Win the War for Money and Success

by Neil Jesani

  As with any savings plan already covered in this book, all college savings plans or strategies are not created equal. The best plans offer lower expenses and special tax advantages to pay for college tuition. A smart college savings plan should allow you to legally “hide” your assets and help you qualify for financial aid, if you fall on the lower income side of the equation.

  Saving for your child’s college education requires a long-term commitment and sizable monthly or annual contribution to a plan or policy. In the same manner that you save for retirement, the earlier you start your plan, the better. The right college savings plan, structured in a tax-efficient manner and constructed during a child’s younger years, will allow for college education choices to be determined by their grades and SAT or ACT scores, as opposed to which schools are most affordable or the scholarships they receive. As a side note, investing in the student’s extra-curricular activities is also a very important part of college admission preparation.

  Following are three of the most viable and popular college savings plans:

  1. Bank CD or Money Market Account

  2. 529 College Savings Plan

  3. Cash Value Life Insurance-based College Savings Plan

  The first plan is your basic savings plan. The amount you save will grow if you exercise discipline and put enough money away each month. However, you are paying taxes on the money you place into savings and you will be paying taxes on the annual interest your money earns. While you do not pay taxes on the money you withdraw from the plan, it is not the most efficient method to save for college. The only time this savings method is ideal is when you started saving for college very late, and you need money in the next couple years. At the time, the safety and liquidity of money is more important than tax advantages or higher earning you would receive with other plans.

  One thing you discover when your child tries to secure financial aid for his education is that all of your assets are used in the calculation. The paradox is that the more you save for college, the less your child will be allowed to receive in financial aid.

  A more efficient way to save for college is the 529 college savings plan. Congress created Section 529 plans in 1996, and they have emerged as one of the popular ways to save money for college. Section 529 plans are officially known as “qualified tuition programs” under federal law.

  A 529 college savings plan or program is a college funding vehicle that has federal tax advantages. There are two types of 529 plans: college funding (or savings) plans and prepaid tuition plans. Although college funding plans and prepaid tuition plans share the same federal tax advantages, there are important differences between them.

  Section 529 College Savings Plans

  529 college savings plans let you save money for college in an individual investment account. Individual states run these plans, which typically designate an experienced financial institution to manage them. To open an account, you fill out an application, choose a beneficiary, and start contributing money. After this, you simply decide when, and how much, to contribute.

  The plan investment managers commonly invest your money based on the age of your daughter or son (this is known as an age-based portfolio). Under this model, when a child is young, most of the portfolio’s assets are allocated to aggressive investments. Then, as a child grows, the portfolio’s assets are gradually and automatically shifted to less volatile investments to preserve principal. The idea is to take advantage of the stock market’s potential for high returns when a child is still many years away from college, then to lessen the risk of these investments in later years. When it is time for college, the beneficiary can use the funds at any college in the US and abroad, as long as it is accredited by the U.S. Department of Education.

  Section 529 Prepaid Tuition Plans

  Prepaid tuition plans let you save money for college, too, but in a different way. Prepaid tuition plans may be sponsored by states (on behalf of public universities) or by private colleges. A prepaid tuition plan lets you prepay tuition expenses now for use in the future. The plan’s money manager pools your contributions with those from other investors into one general fund. The fund assets are then invested to meet the plan’s future obligations. Many plans even guarantee a minimum rate of return.

  The most common type of prepaid tuition plan is a contract plan. With a contract plan, in exchange for your upfront cash payment (or series of payments), the plan promises to cover a predetermined amount of future tuition expenses at a particular college in the plan. These plans have different criteria for determining how much they’ll pay out in the future. If your child ends up attending a school that isn’t in the prepaid plan, you’ll typically receive a lesser amount according to a predetermined formula.

  There are definite advantages to 529 college savings plans. They are federal and state tax-deferred growth. The money you contribute to a state-sponsored qualified 529 plan is after taxed dollars, but it grows tax-deferred each year. Your earnings will be free of federal tax, as long as the money is used for college. Likewise, the money in a 529 plan receives favorable federal estate tax treatment. Your plan contributions are not considered part of your estate for federal tax purposes.

  There are also state tax advantages. States can also add their own tax advantages to 529 plans. For example, some states exempt qualified withdrawals from income tax or offer an annual tax deduction for your contributions.

  Section 529 plans are open to anyone, regardless of income level. It does not necessarily have to be opened by a parent. A grandparent, another relative, or any interested adult can set one up for a child. It also has a high contribution limit. The total amount you can contribute to a 529 plan is generally high. Most plans have limits of $250,000 and up.

