![Debt Optimization Strategies
As part of improving your financial situation,
you might consider reducing your debt load. A
number of strategies can be used to pay off
debt. However, before starting any debt payoff
strategy (or combination of strategies), be sure
you understand the terms of your debts,
including interest rates, terms of payment, and
any prepayment or other penalties.
Understand minimum payments (a
starting point)
You are generally required to make minimum
payments on your debts, based on factors set
by the lender. Failure to make the minimum
payments can result in penalties, increased
interest rates, and default. If you make only the
minimum payments, it may take a long time to
pay off the debt, and you may have to pay large
amounts of interest over the life of the loan.
This is especially true of credit card debt.
Your credit card statement will indicate the
amount of your current monthly minimum
payment. To find the factors used in calculating
the minimum payment amount each month, you
need to review terms in your credit card
contract. These terms can change over time.
For credit cards, the minimum payment is
usually equal to the greater of a minimum
percentage multiplied by the card's balance
(plus interest on the balance, in some cases) or
a base minimum amount (such as $15). For
example, assume you have a credit card with a
current balance of $2,000, an interest rate of
18%, a minimum percentage of 2% plus
interest, and a base minimum amount of $15.
The initial minimum payment required would be
$70 [greater of ($2,000 x 2%) + ($2,000 x (18%
/ 12)) or $15]. If you made only the minimum
payments (as recalculated each month), it
would take you 114 months (almost 10 years)
to pay off the debt, and you would pay total
interest of $1,314.
For other types of loans, the minimum payment
is generally the same as the regular monthly
payment.
Make additional payments
Making payments in addition to your regular or
minimum payments can reduce the time it takes
to pay off your debt and the total interest paid.
The additional payments could be made
periodically, such as monthly, quarterly, or
annually.
For example, if you made monthly payments of
$100 on the credit card debt in the previous
example (the initial minimum payment was
$70), it would take you only 24 months to pay
off the debt, and you would pay total interest of
just $396.
As another example, let's assume you have a
current mortgage balance of $100,000. The
interest rate is 5%, the monthly payment is
$791, and you have a remaining term of 15
years. If you make regular payments, you will
pay total interest of $42,343. However, if you
pay an additional $200 each month, it will take
you only 11 years to pay off the debt, and you
will pay total interest of just $30,022.
Another strategy is to pay one-half of your
regular monthly mortgage payment every two
weeks. By the end of the year, you will have
made 26 payments of one-half the monthly
amount, or essentially 13 monthly payments. In
other words, you will have made an extra
monthly payment for the year. As a result, you
will reduce the time payments must be made
and the total interest paid.
Pay off highest interest rate debts first
One way to potentially optimize payment of
your debt is to first make the minimum
payments required for each debt, and then
allocate any remaining dollars to the debts with
the highest interest rates.
For example, let's assume you have two debts,
you owe $10,000 on each, and each has a
monthly payment of $200. The interest rate for
one debt is 8%; the interest rate for the other is
18%. If you make regular payments, it will take
94 months until both debts are paid off, and you
will pay total interest of $10,827. However, if
you make monthly payments of $600, with the
extra $200 paying off the debt with an 18%
interest rate first, it will take only 41 months to
pay off the debts, and you will pay total interest
of just $4,457.
Use a debt consolidation loan
If you have multiple debts with high interest
rates, it may be possible to pay off those debts
with a debt consolidation loan. Typically, this
will be a home equity loan with a much lower
interest rate than the rates on the debts being
consolidated. Furthermore, if you itemize
deductions, interest paid on home equity debt
of up to $100,000 is generally deductible for
income tax purposes, thus reducing the
effective interest rate on the debt consolidation
loan even further. However, a home equity loan
potentially puts your home at risk because it
serves as collateral, and the lender could
foreclose if you fail to repay. There also may be
closing costs and other charges associated with
the loan.
