Welcome to #AskBedel, a weekly personal-wealth Q&A where you can ask financial planning and investment experts for advice. Each week we’ll be answering your personal finance questions, so be sure to submit your questions to Bedel@BedelFinancial.com, or click on Submit a Question below.
- 1. I planned to purchase medical insurance off the Marketplace, but I have been hearing about insurance options from religious groups. Which is better? Will I still get the same amount of coverage?
- 2. My family member recently passed away and I inherited their estate. Will I owe taxes on my inheritance?
- 3. I recently inherited a large sum of money and I have been thinking about buying a rental property. What are some of the things I need to consider?
- 4. Many of my friends have cancelled their cable or satellite television subscriptions. Does it make sense financially to “cut the cord?”
- 5. I have heard about peer-to-peer lending. Is that a smart way to invest money?
- 6. Which takes the priority on savings, my IRA or my HSA?
- 7. When should I use my debit card and when should I use my credit card?
- 8. We saved to a 529 plan for our child, but they just earned a scholarship. What can we do with the 529 funds now?
- 9. During the divorce, can my husband take a portion, or all, of my IRA?
- 10. Can my child open or fund his or her own HSA?
- 11. What are some things I need to keep in mind when considering socially responsible investing?
- 12. How do I know when it makes sense to refinance my mortgage?
- 13. My wife is a teacher and has a 403b annuity. Should we pay the surrender charges and move her money into an IRA?
1. I planned to purchase medical insurance off the Marketplace, but I have been hearing about insurance options from religious groups. Which is better? Will I still get the same amount of coverage?
Some organizations have formed non-profit groups for the sole purpose of sharing medical expenses. Member’s healthcare expenses are pooled and shared among everyone. If the group has relatively low health expenses, everyone benefits. Premiums are generally lower than typical healthcare insurance premiums. However, they function very differently than a traditional insurance company. One of the biggest differences is that they may not pay all of your claims. Factors such as lifestyle or preexisting conditions determine if costs are eligible to be covered. In many states, they are not held to the same regulations that insurance companies must abide by which means if you aren’t happy, there isn’t much the state can do to help you. Many hospitals and healthcare agencies don’t recognize medical cost sharing as insurance. This could impact your ability to be treated. Purchasing insurance is about transferring risk from yourself to the insurance company. You want to ensure that your insurance coverage will be there to support you when you need it.
2. My family member recently passed away and I inherited their estate. Will I owe taxes on my inheritance?
It’s very unlikely, but it depends. There are three possible taxes involved. The first is estate tax, which is levied at the federal level. If the value of your family member’s estate is under the lifetime exclusion ($11.4M in 2019) then you’re in the clear. If their estate is above the exclusion amount, your inheritance may be reduced by the amount of estate tax owed; however, the tax won’t be paid out of your pocket.
The second possible tax is charged at the state-level. There are six states that still charge inheritance taxes on the person receiving the inheritance. Check the rules for the state in which your family member lived and owned property.
Lastly, some assets have capital gain tax or ordinary income tax implications. For example, if you inherit shares of a stock you will owe capital gain tax if you sell the stocks at a gain. If you inherit an IRA you will owe ordinary income tax on the Required Minimum Distributions and other withdrawals.
Taxes can get confusing. Consult with a tax professional if you’re still not sure whether you will owe Uncle Sam.
3. I recently inherited a large sum of money and I have been thinking about buying a rental property. What are some of the things I need to consider?
The amount of the inheritance can, and should, impact your decision when considering the acquisition of a rental property. However, before making any purchase, make sure you consider your entire financial picture. Revolving debts or liabilities that carry high-interest rates should be paid off prior to any purchase/investment. From there, make sure your emergency fund is sufficiently funded to cover 3-6 months’ worth of expenses. Once those items are taken care of, you can then begin to evaluate the possibility of purchasing a rental property.
As with any investment, you need to exercise due diligence when acquiring property. Rental properties can provide a steady stream of passive income and a slew of deductible expenses. They can complement and provide your existing portfolio with a level of diversification. Upon the sale of the property, it stands to reason you will benefit from the property’s growth in value over the duration in which you own the property. Also, if you find another property with potentially stronger growth prospects, the IRS allows a 1031 exchange, which enables you to sell a property and invest in another like property without paying capital gains taxes.
