Q&A: Linking Estate Planning With Financial Planning

Avoid this estate planning mistake.

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

Question: I’m meeting soon with an estate attorney, but I’m a bit apprehensive because I think estate planning should be done in tandem with financial planning. Is that correct? If so, I’ll need to deal with two different firms. How do I connect them?

Ric: Yes, I agree the work of your financial advisor and your estate attorney overlap and should be done in tandem. The financial advisor helps you develop a comprehensive financial plan that covers everything — including college funding, life insurance, retirement savings, estate planning and more. They can tell you what estate-planning tools you might need — a will, durable power of attorney, living will, living trust — and should refer you to an attorney to get those documents.

Estate Planning Mistakes
Here’s a classic example of the flaws of dealing solely with the attorney on the estate issues. Say the attorney recommends a revocable living trust. This is a common estate-planning tool that helps your heirs avoid probate if you die, ensures that your assets are properly managed if you become incapacitated and has other useful provisions. Attorneys charge a few thousand dollars to prepare a revocable living trust.

At this point, the attorney may say, “Here’s the document, sign here; congratulations, you have a living trust.” He or she pats you on the back, sends you out the door and you’re done. But if you never title your assets into the trust, the document has zero value. Too often, attorneys don’t follow up to see that their clients retitle their assets (brokerage accounts, homes, cars and such) into the trust. If we’re your financial advisor, we can help make sure you do that.

Whom do you visit first — the advisor or the attorney? People usually visit an advisor first and learn what documents are needed, then go see the attorney — but the reverse is OK too.

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.


Trying to Select a College?

These web sites can help.

There are many important factors to consider when selecting a college. Cost and the availability of financial aid are certainly two of the biggest factors, but size, acceptance and graduation rates should also be considered. Here are a few reputable web sites you can use to narrow your search.

College Navigator
This database, created by the U.S. Department of Education, has significant amounts of data with statistics. You can even see each college’s average cost for students of different income levels.

College Board
Enter the name of a college and you’ll get information about its size, cost, acceptance rate, gender breakdown of students and financial aid offerings.

College InSight
This site’s information is similar to the College Board’s but allows you to compare universities simultaneously.

Just click on the name of an institution to see what grants it offers for various majors.

College Week Live
This site claims to be the world’s largest online college fair. It’s used by budget-conscious schools, and you can use the site to speak to admission officers as if you were on campus.

College Results Online
Discover the four-, five- and six-year graduation rates for most institutions. Peer lists are generated automatically, making it easy to compare schools.

AM 849290

The Roth IRA Conversion

You can convert your IRA to a Roth … but should you?

In 2010, Congress began letting everyone convert their Deductible and Non-Deductible IRAs to a Roth IRA. (Previously, conversions were limited to those with Adjusted Gross Incomes of less than $100,000.) Converting is alluring. If you don’t convert, you’ll pay taxes when you make withdrawals in retirement. And you must start making those withdrawals in your early 70s. But withdrawals from Roth IRAs are tax-free, and there’s no requirement to begin withdrawing money at any age.

Those facts suggest that converting to a Roth is a no-brainer. But before you act, read the fine print: The money you convert is fully taxable (which explains why future withdrawals are tax-free; instead of paying the taxes later, you pay up front).

So the choice is yours: Pay the tax now on the current balance so that future withdrawals are tax-free, or pay the tax later when you make withdrawals from the (theoretically higher) balance. So should you pay now or pay later? It’s a simple question, but as with so many issues in the field of personal finance, the answer requires substantial analysis. Getting it wrong could cost you tens of thousands of dollars in unnecessary and premature taxes, and many tens of thousands more in lost wealth.

While I agree with those who say that the Roth Conversion conundrum is a timely issue that investors should address, I do not believe that conversion is necessarily in everyone’s best interests. Let’s examine the 17 notions involved with converting your IRA to the Roth.

It Makes Sense If Your Current Tax Bracket Is Low
Some people are temporarily in a low tax bracket. This can be caused by a variety of reasons: divorce, job loss, temporary work assignment (such as in a tax-free hazardous zone), high and sudden (but short-term) medical expenses, and more. If you are currently in the 12% federal income tax bracket or less and have reason to believe that your income will be higher in retirement, placing you in a higher bracket, converting now makes sense.

