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Bob Carlson's - November 2015

Dear Reader:

Forecasts and predictions will pour forth in the next few months. It’s the time of the year when the financial media are filled with the experts telling us what next year is going to be like. Also, many experts will issue their own detailed forecasts for 2016. Ignore these predictions or treat them as entertainment.

Before considering new forecasts, take a look at past forecasts. You won’t find too many from last year that were very accurate.

For example, a widely-promoted forecast the last few years said the recent federal legislation on foreign bank accounts would cause a collapse of the dollar almost overnight. Readers of the forecast were urged to buy gold and other non-dollar assets. The legislation went into effect and caused disruptions for some people and banks, but it didn’t cause any of the serious effects in the forecast. The dollar’s done quite well while gold’s declined.

More importantly, to be useful to an investor a forecast has to be right more than once or about more than one thing.

Suppose someone accurately predicted the sharp collapse in oil prices. A forecast of such a sharp drop in oil prices likely would be the result of an expectation of an economic calamity. Instead, the drop in oil prices was based more on higher supplies than on lower demand. Lower oil prices helped the global economy, other than sectors and countries that depend oil exports for their revenue. Stocks overall and the U.S. economy did well as oil prices collapsed.

Similarly, a few people before 2007 predicted the collapse of U.S. housing prices. Many recommended investing outside the U.S.,especially in emerging markets. It turns out that those investments fared worse in the crisis than U.S. investments. Others who forecast the crisis were too early. They lost money for several years waiting for the collapse. They also didn’t anticipate things would become as bad as they did, so they exited profitable investments early.

The best investment managers I know don’t invest based on forecasts. Most don’t even make forecasts. Those that do, don’t structure their portfolios based on the forecasts. As a result, they often make solid profits when their forecasts are wrong.

Good investors follow the fundamentals and market trends. They don’t try to find exact tops and bottoms or make dramatic forecasts. They want to make money, not news. They let the markets and economy tell them how to invest.

The Most Common Estate Planning Mistakes

The simplest acts often turn out to be the biggest mistakes cause the most problems for estates. Beneficiary designations and titles to assets are the most likely sources of mistakes and problems. Though estate planners are aware of the common mistakes and the consequences, many people aren’t. Simple, well-intentioned actions and failures to act often result in major problems.

The mistakes we’re going to cover usually involve assets and ways of holding property that avoid probate. Because the property avoids probate, it often doesn’t receive scrutiny from an estate planner, and a planner might not even be told about the property because the owner believes it is taken care of. Let’s take a look at some widely-committed mistakes that can lead to unintended consequences.

Converting financial accounts to joint ownership. Often an aging parent will decide to have one or more financial accounts held jointly with an adult child. The simple move is designed to avoid two problems. First, it substitutes for a financial power of attorney. Instead of having a document drafted that gives the adult child the power to manage the accounts when the parent is unable to, the joint title takes care of that. Each owner has authority over the accounts and can make decisions. Second, the accounts avoid probate. One co-owner automatically has full legal title to the account after the other passes away.

The jointly-held account often creates problems. In most states, half the jointly-held account is subject to the claims of creditors of either co-owner. Your assets could end up in someone else’s hands if your adult child divorces, loses a lawsuit, or runs up big debts. Also, it unfortunately isn’t unusual for adult children to start using such joint accounts to fund their own lifestyles.

There also could be tax problems. The IRS is going to consider the creation of the joint account as a gift of half the account from you to the child. You didn’t intend for the child to own the property. It only was a way to help you manage the assets and avoid probate. But the IRS says you made a gift.

When the account has assets other than cash, your heirs could lose a valuable benefit. After assets are inherited, the heirs increase the basis of the assets to their current fair market value. All the appreciation that occurred while you owned the property isn’t subject to capital gains taxes. When the account is owned jointly, however, the increase in basis only occurs for half the account. The other half is treated as a gift from you to the other co-owner, and that co-owner takes the same tax basis you had in the assets.

Naming one child as beneficiary. Too often a parent decides to keep things simple by naming only one adult child as beneficiary of life insurance or a financial account, including an IRA. The parent’s intent, which often was expressed to the children, is that the child who is named as beneficiary will split the account or insurance evenly with the other children.

The law doesn’t allow you to do things this easily.

