How To Protect Assets From The Nursing Home
When a family member has a health event that requires them to enter a nursing home or need full-time home health care, it can be an extremely stressful financial event for their spouse, children, grandchildren, or caretaker
When a family member has a health event that requires them to enter a nursing home or need full-time home health care, it can be an extremely stressful financial event for their spouse, children, grandchildren, or caretaker. The monthly cost of a nursing home is typically between $10,000 - $15,000 per month and without advanced planning it often requires a family to spend through almost all of their assets before they qualify for Medicaid.
As we all live longer, we become more frail in our 80’s and 90’s, which increases the probability of a long term care event occurring. Many individuals that we meet with have already experienced a long term care event with their parent or grandparents and they have seen first hand the painful process of watching them spend through all of their assets. For couples that are married, it can leave the spouse that is not in need of care in a very difficult financial situation as pensions, social security, and martial assets have to be pledged toward the cost of the care for their spouse. For individuals and widows, the burden is placed on their family or friends to scramble to liquidate assets, access personal financial records, and watch the inheritance for their heirs be depleted in a very short period of time.
I often ask my clients this simple question, “Would you rather your house and assets go to your kids or go to the nursing home?” As you would guess, most people say “my kids”. With enough advanced planning you have that choice and today I’m going to walk you through some of the strategies that we use with our clients to protect assets from long term care events.
Strategies Vary State By State
Since the Medicaid rules vary from state to state, the strategies that I'm presenting in this article can be used by New York State residents. However, if you are resident of another state, this article will still help you to understand asset protection strategies that are commonly used but you should consult with an elder law expert in your state to determine the appropriate application of these strategies.
Long Term Care Insurance
While having a long term care insurance policy in place is ideal because if a long term event occurs it pays out and covers the cost, there are a number of challenges associated with long-term care insurance including:
Insurance companies will rarely issue policies after you reach age 70
If you have any issues within your health history, they may not issue you a policy
The cost of the policies can be expensive
It’s not uncommon for a good long-term care insurance policy to cost an individual between $4,000 and $6,000 per year. The reason why the insurance is more expensive than other types of insurance is there is a high likelihood that if you live past age 65, at some point you will experience a long term care event. Insurance companies don’t like that. Insurance companies like issuing policies for events that have a low probability of occurring, similar to life insurance. In addition, when these long term care policies pay out, they pay out big dollar amounts because the costs are so high. For these reasons, long-term care insurance policies have become more of a luxury item instead of a common solution that is used by individuals and family to protect their assets from a long term care event.
So if you don’t have a long-term care insurance policy, what can you do to protect your assets from a long-term event?
Establish A Medicaid Trust
If an individual does not have a long term care insurance policy to help protect against the cost of a long term care event, the next strategy to consider is setting up a Medicaid Trust to own their non-retirement assets. Non-retirement assets can include a house, investment account, stocks, non-qualified annuities, permanent life insurance policies, and other assets not held within a Traditional IRA or other type of pre-tax retirement account. This is how the strategy works:
Establish a Medicaid Trust
Transfer assets from the individual’s name into the name of the trust
Assets are held in the trust for at least 5 years
The individual experiences a long term care event requiring them to enter a nursing home
Since the trust has owned the assets for more than 5 years, they are no longer countable assets, the individual can automatically qualify for Medicaid as long as their assets outside of the trust are below the asset allowance threshold; Medicaid pays the nursing home for their care, and the trust assets are preserved for the spouse and their heirs.
Medicaid 5 Year Look Back Period
In New York, Medicaid has a 5 year look back period. The 5 year look back period was put into place to prevent individuals from gifting away all of their assets right before or after they experience a long term care event in an effort to qualify for Medicaid. In 2020, New York requires residents to spend down all of their countable assets until they are below the $15,750 asset allowance threshold. Once below that level, the individual qualifies for Medicaid, and Medicaid will pay the nursing home costs. When an individual submits a Medicaid application, they request 5 years worth of financial records. If that individual gave any asset away within the last five years, whether it’s to a person or a trust, those asset will be brought back in as “countable assets” required to be spent down before the individual will qualify for Medicaid.
Example: Jim is 88 years old and has $100,000 in his savings account. His health is beginning to deteriorate and he gifts $90,000 to his kids in an effort to reduce his assets to qualify for Medicaid. Two years later Jim has a stroke requiring him to enter a nursing home, and only has $10,000 in his savings account. When he applies for Medicaid, they will request 5 years worth of his bank records and discover that he gifted $90,000 away to his kids two years ago. That $90,000 is a countable asset subject to spend down even though he no longer has it. But it gets worse, his kids spent the $90,000, so they are unable to return the $90,000 to Jim. Jim is not eligible for Medicaid and there is no cash available to pay for his care.
Medicaid Trust Strategy
For the Medicaid Trust strategy to work, the assets have to be put into the trust 5 years prior to submission of the Medicaid application. Once the assets are owned by the trust for more than 5 years, regardless of the dollar value in the trust, it’s no longer a countable asset, and the individual can automatically qualify for Medicaid.
Example: At age 84, Jim sets up an Medicaid trust, and moves $90,000 of his $100,000 in cash into the trust. At age 90, Jim has a stroke requiring him to enter a nursing home, but now since the assets were in the trust for more than 5 years, he is no longer required to spend down the $90,000, and he qualifies for Medicaid. That $90,000 is now reserved for his kids who are the beneficiaries of the trust.
Establishing a trust instead of gifting assets away to family members can help to preserve those assets against the situation where the individual does not make it past the 5 year look back period and the money gifted has already been spent by the beneficiaries.
How Do Medicaid Trusts Work?
Medicaid trusts are considered “irrevocable trusts” which means when you move assets into the trust you technically do not own them anymore. By setting up a trust, you are essentially establishing an entity, with it’s own Tax ID, to own your assets. The thought of giving away assets often scares individuals away for setting up these trusts but it shouldn’t. Estate attorneys often include language in the trust documents to offer some flexibility. Before I go into some examples, I first want to define some trust terms:
Grantor: The grantor is the person that currently owns the assets and is now gifting it (or transferring it) into their trust. If for example, you are doing this planning for your parents, they would be the “grantors” of the trust.
Trustee: The trustee is the individual or individual(s) that are responsible for managing the assets owned by the trust. This is typically not the grantor. The reason being is if you gift your assets to a trust but you still have full control of it, the question arises, have you really given it away? In most cases, the grantor will designate one or more of their children as trustees. The trustees are responsible for carrying out the terms of the trust
Beneficiaries: The beneficiaries of the trust are the individuals that are entitled to receive the assets typically after the grantor or grantors have passed away. It’s common for the beneficiaries of the trust to be the same as the beneficiaries listed in a person’s will.
Access to Income
When you gift assets to a Medicaid trust, you technically no longer have access to the principle, but grantors still have access to any “income” generated by the trust assets. This is most easily explained as an example.