Conversely, there are also drawbacks to contemplate. If liquidity is a concern, a rental may not be a wise decision as it can take time to sell a property. Opportunity costs should also be considered. Do you feel the return on the property can sufficiently outperform other investment options? What is your desire to be a landlord? Rental homes often have maintenance issues that can occur at any moment. Are you handy enough to handle repairs yourself, or will you need to bring in your local handyman for upkeep? Lastly, pay attention to local taxes and insurance premiums. While you may initially establish what you feel is a desirable rent structure based on the mortgage of the property (if you don’t pay for it in cash), rising taxes and insurance can erode your profit margin faster than you can increase rent.
When making a decision such as this, it’s best to work with your financial advisor and a local real estate agent. Your financial advisor can help you understand the impacts of such a purchase and offer possible alternatives while your agent can help you navigate the area in which you intend to buy. Though rental properties can be a lot of work, they can also provide for a nice return on your investment, so do your homework before jumping in!
4. Many of my friends have cancelled their cable or satellite television subscriptions. Does it make sense financially to “cut the cord?”
Cancelling cable or satellite TV subscriptions and transitioning to streaming services has gained popularity within the last decade. According to the Leichtman Research Group, the largest pay-TV providers in the U.S. lost 1,740,000 subscribers in Q3 2019 alone! 74% of U.S. households now pay for a subscription video on-Demand service, such as Netflix, Amazon Prime, Hulu, etc.
The average American pays $102 per month or $1,224 per year for cable television subscriptions (the cost of internet service is not included in this average). Does it make financial sense to “cut the cord” and substitute cable or satellite in favor of streaming services only?
The short answer – it depends. There are more streaming services popping up due to the popularity of services like Netflix and the cost of streaming services has risen in the last few years. If your TV entertainment needs can be fulfilled by a limited number of streaming services, you would likely benefit from cutting the cord. If you have a difficult time limiting your streaming service choices, you may not see as much as a cost difference. Let’s look at an example:
Average Monthly Cost of Cable Television: $102/month
Consumer #1 (3 Streaming Services)
Netflix (Basic): $9
HBO Now: $15
Consumer #2 (6 Streaming Services)
Netflix (Premium): $16
HBO Now: $15
YouTube TV: $50
Amazon Prime Video: $9
Disney +: $7
If you are thinking about cutting the cord, do your research! Determine what you currently pay for cable or satellite services and compare to the cost of the streaming services you are interested in. If you do not require a ton of different streaming service memberships, you will likely see a decrease in your overall monthly TV expenses! If the opposite is true, cutting the cord may prove to be a “wash” and not worth the time and effort of making the switch.
5. I have heard about peer-to-peer lending. Is that a smart way to invest money?
Peer-to-peer lending is the process of investing your money with a firm that then loans that money out to approved borrowers. In essence, you act as the bank in the transaction and collect any principle and interest payments from the borrower. Numerous companies online offer these services. Some have been around for more than a decade while others are relatively new. A company may specialize in certain lending areas such as small business loans, student debt refinancing, or personal loans, while others may offer a wide assortment of lending. As an investor, these loans may be appealing if you like the idea of investing in people and small businesses. If you are looking to make an investment here are a few things to consider:
- What is the track record of the firm loaning the money? They should have substantial information on their website regarding their past loans. They should also state what their expected default rate would be on loans.
- How risky do you want to be? Many firms will allow you to choose which type of borrower you want to loan your money. The riskier the loan the more return potential.
- Can you spread out your investment over many loans? You need to diversify your investment so that one borrow doesn’t wipe out your investment if they default. Some programs may allow you to invest as little as $25 in a single loan, which allows you to spread out the risk.
- What are the total fees charged to participate in their lending program? The higher the fees charged, the lower your potential return.
- Does this line up with your overall investment strategy?
As with any investment, there are risks in peer-to-peer lending. The biggest risk when loaning money is not getting your money back. Understanding how the company evaluates and approves it loans is an important step before you make a decision.
6. Which takes the priority on savings, my IRA or my HSA?
Individual Retirement Accounts (IRA) and Health Savings Accounts (HSA) are both great tax-efficient accounts to take advantage of if you qualify to contribute. With a Traditional IRA you can make pre-tax contributions, specifically earmarked for retirement, of up to $6,000 if you are under age 50 and $7,000 over age 50 in 2020. Over time, the investments inside of the account grow tax-free. Once you reach age 59 ½, you can take distributions from the account penalty-free, but they are subject to the income tax.