Of course, once one child takes title to the property, it is subject to the claims of any of his or her creditors. So, you don’t want to do this with anyone who might have credit problems. Also, there are likely to be tax consequences if that child does split the property with the other children. As new legal owner of the property, anything he distributes to the other siblings is a gift from him tot them. The $14,000 annual gift tax exclusion allows him to give that amount tax free each year to each of the siblings. Any gifts above that amount, however, reduce his
lifetime estate and gift tax exclusion. And he has to file a gift tax return reporting the gifts.

If the account is an IRA or other qualified retirement plan, the child has to take a distribution, pay income taxes on it, and give the after-tax amount to the other siblings. There’s no provision in the law for an IRA beneficiary to either split the account with others who also weren’t beneficiaries or to rollover part of the account to nonbeneficiaries. The only way to transfer part of the IRA to another sibling is to take a distribution and pay income taxes on it.

Finally, the child has no legal obligation to share the property with the others. There are many instances of one child being given responsibility for an account or an estate and simply claiming that the parents meant for him or her to have all of it.

Failure to name or update. We’ve covered this many times, but it can’t be repeated too often. Failing to name a beneficiary for an IRA or other retirement plan means the estate will be treated as the beneficiary. That eliminates the potential for having a Stretch IRA in which tax deferral can be maximized. Instead, the entire account must be distributed and subject to income taxes within five years.

Failing to name a beneficiary also means that an asset that normally would avoid probate must go through the probate process. It will be considered part of the estate and be distributed according to the terms of either the will or state law. For financial accounts, the company that holds the account might have its own default rules for determining who is the beneficiary when one isn’t named. Of course, you need to keep beneficiary designations up to date. Too many people select beneficiaries when they open an account or buy a policy and never review the decision after marriages, divorces, deaths, and other events.

Not having contingent beneficiaries. The contingent beneficiary receives the property when the primary beneficiary already passed away or declines the property. When there isn’t a contingent beneficiary, then most of the time the consequences are the same as if no beneficiary were named. But sometimes state law or the rules of the account custodian might dictate a strange result.

For example, Max Profits has three adult children and he names them as equal beneficiaries of his IRA. One of the children dies, and then Max dies before updating the beneficiary form. Max didn’t name a contingent beneficiary. Max’s surviving children think they should split the IRA. But the IRA custodian says under its guidelines and state law the children of the deceased child receive one-third of the IRA. That should be your decision and would be if you name contingent beneficiaries.

Naming trusts as IRA beneficiaries. This is another issue we’ve discussed in the past but that bears repeating. I regularly receive questions from readers asking if they should name one of their estate planning trusts as an IRA beneficiary.

In most cases, when a trust is named IRA beneficiary, required distributions from the IRA are accelerated. The ability to stretch out the distributions and maximize tax deferral is lost. Only certain types of trusts can be IRA beneficiaries and maximize tax deferral. We discussed the details in the June 2014 visit.

Naming multiple co-beneficiaries. This is frequently done with IRAs, financial accounts, and even real estate using a Transfer on Death deed or a similar designation. The arrangement can work well. With an IRA, the beneficiaries can agree to split it into separate IRAs. With other assets, they might work well together making decisions about the asset.

Too often, however, the strategy leads to problems. The beneficiaries can’t agree on how to manage the property or how to split it. It can be a major problem with real estate, because they all have to agree on everything. If they agree to sell, then they must agree on a broker, the offering price, and how to respond to each offer. They also might have to contribute equally to property taxes and other expenses until the property is sold.

A better structure is to split the property now or allow the children to benefit equally from the property but have one person manage it or handle the sale. For example, the property can be inherited by a trust or an LLC. The children receive all the income and gains. But only the trustee or the managing member of the LLC makes decisions about the property. That person can be one of the children or it can be an independent professional.

Naming an inappropriate beneficiary. This happens more than you would expect. A minor should not be named the direct beneficiary of property or life insurance. If he or she is, then the child will receive full title and control of the property upon turning 18. When minor children are involved, you need to set up a trust that manages the assets and distributes income and principal either on a schedule you set up or at the trustee’s discretion.

Of course, you don’t want to give property directly to someone who might waste it, including someone with a history of financial mismanagement, substance abuse, or gambling issues. Property also probably shouldn’t be given directly to someone who might be divorced, subject to liability lawsuits, or is in a risky business. Such loved ones can benefit from the property if you have it managed and distributed under the terms of a trust.