Mark & Sarah have traditional IRA’s, their primary residence, and an investment account with a value of $200,000. They do not anticipate needing to access the $200,000 to supplement their income and want to protect that asset from a long term care event so they know that their kids will inherit it. They establish a Medicaid trust with their two children designated a co-trustees and they move the ownership of the house and the $200,000 investment account into the name of the trust. If the holdings in the $200,000 investment account are producing dividend and interest income, Mark & Sarah are allowed to receive that income each year because they always have access to the income generated by the trust, they just can’t access the principal portion of the trust assets.
Revoke Part Of The Trust
Estate attorneys may also build in a feature which allows the trustees to “revoke“ all or a portion of the trust assets. Let’s build on the Mark & Sarah example above:
Mark and Sarah gift their house and the $200,000 investment account to their Medicaid trust but two years later Sarah incurs an unforeseen medical event and they need access to $50,000. Since the trustee was given the power to revoke all or a portion of the trust asset, the trustee works with the estate attorney to revoke $50,000 of the trust assets in the investment account and send it to the grantors (Mark & Sarah). The $150,000 remaining in the investment account continues to work toward that 5 year look back period, and Mark & Sarah have the money they need for the medical expenses.
Gifts To The Beneficiaries
An alternative solution to the same scenario listed above is that the trustees can be given the power to gift assets to the beneficiaries while the grantors are still alive. Essentially the trustees, who are often also the beneficiaries of the trust, gift themselves assets from the trust, and then turn around and gift those assets back to the grantors. In the Mark & Sarah example above, instead of revoking part of the trust assets, their children, who are the trustees, gift $50,000 to themselves, and then turn around and gift $50,000 to their parents (Mark & Sarah) to pay their medical bills. But with gifting powers, you really have to trust the individuals that are serving as trustees of your Medicaid trust because they cannot be required to gift the money back to the grantor.
Putting Your House In The Trust
It's common for individuals to think: “Well all I have is my house, I don’t have any investment accounts, so there is no point in setting up a trust because my house is always protected.” That's incorrect. If you own your house and you experience a long term care event:
Your primary residence is not a countable assets for Medicaid eligibility and you can qualify for Medicaid while still owning your house
Medicaid cannot force you to sell your house while you or your spouse are still alive and then spend down those assets for your care
However, and this is super important, even though your primary residence is not a countable asset and they can't force you to sell it while you or your spouse are still alive, Medicaid can put a LIEN against your house for the amount that they pay the nursing home for your care. So when you or your spouse pass away, the value of your house is included in your estate, Medicaid will force the estate to sell the house and they will recapture the amount that they paid for your care.
Example: Linda’s husband Tim passed away three years ago and she is the surviving spouse. Her only asset is the primary residence that she lives in worth $250,000 with no mortgage. Linda has a stroke and is required to enter a nursing home. Because she has no other assets besides her primary residence, she qualifies for Medicaid, and Medicaid pays for the cost of her care at the nursing home. Linda passes away 2 year later. During that two year period in the nursing home, Medicaid paid $260,000 for her care. Linda's children, who were expecting to inherit the house when she passed away, now find out that Medicaid has a lien against the house for $260,000; meaning when they sell the house, the full $250,000 goes directly to Medicaid, and the kids receive nothing.
If Linda had put the house into a Medicaid trust 5 years prior to her stroke, she would have immediately qualified for Medicaid, but Medicaid would not be entitled to put a lien against her primary residence. When she passes away, since the house is owned by the trust, there is no probate, and her children receive the full value of the house.
Again, the way I phrase this to my clients is, would you rather your kids inherit your house or would you rather it go to the nursing home? With some advance planning you have a choice.
The Cost of Setting Up A Trust
The other factor that has scared some people away from setting up a Medicaid trust is the setup cost. It’s not uncommon for an estate attorney to charge between $3,000 - $8,000 to setup a Medicaid trust. But in the example that we just looked at above with Linda, you are spending $5,000 today to setup a trust, that is going to potentially protect an asset worth $250,000.
The next objection, “well what if I spend the money setting up the trust and I don’t make it past the 5 year look back period?” If that’s the case, the $5,000 that you spent on setting up the trust is just $5,000 less that nursing home is going to receive for your care. To qualify for Medicaid, you have to spend down your assets below the $15,750 threshold so if you have countable assets above that amount, you would have lost the money to nursing home anyway.
Countable Assets
I have mentioned the term “countable assets” a few times throughout this article; countable assets are the assets that are subject to that Medicaid spend down. Instead of going through the long list of assets that are countable it's easier to explain which assets are NOT countable. The value of your primary residence is not a countable asset even though it's subject to the lien. Pre-tax retirement accounts such as Traditional IRA’s and 401(k) plans are not countable assets. Pre-paid funeral expenses up to a specific dollar threshold are also not a countable asset. Outside of those three assets, almost everything else is a countable asset.
Retirement Accounts
As I just mentioned above, pre-tax retirement accounts are not subject to the Medicaid spend down, however, Medicaid does require you to take required minimum distributions (RMD’s) from those pre-tax retirement accounts each year and contribute those directly to the cost of your care. Notice that I keep saying “pre-tax”, that’s because Roth IRA’s are countable assets subject to spend down. If you have $100,000 in a Roth IRA, Medicaid will require you to spend down that account until you reach the $15,750 in total countable assets qualifying you for Medicaid.
Pensions & Social Security
You can use Medicaid trusts to protect assets but they cannot be used to protect “income”. Monthly pension payments and Social Security income are subject to the Medicaid income threshold. For individuals that are single or widowed, your income has to below $875 per month in 2020 to qualify for Community Medicaid and below $50 per month for Chronic Care Medicaid. If an individual is receiving social security, pensions, or other income sources above that threshold, all of that income automatically goes toward their care.
If you are married and your spouse is the one that has entered the nursing home, you are considered the “community spouse”. As the community spouse you are allowed to keep $3,216 per month in income.
Example: Rob and Tracey are married, Rob just entered the nursing home, but Tracey is still living in their primary residence. Their monthly income is as follows:
Rob Social Security: $2,000
Tracy Social Security: $2,000
Rob Pension: $3,000
Total Monthly Income: $7,000
Of the $7,000 in total monthly income that Tracey is used to receiving, once Rob qualifies for Medicaid, she will only be receiving $3,216 per month. The rest of the monthly income would go toward Rob’s care at the nursing home.
Community Spouse Asset Allowance
If you are married and your spouse has a long term care event requiring them to go into a nursing home and you plan to apply for Medicaid, you as the community spouse are allowed to keep countable assets up to the greater of:
$74,820; or
One-half of the couple’s total combined assets up to $128,640 (in 2020)
Take Action
Unless you have a long term care insurance policy or enough assets set aside to offset the financial risk of a long term care event occurring in the future, setting up a Medicaid trust may make sense. But I also want to provide you with a quick list of considerations when establishing a Medicaid trust:
You should only transfer assets to the trust that you know you are not going to need to supplement your income in retirement.
Step up in basis: By establishing a Medicaid trust as opposed to gifting assets directly to individuals, the estate attorney can include language that will allow the assets of the trust to receive a step up in basis when the grantor passes away which can mitigate a huge tax hit for the beneficiaries.