HSA’s are designed to help pay for medical expenses but are more tax-advantageous because of their triple tax benefits.
- First, contributions can be made pre-tax, meaning the income you contribute does not count towards your taxable income. In 2020, the maximum contribution is $3,550 for individuals and $7,100 for a family. Those over age 55 can contribute an additional $1,000.
- Second, many HSAs permit contributions to be invested. Just like an IRA, these investments grow tax-free, allowing for compounding growth.
- Third, for qualified medical expenses, distributions from the account are entirely tax-free. In addition, when you reach age 65, your HSA acts like an IRA. This means you can take distributions from the account for non-medical expenses without penalty—you will only have to pay taxes on the distribution.
Since both accounts offer different tax benefits, you should work with a financial advisor to determine the way to utilize each.
7. When should I use my debit card and when should I use my credit card?
When it’s time to checkout you may be faced with the decision: debit or credit? Credit and debit cards each have their place and there are certainly situations when one is better than the other.
Opt for your credit card when making online purchase because they typically offer greater protection against fraudulent activities. Credit is also preferable when traveling abroad because credit cards typically often have fewer foreign transaction fees. Reach for your debit card if you’re operating on a tight budget. The spending limit is your checking account balance, unlike the credit limit on a credit card. If you’re in need of cash, your best bet is using your debit card at a free ATM since nearly all credit cards charge a much higher rate for cash withdrawals, even up to 24%!
8. We saved to a 529 plan for our child, but they just earned a scholarship. What can we do with the 529 funds now?
Scholarships typically only cover tuition, so there may still be qualified expenses for which you can use the 529 funds, such as room and board or books. If there will still be 529 funds remaining after those expenses, you have three choices:
- Leave the money in place in the event your child decides to continue his/her education beyond undergraduate studies.
- Change the account beneficiary to another child, grandchild, or even yourself for future qualifying educational expenses.
- Pull money from the 529 account. An amount equal to the scholarship award may be withdrawn without penalty. However, the earnings portion of that amount will be taxed as ordinary income.
If you wish to withdraw money over and above the amount of the scholarship, the earnings portion of the non-qualified excess amount will be subject to taxes, including the 10% penalty tax.
Read More: When College Planning Goes Awry
9. During the divorce, can my husband take a portion, or all, of my IRA?
If you had a prenup in place protecting the IRA, then the account is protected assuming the legal documents were drafted correctly. If not, then things can get a bit trickier.
Depending on the state in which you reside and when the assets were earned will dictate how the assets are treated. For example, in community property states, each spouse is entitled to one-half of the assets earned during the marriage. If the account existed prior to marriage, though contributions were subsequently made through out, the courts will calculate the marital portion and divide that figure in half. In the case of common-law states, the IRA owner is the sole owner of the account and the account does not have to be divided equally. Though the splitting of the assets does not have to be equal, it does have to be ‘fair’.
Pay attention to the wording and the type of accounts listed in the divorce order. If your soon-to-be ex-spouse is receiving your Roth IRA versus a traditional IRA, then they likely have a greater benefit (assuming equal account values) due to tax rules governing these account types. Also, if the order states your spouse is entitled to, say, $50,000 (instead of half) of your IRA and the value of the account declines to $75,000, they are now receiving 2/3 of the account as opposed to half as was originally intended.
It’s always best to consult with an experienced attorney in the case of a divorce where investable assets are involved. You want to ensure that you receiving what you are entitled to as well as not foregoing any more than you should.
10. Can my child open or fund his or her own HSA?
Health Savings Accounts (HSAs) are growing in popularity for people with a high-deductible health insurance plan because of their tax efficiency. Contributions into an HSA are deductible and reduce taxable income and also have the option to be invested. Upon distribution, any growth the account earned is completely tax free, so long as the distribution is used to pay for a qualified medical expense.
