October – November 2014 Newsletter

Saving or Investing: Is There a Difference?

Financially speaking, the terms “saving” and “investing” are often used interchangeably. But the concepts behind these terms actually have some important differences. Understanding these differences and taking advantage of them may help you in working toward financial goals for you and your family.

Saving

You may want to set aside money for a specific, identifiable expense. You park this money someplace relatively safe and liquid so you can get the amount you want when you need it. According to the Securities and Exchange Commission brochure Saving and Investing, “savings are usually put into the safest places, or products, that allow you access to your money at any time. Savings products include savings accounts, checking accounts, and certificates of deposit.” Some deposits may be insured (up to $250,000 per depositor, per insured institution) by the Federal Deposit Insurance Corporation or the National Credit Union Administration. Savings instruments generally earn interest. However, the likely trade-off for liquidity and security is typically lower returns.

Investing

While a return of your money may be an important objective, your goal might be to realize a return on your money. Using your money to buy assets with the hope of receiving a profit or gain is generally referred to as investing. Think of investing as putting your money to work for you in return for a potentially higher return, you accept a greater degree of risk. With investing, you don’t know whether or when you’ll realize a gain. The money you invest usually is not federally insured. You could lose the amount you’ve invested (e.g., your principal), but you also have the opportunity to earn more money, especially compared to typical savings vehicles. The investment is often held for a longer period of time to allow for growth. It is important to note, though, that all investing involves risk, including the loss of principal, and there is no assurance that any investing strategy will be successful.

What’s the difference?

Whether you prefer to use the word “saving” or “investing” isn’t as important as understanding how the underlying concepts fit into your financial strategy. When it comes to targeting short-term financial goals (making a major purchase in the next three years), you may opt to save. For example, you might set money aside (i.e., save) to create and maintain an emergency fund to pay regular monthly expenses in the event that you lose your job or become disabled, or for short-term objectives like buying a car or paying for a family vacation. You might consider putting this money in a vehicle that’s stable and liquid. Think of what would happen if you were to rely on investments that suddenly lost value shortly before you needed the funds for your purchase or expense. Saving generally may not be the answer for longer-term goals. One of the primary reasons is inflation–while your principal may be stable, it might be losing purchasing power. Instead, you may opt to purchase investments to try to accumulate enough to pay for large future expenses such as your child’s college or your retirement. Generally, saving and investing work hand in hand. For instance, you may save for retirement by investing within an employer retirement account.

Why is it important?

Both saving and investing have a role in your overall financial strategy. The key is to balance your saving and investing with your short- and long-term goals and objectives. Overemphasize saving and you might not achieve the return you need to pursue your long-term goals. Ignore saving and you increase the risk of not being able to meet your short-term objectives and expenses. Get it right and you increase your chances of staying on plan.

 

Open Enrollment Season Is Here: Give Your Benefits a Check Up

Open enrollment season is your annual opportunity to review your employer-provided benefit options and make elections for the upcoming plan year. To get the most out of what your employer has to offer and potentially save some money, take time to read through the enrollment packets or information you receive before making any benefit decisions.

Review your health plan options

Even if you’re satisfied with your current health plan, compare your existing coverage to other plans your employer is offering for next year. Premiums, out-of-pocket costs, and benefits offered often change from one year to the next and vary among plans. You may decide to keep the plan you already have, but it doesn’t hurt to consider your options.
Some tips for reviewing your health coverage:
• Start by reading plan materials you’ve received in your open enrollment packet and find out as much as you can about your options. Look for a “What’s New” section that spells out plan changes.
• List your expenses. These will vary from year to year, but what you’ve spent over the course of the last 12 months may be a good predictor of what you’ll spend next year. Don’t forget to include co-payments and deductibles, as well as dental, vision, and prescription drug expenses.
• Reevaluate your coverage to account for life changes. For example, getting married, having a baby, or retiring are events that should trigger a thorough review of your health coverage.
• Consider all out-of-pocket costs, not just the premium you’ll pay. For example, if you frequently fill prescriptions, you may save money with a plan that offers the broadest prescription drug coverage with the lowest co-payments, even if it charges a higher premium than other plans.
• Compare your coverage to your spouse’s if he or she is eligible for employer-sponsored health insurance. Will you come out ahead if you switch to your spouse’s plan? If you have children, which plan best suits their needs?
• Take advantage of technology. Some employers offer calculators or tables that allow you to do a side-by-side comparison of health plans to help select the best option.