It Could Increase Your Children’s Inheritance
By converting your IRA to the Roth, you pay the taxes now. If you want your children or grandchildren to inherit the account when you die, they’ll receive the money without having to pay income tax. With proper estate planning, their inheritance can be increased substantially compared to a traditional IRA. Of course, this Roth Conversion feature is of primary value to your heirs, not you.

It Could Increase Your Federal Income Taxes
If you’re in a low tax bracket, be aware that converting could push you into a higher bracket — and possibly even the highest bracket. That’s because the amount you convert is added to your taxable income. So if you earn $20,000 and you convert a $200,000 IRA to the Roth, your income is now $220,000 — putting you in to a higher income tax bracket. This would affect your overall taxable income, not just the dollars involved in the conversion.

It Could Increase Your State Income Taxes
If you live in a state with an income tax and you convert, you’ll owe state taxes. If you later move to a state that has no income tax and convert then, you’ll avoid that state income tax.

It Could Cause You to Pay a 10% IRS Penalty
Say you convert a $100,000 IRA to the Roth, causing you to owe $35,000 in federal income taxes. Are you able to pay the tax from earned income or money held in other accounts? If you use money held in the IRA, and if you’re under age 59½, you’ll owe a 10% IRS penalty in addition to the tax itself. That’s an additional $3,500. (And we haven’t mentioned state taxes — paying those from the IRA could further increase your taxes and IRS penalties.)

It Could Require You to File Estimated Payments
The IRS expects you to pay your taxes within a certain time frame in which you earn the money.

  • Earn January – March, pay by April 15
  • Earn April – May, pay by June 15
  • Earn June – August, pay by September 15
  • Earn September – December, pay by January 15

Ordinarily, this is handled for you by your employer (through payroll deductions). But if you convert a large IRA, you could be required to file IRS Form 1040-ES, making payments roughly each quarter. If you don’t, you could incur interest and penalties.

You May Not Know How Much in Taxes You Owe Until Next Year
Surprisingly, if you own both Deductible and Non-Deductible IRAs and you convert only the Non-Deductible IRA, you won’t know how much you owe in taxes until next year. That’s because the IRS considers conversions to consist proportionately of each type of IRA you own. Let’s say you have $100,000 in IRAs — $40,000 in after-tax contributions and $60,000 in pre-tax contributions. To determine how much of the conversion you’d have to pay taxes on, you divide the pre-tax amount in the account by the total ($60,000/$100,000 = .60). Thus, you would have to pay taxes on 60% of any money you convert. So if you decide to convert $40,000, you’d pay taxes on $24,000. At a tax rate of 24%, that’s $5,760.

But this calculation is based on the year-end value of your IRAs — including the money you converted — not their value on the day you converted. So if your account increases in value by year-end (or if you rollover a pre-tax 401(k) into an IRA) you might pay more in taxes than you expect.

It Doesn’t Necessarily Increase Your Wealth
Conversion is revenue-neutral; whether you convert or not, your future account balance (after taxes) will be the same. Don’t believe me? Here’s the math: Say your Deductible IRA has $100,000 and it doubles between now and retirement, to $200,000. You then withdraw the money, paying 35% in taxes. That’s $70,000, leaving you with $130,000. But instead, let’s say you convert your current IRA of $100,000 to the Roth. You pay 35% in taxes on the current balance. That’s $35,000, leaving you with $65,000. This amount then doubles so that by retirement you have $130,000 — and all withdrawals are now tax-free. So whether you convert or not, you end up with the same amount of money. The only difference is that one strategy has you pay $35,000 in taxes now, while the other has you pay $70,000 later. But the net after-tax value is the same.

The Amount of Wealth Enhancement You Expect to Get Depends on Your Tax Rate Assumptions
Of course, the above assumes that your current tax rate stays the same — and that’s quite an assumption. If your future tax rate is higher, then you benefit by converting and paying taxes at today’s lower rate. And the higher you think your future tax rate will be, the more you benefit by converting. Likewise, if you think your future rate will be lower, converting reduces your future wealth.