For these strategies to work it takes advanced planning so start the process now. Each asset that is transferred into the trust has its own 5 year look back period. The sooner you get the assets transferred into the trust, the sooner that clock starts.
If you are doing this planning for a parent, grandparent, or other family member, it's important to consult with professionals that are familiar with the elder law and Medicaid rules for the state that the individual resides in. These rules, limits, and trust strategies vary from state to state.
Contact Us For Help If you are a New York resident doing this type of planning for yourself or for a family member that is a resident of New York, please feel free to reach out to us with questions. We can help you to better understand how to protect assets from a long term care events and connect you with an estate attorney that can assist you with the establishment of Medicaid trust if the trust route is the most appropriate strategy for asset protection. Disclosure: This article is for educational purposes only. It does not contain legal, Medicaid, or tax advice. You should consult with a professional for advice tailored to your personal financial situation.
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
How Much Life Insurance Should You Have? Top 8 Factors
When we are assisting clients in building their personal financial plan, inevitably one of the most frequent questions that comes up is: “How much life insurance should I have?”
how much life insurance do you need
When we are assisting clients in building their personal financial plan, inevitably one of the most frequent questions that comes up is: “How much life insurance should I have?” It's an important question to ask because if something unexpected were to ever happen to you or your spouse, it could put your family in a very difficult financial situation. To help mitigate this risk, people buy life insurance to guard against this type of unfortunate event but it’s important to know how much life insurance protection you should have. If you have too little, the coverage might not be enough to meet your family’s financial needs. If you have too much, you might be wasting money on insurance that you don’t need.
In this article we're going to go over the top 8 variables that factor into how much life insurance you should have, as well as, what type of insurance might make sense for you.
#1: Amount of Debt
First, you should tally up the total value of all of your outstanding debt.
Mortgage
Student Loans
HELOC
Credit Cards
Car Loans
Any other debt…………..
If you have dependents and something were to happen to you, the goal is to minimize the future annual expenses for your family. If you are married and you are used to having two incomes in the household to pay the mortgage, student loans, and car loans, if one spouse passes away, the family loses that income stream and it could be very difficult to meet the monthly payment on the debt with only one income. The life insurance would payout at the death of the insured spouse and those proceeds can be used to wipe out all of the debt which in turn reduces the monthly expense burden on the family.
#2: Income Level of Each Spouse
If you are married, the income level of each spouse will factor into how much life insurance each spouse should have. If spouse 1 makes $200K per year and spouse 2 makes $40K per year, typically you will need more insurance on spouse 1 than spouse 2. If Spouse 1 passes away, over the next 5 years, that’s $1 million in income that would need to potentially be replaced ($200K x 5 Years). However, if spouse 2 passes away, there would only need to be $200K to cover the next 5 years of income ($40K x 5 years).
A common mistake that married couples make is they blindly go in and purchase two insurance policies with the same death benefit without taking the different income levels into account. For possibly the same combined premium amount, in many but not all cases, couples can be better served by shifting more of the insurance coverage to the spouse with the higher income.
#3: Future College Expenses
If you have children and you expect those children to attend college, if you do not expect to receive large amounts of need based financial aid, it's important to factor in future college expenses into the amount of the insurance coverage. If you have 3 children and you planned on paying for their first 4 years of college, assuming college tuition with room and board is $25,000 per year, that’s $100,000 per child, multiplied by 3, for a grand total of $300,000 in anticipated college costs.
#4: Household Expenses
Everyone has a different lifestyle. One couple that has a combined income of $300,000 may need $250,000 to support household expenses if one of the spouses were to pass away. But another couple making the same $300,000 per year may only need $150,000 per year in income to support the household if one of the spouses passes away. You have to determine how your annual expenses would be impacted based on the untimely death of each spouse.
#5: Outside Savings
The amount of wealth that you have already accumulated absolutely factors into the amount of insurance that you may need. For example, if you sold your business and have $2 million in cash and non-retirement investment accounts, you may essentially be self-insured, meaning if something happened to you, you have accumulated enough savings to meet all of your family’s future financial needs without the need for additional insurance coverage.
However, if you and your spouse are both below the age of 50, have 2 children, and all of your wealth is tied up in 401(k)’s or retirement accounts, if you or your spouse were to pass away, the surviving spouse would have to withdrawal that money from the retirement accounts to meet expenses and pay tax on those distributions. So that $200,000 in their 401(K) may only be $150,000 after the taxes are paid but it depending on your tax bracket. By comparison, personal life insurance policies that you pay for out of pocket, the insurance proceeds are received tax free when paid to your beneficiaries.
So it’s not just a question of how much you have accumulated but also how accessible are those assets to your beneficiaries if they need to use those assets to supplement their income.
#6: Retirement Savings
You also have to consider the impact of an untimely death of a spouse on your retirement projections. If you or your spouse are covered by an employer sponsored retirement plan, like a 401(k) or 403(b), your retirement projections probably have you both making those regular annual contributions up until your retirement date. If one spouse passes away, those retirement contributions that were supposed to be there, no longer will be, which could force the surviving spouse to work longer than they wanted too.
You have to pay close attention to individuals that have pensions. Some pensions require the employee to turn on their pension benefit to reserve the survivor benefit for their spouse. If the employee passes away prior to their pension start date, the generous pension benefit which the family was depending on could be replaced by a much lower lump sum death benefit. In addition, retirees that elect a pension benefit with no survivor benefits to their spouse will sometimes use life insurance to cover the risk that they pass away and the pension stops within the early years of retirement.
#7: Adult Children with Disabilities
For families that have adult children with disabilities, it's not uncommon for the parents to be providing some form of continued financial support for their disabled child for the duration of their adulthood. If the parents were to pass away, the concern is that there has to be enough assets inherited by the child to provide them with support for the remainder of their life. Parents will often set up a Special Needs Trust to serve as the beneficiary of these life insurance policies so if the policies do payout it does not jeopardize the Social Security, Medicaid, Medicare or other government assistance that the disabled child may be receiving.
#8: Estate Plan
For some clients, it’s part of their estate plan that no matter what happens they want to know that $500,000 will go to each child, their favorite charity, to a trust for their grandchildren, or for clients with larger estates to pay the anticipated estate tax. To guarantee that those amounts will be available to meet their estate wishes, individuals can purchase permanent life insurance that will payout at the death of the insured.
Case Study
Let's run through a simple example given the following fact set:
Spouse 1 Income: $200,000 (Age 30)
Spouse 2 Income; $50,000 (Age 31)
Children: Susan Age 4 and Rebecca Age 2
Mortgage: $250,000
Student Loans: $20,000
The couple above has the college savings goal to pay for the first 4 years of the kid’s college expenses which is anticipated to be $25,000 per year.
Total Debt: $270,000
Total Estimated Future College Expense: $200,000 ($25K per year for each child)
From an income replacement standpoint, we would be looking to provide this family with a minimum of 5 years of income replacement. For the coverage on Spouse 1 that would be:
$200K Annual Income x 5 Years = $1M
Total Debt and College Costs = $470K
Total Insurance Coverage on Spouse 1: $1.5M (round up)
For the coverage on Spouse 2 that calculation would be: $50K Annual Income x 5 Years = $250KTotal Debt & College Costs = $470KTotal Insurance Coverage on Spouse 2 = $750K (round up)
How Much Does Insurance Cost?