You may be able to improve
your financial situation by
implementing certain debt
payoff strategies that can
reduce the time you make
payments and the total
interest you pay. Before
starting any debt payoff
strategy (or combination of
strategies), be sure you
understand the terms of
your debts, including any
prepayment penalties.
Note: All examples are
hypothetical and used for
illustrative purposes only.
Fixed interest rates and
payment terms are shown,
but actual interest rates and
payment terms may change
over time.
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June Newsletter
- 1. Atlantic Sun Financial Group Leslie Baker, CPA 7494 SW 60th Ave Ste B Ocala, FL 34476 352-369-9933 leslie.baker@jwcemail.com www.atlanticsunfg.finlsite.com June 2016 Projecting a Happy Retirement Debt Optimization Strategies Common Financial Wisdom: Theory vs. Practice Can I make charitable contributions from my IRA in 2016? Atlantic Sun Financial Group Projecting a Happy Retirement See disclaimer on final page A 2015 study found that 41% of households headed by someone aged 55 to 64 had no retirement savings, and only about a third of them had a traditional pension. Among households in this age group with savings, the median amount was just $104,000.1 Your own savings may be more substantial, but in general Americans struggle to meet their savings goals. Even a healthy savings account may not provide as much income as you would like over a long retirement. Despite the challenges, about 56% of current retirees say they are very satisfied with retirement, and 34% say they are moderately satisfied. Only 9% are dissatisfied.2 Develop a realistic picture How can you transition into a happy retirement even if your savings fall short of your goals? The answer may lie in developing a realistic picture of what your retirement will look like, based on your expected resources and expenses. As a starting point, create a simple retirement planning worksheet. You might add details once you get the basics down on paper. Estimate income and expenses You can estimate your monthly Social Security benefit at ssa.gov. The longer you wait to claim your benefits, from age 62 up to age 70, the higher your monthly benefit will be. If you expect a pension, estimate that monthly amount as well. Add other sources of income, such as a part-time job, if that is in your plans. Be realistic. Part-time work often pays low wages. It's more difficult to estimate the amount of income you can expect from your savings; this may depend on unpredictable market returns and the length of time you need your savings to last. One simple rule of thumb is to withdraw 4% of your savings each year. At that rate, the $104,000 median savings described earlier would generate $4,160 per year or $347 per month (assuming no market gains or losses). Keep in mind that some experts believe a 4% withdrawal rate may be too high to maintain funds over a long retirement. You might use 3% or 3.5% in your calculations. Now estimate your monthly expenses. If you've paid off your mortgage and other debt, you may be in a stronger position. Don't forget to factor in a reserve for medical expenses. One study suggests that a 65-year-old couple who retired in 2015 would need $259,000 over their lifetimes to cover Medicare premiums and out-of-pocket health-care expenses, assuming they had only median drug expenses.3 Take strategic steps Your projected income and expenses should provide a rough picture of your financial situation in retirement. If retirement is approaching soon, try living for six months or more on your anticipated income to determine whether it is realistic. If it's not, or your anticipated expenses exceed your income even without a trial run, you may have to reduce expenses or work longer, or both. Even if the numbers look good, it would be wise to keep building your savings. You might take advantage of catch-up contributions to IRAs and 401(k) plans, which are available to those who reach age 50 or older by the end of the calendar year. In 2016, the IRA catch-up amount is $1,000, for a total contribution limit of $6,500. The 401(k) catch-up amount is $6,000, for a total employee contribution limit of $24,000. Preparing for retirement is not easy, but if you enter your new life phase with eyes wide open, you're more likely to enjoy a long and happy retirement. 1 U.S. Government Accountability Office, "Retirement Security," May 2015 2 The Wall Street Journal, "Why Retirees Are Happier Than You May Think," December 1, 2015 3 Employee Benefit Research Institute, Notes, October 2015 Page 1 of 4