Don’t be so sure that your tax rate in retirement will be higher than it currently is. If you are retiring in 20 years, current tax law could be outdated. Thus, all assumptions about future tax legislation are sheer speculation — hardly justification for making a sound financial decision.

It Could Increase Your Medicare Premium
If you are covered by Medicare, your Part B premium is based on your income. Converting increases that income (if only for a year or two), which could add hundreds of dollars to your monthly Medicare costs.

It Could Cause You to Pay More in Taxes Than You Should
Some investors do everything they can to reduce their income taxes. They save all their money in IRAs, employer retirement accounts, tax-free municipal bonds — and the Roth IRA. By converting their IRAs and employer accounts to the Roth, they are able to generate income in retirement that is 100% tax-free.

But avoiding taxes so completely isn’t necessarily a good result. That’s because the tax code offers a variety of tax deductions, such as the standard deduction, plus deductions for mortgage interest, real estate taxes, charitable contributions, being older than 65 years of age, and other reasons. If all your income is tax-free, these deductions offer you no value. In other words, you might not want to convert and pay income taxes today when some of this taxable income can be offset by tax deductions in retirement. You might actually be better off financially by having some taxable income rather than 100% tax-free income.

It Could Cause Your Taxes to Rise Even Further
In the year you convert, your income rises. That creates the risk that you might lose some or all of your personal exemptions and itemized deductions — and some (or more) of your Social Security benefits may become taxable as well. All this could cause your tax bracket in the year of conversion to be even higher than you anticipate.

Converting at the Wrong Time Could Cause You to Pay More Taxes Than Necessary
A lot of people who converted their IRAs in early 2008 later may have regretted it. Because of the economy, many people discovered that their account values were lower at the end of the year. But if you converted in January 2008, you had to pay taxes based on the value of the account at that time — even though the account might have been worth 40% less 12 months later.

To help protect you against the risk that the account might drop in value shortly after you convert, the old tax law allows use to allow you to “recharacterize” your account. In other words, you get to “unconvert” your IRA from the Roth back to the Deductible or Non-Deductible IRA you originally held. However, current tax law eliminated your ability to do Roth recharacterizations. Now, if you do a Roth conversion and your account falls in value, you cannot “uncovert” leaving you stuck with your decision.

If You Have an Annuity in Your IRA, Things Get Complicated
Your tax obligation isn’t limited to the cash value of the contract. Instead it’s determined by the fair market value of the annuity, which is the cash value of the contract on the day you convert plus the actuarial net present value of any living or death benefits. (Your insurance company can calculate your present net value for you.) For example, if your annuity has a cash value of $50,000 and the death benefit is worth $200,000, you’ll owe taxes on $250,000.

Take extra care if you are only partially converting your variable annuity. When you convert an entire annuity, the annuity itself remains intact. But when you convert only part of an annuity, you are essentially splitting off part of your annuity to create a new IRA. This sounds simple enough, but breaking off a piece of the annuity could be the same as making a withdrawal. Depending on your annuity, a premature withdrawal could trigger the annuity to lock in a living benefit payout percentage earlier — and therefore much lower — than you had expected or planned. It could also cause the annuity to stop providing guaranteed growth or income.

The Money You Convert Becomes Untouchable for Five Years
When you make a direct contribution to a Roth IRA, you can withdraw that money at any time without penalty. The earnings, however, must stay in the account until you are 59½ — or you’ll incur ordinary income tax rates plus a 10% penalty.

The rules for Roth IRA conversions are different. If you convert money to a Roth IRA and are under age 59½, you can’t withdraw the rollover contributions for five years. If you do, you’ll face a 10% penalty. (The rules for distributions of earnings are the same as with direct contributions.) There are exceptions for medical expenses, medical insurance premiums paid during unemployment, first-time homebuyers, death, disability, and higher education. And each conversion has its own five-year holding period.