Finally, special needs individuals shouldn’t receive property directly. This could disqualify them from receiving government benefits or other help. Instead, discuss a special needs trust or supplemental needs trust with an estate planner.

How IRAs Benefit You, Loved Ones, & Charity

There are many ways an IRA can benefit you, your loved ones, and charity. In fact, charitable strategies might leave everyone better off than traditional IRA strategies.

These strategies are appropriate for traditional IRAs, not the tax-free Roth IRAs. I’m also not talking about the $100,000 IRA charitable contribution law that has moved in and out of the tax law in recent years. (Currently, the provision expired at the end of 2014, but there’s a chance it will be reinstated retroactively for 2015 contributions. The problem is we can’t count on that.)

One advantage of these charitable strategies is they can keep your kids from messing up plans for your IRA. It’s not unusual for parents to spend a fair amount of time structuring an IRA inheritance to maximize the after-tax benefits and deferral to their children. Then, after inheriting the IRA, the children mess up all that planning by taking the money out quickly, paying the income taxes, and spending the rest. You might be able to prevent that and still provide substantial benefits to your children.

Another advantage is these strategies can help reduce the problems required minimum distributions cause many people. For a number of people in their late 70s and older, the RMDs increase each year and exceed what they need for spending. The result is higher income taxes and the loss of deferral.

A third potential advantage is the strategies won’t be affected by the proposals to end or curtail Stretch IRAs. The President introduced such proposals in recent budgets, and some members of Congress also favor the change. If you’re worried about such proposals becoming law and want to be in front of things, consider charitable IRA strategies.

Charity as IRA beneficiary. The simplest strategy is to make charitable gifts in your estate through an IRA. You can set up a separate IRA that has roughly the amount you want the charity to receive, and name the charity as the beneficiary. Or you can name the charity as one of several beneficiaries for an IRA, noting either the dollar amount or the percentage of the IRA you want the charity to receive.

After you pass, the charity takes a distribution of its share of the IRA. Since the charity is tax-exempt, it doesn’t owe any income taxes and receives the full benefit of the distribution.

When your children or other loved ones inherit an IRA, they include the distributions in gross income and owe income taxes on them. They really inherit only the after-tax value. But when they inherit non-IRA assets, they increase the tax basis to the current fair market value. They can sell the assets right away and won’t owe any capital gains taxes on the appreciation that occurred while you owned the property.

If you’re going to make a straightforward charitable contribution through your estate, it’s better to make them through an IRA than the rest of the estate.

Charitable remainder trust. There are at least two ways to combine an IRA with a charitable remainder trust (CRT).

The first strategy provides long-term income for your loved ones and prevents them from spending down the assets too quickly. Your estate planner drafts a CRT, usually as part of your will and called a testamentary CRT. (The charity or charities you wish to benefit might have legal forms available.) On the beneficiary designation form for the IRA, you name the CRT as the beneficiary. After you pass, the entire IRA is distributed to the CRT.

The CRT then pays income to a beneficiary or beneficiaries you named in the trust. A typical provision is for the CRT to pay a percentage of the trust assets to the beneficiary for life. The
annual payouts rise and fall with the value of the trust. An alternative is for the trust to pay a fixed annual amount to the beneficiary. IRS regulations limit the amount of income that can be paid to the beneficiary. After the beneficiary passes away, the remainder of the trust is donated to the charity.

If your estate planner runs the numbers, they should show that your beneficiary receives more after-tax money under the CRT than if the IRA is liquidated either shortly after it was inherited or within five years. The beneficiary receives a little more lifetime after-tax money if he or she had stretched distributions over life expectancy and managed the investments as well as the trust. But the purposes of the trust are to ensure the beneficiary doesn’t spend too quickly and also to benefit the charity.

A CRT also can be used during your lifetime to avoid RMD problems and generate lifetime income. You can take a distribution of all or a large portion of the IRA. That amount is included in your gross income. You immediately transfer all or most of the distribution to a CRT. The CRT is set up to pay annual income to you (or you and your spouse) for life. After that, the remainder goes to the charity. As an alternative, you can have the CRT pay income to your children or grandchildren if you don’t need the income.

When you contribute money to the CRT, you receive a charitable contribution deduction. The deduction isn’t equal to the full value of the contribution. Instead, the deduction is the present value of the amount the charity is expected to receive. Current interest rates and tables issued by the IRS are used to determine the deduction. The older you are, the larger the percentage of the contribution you can deduct.