In general, term insurance is cheap and permanent insurance is more expensive. For 90% of the individuals that we work with for their financial plan, term insurance typically makes the most sense. To give you an idea, a $1M 30 Year Term policy with William Penn Insurance Company, for an individual with the following fact set:
Age 30
Gender: Male
Resident of New York
Non-Smoker
Preferred Health Class
The monthly premium would only be $70.46 per month as of July 2020.
New York Residents: We Can Help
Michael Ruger & Rob Mangold are independent insurance agents which means we are not tied to a single insurance company. If you are a resident of New York, we can consult with you, help you to determine the amount of insurance that you need, evaluate you current life insurance coverage, and run free quotes for you across the major life insurance carriers in NY to determine the most appropriate carrier for your insurance policy. Contact Us
Michael Ruger
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
Requesting Mortgage Forbearance: Be Careful
Due to the rapid rise in the unemployment rate as a result of the Coronavirus, Congress passed the CARES Act which includes a provision that provides mortgage relief to homeowners that have federally-backed mortgages.
Due to the rapid rise in the unemployment rate as a result of the Coronavirus, Congress passed the CARES Act which includes a provision that provides mortgage relief to homeowners that have federally-backed mortgages. Homeowners are eligible for a 180 day forbearance on their mortgage payments which can provide much needed financial relief for individuals and families that are struggling due to the COVID-19 containment efforts. Even if you do not have a federally-back mortgage, some banks are voluntarily offering homeowners forbearance options on their mortgage payments. But before you choose this option, you should be aware of the following items:
How does forbearance work?
Who qualifies for mortgage forbearance?
What is the process for requesting a forbearance?
Does forbearance hurt your credit score?
What are the repayment options?
The hidden costs of forbearance
Other options for mortgage relief
How Does Mortgage Forbearance Work?
Mortgage forbearance allows homeowners to defer monthly mortgage payments for a specific period of time. Under the CARES Act, homeowners that qualify, will be able to delay their mortgage payments for the next 6 months. But it’s important to understand that “forbearance” delays mortgage payments, it does not forgive those payment. At some point in the future, you will have to make up for those missed payments.
Who Is Eligible For Mortgage Forbearance?
Under the CARES Act, homeowners that have federally-backed mortgages are eligible for a forbearance up to 180 days. But as I mentioned above, homeowners that do not have federally-backed mortgages may also be eligible but it’s at the discretion of the loan servicer. How do you know if you have a federally-backed mortgage? Here is a list of the federal agencies:
FHA
VA
Freddie Mac
Fannie Mae
USDA
Do You Have A Government Backed Mortgage?
If you are not sure whether or not your mortgage is backed by the federal government, there are a few ways to find out but we recommend not blindly calling the bank that issued your mortgage. The bank that issued your mortgage may be different than the company that “services” your mortgage. It’s not uncommon for lenders to sell the servicing rights of their mortgages to other companies. If you are considering applying for forbearance, you will need to consult with the loan servicer.
As you can image, these loan servicing companies are being overwhelmed right now with homeowners requesting forbearance of their mortgage payments. If you are able to determine whether or not you have a federally-backed mortgage yourself, it will save you time and frustration. Here are a few different ways to determine if your mortgage is backed by a federal agency:
FHA Insurance Payments: If you look at your mortgage statement and you see FHA insurance payments being made, your loan is backed by the FHA. You can also look at your mortgage closing documents, specifically your HUD form.
Fannie Mae & Freddie Mac Websites: Almost 50% of all mortgages issued in U.S. are backed by either Fannie Mae or Feddie Mac. You can run a search on their websites to determine if your mortgage is backed by either of those two agencies.
Contact Loan Servicer: If you are still unable to determine whether or not your mortgage is federally-backed, you can contact your loan servicer. The contact information for your loan servicer is usually listed on your monthly mortgage statement but if you don’t have access to your statement, you may be able to locate your loan servicer via the Mortgage Electronic Registration System
Mortgages Not Backed By A Federal Agency
If your mortgage is not backed by a federal agency, you still may be eligible for a mortgage forbearance but that will be at the complete discretion of your loan servicing company. You will need to contact your loan servicer but unlike federally-backed loans, they are not required to offer you a forbearance. You should be prepared to answer a number of questions such as:
Why are you applying for the forbearance?
How long do you need the forbearance for?
Details about the status of your income, expenses, and employment
The Forbearance Process
Whether you have a federally-backed mortgage or not, you will have to pro-actively reach out to your loan servicing company to request the forbearance; it does not happen automatically. If you qualify for the forbearance, there are two key pieces of information that you should obtain before that call is finished.
Determine the repayment terms for those missed payments
Request your forbearance agreement in writing
Repayment Options
Since you have to repay these missed mortgage payments at some point in the future, it’s incredibly important to understand the terms of the repayment. Some loan servicing companies are requesting a “balloon payment” which means if you are granted a 6 month forbearance, when you reach the end of that 6 month period, all of the missed mortgage payments are due in a lump sum amount; not a favorable situation for most homeowners. Here are the three most common repayment options:
Balloon Payment: All of the missed payments are due as a single lump sum payment at the end of the forbearance term. This is the least favorable option for homeowners.
Extended Term: This option extends the term of your mortgage by the length of the forbearance. If you receive a 3 month forbearance and you have a 30 year mortgage, they will extend the term of your 30 year mortgage by an additional 3 months. This is usually the most favorable option for borrowers.
Re-amortize The Loan: Unlike the “extend the term” option, the maturity date of your mortgage stays the same, and when you restart mortgage payments at the end of the forbearance period, they spread those missed payments over the remaining life of the mortgage. This will result in a slightly higher mortgage payment compared to your mortgage payment prior to the forbearance period.
Get The Forbearance Offer In Writing
With all of these moving parts, it’s extremely important to request that your loan servicer sends you the forbearance agreement in writing. You definitely want to make sure nothing was missed or miscommunicated otherwise you could damage your credit score, end up in a foreclosure situation, or have an unexpectedly large mortgage payment waiting for you at the end of the forbearance period.
Does Mortgage Forbearance Affect Credit?
If done correctly, a mortgage forbearance will not negatively impact your credit score.
Hidden Cost of Forbearance
While there are no late fees assessed on these missed mortgage payments associated with a forbearance agreement, there is additional interest that accumulates over the remaining life of the mortgage when the repayment option involves either an extended term or re-amortization.
Example: Homeowner has a $250,000 federally-backed mortgage, 4% interest rate, with 20 years left on the mortgage. This homeowners was financially impacted by COVID-19 and is granted a 6 month forbearance with an extended term repayment. How much additional mortgage interest did that individual pay over the remaining life of the mortgage due to that 6-month forbearance?
Answer: $3,159
So this option is not “free” by any means but it may be a reasonable price for homeowners to pay compared to the negative financial impact of missing mortgage payments without forbearance.