It Could Impact Financial Aid for Your College Student
IRAs aren’t included among your assets when a college calculates a financial aid package. However, when you convert to a Roth IRA, the money shows up on your tax forms as income for that year. If your income is artificially inflated when you fill out financial aid forms, you’ll have to explain the situation to the school, and they may or may not take that information into consideration.

Not All Funds Can Be Converted
Inherited IRAs, required minimum distributions, 72(t) payments, hardship distributions, corrective distributions of excess deferrals, deemed deferrals, and dividends from employer securities cannot be converted.

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.


Why Paying Capital Gains Taxes on Your Mutual Funds Isn’t So Bad

It’s all about how mutual funds are structured.

The following article refers to mutual funds that are held in taxable accounts. 401 (k) and IRA accounts follow different tax laws.

How can a fund that loses money generate a tax notice saying that it made money? It seems bizarre, but this is not unusual. In fact, having to pay capital gains taxes on an investment that has lost money is the most common complaint of mutual fund shareholders. But it’s not as bad as you may think.

Let’s start with an explanation of how capital gains taxes work. Say you invest $10,000 in a stock and it rises to $30,000. If you don’t sell the stock, there is no tax. But if you do sell the stock, you have to pay a tax on the profit. This profit is called a “capital gain.” You can delay this tax for years — even decades — by holding onto your shares, because you don’t pay the capital gains tax until you sell (assuming the asset appreciated).

Now, let’s see how this tax rule applies to mutual funds. You buy shares of a fund and the fund, in turn, buys stocks. If you sell your shares of the fund for a profit, you incur capital gains, just as if you had sold shares of stock (as in the paragraph above).

But say you keep your shares. No taxes, right? Not necessarily. Why? Because the fund might sell some of the stock it owns. If the fund does this, the fund incurs a capital gain. And since you are the real owner of the fund, you are the one who has to pay the taxes. That’s why the fund distributes Form 1099-DIV to you; this form reveals your share of the capital gains incurred.

That’s the key point: If the fund sells shares of any of the stocks it owns, those sales trigger the capital gain — even though you have not sold any of your shares of the fund. But how can a fund incur a capital gain if it has lost money? Say you invest in a fund that’s 10 years old. You pay $10 for each share. At the end of the year, your fund’s share price is only $8 — meaning you’ve lost money. But soon after, you receive Form 1099-DIV in the mail declaring that you have capital gains of several thousand dollars. How can this be?

It’s simple: Even though you bought shares of the fund for $10 per share, the fund itself owns stocks that it purchased many years ago. It has now sold some of those stocks for a profit. Thus, even though you didn’t enjoy that profit, the fund you own did, and, as a shareholder, you must now pay your share of the taxes on that capital gain. This certainly doesn’t seem fair.

Now here’s the good news. When you sell your shares in the fund, the tax you will be required to pay at that time will be lower than it otherwise would have been because you have, in essence, prepaid your tax. And if you sell your fund for a loss, you’ll actually get a refund for the tax you already paid. In other words, mutual fund shareholders pay a little bit of their capital gains taxes each year, whereas stock investors pay all their taxes at one time. Some people argue that stock investors have the advantage because, by delaying the tax, their money can grow faster.

But this isn’t necessarily true since most fund investors reinvest their capital gains distributions into more shares, and this enables them to compound their growth more effectively than stock investors can. Furthermore, when it does come time to pay that tax, fund investors happily discover that their tax bill is quite small, because they’ve already paid some or most of the taxes due.

So, don’t let mutual fund taxes annoy you too much. Remember: There are worse things than not paying taxes…like not having any money!

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.


When the IRS Wants You

Do your hands shake upon opening letters from the IRS? Don’t panic: Being audited need not be a terrible experience – provided you keep accurate records.

There are three kinds of audits: Correspondence, Office and Field. The Correspondence Audit focuses on simple errors that typically are corrected via mail. For example, letters from the IRS ask you to provide documents (such as receipts) that support information you entered on your tax return. In other cases, the letter may inform you that you underpaid your taxes due to errors you made on your return. In such cases, you’ll be asked to send additional money. Once you pay, the matter is over.