The strategy should significantly reduce the taxes owed on the IRA distribution and your lifetime taxes on the IRA money. It also ensures you have lifetime income and that charity receives a contribution.

Most large charities have offices that will manage and administer a CRT for little or no money when they are a beneficiary of the CRT.

The life insurance twist. This strategy can ensure that your loved ones and a charity receive the full after-tax value of your IRA or more. It is for someone who doesn’t really need the IRA to pay for retirement spending and wants to ensure the maximum after-tax value can pass to others.

First, name your spouse as the primary beneficiary of the IRA and charity as the contingent beneficiary. You can name a donoradvised trust as the charitable beneficiary so that you don’t have to determine the charities now.

Then, you acquire a permanent life insurance policy. It usually is best to obtain a joint and survivor policy issued to you and your spouse with the policy benefit equal to the current value of the IRA. The policy should be owned by an irrevocable life insurance trust. You can use distributions from the IRA to pay the premiums, either RMDs or regular distributions. The trust benefits your children, and perhaps the grandchildren.

Here’s an example of how the strategy can work.

Max Profits is 71 and his wife Rosie is 65. Max has a $2 million traditional IRA, and his first RMD will be about $73,000. He doesn’t need that income to fund his expenses.

Max and Rosie obtain a joint and survivor life insurance policy with a benefit of $2 million for an annual premium of $25,213. They establish a life insurance trust to be the beneficiary and owner of the policy, with their three children and four grandchildren as future beneficiaries of the trust.

Max changes his IRA designation form so that Rosie still is the primary beneficiary but a donor-advised fund is the contingent or secondary beneficiary.

During Max’s lifetime, he takes RMDs from the IRA and contributes a portion of them to the trust to pay the insurance premiums. These should qualify as tax-free gifts under the annual gift tax exclusion. After Max passes away, the IRA is available to Rosie for income and to make gifts to the trust to pay insurance premiums.

After Rosie passes away, the remaining value of the IRA goes to the donor-advised fund. There are no taxes on this transfer. The children and grandchildren then can serve as directors of the fund and make charitable gifts from the fund over the years.

Also after Rosie’s passing, the life insurance policy pays $2 million to the insurance trust, and the trust makes income and principal distributions to the children and grandchildren according to the terms Max and Rosie set when they created the trust. The life insurance proceeds avoid all income and estate taxes for both the trust and the beneficiaries.

The result is that the children and grandchildren receive the IRA’s full initial value without any reduction by taxes, RMDs, or poor investment returns. Max and Rosie both have access to the IRA during their lifetimes. The remainder of the IRA goes to the charitable fund set up by Max and Rosie, and their children and grandchildren oversee it. Because of the leverage in the insurance policy and the lack of taxes, there is more money available than before, so all these goals can be met.

A number of variations in the details are possible. For example, instead of naming Rosie as the sole initial beneficiary of the IRA, a charitable trust could be the beneficiary. It would pay Rosie a lifetime income, and any remainder would go to the foundation or other charities. Or after Max’s passing the IRA could buy an annuity payable to Rosie for life.

A New Flexible, Affordable Long-Term Care Plan

The revolution in planning for long-term care continues.

Longtime readers know that traditional stand-alone longterm care insurance (LTCI) policies aren’t the only way to go. Many people don’t like LTCI because of its use-it-orlose- it nature. If you never file a claim on the LTCI policy, then you and your heirs don’t receive a financial benefit from all the premiums paid during your lifetime. Also, the traditional LTCI market’s been in turmoil since the financial crisis. Many insurers dropped out of the market. Others reduced coverage, hiked premiums, or took other actions. There’s a lot of uncertainty about traditional LTCI.

More and more people are turning to hybrid or combo policies to help cover any LTC expenses. Hybrid policies are either annuities or life insurance policies with LTC riders. Through these, you can obtain affordable LTC coverage, and if you don’t exhaust the policy benefits on LTC, there’s something left for your beneficiaries.

Hybrid policies can be a mixed bag. Some are attractive. Others are too expensive or have limited benefits. In the past we highlighted a couple of very attractive combo annuities, the ForeCare Fixed Annuity (see the July 2013 visit) and the Indexed Annuity Care from State Life Insurance (see the October 2014 visit).

