New Professionals Program – Future Income Protection Plan

Disability insurance is a well-known and valuable tool for protecting future income. In most cases, an individual can get insurance that pays up to 60% of her current income if she becomes disabled. This can be especially valuable for high-income professionals like physicians, who would have a difficult time finding work at a comparable salary in the event of a disability.

As valuable as this resource is, traditional disability insurance has a significant gap for a specific type of professional: those who have recently completed or nearly completed their training, but do not yet receive the salary they expect to eventually earn.

New Professionals Program

For new professionals, the ability to earn your future income, or human capital, may be your largest (or only) asset. Also, medical residencies generally involve long hours and low pay – especially relative to what you can earn later. Traditional disability insurance that pays 60% of current income doesn’t accurately reflect the medical resident’s future earning power.

Disability insurance under the new professionals program provides the ability to get a salary based on future income, rather than current income. In fact, current income isn’t considered when determining benefits – it’s based on a formula.

Let’s consider Nicole, a hypothetical fourth-year ER resident. She’s making $60,000 per year and has a group disability policy provided through the hospital that would cover up to 60% of that salary. She purchased a disability insurance policy using the new professionals program, which gives her an additional $6,500 monthly benefit if she becomes disabled. It also continues to provide a partial, residual benefit if she’s able to return to work at lower pay. This policy would cost her $4,698 per year with the level premium option. However, she also has a graded premium option, which costs less at first, but increases slightly each year. This would initially cost her $2,172.

Nicole completes her residency the next year and receives a contract with a $360,000 salary. She already has a disability insurance policy in place with a future increase option (FIO) that can increase the benefit without having to undergo additional medical underwriting. Also, she can choose to continue paying premiums on the graded option, or she can switch to the certainty of a level premium.

Protecting Your Most Valuable Asset

Most insurance providers now offer disability insurance through the new professionals program. It’s available to various medical professionals, as well as CPAs, attorneys, engineers, architects and others. Medical professionals are generally able to enroll in the program as early as their third or fourth year of medical school. The available benefit starts around $2,500 per month and gradually increases throughout the residency to a maximum of $5,000 to $7,500 per month, depending on the specialty. read more…

Tyler Bartlett featured in “How to Go from Middle Class to Millionaire”

Our very own Tyler Bartlett was recently featured in an article from Guide Vine: How to Go from Middle Class to Millionaire, about the patience and discipline required to become a millionaire. Here’s a snippet:

Here is the good news: millionaire status is very much within the reach of America’s middle-classes who earn higher-than-average incomes. A typical middle-class family has a combined household income of $97,000, with upper middle class households bringing in incomes above $100,000. Bartlett offers an example of a couple living in Seattle. Like typical upper middle class Americans, both are college-educated professionals with good, steady incomes. The couple, a real estate and a sales executive, together earns $150,000 per year. For 13 years, this couple saved as much as $1,000 per month. They maxed out their 401(k)s. Today, they have more than $1 million in investible assets. “They took hard steps,” said Bartlett. “They worked full-time jobs and had the discipline to do the right thing financially.”

Do you have what it takes? Read the full article at Guide Vine here.

Remaining Q&A from Breakfast with Paul Merriman

We recently hosted an event with Paul Merriman, which ended with a Q&A. There were so many great questions asked, we didn’t have time to respond to them all, but we hate to leave any question unanswered. Here are some of the questions we didn’t get to, with answers written by Merriman Advisor Michael Van Sant, and our Associate Advisor team.

question_markWhat factors should be considered in deciding if a couple has enough net worth to self-insure for long-term care?

There are a number of factors to consider in deciding whether to self-insure for long-term care:

Income streams and portfolio assets: Determine your income streams (including Social Security, pensions, and annuity distributions) and compare this value with your spending needs to maintain your desired lifestyle, plus the cost of long-term care. If a gap exists between income and needed funds, determine if your portfolio can be called upon to close the gap.

The most expensive long-term care facilities price out at an average of $300/day, with a typical stay in a nursing home lasting 3 years for a total of $328,500 per person. Taking the benefit of income streams into consideration, long-term care for a couple lasting 3 years would likely result in an out-of-pocket expense of $500,000. If your portfolio can handle that expense, it may be wise to self-insure. A general rule of thumb is that if a couple’s net worth is more than $2,000,000 they can likely afford to self-insure. Some people consider their home as part of their net worth when making this decision. Be sure to consider whether you are truly willing to sell your home and move if necessary. Many people envision receiving care in their homes and should not factor the value of their home into their net worth for these purposes.

Genworth offers useful tools and calculators to determine the costs of care in your area.

Bequest goals: Do you have a desire to leave your children an inheritance of a specific amount? Paying for long-term care out of pocket in the event you will need it could cause that desire to go unrealized. Purchasing long-term care insurance can provide for help in guaranteeing your heirs the inheritance you wish to leave them. Think of long-term care insurance as ensuring an inheritance floor for your survivors.