In an Office Audit, you are requested to bring documentation to an IRS office at a specific time and date. When you confirm the appointment, and if you have the documents requested, see if the agency will let you resolve the matter by correspondence.

The third, and most feared, is the Field Audit. In these cases, an IRS auditor comes to your home or office. This occurs when the IRS suspects major violations. For example, do you really have a home office? The agent needs to see it in order to allow the deduction.

Whichever type of audit it is, it all begins with a letter. When you receive it, the first thing to do is read it, and then read it again. Make certain you clearly understand what the IRS wants you to do. The letter will reveal the mistake the IRS thinks you made, and it will specify the parts of your tax return that the IRS is challenging. The letter also will say what you are expected to do, including when, where, and how you are to respond.

You made and kept a copy of your tax return and all supporting documentation – you did, didn’t you? – and you’ll need to get those papers now. (If you don’t have a copy of your return, the IRS can provide you with one. If you lack the supporting documents, such as receipts, try to replace them by contacting the vendors involved. If you can’t, you’re toast.)

When auditing by correspondence, the IRS will inquire about specific items, and you need respond only to those issues. But in office and field audits, the IRS search is often much broader. In fact, once sitting opposite a revenue agent, you will find yourself answering questions you might not have anticipated and which you may not understand. Therefore, never go to an audit. Instead, send a CPA, Enrolled Agent or attorney to represent you before the IRS, which is another reason why you should hire such a professional to prepare your returns in the first place. By giving the professional your power of attorney, using IRS Form 2848, you don’t have to attend the audit (unless you receive an “administrative summons”).

Also know your rights as a taxpayer by going to www.irs.gov for a copy of Publication 1: Your Rights as a Taxpayerand Publication 3498-A: The Examination Process.

Best approach: Complete your tax returns accurately, file them timely, and keep good records.

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.


How to Choose a Tax Preparer

Point #1: Choose someone else, not yourself.

Given the complexities of current tax law, you might consider hiring a professional to prepare your return for you. Here are tips from the IRS to help you choose a good preparer:

1. Check the person’s qualifications. Ask if the preparer is affiliated with a professional organization that provides its members with continuing education and resources and holds them to a code of ethics. New regulations require all paid preparers (including attorneys, CPAs and enrolled agents) to obtain a Preparer Tax Identification Number before preparing any federal tax returns.

2. Check on the preparer’s history. See if consumers have filed complaints with private watchdog groups. Check for disciplinary actions and valid licenses with the state board of accountancy (for certified public accountants), state bar association (for attorneys) and the IRS Office of Professional Responsibility (for enrolled agents).

3. Ask about the cost of preparing your return. Avoid preparers whose fee is a percentage of your refund and those who claim they can obtain a larger refund for you than other preparers.

4. Make sure the preparer is accessible. You want to be able to contact the preparer throughout the year.

5. Ask the preparer to describe the documents he or she wants to see. Reputable preparers will request to see your records and receipts and will ask you questions to help them prepare your return. Avoid preparers who do not ask for documents and who never ask you questions.

6. Never sign a blank return. Avoid tax preparers who ask you to sign blank tax forms.

7. Will the preparer sign your tax return along with you and include his or her PTIN? The law requires paid preparers to sign the return and include their PTIN, even though you remain responsible for the return’s accuracy. The preparer must also give you a copy of your return.

8. If mistakes are made, will the preparer pay the interest and penalties levied by the IRS? Remember that you’re always legally responsible for the information that appears on your return, even when someone else prepares it. Although you’ll owe the tax, honorable and professional preparers will agree to pay any interest or penalties resulting from their errors. Get their promise in writing and in advance.

If you discover that you’ve become involved with an abusive tax preparer, or if you suspect tax fraud, file Form 14157-A. You can download the form at www.irs.gov or have one mailed to you by calling 800-TAX-FORM (800-829-3676).


10 Tips to Help Ensure Your Charitable Donations Will Be Tax-Deductible

Your good deed can benefit you as well.

