Should You Create a Trust?

Different types of trusts can fill different types of needs.

People often create trusts to help them manage their assets. Here’s a quickie on the basics of a trust, along with a description of common uses.

A trust is created by the grantor (that’s you). The grantor writes the rules governing how the trust is to operate, what it is to do, and how and when to do it. If the trust is revocable, you can change the rules at any time. If the trust is irrevocable, you can’t. (Each form has advantages and disadvantages, including tax implications.)

When creating the trust, you appoint a trustee, who will have the job of managing the trust and its assets. (People often appoint themselves to serve as trustee.) The trustee must follow the trust’s rules, although, some trusts let the trustee use discretion in certain matters.

After you create the trust, it receives gifts from a donor (that’s also usually you, although you might permit your trust to receive gifts from others in addition to you or instead of you). The trustee collects the gifts and invests the money in accordance with the rules of the trust. As a result, the trust will find itself with three things: principal (the money it was given, also called the corpus), interest and dividends earned on the principal (called income), and profits (if any) from increases in value enjoyed by the principal (called capital gains).

The rules you’ve written for the trust will determine who gets the income, capital gains and, ultimately, the principal. The recipient is called the beneficiary. Some trusts have lots of beneficiaries. They can be family members, friends, or charities — anyone you want, in any combination. Some trusts give the income to certain beneficiaries, while others get the capital gains and still others get the corpus — with the trust itself stating who is to get what and when (or under what conditions). It’s the trustee’s job to make sure all this happens in accordance with the provisions of the trust.

Because different trusts do different things, it’s routine for people to have more than one. In fact, having four or five trusts is not uncommon. In some cases, trusts are even created by other trusts or in a will!

Is a trust right for you? Your answers to these questions can help you decide.

  1. Are you worth more than $10 million? If yes, read about the Bypass Trust.
  2. Are you concerned about a family member who has a disability that limits his or her ability in any way? If yes, read about the Special Needs Trust.
  3. Do you fret that your heirs might squander the money you leave to them? If yes, read about the Spendthrift Trust.
  4. Do you own a lot of life insurance? If yes, then read about the Life Insurance Trust.
  5. Would you like a charity to receive a substantial amount of money upon your death? If yes, read about the Charitable Remainder Trust.
  6. Do you have children and expect your spouse to remarry after you die? Then read about the Qualified Terminal Interest Property (QTIP) Trust.
  7. Do you want to make certain that your assets are used for your benefit even if you are unable to manage them yourself? Do you want your assets to go directly to your heirs, avoiding the costs, delay, and publicity of probate? If so, read about the Living Trust.
  8. Do you want the bulk of your assets to go directly to your grandchildren? If yes, then read about the Generation-Skipping Trust.

Bypass Trusts
Also called the credit shelter trust, marital trust, and family trust, this trust is designed to help a married couple avoid estate taxes. Each person may pass to heirs a certain amount of money at death with no estate tax. The bypass trust can increase this. Because tax laws vary year to year, speak with an experienced financial advisor or estate planning lawyer to make sure you have current information.

Special Needs Trusts
This trust provides financial support to a person who is unable to manage his or her own financial affairs. To avoid the risk of interfering with the support that’s otherwise available from social services, the trustee may not want to use these assets for housing, clothing or food.

Spendthrift Trusts
Instead of leaving an heir a bucket of money that he or she may quickly squander, you place that inheritance into this trust. The trust would then distribute the inheritance to the heir later, perhaps when the heir reaches a certain age, or in the form of an allowance, or for specific expenses, such as college or medical expenses.

Life Insurance Trusts
For high net-worth individuals, owning their own life insurance is a big mistake — because the death benefit is subject to estate taxes. To solve this problem, have a life insurance trust own your policy. Instead of paying for the insurance yourself, you’d give that money to the trust, which would pay the premium for you. The trust would be the beneficiary, and your heirs would be the beneficiaries of the trust.

An additional benefit of a life insurance trust: Instead of beneficiaries automatically getting the insurance proceeds immediately upon your death, you can instruct the trust to distribute the money to the heirs more slowly (see Spendthrift Trust above).

Charitable Remainder Trusts
If you plan to donate assets to a charity after your death, you may find it beneficial, instead, to donate to a CRT now. By doing so, you get a tax deduction right now for your gift. You also can name yourself as the income beneficiary (giving yourself an annual income) and the charity gets what’s left after your death, tax free — just as you’ve intended.