Other Options Beside Forbearance
If your bank does not grant you forbearance, or you want to consider other options, the CARES Act did open up other forms of financial relief to taxpayers in the form of:
Each option has it’s own pros and cons but you can read more about these options via the links above.
Michael Ruger
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
IRS Stimulus Checks To Individuals: Eligibility & Timing
The U.S. Senate recently passed the CARES Act which was put in place to help stabilize the economy in the wake of the Coronavirus containment efforts. One of the key items in the bill are the stimulus checks that the IRS will issue to
The U.S. Senate recently passed the CARES Act which was put in place to help stabilize the economy in the wake of the Coronavirus containment efforts. One of the key items in the bill are the stimulus checks that the IRS will issue to individuals and their children. In this article we will review:
The amount of the IRS checks
What makes you eligible to receive a check
Income Limitations & Phaseouts
When To Expect The Payment
Direct Deposit vs Physical Check
Unanswered Questions That Need Clarification
IRS Checks To Individuals
The government plans to immediately begin issuing checks directly to individual taxpayers. Individuals that qualify will be eligible to receive a check for $1,200 plus $500 for each child.
Example: A household that has 2 parents and 3 children may be eligible to receive a payment from the IRS in the amount of $3,900.
Parent 1: $1,200
Parent 2: $1,200
Child 1: $500
Child 2: $500
Child 3: $500
Are You Eligible To Receive A Check From The IRS?
Whether or not you receive a check from the IRS will be depend on your taxable income for either 2019 or 2018.
Single Filer: Less than $75,000
Married Filing Joint: Less Than $150,000
There is a phaseout of the payments between:
Single Filer: $75,000 – $99,000
Married Filing Joint: $150,000 – $198,000
Once above the income limits for a single filer of $99,000 and the joint filer of $198,000, you will not be eligible to receive a check.
If you already filed your taxes for 2019, the IRS will look at your 2019 tax return. If you have not filed your taxes for 2019, then the IRS will look at your income on your 2018 tax return. If you did not file a tax return for either year, then the IRS will look at your wages that were reported to social security in those tax years.
What If You Have Less Income In 2020?
But what happens if you were over those income limits for 2018 and 2019 but because of the Coronavirus, your income will be lower in 2020 making you eligible for the payments? You will not receive a check like everyone else but you will be able to capture the payments as a tax credit when you file your 2020 tax return. The payments from the IRS are really “tax credits” that the government is sending to individuals in advance of the filing of their 2020 tax return. Instead of making individuals wait to file their 2020 tax return, the IRS is sending the money to these individuals now.
Second scenario, what if your income was lower in 2018 and 2019 qualifying you for the IRS check but in 2020 your income will be above the threshold. Answer, we don’t know. As of right now there does not seem to be language in the bill saying that they’re going to recapture the credit when you file your 2020 tax return but this is one of those items that will need to be addressed by the IRS after the fact.
How Long Will It Take To Get The IRS Check?
This is the biggest question mark right now. It seems like the IRS is going to direct deposit these payments to your checking account for anyone that has ACH instructions on file with the IRS. If you have ever received a refund or made tax payments directly from your checking account, this would apply to you. However, what if someone no longer has that bank account? We are not sure how that is going to work. The direct deposits may happen sometime in April.
If the IRS does not have bank account instructions on file, they will have to cut physical checks. The last time Congress issued checks to people as part of a stimulus package was 2008 and it took 2 months for those checks to arrive. If this follows a similar path, individual taxpayers might not receive these IRS checks until May but this is another item that still needs to be addressed by the IRS.
Michael Ruger
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
$5,000 Penalty Free Distribution From An IRA or 401(k) After The Birth Of A Child or Adoption
New parents have even more to be excited about in 2020. On December 19, 2019, Congress passed the SECURE Act, which now allows parents to withdraw up to $5,000 out of their IRA’s or 401(k) plans following the birth of their child
New parents have even more to be excited about! On December 19, 2019, Congress passed the SECURE Act, which now allows parents to withdraw up to $5,000 out of their IRA’s or 401(k) plans following the birth of their child without having to pay the 10% early withdrawal penalty. To take advantage of this new distribution option, parents will need to know:
Effective date of the change
Taxes on the distribution
Deadline to make the withdrawal
Is it $5,000 for each parent or a total per couple?
Do all 401(k) plans allow these types of distributions?
Is it a per child or is it a one-time event?
Can you repay the money to your retirement account at a future date?
How does it apply to adoptions?
This article will provide you with answers to these questions and also provide families with advanced tax strategies to reduce the tax impact of these distributions.
SECURE Act
The SECURE Act was passed in December 2019 and Section 113 of the Act added a new exception to the 10% early withdrawal penalty for taking distributions from retirement accounts called the “Qualified Birth or Adoption Distribution.”
Prior to the SECURE Act, if you were under the age of 59½ and you distributed pre-tax money from an IRA or 401(k) plan, in addition to having to pay ordinary income tax on the amount distributed, you were also hit with a 10% early withdrawal penalty from the IRS. The IRS prior to the SECURE Act did have a list of exceptions to the 10% penalty but having a child or adopting a child was not on that list. Now it is.
How It Works
After the birth of a child, a parent is allowed to distribute up to $5,000 out of either an IRA or a 401(k) plan. Notice the word “after”. You are not allowed to withdraw the money prior to the child being born. New parents have up to 12 months following the date of birth to process the distribution from their retirement accounts and avoid the 10% early withdrawal penalty.
Example: Jim and Sarah have their first child on May 5, 2025. To help with some of the additional costs of a larger family, Jim decides to withdraw $5,000 out of his rollover IRA. Jim’s window to process that distribution is between May 5, 2025 – May 4, 2026.
The Tax Hit
Assuming Jim is 30 years old, he would avoid having to pay the 10% early withdrawal penalty on the $5,000 but that $5,000 still represents taxable income to him in the year that the distribution takes place. If Jim and Sarah live in New York and make a combined income of $100,000, in 2025, that $5,000 would be subject to federal income tax of 22% and state income tax of 6.85%, resulting in a tax liability of $1,440.
Luckily under the current tax laws, there is a $2,000 federal tax credit for dependent children under the age of 17, which would more than offset the total 22% in fed tax liability ($1,100) created by the $5,000 distribution from the IRA. Essentially reducing the tax bill to $340 which is just the state tax portion.
TAX NOTE: While the $2,000 fed tax credit can be used to offset the federal tax liability in this example, if the IRA distribution was not taken, that $2,000 would have reduced Jim & Sarah’s existing tax liability dollar for dollar.
For more info on the “The Child Tax Credit” see our article: More Taxpayers Will Qualify For The Child Tax Credit
$5,000 Per Parent
But it gets better. The $5,000 limit is available to EACH parent meaning if both parents have a pre-tax IRA or 401(k) plan, they can each distribute up to $5,000 from their retirement accounts within 12 months following the birth of their child and avoid the 10% early withdrawal penalty.