At the end of last year, perhaps you were feeling generous. You’d also like to get a tax deduction for your generosity. Charitable intentions, however, don’t guarantee you’ll get the deduction. For that, you generally must itemize your deductions on Form 1040.

If you’re 70½ or older, you have another option. You can donate money directly from your IRA, and the amount you give (up to $100,000) is not counted as taxable income. The donation is considered a qualified charitable distribution (QCD) and satisfies your required minimum distribution (RMD) requirements. And you avoid the risk of increasing the amount you pay for Medicare Part B or causing your Social Security benefits to become taxable. Note: Gifts from your IRA to charity must be transferred directly to the charity; you lose the above benefits if you withdraw money from your IRA and then write a check to the charity. As always, talk to your Financial Planner and tax professional before taking any action.

10 more tips on making charitable donations:

1. Give to qualified charities. Only gifts to eligible organizations are tax deductible. Select Check, a searchable online tool available on www.irs.gov, lists most eligible organizations. In addition, churches, synagogues, temples, mosques and government agencies are eligible to receive deductible donations even if they are not listed in the tool’s database.

2. Determine the fair market value. The IRS says the fair market value of clothing, household goods, appliances, furniture, shoes, books and other items is the price a willing buyer would pay for them. Items generally must be in good used condition or better to be deductible. For items worth more than $5,000, you must submit an appraisal. Some charities will pay for an appraisal; find out before you donate. By law, a charity cannot tell you what your donated items are worth. You should determine that with the help of your tax advisor.

3. The calendar is key. Contributions are deductible in the year made. Thus, donations made via credit card before the end of 2018 count for 2018 even if the credit card bill isn’t paid until 2019. Also, checks count for 2018 if they are mailed in 2018. Contributions made by text message are deductible in the year your contribution is charged to your telephone or wireless account (even though you might pay the bill the following year).

4. Save your receipts — even for cash gifts. Cash donations, regardless of the amount, must be proven by a bank record such as a canceled check or credit card receipt showing the name of the charity, or a written document from the organization showing its name, the date and the amount donated. For noncash donations worth $250 or more, including clothing and household items, get from the charity a receipt showing its name, date of the gift and a reasonably detailed description of the property. If a donation is left at a charity’s unattended drop site, keep a written record that includes that same information, as well as the fair market value of the property at the time of donation and the method used to determine that value.

5. Some items have special rules. The deduction for a car, boat or airplane donated to charity is usually limited to the gross proceeds from its sale. This rule applies if the claimed value is more than $500. You should get a Form 1098-C or a similar statement from the organization and attach it to your tax return. If your deductions for all noncash contributions total more than $500, you must fill out and submit Form 8283 with your return.

6. Donations to individuals don’t qualify for a tax deduction. That’s true no matter how deserving you believe an individual to be. This includes handouts to the homeless and office or neighborhood collections for someone experiencing difficult times (perhaps due to illness or a tragedy such as an accident or fire). If the deduction is important to you, consider working with a qualified charity such as the Red Cross, which provides disaster and other relief.

7. Participate in payroll deductions for charity. Your employer might participate in a charitable giving program that allows you to give directly from your paycheck. If you contribute by payroll deduction, you must retain a pay stub, Form W-2 or other document from the employer showing the total amount withheld, along with the pledge card giving the name of the charity.

8. Appreciated assets can be valuable. Donating property that has appreciated in value, such as stocks, can provide a double benefit — in that not only can you deduct the fair market value (as long as you’ve owned the property for at least one year), but you will also avoid paying capital gains tax. Normally, appreciated assets are subject to capital gains tax when sold or gifted, but there is an exception for those donated to qualified charities.

9. You can’t deduct the value of your time. This is true even if you can easily put a dollar value on your time. For example, if you’re a professional — such as a lawyer, doctor or architect — and normally charge $300 per hour for your services, you can’t deduct that amount for donating an hour of service to a charity. However, out-of-pocket costs related to volunteering are deductible, provided they’re not reimbursed to you or considered personal in nature. These might include transportation and travel expenses, uniforms and supplies. As always, documentation is essential.