- 2. Debt Optimization Strategies As part of improving your financial situation, you might consider reducing your debt load. A number of strategies can be used to pay off debt. However, before starting any debt payoff strategy (or combination of strategies), be sure you understand the terms of your debts, including interest rates, terms of payment, and any prepayment or other penalties. Understand minimum payments (a starting point) You are generally required to make minimum payments on your debts, based on factors set by the lender. Failure to make the minimum payments can result in penalties, increased interest rates, and default. If you make only the minimum payments, it may take a long time to pay off the debt, and you may have to pay large amounts of interest over the life of the loan. This is especially true of credit card debt. Your credit card statement will indicate the amount of your current monthly minimum payment. To find the factors used in calculating the minimum payment amount each month, you need to review terms in your credit card contract. These terms can change over time. For credit cards, the minimum payment is usually equal to the greater of a minimum percentage multiplied by the card's balance (plus interest on the balance, in some cases) or a base minimum amount (such as $15). For example, assume you have a credit card with a current balance of $2,000, an interest rate of 18%, a minimum percentage of 2% plus interest, and a base minimum amount of $15. The initial minimum payment required would be $70 [greater of ($2,000 x 2%) + ($2,000 x (18% / 12)) or $15]. If you made only the minimum payments (as recalculated each month), it would take you 114 months (almost 10 years) to pay off the debt, and you would pay total interest of $1,314. For other types of loans, the minimum payment is generally the same as the regular monthly payment. Make additional payments Making payments in addition to your regular or minimum payments can reduce the time it takes to pay off your debt and the total interest paid. The additional payments could be made periodically, such as monthly, quarterly, or annually. For example, if you made monthly payments of $100 on the credit card debt in the previous example (the initial minimum payment was $70), it would take you only 24 months to pay off the debt, and you would pay total interest of just $396. As another example, let's assume you have a current mortgage balance of $100,000. The interest rate is 5%, the monthly payment is $791, and you have a remaining term of 15 years. If you make regular payments, you will pay total interest of $42,343. However, if you pay an additional $200 each month, it will take you only 11 years to pay off the debt, and you will pay total interest of just $30,022. Another strategy is to pay one-half of your regular monthly mortgage payment every two weeks. By the end of the year, you will have made 26 payments of one-half the monthly amount, or essentially 13 monthly payments. In other words, you will have made an extra monthly payment for the year. As a result, you will reduce the time payments must be made and the total interest paid. Pay off highest interest rate debts first One way to potentially optimize payment of your debt is to first make the minimum payments required for each debt, and then allocate any remaining dollars to the debts with the highest interest rates. For example, let's assume you have two debts, you owe $10,000 on each, and each has a monthly payment of $200. The interest rate for one debt is 8%; the interest rate for the other is 18%. If you make regular payments, it will take 94 months until both debts are paid off, and you will pay total interest of $10,827. However, if you make monthly payments of $600, with the extra $200 paying off the debt with an 18% interest rate first, it will take only 41 months to pay off the debts, and you will pay total interest of just $4,457. Use a debt consolidation loan If you have multiple debts with high interest rates, it may be possible to pay off those debts with a debt consolidation loan. Typically, this will be a home equity loan with a much lower interest rate than the rates on the debts being consolidated. Furthermore, if you itemize deductions, interest paid on home equity debt of up to $100,000 is generally deductible for income tax purposes, thus reducing the effective interest rate on the debt consolidation loan even further. However, a home equity loan potentially puts your home at risk because it serves as collateral, and the lender could foreclose if you fail to repay. There also may be closing costs and other charges associated with the loan. You may be able to improve your financial situation by implementing certain debt payoff strategies that can reduce the time you make payments and the total interest you pay. Before starting any debt payoff strategy (or combination of strategies), be sure you understand the terms of your debts, including any prepayment penalties. Note: All examples are hypothetical and used for illustrative purposes only. Fixed interest rates and payment terms are shown, but actual interest rates and payment terms may change over time. Page 2 of 4, see disclaimer on final page