  While there are definite advantages to a 529 plan, it also has its potential downsides. These plans do not guarantee your investment return due to typical stock market volatility. You can lose some or all of the money you have contributed if you have made some serious wrong decisions about the investments. Even though prepaid tuition plans typically guarantee your investment return, some plans change the benefits they will pay out due to projected actuarial deficits.

  There are penalties on non-qualified withdrawals. If you want to use the money in your 529 plan for something other than college, it will cost you. With a 529 college savings plan, you’ll pay a 10% federal penalty on the earnings part of any withdrawal that is not used for college expenses (a state penalty may also apply). You will pay income tax on the earnings, too. With a prepaid tuition plan, you must either cancel your contract to get a refund or take whatever predetermined amount the plan will give you for a non-qualified withdrawal (some plans may make you forfeit your earnings entirely; others may give you a nominal amount of interest.)

  There are typically fees and expenses associated with 529 plans. They might charge an annual maintenance fee, administrative fees, and an investment fee based on a percentage of your account’s total value. Prepaid tuition plans may charge an enrollment fee and various administrative fees.

  While 529 plans are efficient, its amount is included in the calculation of parents’ assets when determining financial aid. You have to consider this downside, and the other potential liabilities of the 529 plan before deciding to take this track in a savings plan for college.

  Cash Value Life Insurance Plan

  Using cash value life insurance such as whole life and indexed universal life as a savings vehicle for college provides almost all the advantages of 529 college savings plans while eliminating some disadvantages.

  Whole life insurance cash values receive pretty much the same favorable tax treatment as 529 plans. The money you put into life insurance is after tax dollars and the growth within the policy is tax-deferred. Utilizing policy loans, you can make tax-deferred loans to fund your child’s college experience. The policy’s cash values can be withdrawn as a policy loan without any tax consequences for any purpose and at any time. If you do not use the money for
qualified college expenses, there is no 10% IRS penalty as there is with 529 plans.

  This is a life insurance policy. Your family gets life insurance protection while also meeting the important financial goal of college financial planning. If you die prematurely, the death benefit is there to provide sufficient funds for your child’s education at the college of his or her choice.

  Life insurance allows you to include a waiver of premium rider for a very miniscule cost. This means that if you become totally disabled because of a sickness or injury, the insurance company will pay your life insurance premiums. Therefore, your college savings plan will be self-completing. No other plans will continue putting payments in for you if you cannot do so because of a disability.

  In whole life insurance plans, you have the safety of a guaranteed cash value. You don’t have to risk losing it in the stock market! When you start out the plan, you will know how much you will have in assets when the time comes to access the money for college. With indexed universal life, you will have the opportunity to invest in the stock market and take advantage of potential increases in value while limiting stock market losses with a zero percent return floor.

  This plan is one of the few ways to legitimately “hide” assets when computing financial aid eligibility. Since life insurance values are not included in the federal methodology for calculating financial aid, you will not be penalized for saving money in this way for college.

  A cash value life insurance plan has its owned drawback – it only works well if you start while the child is very young, unless you are trying to shelter your money for financial aid purposes.

  Summary

  It takes consistency and discipline to save the large amount of money needed for college. To be successful at it, parents need to formulate a plan early and stick with it. A traditional savings plan offers limited advantages. The 529 plan for college savings was implemented by the government to aid parents in setting money aside for college. It offers tax-deferred growth and limited tax liabilities when money is taken out for college. However, these plans are affected by market conditions, fees and expenses, and subject to heavy penalties if taken out early or not used for education.

  Whole life insurance offers an attractive alternative with the same benefits as the 529 plan with additional advantages. It is not something that you include in your assets when applying for financial aid, the insurance company will continue paying your premiums if you become disabled, and you have greater flexibility with how you use your money.

  Be sure to explore all the options of the available plans. You will need a great deal of money to put your children through college, so start early. The longer you wait, the more difficult it will be to meet your goals.

  CHAPTER 14

  Doubling Retirement Income

  “The question isn’t at what age I want to retire; it’s at what income.”

  George Foreman

  Y

  ou have spent the last thirty or forty years working diligently at your chosen profession. You are successful and earned a reputation for being good at what you do. Throughout your working years, you saved meticulously for your retirement. The portfolio you established accumulated a great deal of money. A couple of investments did not go as well as you hoped, but overall, you did quite well. You own a nice home and have a vacation house at the beach. You traveled with your family and got your kids through college. They are doing well on their own, and you decide it is time to fold your tent.

  Now what?

  This is a question many people ask when they retire. The question covers a multitude of subjects. What are you going to do every day? Are you going to miss working? Is your spouse going to beg you to find something else to do? These are all very real issues you have to figure out. However, the most important situation you face is how to spend your money in order to get the most out of your savings and assets you have put together during your working years.

