an advisor.

Here are the eight categories you should consider when evaluating your advisor:

Category #1: Your relationship.
Do you feel comfortable talking with your advisor? Do you look forward to conversations, and when done, are you happy to have had the conversation?

Category #2: Services provided.
Is your advisor delivering services that are of value to you? Think of all the services you get, and ask if you’d be unhappy if any of them ceased. If you wouldn’t miss them, they aren’t of value. Also think of services you’d like to receive but aren’t currently receiving. Have you asked your advisor to provide them?

Category #3: Investment performance.
Are your returns competitive, based on your goals, risk tolerance, and personal situation? You should have a benchmark relevant to your situation for comparison purposes; your advisor can provide one for you.

Category #4: Investment risks.
Has your account fluctuated in value beyond your comfort level? If so, have you discussed this with your advisor, and are you satisfied with the results of that conversation (i.e. your investments were changed to better reflect your comfort level, or your advisor’s explanation made you more comfortable with the level of volatility you’re experiencing)?

Category #5: Outlook.
In times of economic volatility, is your advisor still equipped to effectively advise you? Has your advisor kept you up-to-date on his thoughts and perspective? Is your portfolio still properly positioned? If your advisor has been making or suggesting major changes in your investments, he may have lost confidence in his prior advice — rendering suspect the confidence you can place in his current advice. Even worse would be an advisor who does not seem able to articulate an effective, cohesive strategy going forward. And worst of all would be an advisor who has been and continues to be completely silent — no calls, no emails, no letters, no contact, and no responses to yours.

Category #6: Team-based or solo?
There is a lot of value in team practices vs. solo advisors. Don’t assume your advisor is part of a team just because he works at a national bank, insurance company, or brokerage firm. In most firms, each advisor works independently, with little to no regard for the advice, services, or strategies provided by others in the firm. Clients working with solo advisors are thus more dependent on the actions and decisions of that advisor than those who work as part of a team. Teams also provide greater depth and experience.

Category #7: Costs.
Are the total costs you’re paying competitive? It is foolish to try to seek the lowest costs possible, but it is equally foolish to be paying costs that are significantly higher than those available elsewhere. Your advisor can benchmark costs for you, and a quick Internet search or a few calls to other firms can give you an idea of what others charge.

Remember that there’s always a trade-off between costs and services/quality, and those you contact will try hard to convince you to switch firms. Therefore, it’s important when exploring costs that you examine all costs — not just the advisor’s fee, but also the costs of the investments that the advisor has recommended for you.

Category #8: Regulatory compliance.
Maybe you checked with FINRA, the SEC, and state regulators before hiring your advisor to make sure he had a clean record. But how do you know that there haven’t been complaints, violations, or fines issued in the years since you’ve been a client? Checking your advisor’s background every 3–5 years is a good idea.

Originally published in The Truth About Money

Do You Have the Right Auto Insurance Coverage?

This checklist can also help you lower your auto insurance costs.

Auto policies offer a wide range of coverage. Have you really examined yours lately? Start with the “declaration page;” usually you receive it as part of your premium notice. If you can’t find yours, ask your agent or insurance company to send you a copy.