- 3. Common Financial Wisdom: Theory vs. Practice In the financial world, there are a lot of rules about what you should be doing. In theory, they sound reasonable. But in practice, it may not be easy, or even possible, to follow them. Let's look at some common financial maxims and why it can be hard to implement them. Build an emergency fund worth three to six months of living expenses Wisdom: Set aside at least three to six months worth of living expenses in an emergency savings account so your overall financial health doesn't take a hit when an unexpected need arises. Problem: While you're trying to save, other needs--both emergencies and non-emergencies--come up that may prevent you from adding to your emergency fund and even cause you to dip into it, resulting in an even greater shortfall. Getting back on track might require many months or years of dedicated contributions, leading you to decrease or possibly stop your contributions to other important goals such as college, retirement, or a down payment on a house. One solution: Don't put your overall financial life completely on hold trying to hit the high end of the three to six months target. By all means create an emergency fund, but if after a year or two of diligent saving you've amassed only two or three months of reserves, consider that a good base and contribute to your long-term financial health instead, adding small amounts to your emergency fund when possible. Of course, it depends on your own situation. For example, if you're a business owner in a volatile industry, you may need as much as a year's worth of savings to carry you through uncertain times. Start saving for retirement in your 20s Wisdom: Start saving for retirement when you're young because time is one of the best advantages when it comes to amassing a nest egg. This is the result of compounding, which is when your retirement contributions earn investment returns, and then those returns produce earnings themselves. Over time, the process can snowball. Problem: How many 20-somethings have the financial wherewithal to save earnestly for retirement? Student debt is at record levels, and young adults typically need to budget for rent, food, transportation, monthly utilities, and cell phone bills, all while trying to contribute to an emergency fund and a down payment fund. One solution: Track your monthly income and expenses on a regular basis to see where your money is going. Establish a budget and try to live within your means, or better yet below your means. Then focus on putting money aside in your workplace retirement plan. Start by contributing a small percentage of your pay, say 3%, to get into the retirement savings habit. Once you've adjusted to a lower take-home amount in your paycheck (you may not even notice the difference!), consider upping your contribution little by little, such as once a year or whenever you get a raise. Start saving for college as soon as your child is born Wisdom: Benjamin Franklin famously said there is nothing certain in life except death and taxes. To this, parents might add college costs that increase every year without fail, no matter what the overall economy is doing. As a result, new parents are often advised to start saving for college right away. Problem: New parents often face many other financial burdens that come with having a baby; for example, increased medical expenses, baby-related costs, day-care costs, and a reduction in household income as a result of one parent possibly cutting back on work or leaving the workforce altogether. One solution: Open a savings account and set up automatic monthly contributions in a small, manageable amount--for example, $25 or $50 per month--and add to it when you can. When grandparents and extended family ask what they can give your child for birthdays and holidays, you'll have a suggestion. Subtract your age from 100 to determine your stock percentage Wisdom: Subtract your age from 100 to determine the percentage of your portfolio that should be in stocks. For example, a 45-year-old would have 55% of his or her portfolio in stocks, with the remainder in bonds and cash. Problem: A one-size-fits-all rule may not be appropriate for everyone. On the one hand, today's longer life expectancies make a case for holding even more stocks in your portfolio for their growth potential, and subtracting your age from, say, 120. On the other hand, considering the risks associated with stocks, some investors may not feel comfortable subtracting their age even from 80 to determine the percentage of stocks. One solution: Focus on your own tolerance for risk while also being mindful of inflation. Consider looking at the historical performance of different asset classes. Can you sleep at night with the investments you've chosen? Your own peace of mind trumps any financial rule. It might not always be possible to follow some common financial wisdom. Note: All investing involves risk, including the possible loss of principal, and there can be no assurance that any investment strategy will be successful. Page 3 of 4, see disclaimer on final page