Decide whether to contribute to a flexible spending account

You can help offset your health-care costs by contributing pretax dollars to a health flexible spending account (FSA), or reduce your child-care expenses by contributing to a dependent-care FSA. The money you contribute is not subject to federal income and Social Security taxes (nor generally to state and local income taxes), and you can use these tax-free dollars to pay for health-care costs not covered by insurance or for dependent-care expenses. If your employer offers you the chance to participate in one or both types of FSAs, you’ll need to estimate your expenses for the upcoming year in order to decide how much to contribute (subject to limits). Your contributions will be deducted, pretax, from your paycheck. One thing to watch out for this open enrollment season: Because of a change to the “use-it-or-lose-it” rule, employers may now allow participants the chance to roll over $500 of health FSA funds that are unused at the end of one plan year to the next plan year. So before you decide how much to contribute to your health FSA, read through your employer’s materials to see whether this change will apply to you–employers aren’t required to adopt this new carryover approach. If your employer has not, you’ll lose any contributions you don’t spend by the end of your benefit period (including any grace period). And remember, you must enroll in a health or dependent-care FSA each year; enrollment is not automatic.

Find out what other benefits and incentives are available

Many employers offer other voluntary benefits such as dental care, vision coverage, disability insurance, life insurance, and long-term care insurance. Even if your employer doesn’t contribute toward the premium cost, you may be able to conveniently pay premiums via payroll deduction. To avoid missing out on savings opportunities, find out whether your employer offers other discounts or incentives. Common options are discounts on health-related products and services, such as gym memberships and eyeglasses, or wellness incentives such as a monetary reward for completing a health assessment.

Get the information you need

Ask your benefits administrator for help if you have any questions about your benefits, the options available to you, or enrollment instructions or deadlines. You generally have only a few weeks to make important decisions about your benefits, so don’t delay.

 

Leaving Assets to Your Heirs: Income Tax Considerations

An inheritance is generally worth only what your heirs get to keep after taxes are paid. So when it comes to leaving a legacy, not all property is created equal–at least as far as federal income tax is concerned. When evaluating whom to leave property to and how much to leave to each person, you might want to consider how property will be taxed and the tax rates of your heirs.

Favorable tax treatment for heirs:

Roth IRAs

Assets in a Roth IRA will accumulate income tax free and qualified distributions from a Roth IRA to your heirs after your death will be received income tax free. An heir will generally be required to take distributions from the Roth IRA over his or her remaining life expectancy. (Of course, your beneficiaries can always withdraw more than the required minimum amounts.) If your spouse is your beneficiary, your spouse can treat the Roth IRA as his or her own and delay distributions until after his or her death. So your heirs will be able to continue to grow the assets in the Roth IRA income tax free until after the assets are distributed; any growth occurring after funds are distributed may be taxed in the future. Note: The Supreme Court has ruled that inherited IRAs are not retirement funds and do not qualify for a federal exemption under bankruptcy. Some states may provide some protection for inherited IRAs under bankruptcy. You may be able to provide some bankruptcy protection to an inherited IRA by placing the IRA in a trust for your heirs. If this is a concern of yours, you may wish to consult a legal professional.

Appreciated capital assets

When you leave property to your heirs, they generally receive an initial income tax basis in the property equal to the property’s fair market value (FMV) on the date of your death. This is often referred to as a “stepped-up basis,” because basis is typically stepped up to FMV. However, basis can also be “stepped down” to FMV. If your heirs sell the property with a stepped-up (or a stepped-down) basis immediately after your death for FMV, there should be no capital gain (or loss) to recognize since the sales price will equal the income tax basis. If they sell the property later for more than FMV, any appreciation after your death will generally be taxed at favorable long-term capital gain tax rates. If the appreciated assets are stocks, qualified dividends received by your heirs will also be taxed at favorable long-term capital gain tax rates. Note: If your heirs receive property from you that has depreciated in value, they will receive a basis stepped down to FMV and will not be able to claim any loss with respect to the depreciation before your death. You may want to consider selling depreciated property while you are alive so that you can claim the loss.