  1. The most important — and state-required — part of your policy is your liability coverage (Part A). This protects you against lawsuits arising from property damage or bodily injury for which you may be legally responsible due to an auto accident. Your liability coverage might be written as a single amount, which is the maximum your policy will pay,  such as $500,000. Sometimes, coverage is written in split amounts, such as $100,000/$300,000/$50,000. The first number refers to the maximum coverage for injuries to one person. The middle figure refers to the maximum coverage available for all those injured in the accident, and the third figure is the maximum that will be paid for property damage to vehicles, structures, etc. Although each state sets the minimum amount of liability coverage that you must maintain, make sure your coverage is significantly more.
  2. Medical payment coverage (Part B) is optional and usually ranges from $1,000 to $10,000 per insured who is injured in an accident. The insured usually includes a spouse and children of the insured. In some states it also includes the insured’s non-family-member passengers. If you already have excellent health insurance, you can drop this coverage, which will save you money. However, you may prefer to maintain only enough coverage here to offset your health insurance policy’s deductible, as well as its 20% co-payment requirement. Thus, you should review your auto policy in the context of your other insurance coverage.
  3. Uninsured and underinsured motorist coverage (Part C) pays for bodily injury and property damage when you or your vehicle is in an accident caused by an uninsured motorist or hit-and-run driver. This coverage may duplicate your health insurance and/or your collision coverage, but uninsured motorist coverage also can compensate you for “pain and suffering,” which the others do not.
  4. Collision and Comprehensive (Part D, also known as “other than collision”) compensates you for damage to your car regardless of who is at fault. Each portion has a separate deductible. The higher the deductible, the lower the cost, but the more you must pay out-of-pocket in the event your car is damaged.
  5. Some states require you to carry Personal Injury Protection. Unless it’s mandatory, avoid this feature – and its cost – by maintaining separate and more comprehensive health and disability insurance.

You can lower the cost of your auto insurance if you:

  • have had no accident or ticket during the last three years
  • are insuring more than one car with the same company
  • have a teenage driver who has taken an approved driver education course and/or is eligible for a good student discount
  • have a child who is in college and away from home most of the year
  • maintain your homeowner policy with the auto insurer
  • equip your car with anti-theft devices, air bags and/or automatic seat belts
  • are age 50 or older
  • don’t drive to work
  • commute less than 10 miles to work
  • buy a car with high safety ratings.

Check on your car’s rating at the Insurance Institute for Highway Safety’s web site, www.iihs.org.


Are You Susceptible to Investment Fraud?

Here are common traits of victims — and a quiz that might predict vulnerability.

Investment fraud schemes cost Americans tens of billions of dollars annually. But you probably think that you would never fall for any of them.
The AARP Fraud Watch Network recently released a study revealing traits common to victims, noting three key differences between investment fraud victims and the general investor population:

  • Psychological mindset. Victims prefer unregulated investments, such as gold and real estate schemes, rather than stocks, bonds and mutual funds. They measure success in life by the amount of wealth they accumulate — and their willingness to take risks leaves them susceptible to aggressive sales pitches.
  • Behavioral characteristics. Victims make five or more investment decisions per year and tend to respond to ads they see online, in emails and on TV commercials.
  • Demographics. Victims tend to be older than the overall population, male, married and military veterans. They also typically describe themselves as ideologically conservative.

AARP published the seven-question quiz to help you learn if you have the traits that predispose you to becoming a fraud victim.

Investment Fraud Vulnerability Quiz
1. How many times per year do you make an investment decision, such as selling one stock and buying another or investing in something new?
a. None
b. 1 – 2
c. 3 – 4
d. 5 or more

Score 3 for d, 2 for c, 1 for b and 0 for a.

2. In a typical month, how many solicitations do you receive from salespeople urging you to invest money in something — via phone calls, email and letters?
a. None
b. 1 – 7
c. 8 – 15
d. More than 15

Score 3 for d, 2 for c, 1 for b and 0 for a.

3. Have you ever made an investment in response to any of the following? (yes or no)
a. An ad you saw on television
b. A solicitation via email
c. A call from someone you didn’t know
d. A presentation you attended as part of a free lunch or dinner seminar

Score 2 for each “yes.”

4. Do you strongly agree, somewhat agree, somewhat disagree or strongly disagree with the following statements?
a. Some of the most important achievements in life include acquiring money.
b. The most profitable financial returns often are found in investments that are not regulated by the government.
c. I don’t mind taking some risks with my money, as long as I think there’s a chance it might pay off.
d. I like to keep my eyes and ears open for emerging investment opportunities that others haven’t yet heard about.

For each, score 2 for strongly agree, 1 for somewhat agree, and 0 for somewhat disagree or strongly disagree.