10. Your deduction may have limits. If you contribute more than 20 percent of your adjusted gross income (AGI) to charity, some limits may apply. The rules are complicated (ask your accountant), but in general you can deduct appreciated capital gains up to 20 percent of AGI, noncash assets worth up to 30 percent of AGI and cash contributions up to 50 percent of AGI.

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.


Should You Rent Out Your Summer Home?

There are a lot of factors that you need to consider first.

If you own a second property, you might be tempted to rent it out to generate income and defray the costs of ownership. While the idea sounds attractive, there are downsides. First, you don’t get to use the property while it’s rented — meaning you miss out on enjoying it during peak season.

And owning a rental property means you’re operating a business. To compete with other properties, you’ll need to invest in furniture and kitchenware, the latest electronics, beds with quality mattresses and sheets, artwork, and more. Plumbing fixtures should be top-notch, including showerheads that deliver strong, consistent water pressure. You’ll have to pay someone to tidy up the place and launder between each guest stay. And you’ll incur liability insurance and lodging taxes.

And that’s assuming everything goes well — but watch out for the renter who trashes the property with late-night parties. Landlords have plenty of stories to tell about renters who destroyed furniture, damaged walls and stole property, from appliances to towels. Because of this, landlords tend to install durable but less comfortable furniture and lower-cost appliances — serviceable for renters but not ideal when you’re using the property yourself. Indeed, it’s hard to serve two masters.

This is why you need to check on the property often. If you don’t live close enough, you’ll need to hire someone. If you’re not handy, you’ll pay for repairs too, further adding to your costs. Management companies typically charge 20 percent to 50 percent of the rental cost.

Despite all this, you might still want to list the house for rent. If that’s the case, do the math. Determine how much you’ll pay for maintenance, utilities, taxes, insurance, repairs and amenities. Add more for preventive maintenance and for wear and tear, and don’t assume the property will be rented 100 percent of the allotted time. Will you be able to charge enough in rent to cover the costs? If so, and if you don’t mind the issues noted above, then you can consider proceeding. A conversation with your Financial Planner might help you decide.


What You Should Know About Your Home Insurance Before a Disaster

Make sure you and your loved ones are financially well-protected.

Next time you hop on a plane for a long flight, here’s a great read to take along with you:
Your homeowners insurance policy. OK, it might not be as exciting as a novel by your favorite author, but reading it could save you hundreds — even thousands — of dollars in the future. We’re talking about the costs you could incur from injuries or damage in a natural disaster, such as a hurricane, tornado, flood, wildfire or earthquake.

Do you have adequate insurance protection from such events?
It’s important to find out, because disasters will occur. And reading your documents after the disaster is a poor strategy. Many Texas and Florida residents who fled hurricanes Harvey and Irma discovered after they returned to their homes that their homeowners insurance contracts will pay for damage caused by wind, fire, lightning, hail and fallen trees — but not for damage from flooding.

For flood coverage, you generally need to buy a separate policy from the National Flood Insurance Program, administered by the Federal Emergency Management Agency.
And remember this: Flood insurance policies don’t pay claims for damage that occurs within 30 days of buying the policy. So don’t wait for a storm to approach to buy your policy. Get it now.

If you’re a renter, the landlord’s insurance doesn’t cover your possessions, so buy renters insurance.

Earthquake insurance
Standard home insurance or renters insurance won’t protect against earthquake damage, but a separate earthquake policy can fill the gap. You might be tempted to skip this coverage unless you live in California, which has the nation’s highest risk of quakes. But quakes happen in other parts of the country too, such as the one centered in Virginia that damaged the Washington Monument in 2011 and another large one that same year in Oklahoma. Quakes can happen in just about every state.

Industry groups say half the losses from the Virginia quake were uninsured, and few of those who suffered losses in Oklahoma had coverage. (Oklahoma is one of six states the U.S. Geological Survey has identified as being at high risk for earthquakes caused by human activities, such as oil and gas fracking.) Even in California, fewer than 10 percent of homes carry earthquake insurance, according to the California Earthquake Authority.

