December 2019 Newsletter

Getting things in order before ringing in the new year can be stressful. There are holiday preparations, work deadlines and family gatherings to attend. But for many, tackling the financial to-do list is the most taxing.

After more than 30 years of working in finance (as an auditor, investor, tax preparer and consultant), I’ve witnessed the impacts of deferring a financial checkup. I’ve seen people leave hundreds — often thousands — of dollars on the table because they missed out on tax savings, credit card bonuses and several other opportunities.
Of course, many financial consequences stem from failure to take action. Here are the eight biggest money mistakes I see people making at the end of every year:

1. Not cleaning up monthly statements

You’ve probably heard this advice several times. But I’ve worked with a handful of clients who needed my help primarily because they slacked off on their annual financial cleanups.

What to do: Gather your last three monthly statements and look for services, subscriptions and memberships that you rarely use.

Ask yourself: What unnecessary expenses can I cut before the year is over? Once you’ve identified the services that add little or no value to your life, cancel them immediately.

In most cases, I recommend calling to cancel rather than doing it online. Some vendors may give you a prorated credit, meaning you’ll only be charged a partial amount of the full subscription price. Or, if you’re extremely persuasive, you might even get them to waive this month’s fee altogether.

2. Not taking advantage of rewards credit cards

If you’ve been wanting to sign up for a new credit card, the holiday season is a great time to do it. Many companies offer generous perks, such as welcome bonuses and big cash back rewards — just in time for the shopping craze.

What to do: There’s no “perfect” credit card for the holidays. It all depends on your purchasing priorities, so look closely at the bonuses categories for the places you plan to do most of your shopping.

If you plan on getting most of your gifts and holiday needs on Amazon, for example, focus on credit card offers with extra benefits that are unique to Amazon.

3. Not using up your FSA account

A flexible spending account (FSA) allows you to use pretax dollars (up to $2,700 in 2019) to pay for out-of-pocket medical expenses. The downside, however, is that money in an FSA doesn’t carry over from year to year.

What to do: Unless your plan includes a rollover or deferral provision, check your remaining FSA balance and be sure to use up all funds by Dec. 31.

Consider stocking up on items that you plan to use the during the following year (e.g., sunscreen, bandages or contact lens solution). Schedule that appointment with your optometrist for new reading glasses. Go to your dentist for the teeth cleaning you’ve been putting off.

4. Not contributing enough to your 401(k)

If you have a 401(k) plan through your employer, it’s important to make sure it’s on track with your retirement goals every year. Otherwise, you could lose out on a lot of money and end up working longer than you had intended.

What to do: Some companies will match employee 401(k) contributions by up to a certain percentage (usually 3% to 6%) of their salary. If your employer offers you this “free money” perk, then, at the very least, aim to put enough of your paycheck into your 401(k) each month to get the maximum company match.

For the 2019 tax year (returns filed in 2020), the maximum contribution to a 401(k) account for those under the age of 50 is $19,000. If you’re over 50, you can add an extra $6,000 catch-up contribution, for a total of $25,000.

Also, if you receive an end-of-year bonus, allocating a portion of it your 401(k) is a relatively pain-free way to optimize contributions. Remember, when you make voluntary contributions to your plan, you reduce your taxable income. So, the more money you put in, the more you’ll lower your tax bill.

5. Not planning for major 2020 events

Accumulating the necessary funds for big-ticket items (e.g., a wedding, car or house) requires a fair amount of time, so it’d be wise to make financial preparations for any costly plans you have for 2020.

What to do: Write down any big purchases or significant life events you have planned in the foreseeable future.

For each one, determine the projected date and total amount needed to finance it. Then divide the estimated total by the number of months until the big day (this will tell you how much you need to save each month in order to reach your goal).

Keep in mind that things don’t always turn out the way we expect them to, so don’t rule out the option of postponing the event or purchase altogether if you need a longer savings runway.

6. Not kicking losers to the curb

Capital gains (the profit you get after selling a capital asset, such as stocks, bonds or real estate) and losses (when you sell a capital asset for less than what you paid for it) impact your taxes, so make it a point to get rid of any low-performing investments.

What to do: Access your portfolio and identify any investments that are in a losing position. Ask yourself: Are there any stocks or mutual funds currently worth significantly less than the amount that I paid for them? Which ones have a poor long-term performance outlook?

If you plan on selling any, make sure you do it before Dec. 31 in order to lock in a capital loss on your tax return. Capital losses on stocks, funds and other investments can be used to reduce income from capital gains.

7. Not putting idle cash to work

You work hard, and so should your money. It still shocks me to see so many people carrying a large cash balance in their checking account and only earning a fraction of 1% on savings.

What to do: If you haven’t done it already, consider shuttling your cash over to a high-yield savings account.

It only takes a few steps and you could earn up to 20 times more compared with a typical traditional savings account. The best online savings accounts can easily earn you an annual percentage yield (APY) of 1.70% or higher.

8. Not getting tax documents in order

Doing your taxes is a painful struggle. But waiting until February, March or April to get your documents in order will make the process even more stressful.