If you’re concerned that making the gift to the CRT denies your children their inheritance, you can buy a life insurance policy equal to the size of your gift, naming your children as beneficiaries of the insurance, using some of the trust’s income to pay the policy’s premiums (see Insurance Trust above).

QTIP Trusts
Say you die leaving a spouse, minor children and assets. Further, say your spouse remarries, then dies. Result: Your spouse’s new spouse gets all your money, and your children are left with nothing. (We’ve seen this happen too many times.) To avoid this scenario, consider the Qualified Terminal Interest Property Trust. Instead of leaving your assets to your spouse when you die, you leave your assets to the QTIP trust.

The trust gives income to your surviving spouse for his or her lifetime. But when your spouse dies, the assets remain in the trust for the benefit of your children. Because your spouse doesn’t directly own the assets, he or she can’t convey them to a new spouse and his or her own heirs.

Living Trusts
This tool is designed to pass your assets to heirs without going through probate. Also, it can help insure that your assets will be used for your benefit and welfare if you become unable to manage your own affairs.

Generation-Skipping Trusts
Such trusts, intended for truly wealthy estates, can preserve your assets for several generations while avoiding estate taxes. You can fund a GST with the same amount as the bypass trust for the benefit of your grandchildren and great grandchildren, and the assets will appreciate free of income and estate taxes. Such assets can also be protected from creditors.

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. The use of trusts involves a complex web of tax rules and regulations. Consider enlisting the counsel of an estate planning professional and your legal and tax advisors prior to implementing such sophisticated strategies. The cost and availability of life insurance depend on factors such as age, health, and the type and amount of insurance purchased. Before implementing a strategy involving life insurance, it would be prudent to make sure that you are insurable by having the policy approved.

Q&A: Sharing Net Worth with Adult Children

What should I tell my family about my assets?

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

Question: My wife and I are in our early 70s, and we have three children in their early 40s — all married — and seven grandchildren ranging in age from 3 to 14. We’re retired and have a substantial estate — a net worth of about $5 million. My question is what to tell our children about our assets. We’re generous to them and the grandkids, but I don’t want to say something that would cause our children to change their behavior. It’s not that we want to keep secrets, but what if anything should we tell them? Should we be specific or just give them general information? I don’t think we should discuss this with the grandchildren — at least not anytime soon. Do you agree?

Ric: First, we believe keeping secrets is unwise when it comes to estate planning. You should have an estate plan in place that does two major things: protects your assets while you’re alive and provides for their distribution to your designated heirs after you’re gone.

Estate planning tools are available to help protect you and the management of your assets should you and your wife become incapacitated or unable to handle your affairs. These include everything from medical directives to revocable living trusts. You should arrange for these now if you haven’t already. This is important because you and your wife are (actuarially speaking) going to live for many years. Statistically, at least one of you can be expected to live well into your 90s. That means your children who are currently in their early 40s will be in their mid-to-late 60s by the time you and your wife pass away.

Assuming your three children will be your primary heirs, this question arises: Will they need the money in their 60s as much as they need the money right now in their 40s? I’d argue that it is this stage of their lives when they need the money most. They’re raising kids, buying houses and cars, saving to send your seven grandchildren to college, and more. This likely puts them under a great deal of financial and emotional stress.

You should ask whether that stress could be eased somewhat if they were to know there is an inheritance coming one day. Perhaps they wouldn’t need to save as much for retirement knowing part of it will be covered by you. This could let them shift their savings to the kids’ college costs. Conversely, if your plan is to help pay for college for the grandchildren, your kids could shift their saving emphasis to retirement.

Thus, knowing your intentions — when you plan to give them money, how much and for what purpose — can help your children make mature, rational and important decisions. On the other hand, you must also evaluate whether they might change their behavior for the worse. Might the news prompt them to take off for Tahiti and party? Might they quit a job? Might they become slovenly or abusive, saying in effect, “Hey, my daddy’s rich, so I don’t have to work real hard anymore — let’s have fun”? Or perhaps one of your in-laws might say, “I think I’ll simply divorce now because I’ve got this windfall coming and I’ll just negotiate that in the divorce settlement. Or perhaps I’ll quit my job.”