Earthquake insurance premiums could exceed the cost of your homeowners policy in high-risk regions. Annual coverage in California costs about $1.75 per $1,000 of coverage, while premiums in lower-risk states can cost as little as 50 cents per $1,000.

Inventory your possessions
When you file a homeowners insurance claim, you’ll need to submit a list of items that were lost, stolen or damaged. Having that list at your fingertips will ease the process and get your claim settled faster, so it’s wise to keep a current inventory of all your valuables. (Home inventory software available online can make this task easier.)

If you haven’t done so in the past, start keeping receipts now — especially for any big-ticket items. Take and then print photographs of everything, and write descriptions and dates on the backs of the photos, or — better yet — make a video, narrating as you move along, getting close-up shots as well as far-away views. When describing items, include the brand and model, condition, purchase price, replacement cost, current value, serial number, and date and location of purchases.

Read your policy to learn if big-ticket items will be adequately covered. You might need to insure certain items, like expensive jewelry, separately. Keep your inventory list in at least two places outside your home — such as in a safe, at a friend’s or family member’s home, or in your email.

Mortgage and taxes
Even if your house is uninhabitable or was destroyed, as difficult as it may be, you must keep paying the mortgage and property taxes. Inform your mortgage holder of the damage. Remember, the lender has a financial interest in seeing that the house is rebuilt. Some lenders require two signatures on checks and may require insurance payments to be placed in an escrow account. They might issue payments to contractors after work is completed in stages and passes inspection to guard against fraud.

Don’t wait for the next natural disaster. Protect your property now with the right kinds and amounts of insurance. And be sure to read your insurance policies to make sure you fully understand what’s in them.


Never Make a Major Real Estate Decision on Vacation

You may later regret what seemed like a good idea at the time.

You’re on vacation, having a great time. You’re relaxed, enjoying the warm weather, great views and terrific food. You casually say to your spouse, “Wouldn’t it be great to live like this more often?” You agree it would, so you buy a home in the area. No more hotels! No more packing and unpacking! It’s yours — a home away from home!

Will you live to regret this real estate decision? Many do, for these reasons:

  • You realize you can’t visit the property as often as you’d hoped.
  • You soon get bored traveling to the same place every vacation.
  • You underestimated the cost of furnishing a second home — everything from furniture to televisions to kitchen utensils.
  • You didn’t anticipate the time needed for repairs and maintenance. When you do go to the house, you spend most of your time fixing leaking faucets, not relaxing at the pool or ski lodge.
  • There’s no room service. You have to cook all your meals — and that means going to the grocery store instead of the beach. This vacation trap is quite common. Lost in the fantasyland of vacation, it’s easy to be struck by inspiration — and then make a decision you’d never make at home, where you can think more logically.

Making a major real estate decision while on vacation is a terrible idea. If you’re really thinking about buying a second home, take your time. Consider the long-term consequences and keep the following in mind:

  • It’s a vacation home, not an investment property. You can’t have it both ways: The property will be a place for you to enjoy — or a rental to produce income. Few owners of second homes succeed in doing both. Why? Because you won’t decorate the same if you rent it out — and that means you won’t enjoy the house as much when you are there. And tenants will want to rent the property at the best times — exactly when you want to be there.
  • Be realistic about how often you will use the property. Think long and hard about how often you’ll be able to visit. Understand that owning a vacation home might prevent you from visiting other destinations. Is that a tradeoff you’re willing to make?
  • Add 20% to the costs you’re expecting. From the mortgage and property taxes to maintenance and furnishings, you are going to spend more on your vacation home than you anticipate — just as you have done with your primary residence.
  • Will the house fit your future lifestyle? That vacation spot might fit your family’s lifestyle perfectly. But if your kids are all grade schoolers, will they want to spend the entire summer at that house as teenagers?
  • Are you assuming the property will grow in value? Remember: Real estate values don’t always rise.

This doesn’t mean you shouldn’t buy a vacation home. Just be sure to consider all aspects of any real estate decision, so you can avoid buyer’s remorse. If you’re thinking about buying a vacation home, you might want to talk with your financial planner before you talk to a real estate agent.