  When it comes time to spending your savings at retirement, you need to have as much discipline and methodology to liquidate your money as you did when you were accumulating it. A very real problem that retirees face is outliving their money. This is a direct result of better medical care, nutrition and healthier lifestyles that have developed over the years.

  One of your sources of income during retirement perfectly illustrates this point. You will be able to collect Social Security when you retire. When Franklin Roosevelt started the Social Security program in the early 1930s, life expectancy was only 62 years of age. If a person collected, the odds were that it wasn’t going to be for a long time. Now, life expectancy is projected into the late ’70s with many people hitting their 80s and 90s. Most of these people are not just sitting around waiting to die. They are out there being active in their communities, traveling and living life. It takes money to do that.

  That is why you have to approach your retirement looking at the long-term ramifications. It is not unheard of for a successful professional to put in a good thirty years of work and retire at 55. The chances are good you have another 30 years of living to worry about!

  When looking at the different savings plans, a successful professional like yourself at retirement will have accumulated a very nice nest egg through a diversified portfolio by following the suggestions in this book. You will be receiving Social Security, which is not much of a factor in the grand scheme of things. Let’s review what you saved through your own initiatives.

  When spending your savings, there are four factors you always have to consider. You need to know how the government requires you to report any disbursements of your portfolio on your income tax. Likewise, you should know what assets could have estate tax implications. Knowing what your rate of return is on each of your investments will also help you establish a priority on what monies to tap first. Finally, you have to take into account if any of your investments have a death benefit for your beneficiaries.

  For our example here, let’s say Dr. Sam was an excellent general practitioner and is retiring. Through his efforts working with various professionals, he has five buckets of savings to draw from in his retirement. They are:

  1. CD’s and savings accounts - $500,000

  2. Brokerage account with investments in stocks, commodities, mutual funds, etc. - $1,000,000

  3. Qualified retirement plans (IRA, defined benefit plan, defined contribution plan, etc.) - $2,000,000

  4. Real Estate (primary home, vacation home) - $1,000,000

  5. Whole life insurance - $1,000,000 cash value/$3,000,000 death benefit

  I have listed these in the order in which Dr. Sam should withdrawal moneys to fund his retirement life. Follow along as I explain the rationale.

  In bucket #1, the good doctor accumulated a half million dollars in various CDs and savings accounts. He already paid income tax on the money he originally put into these savings. He has also paid income tax every year on any interest the money earned. That interest is miniscule. He won’t pay income tax on any of the money he takes out, the rate of return on his money is small, and whatever interest that is reportable every year will become lower the more he takes out. For these reasons, it makes sense that this is the first batch of money he takes for retirement. It doesn’t increase his income taxes to withdraw these funds, as it reduces the size of his estate, and there is no death benefit attached to it.

  Dr. Sam should then move on to his brokerage account. Like his savings, Sam used after-tax dollars to invest, and he has been paying income tax on any earnings and dividends over the years. His money earns more here than in his traditional savings accounts, so that is one reason to use this bucket second. Any withdrawals do not have to be reported on his income tax since they’ve been taxed already through the years. With no death benefit available here, this becomes bucket number two for him to take from.

  The doctor’s qualified retirement plans require different considerations. Remember, the money he put into these plans avoided income tax when invested. Likewise, the earning
s and interest accumulated over the years were also not taxed. If the money was invested well, he should have had a decent rate of return over time. When he withdraws this money, he will have to report this on his current income tax.

  Now you might think that with good earnings and knowing that it is reportable income when tapped, these retirement plans should be the last thing he wants to access. This is where the Internal Revenue Service comes in. Remember, Congress established the framework for these plans and worked them into the tax code of the IRS. Their creation was to encourage retirement savings for all of the reasons mentioned in previous chapters. When created, these plans had an Required Minimum Distribution (RMD) built into them. This means that when the doctor reaches 70 ½ years old, he has to start taking an income from his plans whether he needs it or not. It is the IRS’s way of saying, “We let you exempt all this money from income tax for years. It’s time to start paying up!” Ideally, it might be one of the last buckets of money the doctor wants to dip into, but at a certain point, he doesn’t have a choice.

  Real estate allows a person flexibility on what to do with it. In the doctor’s case, he has two homes. For some people, they want to downsize their main home, while others want to keep it for the children and grandchildren to return to. Others buy the vacation home with the idea to sell the main home, and move permanently to the vacation home at retirement. It is all a matter of personal choice. Factors such as equity, property taxes, and location also come into play. A home is a big asset that can be accessed in the case of some catastrophic emergency and is usually one of the last buckets to utilize.