- 4. Atlantic Sun Financial Group Leslie Baker, CPA 7494 SW 60th Ave Ste B Ocala, FL 34476 352-369-9933 leslie.baker@jwcemail.com www.atlanticsunfg.finlsite.com Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2016 IMPORTANT DISCLOSURES Broadridge Investor Communication Solutions, Inc. does not provide investment, tax, or legal advice. The information presented here is not specific to any individual's personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliablewe cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice. Can I name a charity as beneficiary of my IRA? Yes, you can name a charity as beneficiary of your IRA, but be sure to understand the advantages and disadvantages. Generally, a spouse, child, or other individual you designate as beneficiary of a traditional IRA must pay federal income tax on any distribution received from the IRA after your death. By contrast, if you name a charity as beneficiary, the charity will not have to pay any income tax on distributions from the IRA after your death (provided that the charity qualifies as a tax-exempt charitable organization under federal law), a significant tax advantage. After your death, distributions of your assets to a charity generally qualify for an estate tax charitable deduction. In other words, if a charity is your sole IRA beneficiary, the full value of your IRA will be deducted from your taxable estate for purposes of determining the federal estate tax (if any) that may be due. This can also be a significant advantage if you expect the value of your taxable estate to be at or above the federal estate tax exclusion amount ($5,450,000 for 2016). Of course, there are also nontax implications. If you name a charity as sole beneficiary of your IRA, your family members and other loved ones will obviously not receive any benefit from those IRA assets when you die . If you would like to leave some of your assets to your loved ones and some assets to charity, consider leaving your taxable retirement funds to charity and other assets to your loved ones. This may offer the most tax-efficient solution, because the charity will not have to pay any tax on the retirement funds. If retirement funds are a major portion of your assets, another option to consider is a charitable remainder trust (CRT). A CRT can be structured to receive the funds free of income tax at your death, and then pay a (taxable) lifetime income to individuals of your choice. When those individuals die, the remaining trust assets pass to the charity. Finally, another option is to name the charity and one or more individuals as co-beneficiaries. (Note: There are fees and expenses associated with the creation of trusts.) The legal and tax issues discussed here can be quite complex. Be sure to consult an estate planning attorney for further guidance. Can I make charitable contributions from my IRA in 2016? Yes, if you qualify. The law authorizing qualified charitable distributions, or QCDs, has recently been made permanent by the Protecting Americans from Tax Hikes (PATH) Act of 2015. You simply instruct your IRA trustee to make a distribution directly from your IRA (other than a SEP or SIMPLE) to a qualified charity. You must be 70遜 or older, and the distribution must be one that would otherwise be taxable to you. You can exclude up to $100,000 of QCDs from your gross income in 2016. And if you file a joint return, your spouse (if 70遜 or older) can exclude an additional $100,000 of QCDs. But you can't also deduct these QCDs as a charitable contribution on your federal income tax return--that would be double dipping. QCDs count toward satisfying any required minimum distributions (RMDs) that you would otherwise have to take from your IRA in 2016, just as if you had received an actual distribution from the plan. However, distributions (including RMDs) that you actually receive from your IRA and subsequently transfer to a charity cannot qualify as QCDs. For example, assume that your RMD for 2016 is $25,000. In June 2016, you make a $15,000 QCD to Qualified Charity A. You exclude the $15,000 QCD from your 2016 gross income. Your $15,000 QCD satisfies $15,000 of your $25,000 RMD. You'll need to withdraw another $10,000 (or make an additional QCD) by December 31, 2016, to avoid a penalty. You could instead take a distribution from your IRA and then donate the proceeds to a charity yourself, but this would be a bit more cumbersome and possibly more expensive. You'd include the distribution in gross income and then take a corresponding income tax deduction for the charitable contribution. But the additional tax from the distribution may be more than the charitable deduction due to IRS limits. QCDs avoid all this by providing an exclusion from income for the amount paid directly from your IRA to the charity--you don't report the IRA distribution in your gross income, and you don't take a deduction for the QCD. The exclusion from gross income for QCDs also provides a tax-effective way for taxpayers who don't itemize deductions to make charitable contributions. Page 4 of 4