You know these people better than anyone else. You know your relationships with them and your attitudes about them. You need to evaluate whether your disclosure would do more harm than good and whether you should limit its nature and timing.

You might conclude that what you and your wife disclose about your assets could have a positive impact, easing the stress and pressure of your children’s own financial planning to the benefit of them and your seven grandchildren. You might conclude otherwise. At the very least you need to let them know that you have your estate planning in place and what your desires are regarding your funeral and charitable intent. You need to tell them who the executor of the will is and who the trustee of the trust is — and the executor/ trustee needs a copy of your documents because after you’ve passed it’s too late for them to ask questions. You might also decide to start giving your heirs some money right now, or annually.

So, yes, have the conversation, but you and your wife need to evaluate to what extent you should go, how much detail to give and when you will do it. (I agree with you that you needn’t include young grandchildren.)

If this seems daunting — and it does for many — a financial advisor can facilitate this conversation. It’s not uncommon for clients to bring their kids with them to an appointment when they’re ready to talk. This can remove some of the emotion and embarrassment — yes, occasionally there is an embarrassment of riches.

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: Sell or Ride Out Market Downturns?

Wall Street financial market capitalization sign with American flags

Instead look for rebalancing opportunities.

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

Question: What does your firm do when the stock market takes one of its big nosedives? Do you go to cash, or do you just ride it out?

Ric: Think about what you just asked in the simplest terms. You’re really asking whether one should sell when the market goes down. That’s a classic mistake made by millions of investors. We don’t do that. But we don’t just “ride it out” either. Instead, we do something smarter: We typically look for rebalancing opportunities.

On Jan. 26, 2018, the Dow reached 26,617, an all-time high. Investors were euphoric. Fast-forward to the week of Feb. 5, 2018. By the end of the week the Dow had lost 2,426 points, or 9.1 percent of its value from its all-time high. A large number of investors sold their stock funds — Alight Solutions’ 401(k) Index said on Feb. 5, the day the Dow suffered a 1,175-point decline, retirement savers moved money from the stock market to money market and fixed income funds at a rate 12 times higher than average.

Perhaps you’re thinking, though, why not sell before the market goes down? There’s a reason why not: Nobody knows when a nosedive is coming, and if you make a lucky guess and get out before the market nosedives, you’d have to be lucky again and guess when to get back in. It’s extremely difficult to get both calls right: when to sell and when to rebuy.

Plus, market downturns are times when you can consider many stocks as being “on sale.” If you were listening to my radio show during the crash of 2008 and 2009, you’ll recall what we were saying: “This is the greatest buying opportunity of a lifetime.”

Think of it this way: If you have a favorite flavor of ice cream and suddenly you see it’s on sale for half the regular price, are you going to take back the ice cream that you bought last week or buy more right now at the discount? I hope you’d buy more!

An index is a portfolio of specific securities (common examples are the S&P, DJIA, NASDAQ), the performance of which is often used as a benchmark in judging the relative performance of certain asset classes. Indexes are unmanaged portfolios and investors cannot invest directly in an index. Past performance does not guarantee 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.

Q&A: Is Asking About a Potential Claim the Same as Filing One?

The answer might surprise you and help save you money.

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

Question: We purchased a farm, but the insurance company we were with doesn’t offer farm insurance, so we approached another carrier. That company told us we’re uninsurable because we filed too many claims. However, we haven’t filed any claims!

We merely called our original company a few times to ask about existing coverage on a few things, including a tree our neighbor was worried about.
We merely wanted to know whether our insurance would pay for fixing the neighbor’s fence if the tree were to fall (not that we believed it would fall).
It turns out that, because the company doesn’t have agents, our inquiries were routed to the claims department and were logged as claims. We were shocked. Is this common practice in the insurance business?

Ric: Yes. Asking about a potential claim is the same as filing one. Industry data shows that those who ask end up filing claims more often than those who don’t ask. Even asking your agent (if you have one) can count as filing.

Also, insurers often deny people because of what they are insuring. For example, if the prior owner of your house filed many claims, you could be denied even though you never filed any claims yourself! So you should ask the seller about their insurance claims history on the house before you buy it — to make sure you can buy insurance and won’t have to pay higher-than- normal costs.