ADVANCED TAX STRATEGY: If both parents are planning to distribute the full $5,000 out of their retirement accounts and they are in a medium to high tax bracket, it may make sense to split the two distributions between separate tax years.
Example: Scott and Linda have a child on October 3, 2025 and they both plan to take the full $5,000 out of their IRA accounts. If they are in a 24% federal tax bracket and they process both distributions prior to December 31, 2025, the full $10,000 would be taxable to them in 2025. This would create a $2,400 federal tax liability. Since this amount is over the $2,000 child tax credit, they will have to be prepared to pay the additional $400 federal income tax when they file their taxes, since it was not fully offset by the $2,000 tax credit.
In addition, by taking the full $10,000 in the same tax year, Scott and Linda also run the risk of making that income subject to a higher tax rate. If instead, Linda processes her distribution in November 2025 and Scott waits until January 2026 to process his $5,000 IRA distribution, it could result in a lower tax liability and less out of pocket expense come tax time.
Remember, you have 12 months following the date of birth to process the distribution and qualify for the 10% early withdrawal exemption.
$5,000 For Each Child
This 10% early withdrawal exemption is available for each child that is born. It does not have a lifetime limit.
Example: Building on the Scott and Linda example above, they have their first child October 2025, and both of them process a $5,000 distribution from their IRA’s avoiding the 10% penalty. They then have their second child in November 2026. Both Scott and Linda would be eligible to withdraw another $5,000 each out of their IRA or 401(k) within 12 months after the birth of their second child and again avoid having to pay the 10% early withdrawal penalty.
IRS Audit
One question that we have received is “Do I need to keep track of what I spend the money on in case I’m ever audited by the IRS?” The short answer is “No”. The new law does not require you to keep track of what the money was spent on. The birth of your child is the “qualifying event” which makes you eligible to distribute the $5,000 penalty free.
Not All 401(k) Plans Will Allow These Distributions
This 10% early withdrawal exception will apply to all pre-tax IRA accounts but it does not automatically apply to all 401(k), 403(b), or other types of qualified employer sponsored retirement plans.
While the SECURE Act “allows” these penalty-free distributions to be made, companies can decide whether or not they want to provide this special distribution option to their employees. For employers that have existing 401(k) or 403(b) plans, if they want to allow these penalty-free distributions to employees after the birth of a child, they will need to contact their third-party administrator and request that the plan be amended.
For companies that intend to add this distribution option to their plan, they may need to be patient with the timeline for the change. 401(k) providers will most likely need to update their distribution forms, tax codes on their 1099R forms, and update their recordkeeping system to accommodate this new type of distribution.
Ability To Repay The Distribution
The new law also offers parents the option to repay the amounts to their retirement account that were distributed due to a qualified birth or adoption. The repayment of the amounts previously distributed from the IRA or 401(k) would be in addition to the annual contribution limits. There is not a lot of clarity at this point as to how these “repayments” will work so we will have to wait for future guidance from the IRS on this feature.
Adoptions
The 10% early withdrawal exception also applies to adoptions. An individual is allowed to take a distribution from their retirement account up to $5,000 for any children under the age of 18 that is adopted. Similar to the timing rules of the birth of a child, the distribution must take place AFTER the adoption is finalized, but within 12 months following that date. Any money distributed from retirement accounts prior to the adoption date will be subject to the 10% penalty for individuals under the age of 59½.
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
4 Things That Elite Millennials Do To Fast Track Their Careers
As a young professional, your most valuable asset is your career. While you can watch endless videos on the benefits of making Roth IRA contributions or owning real estate, at the end of the day if you're making $400,000 instead of
As a young professional, your most valuable asset is your career. While you can watch endless videos on the benefits of making Roth IRA contributions or owning real estate, at the end of the day if you're making $400,000 instead of $70,000 before reaching the age of 40, you will have the opportunity to build real wealth faster.
As the owner of an investment firm, I have had the opportunity to work with a lot of very success Millennials that have either successfully grown a business or have climbed the corporate ladder much faster than their peers. Even though these elite young professionals all have different backgrounds, personalities, and skill sets, I have noticed that there are 4 things that make them similar and I’m going to share them with you today.
They Take Risks Early & Often
Think about the last time you left a job; whether it was to take a job with a different company, start your own business, or take a new position within your current company, you probably spent days or maybe weeks in mental turmoil asking yourself questions like:
“Am I making the right decision?”
“What if I get to this new company and the position is not what they say it’s going to be?”
“Should I risk going out on my own and starting a company?”
We have all been there, and it’s awful. All you can think about is, “What if this does not work out the way I expect?”. What I have noticed with this group of successful millennials is that they are able to recognize the uncertainty in those situations, but still choose to jump forward without ever looking back. They are like cats in the way that no matter where they land down the road, the one thing they feel certain about is that they will land on their feet.
This is not just something that they do once or twice, but rather multiple times throughout their working careers. In general, the young professionals that really surge forward are the ones that take risks early on in their careers. Starting a business or making a big career change when you are 25 with no mortgage and no family to support is typically easier to manage then taking that same risk when you have a mortgage and/or family to support. We have seen young professionals start businesses and in year two or three the business nearly goes under, but they somehow held on, pushed forward, and they turned it into a wildly successful business. There is no perfect age to take these leaps, but it’s just acknowledging that without a lot of advanced planning it becomes much more difficult to take these risks as your personal expenses grow.
Sense Of Purpose
When you talk with this group of successful Millennials, they all have a very strong sense of purposes. Now, sense of purpose does not necessarily mean that they have life all figured out. Many of the professionals in this elite group will jokingly admit that they have no idea what the future holds for them, however, they can tell you at length what they love about their career and their explanation will often sound very different than if you were to ask their coworkers what they love about their job.
Example, we have a client that provides custom software to companies and they have rising star on their team. Looking at this employee’s resume and position within the company you would say “Ok, typical software developer, coder, very techy, etc.” However, this employee has taken it upon himself to post videos to social media everyday as he builds robot armies, provides free strategies for solving problems using custom software, and he has amassed a huge following of tech fans wanting more.
This was not something that his supervisor asked him to do or a task that is at all part of his job description. Nope, he is sincerely passionate about helping companies to solve everyday problems using custom software and he puts it all out there for the world to see. Such a clear sense of purposes that has allowed him to turn something ordinary into something extraordinary. The tip here: figure out what you love and try to incorporate it into your career.
They Say “No”
This is kind of an odd one, but I have noticed this trait to be common among successful younger business owners and executives. They know when to say “No” to an opportunity. For most professionals, the power of “No” comes later on in their careers after they have seen enough opportunities turn into complete train wrecks. Most younger professionals do not have 30 years of battle tested experience in an effort to execute their growth plans, they dine at what I call “the buffet of opportunity”.
When you start a company or lead a team of executives, usually the main goal is to grow the company as fast as possible, so when you are presented with 3 growth ideas, you may decide to chase 2 or all 3 in an effort to grow the company. Sometimes that’s ok, but what I have seen these successful Millennials recognize is that by committing all of their resources toward what they feel is the single best opportunity they are able to either succeed or fail FASTER. A concept that was identified by Elon Musk of Tesla.