What to do: If you haven’t already developed a system for organizing your tax records, you might as well start right now. It’s always smart to keep all your filed tax returns and supporting documents for at least three years.

While employers typically give out W-2 and 1099 forms sometime in January, there’s still a lot you can gather right now. (If you’re unsure about what you need, here’s a helpful checklist from the IRS.)

^{Source: Jim Brown, December 5, 2019}

The Federal Reserve held interest rates steady following its two-day meeting this week and indicated that no action is likely next year amid persistently low inflation.

Concluding a year that saw the central bank take down its benchmark rate three times, the Federal Open Market Committee on Wednesday met widely held expectations and kept the funds rate in a target range of 1.5%-1.75%.

In its statement explaining the decision, the committee indicated that monetary policy is likely to stay where it is for an unspecified time, though officials will continue to monitor conditions as they develop. The decision to keep rates unchanged was unanimous, following several dissents in recent meetings.

“The Committee judges that the current stance of monetary policy is appropriate to support sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective,” the statement said.

“The Committee will continue to monitor the implications of incoming information for the economic outlook, including global developments and muted inflation pressures, as it assesses the appropriate path of the target range for the federal funds rate,” the committee added.

The language is consistent with recent statements from Fed Chairman Jerome Powell and his colleagues, who have said policy is in “a good place” and likely to remain unchanged as long as current conditions persist.

Those sentiments also were reflected in the likely path forward.

‘Dot plot’ shows no 2020 hike now

Through the “dot plot” of individual members’ future projections, the FOMC indicated little chance of a cut or increase in 2020.

At the committee’s September meeting, individual members were split on what could happen next year, with eight members seeing no change and nine indicating the likelihood of one or more increases. One member even foresaw three hikes. On balance, the estimate then was for at least one hike in 2020.

Wednesday’s projections saw a decided downward shift in the dots, with just four of 17 members anticipating one quarter-point move up in 2020.

There also was a general downward shift for 2021, with the chart pointing to at least one and possibly two increases. The central projection came down for each of the four years included in the committee’s estimates. The median expectation for the funds rate is 1.6% in 2019 and 2020, down from 1.9% in the September estimate, and rising to 1.9% in 2021, compared with the previous estimate of 2.1%. The 2022 projection also came down to 2.1% from 2.4%, though the longer-run estimate remained consistent at 2.5%.

GDP forecast

The more dovish tilt came without any changes in expectations for U.S. economic growth. The committee again projected 2019 to finish with a 2.2% gain in gross domestic product, followed in consecutive years by 2%, 1.9% and 1.8% gains.

Members did reduce their inflation expectations this year.

They now see the core personal consumption expenditures gauge to register just 1.6% growth this year, down from the 1.8% projection in September. They kept their estimates consistent at 1.9% in 2020 and 2% for the following two years.

The committee releases its economic estimates quarterly. While only 10 members vote on rate policy, all 17 FOMC officials have input on the economic and rate projections.

The FOMC operates under a dual mandate of full employment and price stability. Unemployment is running at a 50-year low and job creation is coming off a blockbuster November.

However, inflation has remained stubbornly below the 2% level that the Fed considers healthy. Members in recent weeks have discussed multiple strategies to address the issue, though Wednesday’s statement did not indicate any changes to the Fed’s approach.

The statement also did not elaborate on any matters relative to the upset in overnight repo operations that took place in mid-September. Overnight interest rates spiked following a cash crunch, and the Fed since then has been conducting a series of operations to keep liquidity flowing and to make sure the funds rate stays in the target range.

An implementation note attached to the meeting statement did say the Fed’s offering rate is now 1.45%, down 10 basis points in October.

^{Source: Jeff Cox, December 11, 2019}

Home is where the heart is. And it can also be where the assets are. As of 2011, home equity made up about three-quarters of the average American’s net worth, according to the U.S. Census Bureau. Despite this high figure, the home doesn’t always factor into retirement planning calculations.

For clients with ample assets, home equity is a less pressing issue. In that case, there’s no reason to “concern yourself with the house,” said David Imhoff, CPA/PFS, owner of Cornerstone Wealth Advisors LLC in Overland Park, Kan., because “we look at the house as the asset of last resort.”

But retirees of more modest means may need every possible option, including home equity. “It’s really surprising that more people don’t pay attention to it,” said Geoff Sanzenbacher, Ph.D., research economist at the Center for Retirement Research at Boston College. “The house can be a potential source of wealth.”

Yet, according to a 2016 Urban Institute survey, only 6% of older Americans are interested in tapping their home equity.

Including housing wealth—and sometimes the debt that accompanies it—during retirement planning can show clients a more realistic view of their retirement possibilities. At the very least, it can help them envision what their housing situation might look like and changes they need to make.

Our experts weigh in on the role that home equity plays in retirement planning decisions.