You might want to contact your financial advisor (not the insurance company) in the future to inquire about coverages and whether or not to file a claim. That way, if your advisor suggests that filing isn’t worthwhile, your claims history won’t be affected.

It might be possible to get your original insurer to provide a document stating that there were several inquiries without a claim. You could then give that letter to another carrier’s underwriters to get an exception to your uninsurable status.


Q&A: Charitable Remainder Trusts

What is a CRT and how does it work?

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

Question: My wife and I own an asset worth about $500,000 with no basis. If we sold it, we would lose maybe 30 percent in state and federal taxes. I see a chance to eliminate those taxes and support a charity I believe in by setting up a charitable remainder trust. I don’t believe we need the proceeds of this asset to live on. We have about $1 million saved in IRAs. We need only about $6,000 a month for expenses, and between the two of us we’ll get $4,300 in Social Security. What’s your opinion of the charitable remainder trust strategy?

Ric: First, let’s explain what a charitable remainder trust (CRT) is and how it works, for those who may not be familiar. You establish an irrevocable trust and gift assets to it — cash or securities, typically. You continue to receive income from the trust, and whatever you don’t receive will go to your designated charity at some future date (perhaps as late as your death).

There are lots of tax benefits of creating CRTs. You can donate appreciated securities (avoiding capital gains taxes). And future growth in the asset’s value occurs outside your estate, reducing future estate taxes.

The downside is that these trusts are irrevocable; once you create and fund them, the decision cannot be undone. So you should hope that you never need the money you’ve given to the trust (beyond the income you’re allowed to receive).

Based on what you’ve said about your assets and needs, it seems you are a candidate to consider a CRT. However, be sure to get more comprehensive financial advice before you proceed.

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.


Preparing for the Vacation of Your Life — Your Retirement

A guide for planning that ultimate “vacation.”

Planning vacations can be a lot of work. Sometimes it seems that researching destinations, booking transportation and lodging, and, of course, packing can take up as much time as the vacation itself. But how much time do you spend planning for what could be the greatest vacation of your life?

Six Retirement Realities
Before you start planning, it is important to understand some basic retirement truths:

1. You’ve got a long way to go.

People are living longer. For a married couple ages 65, one partner will, on average, live to be 91. And based on the rapid rate of scientific advancement, some futurists predict we may soon be living to 120 and beyond. Whether you retire in five years or 50, you need to plan to be retired for a long time.

2. The money you begin retirement with may be the most you will ever have.

Once you stop working, the paychecks stop coming in. You will need to supplement any pensions or Social Security benefits with the money you’ve saved for retirement.

3. You have a finite amount of money in your retirement accounts — and it’s less than you think.

Even if you have money socked away in IRAs and 401(k)s, withdrawals are typically taxable and state and federal taxes may be as high as 40 percent.

4. Your expenses won’t go down in retirement; they will change and will probably go up.

They call it free time, but few things are really free. Hobbies, movies, meals out, travel, health care and possibly assisted living all cost money.

5. You need to factor in inflation.

It is a safe bet that things will cost more in the future.

6. Financial market returns come with risk.

Although investing is important to meeting your financial goals, you don’t want to be playing catch-up. The higher the potential returns, the greater the risk.

Planning Your Trip
Just like a great vacation, meeting your retirement goals requires careful planning. The process begins by understanding the realities you face and continues by asking questions about your goals and the resources you might rely on. Here are a few questions to get you started:

  • Do you have other savings? How much have you saved in retirement accounts and elsewhere?
  • Will you receive a pension or Social Security benefits? How much?
  • Do you plan to work in retirement? How much? How long?
  • Will you receive an inheritance?
  • Are you willing to spend principal in retirement?
  • What is your medical history? Your family’s?
  • Do you want to leave a legacy?

So How Much Do I Need?
When it comes to determining need, no two people are exactly alike, and a one-size-fits-all approach won’t work. Most of us will need to rely on the money that we save, and invest in various retirement accounts such as IRAs, 401(k)s or other retirement plans. One approach to planning your future is to reverse engineer your retirement.