I was able to identify this trait through the actions of one of our clients. A young business owner that had a company in the energy sector and the company had been experiencing double digit growth for a number of years. Since they had cash and they were looking for ways to grow the company, instead of just selling their product and then hiring third party contractors for the install, they decided that they could produce additional revenue by handling the installation themselves.
Two years after that decision was made, I was having breakfast with the owner of the company and he said that decision almost bankrupted the company. While they were very good at producing their product, they were horrible at running construction teams and managing the liability associated with the installation process. He said, “I should have just said no and stuck to what we were good at.”
That experience made me aware of the Power of No being used by other young business owners and executives. We have had clients that have said “No” to:
A large new client because it would tie the fate of their company to that client
Joint working relationship with other companies
Providing services related too but not associated with their core business
New investors in the company
Selling the company
All of these decisions are tough decisions to make, but I have noticed that our most successful young professionals are not afraid to look opportunity in the eye and say “not today”.
The L-Factor
An executive from Yahoo named Tim Sanders wrote a book a number of years ago called The Likeability Factor. The main idea of the book is people choose who they like and they tend to buy from them, hire them, and purposefully spend more time with them. It may not be a surprise that many of the successful young professionals that we see growing businesses and sprinting up the corporate ladder have what Tim Sanders calls a high “L-Factor”.
Think of the clients and co-workers that show up at your office door and you know it’s going to be a fun and engaging conversation. Those are the high L-factor people in our lives. It’s been shown that those High L-factor executives tend to survive layoffs time after time because even though their actual position may be getting eliminated, the powers that be sometimes find a place for that person to land for no other reason than they liked them and wanted to keep them with the company.
While I’m sure all of us can think of someone that is in a position of power that has an L-factor of zero, there are far many more business owners and executives that have made it to where they are today because they are likeable.
I feel like I could give you endless examples of instances where I have seen likeability play out in favor of successful young professionals, but I think everyone understands the general idea. The one thing that I will point out though that is also in Tim’s book is that any level, you have the ability to raise your L-Factor. Likeability is a skill like listening, negotiating, or public speaking. It comes very natural to some people, but others have to work at it.
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
Should I Payoff My Mortgage Early?
As a financial planner, clients will frequently ask me the following question, “Should I apply extra money toward my mortgage and pay it off early?”. The answer depends on several factors such as:
As a financial planner, clients will frequently ask me the following question, “Should I apply extra money toward my mortgage and pay it off early?”. The answer depends on several factors such as:
The status of your other financial goals
Interest rate
How long you plan to live in the house
How close you are to retirement
The rate of return for other available investment options
Status of your other financial goals
Before you start applying additional payments toward your mortgage, you should first conduct an assessment of the status of your various financial goals.
For clients that have children, we usually start with the following questions:
“What are your plans for paying for college for your kids? Are the college savings accounts appropriately funded?”
The cost of college keeps rising which requires more advanced planning on behalf of parents that have children that are college bound, but before committing more money toward the mortgage, you should have an idea as to what your financial aid package might look like, so you have a ballpark idea of what you will have to pay out of pocket each year for college.
If you have an extra $5,000 sitting in your savings account, you can either apply that toward the mortgage, which is a one-time benefit, or you can put that money into a college 529 account when your child is 5 years old, and let it accumulate for 13 the next years. Assuming you get a 6% rate of return within that 529 account, you will be able to withdrawal $10,665 all tax free when it comes time to pay for college.
Here is the list of other questions that we typically ask clients before we give them the green light to escalate the payments on their mortgage:
Is there enough money in your retirement accounts to fulfill your plans for retirement?
Do you have any other debt? Student loan debt, credit card debt, HELOC?
How many months of living expense have you put aside in an emergency fund?
Are there any big one-time expenses coming up?
Do you have the appropriate amount of life insurance?
Do you foresee any career changes in the near future?
If there are financial shortfalls in some of these other areas, it may be better to shore up some of the weaknesses in your overall financial plan before applying additional cash toward the mortgage.
What is the interest rate on your mortgage?
The interest rate that the bank or credit union is charging you on your mortgage has a significant weight in the decision as to whether or not you should pay off your mortgage early. We tell clients that you should look at the interest rate on debt as a “risk free rate of return”. If you have a mortgage with a 4% interest rate and you have $5,000 in cash sitting in your savings account, by applying that $5,000 toward your mortgage you are technically earning a 4% rate of return on that money because you are not paying it to the bank. The reason it is “risk free” is because you would have paid that money to the bank otherwise.
It’s important to understand the risk-free concept of paying off debt. Clients will sometimes ask me “Why would I put more money toward my mortgage with an interest rate of 4% when I can invest it in the stock market and get an 8% rate of return?”
My answer is, “It’s not an apple to apple comparison because you are comparing two different risk classes.” You have to take risk in the stock market to obtain that possible 8% rate of return, as compared to applying the money toward your mortgage which is guaranteed because you are guaranteed to not pay the bank that interest. It would be more appropriate to compare the interest rate on your mortgage to a CD rate at a bank, or the interest rate for a money market account.
After this exchange, the client will frequently comment, “Well, I can’t get 4% in a CD at a bank these days”. In those cases, if they have idle cash, it may be advantageous to apply the cash toward the mortgage instead of letting it sit in their savings account or a CD with a lower interest rate.
Interest rate below 5%
When the interest rate on your mortgage is below 5%, it makes the decision more difficult. Depending on the interest rate environment, there may be lower risk investments other than stocks that could earn a higher rate of return compared to the interest rate on your mortgage. You may also have some long term financial goal like retirement that allows you to comfortably take more risk and assume a higher long term annualized rate of return in those higher risk asset classes. When you have a lower interest rate on your mortgage, applying additional cash toward the mortgage may still be the prudent decision, but it requires more analysis.
Interest rate above 5%
When we see the interest rates on a mortgage above 5% the decision to pay off the mortgage early gets easier. Based on the examples that we have already covered, if the interest rate on your mortgage is 6%, by applying more cash toward the mortgage you are earning a risk-free rate of return of 6%, that’s a pretty good risk-free rate of return in most market environments. For our readers that had mortgages in the early 80’s, they saw mortgage rates north of 15%. That’s a nice risk-free rate of return, but hopefully we never see the interest rate on mortgages that high ever again.
How long do you plan to live in the house?
If you plan to sell your house within the next 5 years, applying additional payments toward the mortgage has a positive financial impact, but it’s typically not as strong as when you compare it to someone that has 20 years left on mortgage and they plan to be living in the house for the next 20+ years.
It’s a lesson in compounding interest. Example, you have the following mortgage:
Outstanding balance: $200,000
Interest rate: 4%
Years left on the mortgage: 20 Years
You have $20,000 sitting in your savings account that you are considering applying toward the mortgage. If you plan to sell the house a year from now, applying $20,000 toward the mortgage would save you $800 in interest.
If you plan to stay in the house for the full 20 years, applying the $20,000 toward your mortgage today would save you $9,086 in interest over the remaining life of the mortgage.