However, the IRS has strict guidelines regarding who is eligible for an HSA, preclude minor children from opening an account of their own. To open an HSA, an individual must:
- Be covered by a qualified high-deductible health plan (HDHP)
- Not be covered by any other type of health insurance
- Not enrolled in Medicare
- Not be claimed as a dependent on another individual’s tax return
However, the 2010 Affordable Care Act allows for adult children to remain on their parents’ health insurance up to the age of 26 years old. This means that even if your adult child is filing their own tax return, so long as they are covered by the parent’s health insurance, he or she is eligible to open an HSA and contribute the maximum allowed under a family plan ($7,100 in 2020) into their own account. If your adult child is financially unable to contribute the maximum amount, you are able to make the HSA contributions on their behalf. It is important to be aware, though, that even if your child is on your insurance plan, you are not able to use your own HSA funds to pay for their qualified medical expenses if they cannot be claimed as a dependent for tax purposes.
HSAs offer many important benefits when it comes to an individual’s health care expenses. However, every situation is different and it is best to speak with a tax professional first before making any decisions.
11. What are some things I need to keep in mind when considering socially responsible investing?
Socially Responsible Investing (SRI) has gained a lot of traction over the years for those who want to invest with the purpose of social and/or environmental betterment. SRI investing is done by actively eliminating investments based on specific ethical guidelines. Just like with any investment, there is research and due diligence that needs to be done before investing. Here are three things to keep in mind when considering SRI.
- What classifies as investment to be socially responsible can be vague because there is no universal guideline. For example, a mutual fund or ETF can consider themselves SRI by actively avoiding oil stocks alone. However, they could still be invested in other areas you may not find ethical—tobacco, gambling, weapons, etc. It is important to understand your reasoning behind choosing socially responsible investments and then doing your research.
- There is a perception that socially responsible investing will underperform the broader market. This is certainly not a universal truth. Some SRI investments will underperform, while others will outperform. It is important to research any investment before acting.
- SRI investing is very similar to ESG (Environmental, Social, and Governance) investing and Impact Investing. In fact, sometimes you may even see the terms used interchangeably. While there are subtle differences, all three focus their investment selection process on including companies that will more closely align with an investors ethical or social values. An important distinction between these types of investments is how the portfolio is constructed. Some funds may begin with a particular universe of companies (like the S&P 500, for example) and then screen-out or eliminate companies that are involved in areas that some may find objectionable, such as tobacco, weapons manufacturing, or gambling. Other funds may be much more selective when deciding which companies to include in their portfolios and invest only in companies whose operations and business models fit within the fund’s strict ethical, social, or moral guidelines.
Socially Responsible Investing can help you invest in line with your ethical values. However, you need to first ask yourself what the purpose of your investment is and then complete your research.
12. How do I know when it makes sense to refinance my mortgage?Refinancing can be a great idea if the interest rate on your refinanced loan is at least one percent less than your current interest rate. All other things equal, the lower the interest rate means a lower monthly payment.
Another way to justify a mortgage refi is by looking at the break-even point. Similar to when you first took out a mortgage, there are closing costs associated with refinancing. To calculate your break-even point, divide your closing costs by the difference in your monthly mortgage payments under the refi. For example, if the closing costs are $2,000 and the monthly payment decreases by $100 per month, the break-even point is 20 months. If you plan on selling the home before the break-even point, then refinancing doesn’t make sense.
You should also consider the timing of the refi. You build equity in your home when you pay down the principal. However, during the first years of your mortgage, most of the monthly payment goes toward interest. Let’s say you’re 12 years into a 30 year loan when you decide to refinance into another 30 year loan. This means you’re going back to paying mostly interest, and once it’s all said and done you’ll have made 42 years worth of mortgage payments!
13. My wife is a teacher and has a 403b annuity. Should we pay the surrender charges and move her money into an IRA?
Before deciding to surrender an annuity and incurring a surrender charge, you will want to look at the total expenses of the annuity versus the expenses of the IRA. If the surrender charges can be made up within a 1-2 year period because of lower ongoing expenses in the IRA, then you might want to surrender. Also, while annuities will typically have lower quality investment options than an IRA, sometimes annuities will have investments with attractive guaranteed returns. As a result, the investment options available can have an impact on your decision to surrender.
Prior to implementing any investment strategy referenced in this article, either directly or indirectly, please discuss with your investment advisor to determine its applicability. Any corresponding discussion with a Bedel Financial Consulting, Inc. associate pertaining to this article does not serve as personalized investment advice and should not be considered as such.
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