5. Which of the following best describes your worldview?
a. Liberal
b. Moderate
c. Conservative

Score 2 for c and 0 for a or b.

6. What is your gender?
a. Male
b. Female

Score 2 for a and 0 for b.

7. What is your age group?
a. Under 18
b. 19 – 39
c. 40 – 54
d. 55+

Score 2 for d, 1 for c and 0 for a or b.
High risk: 14 – 28
Moderate risk: 8 – 13
Low risk: 0 – 7

Did you score a high number on the quiz? If so, you should apply greater caution when receiving unsolicited investment pitches and adhere to these protection tips:

  • Do: Invest only with advisors who act in a fiduciary capacity.
  • Don’t: Make an investment decision based solely on a TV ad, a telemarketing call or an email.
  • Do: Put yourself on the Do Not Call registry.
  • Do: Get a telephone call blocking system to screen out potential scammers.
  • Do: Limit the amount of personal information you give to salespeople until you verify their background.
  • Don’t: Make an investment decision when you are under stress — such as soon after a job loss or the death of a loved one.

Of course, the best way to avoid investment scams is to talk with your Financial Planner

Originally published in Inside Personal Finance.

10 Taboos Between You and Your Advisor

advisor answering client investment questions

Follow these tips to help prevent being taken advantage of.

Here are 10 things you should never do with a financial advisor:

Taboo #1: Never write a check made payable to your advisor, other than for his fee.
When investing money, your checks should be made payable only to mutual funds, ETFs, brokerage firms, or insurance companies. No legitimate advisor would ever allow a client to write a check for investments or insurance payable to him personally or to his firm.

Taboo #2: Never allow your advisor to list himself as a joint owner, beneficiary, or trustee on your accounts.
Your money is yours, not your advisor’s. Keep it that way. The only place your advisor’s name should appear on documents is a citation as “advisor of record.”

Taboo #3: Never lend money to your advisor.

Taboo #4: Never let your advisor sign your name to any document.
Many transactions require your signature — particularly those involving the disbursement of funds from your account. If you are in urgent need of cash, you might be tempted to urge your advisor to bend the rules. Don’t. Forgery is a felony.

Taboo #5: Never let your advisor allow you to sign a blank form or contract.
It’s a violation of FINRA rules and a pretty dumb thing to do. Cross out sections that do not apply.

Note: For privacy considerations, it is common for your advisor to send you documents that omit account numbers and other identifying information. It’s okay to sign such forms; your advisor will fill in the missing data after you return the forms. This step is designed to reduce the risk of identity theft.

Taboo #6: Never let your advisor list his firm’s address instead of yours on account statements.
You should receive monthly or quarterly statements directly from the mutual fund, brokerage firm, or insurance company. Never let your advisor arrange for the statements to go to his office instead of to you.

Taboo #7: Never let your broker or advisor sell you an investment that isn’t available from others.
Some advisors sell in-house or proprietary investment products. There’s only one reason they do that: because they earn compensation for doing so. If an investment product is not available elsewhere, it is probably high in risk and low in liquidity — meaning you could find it very difficult to sell for as much as you invested. Like a box of cereal, all the investments and insurance products your advisor recommends should be available from any number of sources, not just him.

Taboo #8: Never let your advisor receive a share of your profits.
I’d never let an advisor share in my profits unless he was also willing to reimburse me for my losses — and while you might find an advisor offering the former, no one would ever agree to the latter.

It’s your money, so you get to keep all of the profits.

Taboo #9: Never let your advisor assign any agreement with you to another advisor.
One day, your advisor may retire or sell his practice. If so, you are immediately relieved of any and all contractual obligations you may have had with him or her. Never let an advisor — or his successor — make you think you are obligated to work with the successor. Assignment is an SEC violation.

Taboo #10: Never let your advisor invest your money in something you don’t understand.
If you don’t understand an investment or strategy, don’t invest in it. Bernie Madoff’s clients used to joke that he put their money into a “black box.” They aren’t laughing anymore.