Should I payoff my mortgage before I retire?
When we are helping clients prepare for retirement, we remind them that with all of the unknowns that the future holds, the one thing that you have 100% control over both now and in the future are your annual expenses. You don’t have control over market returns, inflation, tax rates, etc, so the goal is to give you the most flexibility in retirement and minimize your expenses. It not uncommon for the mortgage to be your largest monthly expense.
It is for this reason that retirement serves as kind of a wild card in this rate of return analysis. During the accumulation years, you may be assuming an 8% rate of return on your retirement account because you had an overweight to stocks in your portfolio. Now that you are transitioning over to the distribution phase, it’s common for investors to decrease the risk level in their retirement accounts, which is often accompanied by a lower assumed rate of return over longer time periods. It makes that gap between the interest rate on your mortgage and the assumed rate on your investment accounts smaller, thus giving more weight to escalating the payoff of the mortgage.
Additionally, no mortgage means less money coming out of your retirement accounts each year, which helps investors manage the risk of outliving their retirement savings.
While we like our clients to retire with as little debt as possible, there are scenarios that arise where it does make sense to have a mortgage in retirement. Both of these scenarios stem from the situation where 100% of the client’s assets are tied up in pre-tax retirement accounts.
If they have $50,000 left on the mortgage and they are about to retire, we typically would not advise them to distribute $50,000 from their retirement account to pay off the mortgage because they will take a big income tax hit by realizing all of that additional taxable income in a single tax year. In these cases, it may make sense to continue to make the regular monthly mortgage payments until the mortgage is paid in full.
In a similar situation when clients want to buy a second house in retirement, but most of their money is tied up in pre-tax retirement, instead of incurring a big tax hit by taking a large distribution from their retirement accounts, it may make sense for them to just take the mortgage and make regular monthly payments. This strategy spreads the distributions from the retirement accounts over multiple tax years which could more than offset the interest that you are paying to the bank over the life of the loan. In addition, the money in your retirement accounts is allowed to accumulate tax deferred for a longer period of time.
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
Do I Have To Pay Tax On A House That I Inherited?
The tax rules are different depending on the type of assets that you inherit. If you inherit a house, you may or may not have a tax liability when you go to sell it. This will largely depend on whose name was on the deed when the house was passed to you. There are also special exceptions that come into play if the house is owned by a trust, or if it was gifted
Do I Have To Pay Tax On A House That I Inherited?
The tax rules are different depending on the type of assets that you inherit. If you inherit a house, you may or may not have a tax liability when you go to sell it. This will largely depend on whose name was on the deed when the house was passed to you. There are also special exceptions that come into play if the house is owned by a trust, or if it was gifted with the kids prior to their parents passing away. On the bright side, with some advanced planning, heirs can often times avoid having to pay tax on real estate assets when they pass to them as an inheritance.
Step-up In Basis
Many assets that are included in the decedent’s estate receive what’s called a step-up in basis. As with any asset that is not held in a retirement account, you must be able to identify the “cost basis”, or in other words, what you originally paid for it. Then when you eventually sell that asset, you don’t pay tax on the cost basis, but you pay tax on the gain.
Example: You buy a rental property for $200,000 and 10 years later you sell that rental property for $300,000. When you sell it, $200,000 is returned to you tax free and you pay long-term capital gains tax on the $100,000 gain.
Inheritance Example: Now let’s look at how the step-up works. Your parents bought their house 30 years ago for $100,000 and the house is now worth $300,000. When your parents pass away and you inherit the house, the house receives a step-up in basis to the fair market value of the house as of the date of death. This means that when you inherit the house, your cost basis will be $300,000 and not the $100,000 that they paid for it. Therefore, if you sell the house the next day for $300,000, you receive that money 100% tax-free due to the step-up in basis.
Appreciation After Date of Death
Let’s build on the example above. There are additional tax considerations if you inherit a house and continue to hold it as an investment and then sell it at a later date. While you receive the step-up in basis as of the date of death, the appreciation that occurs on that asset between the date of death and when you sell it is going to be taxable to you.
Example: Your parents passed away June 2019 and at that time their house is worth $300,000. The house receives the step-up in basis to $300,000. However, lets say this time you rent the house or don’t sell it until September 2020. When you sell the house in September 2020 for $350,000, you will receive the $300,000 tax-free due to the step-up in basis, but you’ll have to pay capital gains tax on the $50,000 gain that occurred between date of death and when you sold house.
Caution: Gifting The House To The Kids
In an effort to protect the house from the risk of a long-term event, sometimes individuals will gift their house to their kids while they are still alive. Some see this as a way to remove themselves from the ownership of their house to start the five-year Medicaid look back period, however, there is a tax disaster waiting for you with the strategy.
When you gift an asset to someone, they inherit your cost basis in that asset, so when you pass away, that asset does not receive a step-up in basis because you don’t own it and it’s not part of your estate.
Example: Your parents change the deed on the house to you and your siblings while they’re still alive to protect assets from a possible nursing home event. They bought the house 30 years ago for $100,000, and when they pass away it’s worth $300,000. Since they gifted the assets to the kids while they were still alive, the house does not receive a step-up in basis when they pass away, and the cost basis on the house when the kids sell it is $100,000; in other words, the kids will have to pay tax on the $200,000 gain in the property. Based on the long-term capital gains rates and possible state income tax, when the children sell the house, they may have a tax bill of $44,000 or more which could have been completely avoided with better advanced planning.
How To Avoid Paying Capital Gains Tax On Inherited Property
There are ways to both protect the house from a long-term event and still receive the step-up in basis when the current owners pass away. This process involves setting up an irrevocable trust to own the house which then protects the house from a long-term event as long as it’s held in the trust for at least five years.
Now, we do have to get technical for a second. When an asset is owned by an irrevocable trust, it is technically removed from your estate. Most assets that are not included in your estate when you pass do not receive a step-up in basis; however, if the estate attorney that drafts the trust document puts the correct language within the trust, it allows you to protect the assets from a long-term event and receive a step-up in basis when the owners of the house pass away.
For this reason, it’s very important to work with an attorney that is experienced in handling trusts and estates, not a generalist. It only takes a few missing sentences from that document that can make the difference between getting that asset tax free or having a huge tax bill when you go to sell the house.
Establishing this trust can sometimes cost between $3,000 and $6,000. But by paying this amount upfront and doing the advance planning, you could save your heirs 10 times that amount by avoiding a big tax bill when they inherit the house.
Making The House Your Primary
In the case that the house is gifted to the children prior to the parents passing away and the house is not awarded the step-up in basis, there is an advance tax planning strategy if the conditions are right to avoid the big tax bill. If one of the children would be interested in making their parent’s house their primary residence for two years, then they are then eligible for either the $250,000 or $500,000 capital gains exclusion.
According to current tax law, if the house you live in has been your primary residence for two of the previous five years, when you go to sell the house you are allowed to exclude $250,000 worth of gain for single filers and $500,000 worth of gain for married filing joint. This advanced tax strategy is more easily executed when there is a single heir and can get a little more complex when there are multiple heirs.
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