Begin with the best estimate of the projected annual income you’ll need. Then you can subtract the following:

  • Income from part-time work or a second career
  • Pensions/Social Security benefits
  • Nonretirement savings (consider rate of return, accessibility and need for a cash reserve)
  • Any inheritance you might receive

What’s left over is your remaining need. Next, look at your sources of income and how they might change in the future. Consider:

  • When will you stop working completely?
  • How long might any inheritances or nonretirement savings last?

Now you can anticipate how much income you might need from your retirement plans and project that need over your life expectancy. And don’t forget inflation. When you determine your remaining annual income needs, you can convert that amount into a percentage of your projected retirement account assets. Finally, you can determine the rate of return you’ll need and build a diversified portfolio accordingly.

Say you retire with $1 million in your retirement account. You need $40,000 per year in additional income, (4 percent of your account’s value). Congratulations! With a properly diversified portfolio, you should be able to meet your goals. And by the way, 4 percent is near the top of what we’d advise you to withdraw on an annual basis. Remember, this vacation has a long way to go, and you need to compensate for increasing expenses over time.

Wait a Minute, I’m Nowhere Near Retirement and I Don’t Have $1 Million in My 401(k) Plan
No matter when you think you’ll retire, the time to start planning is now. The first step is to pay off credit cards and other high-interest, nondeductible debt you might have. Then you should build up a cash reserve of at least three to 12 months of salary should you face any reduction in your current income. Now you are ready to start working on your retirement goals.

The basic goal is to save, invest and grow assets to provide a required income for as long as you live, and one of the best tools you have is your workplace retirement plan. For many, that’s a 401(k), although there are similar plans depending upon where you work. Some of the benefits of using your employer’s plan include:

  • It’s convenient — You can do it all at work, and recordkeeping, document planning and other paperwork is done for you.
  • It’s automatic — Money is deducted from every paycheck and invested in funds of your choice.
  • Tax advantages — If you are in a 25 percent tax bracket, every $1 you invest only reduces your take-home amount by 75 cents. And the money you earn isn’t taxed until withdrawn.
  • It forces you to save — You can’t spend your contributions and you probably won’t even miss the money.

But What If I Can’t Afford to Contribute to My Retirement Plan?
Most employers will match employee contributions up to a certain amount, typically 3 percent of your salary or more. That’s free money! Start there and slowly increase the amount you contribute. Additional strategies include:

  • Add 1 percent every six months.
  • Increase contributions by 50 percent of any future raises or bonuses.

You may be surprised to see you really won’t miss the money you contribute. After all, 1 percent of $50,000 is less than $10 per week, and that’s less than $7 after taxes. If you want to save even more, you might look at reducing your expenses, such as:

  • Drive an older car.
  • Own a modest home.
  • Limit travel.
  • Eat out less and bring lunch to work.
  • Re-assess costs of cable, phones, etc.

OK, But I’m Not Sure How I Should Be Investing the Money I’m Saving
If professional money managers can’t consistently outperform the market, how can you? The answer is that you can’t. But, more importantly, you don’t need to. First, let’s look at some of the ways you should not invest.

  • DON’T: Buy the fund that had the best return last year.
    Past performance is no indication of future results. The fact that a fund did well last year, the last five years, or the last 10 years is no indication of how it will perform tomorrow.
  • DON’T: Buy when the market is soaring and sell after the market drops.
    This is what so many people do, and it is the exact opposite of what you should be doing.
  • DON’T: Invest in a fixed account to “play it safe.”

Although fixed accounts offer low risk, they also offer low returns — and those returns probably won’t get you where you want to go.

The bottom line is that nobody can predict the future, and neither should you. So, what should you do?

  • DO: Maintain a long-term focus.
  • DO: Diversify across all asset classes (asset allocation).
  • DO: Save consistently to take advantage of dollar-cost averaging and compound growth.
  • DO: Use strategic rebalancing to maintain your proper allocation.

This is going to be the vacation of your life and you deserve it! You just need to take an honest look at where you are, where you want to be and how you are going to get there. That is what we at Edelman Financial Engines are here to help you do.

Sound Easy? Maybe Not
Planning a vacation is one thing, but proper financial planning involves a great deal more time and expertise. Although some people may feel comfortable doing things on their own, many people need help. For those people, it’s important to work with competent experienced financial planners who can coordinate with your own tax and legal advisors.

Bon voyage!