This month we look at a brand-new and very attractive hybrid life insurance policy from Nationwide Life and Annuity Insurance Company.

There are several unique features to the Nationwide YourLife® No-Lapse Guarantee SUL II (SUL II).

One feature is that one policy covers both life insurance and LTC for two people. Also, the two don’t have to be a married couple. Of course, a married couple can use the policy. But unlike many other policies, this one can be established for an adult child and one parent, or by domestic partners. Any two people with an insurable interest can be covered under one policy.

While SUL II is a permanent life insurance policy, it isn’t a cash value policy. Instead, it is a permanent, nocash-value policy with guaranteed benefits and premium to age 100. That makes this policy cheaper than the hybrid cash value life insurance policies. In essence, it is a Term to 100 policy with a big LTC benefit kicker.

With Nationwide’s new SUL II approach you will never pay more into the policy than will be paid out in either LTC benefits or a life insurance benefit. So, the first step should be to determine who should be the life insurance beneficiary after the second insured passes. (If there’s no one to receive a life insurance benefit, then you should consider an annuity with an LTC rider instead of the life insurance combo strategy.)

Each insured person will select his or her maximum LTC benefit. While the life insurance benefit can be higher, the SUL II maximum total LTC benefit for each person is $10,000 per month for 50 months, as set by current HIPPA regulations, or a total $500,000 payout. If Max and Rosie Profits, a married couple, take out a policy with a $500,000 life benefit, they can each select an LTC benefit ranging from $50,000 to a maximum of 50% of the life insurance benefit, $250,000 in this case. They can each select the maximum LTC benefit of $250,000. To obtain more LTC coverage, they simply buy a higher value of life insurance. The amount of the LTC coverage affects the premium.

Next, choose the premium payment schedule. You can choose either a single sum deposit, continuous annual deposits, or anything in between. A popular choice is 10 level annual payments creating a policy with coverage to age 100.

The LTC coverage is triggered in the same ways as in traditional LTCI policies and most hybrid policies. Your licensed healthcare professional certifies that either you have a severe cognitive impairment or are unable to perform two or more of the six activities of daily living.

After a 90-day waiting, or elimination, period the monthly LTC payments begin. LTC payments last for up to 50 months if you take the maximum monthly payment of 2% of the maximum LTC benefit. You can extent the duration of the payments by electing a monthly benefit payment of less than 2% of the maximum LTC coverage. (There is a separate 90-day elimination period for each insured.)

Another advantage of the SUL II Hybrid policy is that the LTC coverage is a cash indemnity benefit, not a reimbursement. With a cash indemnity plan the full contractual LTC benefit amount is paid to you in full each month without your having to prove that care took place or the cost of care. To ensure the LTC benefits are tax free, a Plan of Care must be submitted when the claim is filed. In general, Nationwide will place no restrictions on how the benefits are used, which means informal caregivers and immediate family members can provide care.

Another advantage of cash indemnity is that the insured is in full control of how the monthly LTC benefits are spent. Benefits can be used as needed for items or services—such as home modifications, transportation, or prescriptions—without the permission of Nationwide. You don’t even have to spend the monthly check on LTC. In a reimbursement policy, you have to submit invoices from the care providers to the insurer and wait for reimbursement.

As LTC benefits are used, the amount of the life benefit is reduced, but even if both of the insureds use the entire LTC benefit, a minimum life benefit of 10% of the face value up to a maximum amount of $50,000 will be paid to a beneficiary. Of course, if neither of you required LTC, the beneficiary receives the full life insurance benefit. If some of the LTC benefits are used but not the maximum, then the beneficiary receives the initial life insurance benefit minus the LTC benefits received. If the entire LTC benefit is used, then the LTC benefit payments stop.

You must be in relatively good health to qualify, because there is full underwriting for both the life insurance and LTCI coverage. A complimentary visit by a paramedic is required. That’s good for those who qualify. It means the insurer isn’t likely to have the excessive claims problems encountered by insurers who issued LTCI policies with inadequate underwriting.

Of course, Nationwide is a well-known, conservative, diversified insurer that has excellent financial safety ratings.

For details about Nationwide’s SUL II hybrid life insurance policy with LTC rider and to request your personalized Hybrid Life LTC Kit, contact my insurance experts David Phillips or Todd Phillips at Estate Planning Specialists (888-892-1102).