Not as favorable tax treatment for heirs

Tax-deferred retirement accounts

Assets in a tax-deferred retirement account (including a traditional IRA or 401(k) plan) will accumulate income tax deferred within the account. However, distributions from the account will be subject to income tax at ordinary income tax rates when distributed to your heirs (if there were nondeductible contributions made to the account, the nondeductible contributions can be received income tax free). An heir will generally be required to take distributions from the tax-deferred retirement account over his or her remaining life expectancy. (Of course, your beneficiaries can always withdraw more than the required minimum amounts.) If your spouse is the beneficiary of the account, the rules may be more favorable. So your heirs will be able to defer taxation of the retirement account until distribution, but distributions will generally be fully subject to income tax at ordinary income tax rates. Note: Your heirs do not receive a stepped-up (or stepped-down) basis in your retirement accounts at your death. Even though distributions are taxable, your heirs will nevertheless generally appreciate receiving tax-deferred retirement accounts from you. After all, they do get to keep the amounts remaining after taxes are paid.

Toxic or underwater assets

Your heirs might not appreciate receiving property that is subject to a mortgage, lien, or other liability that exceeds the value of the property. In fact, an heir receiving such property may want to consider disclaiming the property.

Life insurance and cash

Life insurance proceeds received by your heirs will generally be received income tax free. Your heirs can generally invest life insurance proceeds and cash they receive in any way that they wish. When doing so, yours heirs can factor in how the property will be taxed to them in the future.

 

I’m looking to buy a home. What are some common mortgage mistakes to avoid?

Navigating the complex world of mortgages can be difficult. As a result, it’s easy to make mistakes when applying for a mortgage loan. Here are some common mortgage mistakes you should try to avoid:

• Taking on a mortgage that is too big for you to handle. The mortgage you are qualified or pre-approved for isn’t necessarily how much you can afford. Be sure to examine your budget and lifestyle to make sure that your mortgage payment–including any extras, such as mortgage insurance–is within your means.
• Neglecting to read the fine print. Before you sign any paperwork, make sure that you fully understand the terms of your mortgage loan and the costs associated with it. For example, are you are applying for an adjustable-rate mortgage? If so, it’s important to be aware of how and when the interest rate for the loan will adjust.
• Overlooking your credit. A positive credit history may not only make it easier to obtain a mortgage loan, but potentially could also result in a lender offering you a lower interest rate. Be sure to review your credit report and check it for inaccuracies. You may have to take the necessary steps to improve your credit history, such as paying your monthly bills on time and limiting credit inquiries on your credit report (which are made every time you apply for new credit).
• Putting down too little. While it is possible to obtain a mortgage with a minimal down payment, a larger down payment may help you get more attractive mortgage terms. In addition to requiring private mortgage insurance, lenders generally offer lower loan limits and higher interest rates to borrowers who have a down payment of less than 20% of a home’s purchase price.
• Forgetting to shop around. Be sure to shop around among various lenders and compare the types of loans offered, along with the costs and rates associated with those loans. Consider each lender’s customer service reputation as well.

 

What factors could negatively impact my credit report?

Having a good credit report is important when it comes to personal finance, because most lenders use credit reports to evaluate the creditworthiness of a potential borrower. Borrowers with good credit are presumed to be more creditworthy and may find it easier to obtain a loan, often at a lower interest rate. A number of factors could negatively impact your credit report, including:

• A history of late payments. Your credit report provides information to lenders regarding your payment history over the previous 12 to 24 months. For the most part, a lender may assume that you can be trusted to make timely monthly debt payments in the future if you have done so in the past. Consequently, if you have a history of late payments and/or unpaid debts, a lender may consider you to be a high credit risk and turn you down for a loan.
• Too many credit inquiries. Each time you apply for credit, the lender will request a copy of your credit history. The lender’s request then appears as an inquiry on your credit report. Too many inquiries in a short amount of time could be viewed negatively by a potential lender, since it may indicate that the borrower has a history of being turned down for loans or has access to too much credit.
• Not enough good credit. You may have good credit, but not enough of it. As a result, you may need to build up more of your credit history before a lender deems you worthy to take on any additional debt.
• Uncorrected errors on your report. Uncorrected errors on a credit report could make it difficult for a lender to accurately evaluate creditworthiness, and could result in a loan denial. If you have errors on your credit report, it’s important to take steps to correct your report, even if it doesn’t contain derogatory information.

Finally, if you are ever turned down for a loan, there is a way to find out the reason behind it. Under federal law, you are entitled to a free copy of your credit report as long as you request it within 60 days of receiving notice of a company’s adverse action against you. For more information, visit the Federal Trade Commission’s website.

 

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