Neither Financial Engines Advisors L.L.C (also referred to as Edelman Financial Engines) nor its affiliates offer tax or legal advice. Interested parties are strongly encouraged to seek advice from qualified tax and/or legal experts regarding the best options for your particular circumstances. 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.

Paying Off Your Credit Card Debt

Simple steps to help eliminate your debts.

What’s the first thing you do when driving to a place you’ve never been? You look at a map. And where’s the first place you look? Where you are. Only after finding your current location do you then seek the place you’re trying to reach. By comparing the two, you can figure out how to get there.

First Steps for Paying Off Your Debts
And that’s the first thing you’ve got to do with your debts: You must become an expert on where you are. Do you know exactly how much money you owe and to whom you owe it? Can you tell me the cost of that debt — the interest rate and minimum payment?

Too often, people in debt have no idea how much they owe. If you don’t know the details, you can’t fix the problem. Telling your mechanic that the car doesn’t work is not much help. He’s got to know exactly where the problem is — before he starts repairs. Similarly, if you don’t have a firm grasp of exactly what you owe, to whom you owe it, and what the payment terms are, forget about trying to eliminate your debts. So let’s start there.

Take a sheet of paper and make four columns. In the first column, list the name of each creditor (who it is you owe). In the second column, list the amount you owe to that creditor. Third, state the interest rate each is charging you, and fourth, state the minimum payment you must make each month.

Now that you have your list, I’ll bet you wrote them down as you thought of them, in random order. So let’s do it again, but this time start with the creditor which charges you the highest interest rate. Place the 21% credit card above the 18% credit card, which appears above the 14% card and so on — even if you owe more to the 14% card than to the 21% card.

I emphasize the rate instead of the balance because we have to stop the bleeding before we can cure the patient. You’re not going to get rid of your debt overnight, and until you do, additional interest charges are accruing. Therefore, you must reduce the speed with which interest charges are accumulating, and that means we have to focus on the debt that’s charging you the highest interest.

Now that you have listed all your debts in the proper order, look at column four: the minimum monthly payment. Each month make certain you pay the minimum payment to each creditor. Never skip a payment and always send at least the minimum. If you don’t, the creditor will make a note in your credit file, and this will haunt you when you try to buy a house or a car. Make sure you stay current. I cannot overemphasize the importance of this.

After you pay the minimum to each creditor, devote all your remaining money exclusively to the creditor that charges you the highest rate. Do not spread this money evenly among all the debts. Instead, send whatever you have left entirely to the most expensive creditor. After you finish paying off that creditor, go down your list to the next — highest creditor, again devoting all resources (beyond the minimum payments) to that creditor until that debt is gone too, and keep repeating this process until they’re all gone.

Empty Your Bank Account
To accelerate this process, withdraw any money you have in the bank and send it off to the creditor at the top of your list.

If this advice shocks you, please understand that it makes absolutely no sense to have money in the bank earning tiny amounts while you have debts that cost 18% or 21%. While you’re at it, liquidate any other assets you have, such as savings bonds, stocks, mutual funds, and even baseball cards.

Liquidate your assets, with one exception: Do not liquidate your IRA or company retirement accounts. The tax penalties would be so high, and you would be jeopardizing your future retirement to such an extent, that it’s not worth it.

“But if I close my bank account, I won’t have any money,” you might be complaining. Well, you don’t have any money now! You just don’t realize it. And if you’re worried about needing cash in the event of an emergency, what do you think a credit card is for?

Credit cards are great. Credit card debt isn’t. Credit cards are wonderful cash management tools, and you should obtain one and keep it with you. If the car breaks down during a road trip, you can pay for repairs and overnight lodging. If Aunt Ida needs you to care for her, you can buy a plane ticket to see her right away.

The problem isn’t credit cards, it’s. not paying them off every month and owning assets that produce lower returns than the cost of the debt.

Get Out of Debt by Getting into Debt
Next, go borrow some more money. And get as much as you can — provided that (a) the amount of money you are now borrowing is not more than the total amount of debts you already have and (b) the interest rate you’ll have to pay on this new debt is less than the rate you’re currently paying.

See how this trick works? Say you owe $5,000 to an 18% Visa card. Maybe you can get a new Visa card from another bank that charges only 14%. Take $5,000 from the new card to pay off the balance on the old card — and in essence, you’ll cut your interest rate to 14% from 18%. Do this as often as you can to reduce your interest charges while you’re working to eliminate the debts themselves. Just be sure to consider any transfer fees that may apply.