New Uses of Reverse Mortgages

Proper use of a reverse mortgage can extend the life of your wealth. Changes were made in reverse mortgages in 2013. The changes allow new strategies, and recent research revealed a few creative ways to use them. Today’s low interest rates also create an opportunity that will disappear when rates rise. Many of you should consider a reverse mortgage now.

Home equity is perhaps the least used asset in retirement planning, and that’s a shame. Home equity often is among the most valuable assets people own, yet many people consider home equity to be either something to leave their children or a reserve for late in life medical or long-term care expenses. They don’t know how to use it to generate income.

In a reverse mortgage, formally known as a home equity conversion mortgage (HECM), you borrow money and the loan is backed by your home equity. Unlike a traditional mortgage, you don’t make any payments as long as the home is your principal residence. The loan principal, interest, and fees accumulate until you move, sell, or pass away. The loan is paid from the sale proceeds of the home. Your heirs can receive any equity remaining after the loan is paid.

You and your estate never will have to pay more than the value of your home equity. Most HECMs are insured by the federal government. It reimburses the lender if the loan balance exceeds the value of your home. Federally insured loans are available up to a home equity of $625,500 in 2015. You must be at least age 62 to be eligible for a federally-guaranteed HECM. There are private reverse mortgages for those who want to use more home equity, though few lenders are in the market.

You can receive the HECM as a lump sum, annuity, or line of credit. However you take the loan proceeds, they are tax free. They don’t trigger any of the stealth taxes (higher Medicare premiums, taxes on Social Security benefits, etc.) or affect eligibility for any federal programs.

Traditionally HECMs were best used as a last resort, for someone in his or her late seventies or older who had no other source of funds. They were used to pay for essential home repairs or medical expenses in most cases.

Those still are good uses for a HECM, but there are other strategies to consider.

Under the new strategies, it is important not to wait until you need the money to set up a HECM. Instead, consider arranging the HECM now (or as soon as you turn 62) while interest rates still are low. Set up the HECM as a line of credit. You don’t draw on it until it is needed, and there are no costs other than the initial fees until you draw on it. This is being called a standby reverse mortgage.

You home equity now is liquid, and there are no limits to how the loan proceeds can be used. You can use the loan to pay unplanned expenses, give an early inheritance to loved ones who need the money now, help pay for education, or any other expense that arises.

An important element of the new strategies is that you can pay down the HECM balance after you tap the line of credit. That resets the amount you can borrow and stops the interest from compounding.

Suppose one of your cars unexpectedly breaks down. You need a new car. Because you’re retired and without a paycheck, you don’t qualify for an auto loan at a reasonable rate, or you don’t want to give the lender all the details they require. You also don’t want to draw down your investment portfolio. But you’re confident your income will be enough in coming months and years to pay for the vehicle. Or you want to sell some investment assets at a better time and use the sale proceeds to pay for the auto.

You can draw against your HECM to buy the car. No payments are due on the HECM. That allows you to pay the loan on your own schedule, or on no schedule. Your daily life style isn’t affected by the sudden need to make a major purchase, and your investment strategies aren’t disrupted by the spending need.

The standby reverse mortgage also can help make your investment portfolio last longer. Suppose there’s a market downturn that causes a significant decline in your portfolio value. You’re confident that it is temporary, though there’s no way of telling how long the balance will be down. If you continue to take distributions from the portfolio to fund regular spending, then you essentially are drawing principal by bringing the portfolio balance even further below your planned level.

Instead, during this period you can draw on the standby reverse mortgage. This allows your portfolio to recover, and it will recover to the planned baseline level faster, because you either aren’t drawing from it or are drawing less. After the portfolio recovers, sell some assets to pay the HECM. That stops the compounding of interest on the HECM and makes the full balance of the standby HECM available for future situations.

This strategy substantially extends the life of a portfolio when used systematically, according to research published by three financial planners: Shaun Pfeiffer, John Salter, and Harold Evensky.

Another advantage of the HECM is that there could come a time when you can’t pay down the loan and even have to continue borrow to the maximum allowed. While that means there might not be any equity for your loved ones to inherit, it also means you have a level of security. The really good news for you is that the balance due on the HECM can accumulate to something exceeding your
home equity, but you and your estate won’t be liable for that excess. The amount paid from your assets can never exceed the home equity.

The amount you can borrow depends mainly on three factors: the value of your home equity (up to the insurable ceiling, which is $625,500 in 2015), current interest rates, and your age.