No longer ‘free and clear’

Perhaps the first decision retirees need to make is whether to carry a mortgage. It used to be a given that a mortgage would be paid off by retirement, but that’s less true today. Between 1998 and 2012, the proportion of seniors carrying a mortgage rose from 23.9% to 35%, according to Fannie Mae. Not only are more retirees carrying a mortgage, but they also owe more than in the past. According to a report from the Center for Retirement Research, using data from the Federal Reserve’s Survey of Consumer Finances, from 2001 to 2013, the housing debt-to-income ratio rose by 52 percentage points for Americans 55 and older, while it grew by a much lower rate for younger households.

“Practically, that means they need more money for retirement, and they have to do something more than what they’ve been doing to this point,” Sanzenbacher said. Some retirees should consider downsizing as a way to reduce housing expenses, Sanzenbacher said. Others might want to postpone retirement so they can make more headway on their mortgage, he advised.

Despite the trends, paying off the mortgage remains a pressing goal for many, said Lori Luck, CPA/PFS, president/shareholder at CLS Financial Advisors in Portland, Ore. That’s what many of her clients aim to do, depending on the magnitude of the mortgage and the mortgage interest rate. They may consider accelerating paying off the mortgage at or near retirement to avoid the emotional pain of a future fixed housing payment, if they can use investment funds that don’t trigger adverse income tax consequences and can otherwise meet their retirement goals.

Even clients who have the cash flow to continue mortgage payments have an aversion to debt in retirement, CPAs said. “People can’t imagine not going to work every day and getting paid while they still have this debt to pay off,” said Kelley Long, CPA/PFS, a resident financial planner with Financial Finesse in Chicago.

However, CPAs are quick to point out that paying off the mortgage isn’t always a positive in retirement—as long as retirees have the cash flow to support the payments.

“Does it make sense to pay off a mortgage with 3% or 4% interest versus taking money out of your portfolio that could be earning more?” asked Nate Wenner, CPA/PFS, who is a principal and regional director with Wipfli Hewins Investment Advisors LLC in Minneapolis. On top of that, withdrawals from retirement or investment portfolios could generate taxes, Wenner cautioned (while mortgage interest and home-equity loan interest payments are often tax-deductible).

Considering the options

Even without a mortgage, housing continues to be a big-ticket item on many retirees’ balance sheets. “Everyone needs a place to live,” Wenner said. “So I don’t necessarily look at someone’s home or home equity as an investment asset.”

For retirees looking to extract home equity, the most straightforward approach is downsizing; that is, trading a sprawling family home for smaller digs better suited to an empty nest. Boston College’s Center for Retirement Research attempted to quantify how much cost savings retirees could realize through downsizing. The center estimated that homes cost 3.25% of their value to maintain each year. So moving from a home valued at $250,000 to one that costs $150,000 should save retirees $3,250 a year. In addition, the center calculates that retirees could generate an additional $3,000 a year in earnings if they invest the difference in instruments that earn an annual 4% return (minus $25,000 for real estate commissions and moving costs).

But what may make financial sense doesn’t always square with retirees’ emotions. “People really want to age in place, and a lot of people have the idea of leaving their house to their kids, which gets in the way of downsizing,” Sanzenbacher said. What’s more, many retirees may be willing to downsize their space but not necessarily their lifestyles, Wenner said.

“If you move from a $500,000 home in the suburbs to a $500,000 condo downtown, that’s not going to save you much,” he said. And some retirees end up in even bigger homes than before. While half of retirees who move find smaller homes, 30% actually increase their living space, according to research from Merrill Lynch and Age Wave.

Unconventional uses of home equity

For retirees who are adamant about staying put, another option is a reverse mortgage. This type of loan allows those 62 and older to draw on equity from the home and repay it only when they move, sell, or die. To qualify, retirees must have substantial equity or no mortgage. They must also have the financial wherewithal to maintain the property.

High fees and sometimes deceptive lending practices have led some CPAs to shun these products. However, some CPAs have started to take a second look in recent years for certain clients in certain circumstances thanks to new consumer protections put in place by the Consumer Financial Protection Bureau (CFPB), said Long, who recommends reverse mortgages for some clients. President Donald Trump’s administration has voiced opposition to the CFPB and its director, causing those who support the agency to worry that those protections may be undone.

In the meantime, Long believes reverse mortgages can be used for retirees who need additional assets, but only after other options have been exhausted.

Others suggest obtaining a type of federally insured reverse mortgage known as a home-equity-conversion mortgage (HECM) line of credit before a cash flow situation becomes dire. If retirees don’t tap the line of credit, it can continue to grow. In an article in the Journal of Financial Planning, authors John Salter, Shaun Pfeiffer, and Harold Evensky recommend keeping a standby line of credit to access only when significant portfolio declines would force retirees to sell depreciated assets at an inopportune time. The move can significantly reduce portfolio risk, the authors argue.

Sanzenbacher pointed to another strategy: property tax deferral. These programs are available to seniors below certain income thresholds in some states, including Massachusetts, Minnesota, and Washington. Under the programs, seniors who qualify can cap how much they pay each year in property taxes. The deferred taxes must be repaid, with interest, but only after the home is sold.

Given the precarious financial situation of many retirees, giving full consideration to the role of home equity adds a potential valuable option to the retiree tool box.

^{Source: Ilana Polyak, March 24, 2017}