Keep in mind that this is just a temporary solution. The real goal is to eliminate the debts, not merely reduce their cost. And be sure you understand the terms of your new card: Many card issuers offer introductory rates to get you to switch, but these “teaser rates” often last only a few months, after which time the rate rises dramatically — perhaps to a rate even higher than the rate you’re currently paying. In other cases, the low rate applies only to new purchases, not to existing balances that you transfer from another card. Execute this strategy carefully, or you’ll defeat the purpose.


Minimum Payment = Maximum Expense

Credit cards: A minimum payment might help you in the short-term, but could be one of your most expensive decisions.

Want to be your credit card company’s favorite customer? Just max out your card’s limit, agree to pay interest at a rate of 18% to 25%, and make only the minimum payment each month.

The minimum monthly payment is set by each card issuer, but it’s typically about 2% of the outstanding balance. Card companies want you to pay only the minimum, so that most of your payment is interest, not principal.

While you might be tempted to make only the minimum payment, that could be one of the most expensive decisions you ever make. Let’s see how three strategies affect the total cost, assuming the card has a balance of $5,000 and no further purchases are made.

Impact of Paying Only Minimum Payment

*The minimum is assumed to be 2% of the outstanding balance. The payment starts at $100 a month and gradually declines: The first $75 is interest; only $25 is applied against principal. Thus, in month 2, the new balance is $4,975 — so the new minimum is $99.50 (two percent of $4,975).

As you can see, making the minimum payment is expensive. That’s ironic, because people choose the minimum payment precisely because they think doing so saves them money (which it does — but only in terms of monthly cash outlay). That’s why you must always pay more than the monthly minimum. How much more? Ideally, you’ll pay off the entire balance!


Invest or Pay Off Student Debt?

What matters most to your financial plan.

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

Question: My husband is a physician. He graduated a couple of years ago with about $200,000 in student loan debt. We have a fixed 2.875% interest rate on $150,000 of that debt and a 4.5% fixed rate on the remaining $50,000. Both are 30-year loans. At this time he’s making a pretty good salary, and we’re good savers. We’re maxing out the retirement accounts that he’s eligible for, earning about 10% on them, and we have 529 plans in place for our kids. We’re left with about $70,000 a year that we want to start investing. Should we use that money to pay off those loans before we start investing? And what about the fact that my husband — as good as he is at his job — has an occupational risk of being sued? How should that factor into our planning?

Ric: From a cash-flow perspective, it seems you’re doing everything right. After taking care of your retirement and your kids’ college educations, you still have a large sum available to invest. You should be well on your way to meeting all of your goals despite (or perhaps because of) your debt. Both the interest rates you’re being charged are low, so I would suggest paying only the minimum on them; there is no reason to pay more per month. Instead, divert excess money toward your investments.

Consider: Is it reasonable to assume that a properly diversified portfolio could earn at least as much as the debt is costing you? History says it could — and investing your cash means it remains available to you (subject to market values) if you need it. By contrast, money you give to the lender is gone forever.

As for your concern that your husband could be sued — let’s face it, physicians do get sued more often than any other occupation — there are two answers. First, your husband needs to carry proper liability insurance protection; second, there are asset-protection strategies you can engage in to protect you. You and your husband should talk with an attorney.

And I’ll take it a step further: Not only is your husband at risk of being sued, but he’s also in an occupation where his income might be threatened by changing federal policy. Both of these issues reinforce my advice that you invest instead of paying off the loans early. After all, liquidity can make the difference between financial security and financial devastation.


Know Before You Go – Your options when you retire or change jobs

Know your choices when it comes to 401 (k) distributions.

A recent survey by Financial Engines1 found that 52 percent of workers between the age of 35 and 65 have left a job where they had money in the employer’s 401(k) plan. You may assume that you should take the money with you when you leave, but is that really your best option?

You might be retiring, or leaving to focus on family matters, or simply moving on to a new opportunity. Regardless, you will need to decide what to do with the money you have accumulated in your workplace retirement account. When the time comes, you have several choices.