The older you are, the higher the percentage of your home equity you can borrow. That’s because you aren’t expected to live as long as a younger person, so there’s less risk that the principal, interest, and fees will exceed the home’s equity.

Interest rates are the reason you should consider arranging a HECM now if you are 62 or older, regardless of how you want to use it. Current interest rates determine the percentage of your home equity you can borrow, and the percentage declines rather steeply as rates rise. When the rate used is 5% or less, a 62 year old can borrow about 52.6% of the home’s equity. But when the rate used is 7%, the amount that can be borrowed drops to 34.3%. These are estimates, because several variables determine the borrowing limit. The interest rate used to calculate the maximum you can borrow is different from the rate that actually will be charged on your loan, and the rate used to limit your borrowing is higher than the rate you’ll be charged on the loan.

The major disadvantage to the HECM is that upfront fees and interest rates are higher than on other types of mortgages. If you’re confident of being able to obtain and make payments on a home equity loan, you might not want a HECM. But a HECM doesn’t require lifetime payments and allows the balance due to be more than the value of the home equity. The fees and higher rate on the HECM are like premiums on longevity insurance that help limit the possibility that you’ll run out of money or have to sell your home to raise cash.

Is a Five-Star Medicare Plan Right for You?

Medicare has a star rating system for Medicare Advantage and Part D prescription drug plans. A top rating could benefit both plan members and sponsors.

The plans are rated from one to five stars (with half stars awarded) based on a number of measures of quality of care, member experience, and plan administration. Five stars is the top rating.

A benefit for any Medicare member is that when there is at least one five-star plan available in your area, you can switch to it at any time during the year. You aren’t restricted to the annual open enrollment period. You can move from traditional Medicare to a five-star Advantage plan, or move from an Advantage plan to a five-star Advantage plan any time. You also can switch to a five-star Part D plan from another Part D plan when you want.

Such a change can be made only one time during the year.

The plans also receive a benefit. Bonus payments per enrollee are made to each plan with four or more stars. The higher the plan’s rating, the higher the bonus. A portion of the bonuses must be used to provide additional benefits to enrollees or to reduce their out-ofpocket costs.

Like most such ratings, the star ratings should be only one factor in your decision. First, there are only a small number of five-star plans around the country. There might not be one available to you. Second, the ratings are generic. Medicare might weigh the factors differently than you do.

Third, a high rating doesn’t mean the plan is right for you. When a Part D plan has five stars but doesn’t cover a medication you need, there’s probably a better plan for you. You have to consider all the usual factors to see if a plan is a good fit for you.

You can review more than an overall rating on the Medicare web site. You can see how each plan performed in the different categories. Advantage plans are measured in five categories while Part D plans are measured in four categories.

You Should Fear FOMO

The youngsters these days reduce every thought to an acronym or abbreviation. A commonlyused acronym is FOMO, or fear of missing out. While adults generally don’t have much use for the expression, it’s a good one to keep in mind when considering financial decisions. Too many people make financial decisions, especially investment decisions, partly under the spell of FOMO. In the old days, people were most likely to make this mistake after hearing friends, neighbors, and relatives talk about what they were doing with their money and how well it was working out. That process helped spur the boom in technology stocks in the late 1990s. FOMO is even more of a risk now because of all the financial media. The media is omnipresent and focuses on the short-term, emphasizing what’s generating the highest returns and what is losing money for investors now. All the media plus the return of short-term volatility to the markets make it hard to resist FOMO.

Experienced, successful investors know the worst reason to invest or make a financial decision is because of the fear of missing out. When something made a strong move (either higher or lower) and is generating a lot of media attention, it probably is nearing the end of a cycle. A day trader or professional trader might need to focus on the short term, but for the rest of us it is dangerous. You need a strategy and a process, and then you need to follow them.

That wraps up this month’s visit. Of course, I’ll be back next month with a new batch of research, insights, and recommendations on the key personal finance issues. There might even be an update on what Congress is doing, since we’re nearing the end of the year. Until then, be sure to check in to the web site periodically for fresh updates.

P.S.: Make an early start to your year-end financial planning. Too many people wait until the calendar is well into late November or December. By then, the calendars of any financial professionals you need to work with are filling up, and the mutual funds and brokers are swamped with requests. At that time, mistakes and oversights are more likely.

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