Leave your money where it is
Doing nothing is always an option, and in this case, it may be the best one you have. Surprisingly, 42 percent of survey respondents didn’t know it was even possible. The greatest benefit of remaining in a former employer’s plan is having access to the institutional buying power and high-quality plan design that many leading employers have made available. The result: potentially lower fees and higher quality investment options.

In some cases, remaining in a former employer’s 401(k) plan may not be the best choice. For example, if you change jobs frequently you might wind up with multiple accounts that can make retirement planning more difficult. In this case, you might consider consolidating your accounts into your current employer’s plan. Regardless, it helps to speak with an independent financial advisor to get an unbiased opinion.

Do a rollover to an IRA
Many advisors will tell you that your best choice is to rollover or transfer your 401(k) money into an IRA. When a salesperson tells you this you need to ask one question; What’s in it for them? Most 401(k) plans do not charge a separate fee for transactions within the account. But an IRA set up with a brokerage firm may charge commissions for each transaction you make or an investment advisor where you pay and annual fee on the account value. It is also important to understand any other fees you may be charged to maintain the account. This is especially true if you are considering a rollover to a variable annuity, where high fees, lock-up periods and surrender charges can limit the availability of your funds and seriously eat into your savings.

You should also consider how you will manage your new IRA. If you are comfortable making investment decisions on your own, you might benefit from the expanded investment options available to you in a separate IRA account. But keep in mind that unlike a 401(k), IRA accounts are not covered by the Employee Retirement Income Security Act. This leaves brokers free to recommend investments that may not necessarily be in the best interest of the investor. And since many workers may not fully understand the nature of these transaction, they may end up with investments or accounts that are not in their best interest.

Withdraw the money
This is probably your worst choice. Unless you are facing severe financial stress, your 401(k) money should be used for one purpose only – your retirement. Withdrawals of pre-tax contributions, employer matching contributions and any earnings will be taxable as ordinary income. And if you are under age 59½, a 10 percent IRS penalty may apply as well.2 The Financial Engines survey found that more than 28 percent of retirement investors were not aware that they could incur such tax costs and penalties.

In some instances, you may avoid taxes and penalties if the money is deposited into a new qualified account within 60 days. This is referred to as a rollover. If you have the choice, you should opt instead for a direct transfer of funds instead of receiving a check. This avoids any possible errors, back-up withholding, or potential for incurring taxes and penalties

A Side-by-Side Comparison

If you are considering an IRA rollover or transfer, you should consider these factors:

  • The investment options available for diversification
  • Any costs and account-related fees and expenses
  • The level of service available
  • The availability for penalty-free withdrawals between ages 55 and 59 ½.
  • Whether the account offers legal protection from creditors under federal law.
  • The amount of the required minimum distribution (RMD) once you reach age 70 ½.
  • Any factors relating to employer stock.
  • Any state tax considerations.

Financial Engines research revealed that plan participants in employer plans that have adopted Financial Engines services, on average, have access to funds with fees that are below the industry average3. Comparing in-plan fees versus the industry averages, participants who keep their 401(k) savings in the workplace retirement plan, rather than rolling out to retail products, can potentially increase their retirement savings by 4.7 percent after 10 years on a $100,000 initial balance. This represents additional savings of more than $4,600 for the employee to potentially live on in retirement4.

Unbiased Advice Can Help Employees Make the Right Decisions
Every worker’s situation is different and with a range of distribution options available, how can you know which choice is best for you?  One approach is to get unbiased professional guidance from an independent financial advisor.  Nearly 80 percent of respondents to the Financial Engines survey believed it is important to get financial advice from an advisor who is a fiduciary. That is, an advisor who is required to put your interests above their own. However, 69 percent also said they had never consulted a financial professional about their retirement distribution strategies. That may be a missed opportunity, especially when nearly 80 percent of those who did consult a financial advisor said they felt more confident about their distribution strategy.

1. Reconsidering the 401(k) Rollover, Financial Engines, June 2019
3 ICI Research Perspective, Trends in the Expenses and Fees of Funds, March 2019
4 Savings on $100,000 with a 5% compound growth rate over 10 years; analyzed fees for 60/40 equity/bond portfolios and found a 0.31% differential in underlying fund fees when comparing in-plan fees at plan sponsors offering Financial Engines’ services vs industry averages; based upon Edelman
Financial Engines data as of 5/31/19 and ICI 2018 industry average.

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.