Sleep at night: Purchasing long-term care insurance, even if you could self-insure, can help you not to worry about the “what-ifs.”

Other care options: Who will care for you if you do not have coverage or the means to pay for long-term care? If your children are not close by or you can’t or don’t want to rely on them for care, long-term care insurance will provide for a caretaker.

Do you believe in the bucket strategy?

The bucket strategy is a financial planning concept that involves separating money into different buckets to achieve different goals. At a minimum there are two buckets. The first is for any expenses you are expecting in the next 2-3 years. The money in this bucket is always kept as cash or cash equivalent, with the belief that investing in the market is too risky and volatile in the short term. The second bucket is money you won’t need in the near term and is therefore invested in stocks and bonds. There can be multiple buckets and deeper planning involved, but this the basic description.

Back to the question, does Merriman believe in the bucket strategy? While we certainly weigh your short-term needs with your long-term goals, our strategy dives much deeper than the idea that everyone’s lives can fit into two buckets. We spend a lot of time up front covering all areas of your financial life to get a truly comprehensive understanding of your situation before we recommend an investment strategy. Only in this way can we ensure we are recommending an investment strategy designed to help you stay on track. We believe prudent asset allocation is the most powerful tool to align portfolios with client return objectives and risk tolerances. We also hold regularly scheduled reviews and make necessary adjustments to stay on track to meeting short and long-term goals.

What is the best investment to generate income and preserve principal?

At Merriman, we believe in a total return approach that is designed using academic research to achieve long-term growth. We do not use any specific investment to generate income. Rather, we use dividends, interest and appreciation to fund each client’s income needs.

We have two different core strategies (MarketWise and TrendWise) available for clients, and we build portfolios from those and other specialized securities, based on their risk tolerance

  • Our MarketWise portfolios, which are fully invested at all time, use low-cost mutual funds that are diversified among various asset classes.
  • TrendWise is an actively managed strategy that uses a trend-following discipline to limit downside potential.

When frequent withdrawals are needed from the portfolio, your advisor will help to preserve principal by being sensitive to costs associated with trading fees. If your advisor knows of an upcoming distribution, they will allow cash from dividends and interest to build up to reduce trading costs.
If you need to withdraw from the portfolio and there is not cash available, your advisor will use appreciation to trim from the asset class that is most overweight. This allows for a periodic rebalance to ensure your portfolio is in line with its target allocation. Using this approach, we are able to sell high while letting the underperforming investments recover.

How does Merriman add value to investment accounts?

Merriman adds value to the investment accounts in two ways:

First, we build our portfolios using an academic approach that is evidence-based. We recognize that markets are generally efficient and, through broad diversification and proper asset allocation, we create portfolios that meet each client’s risk tolerances and long-term objectives. The universe of investment products is very large and new products come out all the time; 95% percent of them are worthless, 5% of them are worth investigating, and 1% of them are actually worth investing in. Merriman’s research department culls through this vast and complex set of products to find those that will truly enhance investor returns and reduce their risk over the long-term. The average individual investor has neither the time, nor the expertise, nor the access to find the needles in the haystack. We provide portfolios that offer better value over the long run by combining carefully selected investments that have higher expected returns, like small companies and value companies, while including other assets classes that have a lower correlation to US equities, like reinsurance, international equities, global real estate, and peer-to-peer lending.

Second, as your Wealth Manager, we provide guidance and behavioral coaching through different market cycles. As an example, portfolios are regularly rebalanced to restore target allocations by trimming asset classes that have done well and adding to asset classes that have lagged – this is done with an objective perspective. This disciplined approach will help ensure your investments are still the right fit for your wealth management plan.

Is it reasonable to evaluate performance by comparing returns to appropriate index?

When evaluating performance, comparing returns to an appropriate index can be helpful, but an investor must also keep in mind the long-term goals of the portfolio. It should be stressed that comparing returns to an appropriate index is sometimes easier said than done. Typically, a well-diversified portfolio made up of many different asset classes will not compare accurately with some of the most commonly referenced indices – e.g. The Dow Jones Industrial Average, S&P 500 or the NASDAQ.

Your advisor should be able provide the most appropriate index that can be used for comparing returns. An investor should also be careful to recognize the long-term goals set forth when creating a portfolio. Often, short-term market volatility will not reflect the long-term objective of a portfolio, and typically comparisons made in the short run provide little to no help.

If Merriman can’t see the future or rely on past performance, how do you use research?

As stated in the question, past performance is unlikely to repeat exactly, and because of that, we’re not able to predict the future. However, over periods of time long enough to include multiple market cycles, there are trends that emerge with investing. By studying the past, research helps us identify strategies to improve client performance in the long run.

First, research helps create our asset allocations. History has shown that various asset classes (US stocks, international stocks, bonds, real estate, etc.) have rotated in and out of favor at different times. Research helps identify the correct amount to hold in each asset class to provide the greatest expected return for a given amount of risk.

Next, research helps identify appropriate times to rebalance portfolios. If a client’s appropriate portfolio is 50% stocks and 50% bonds, and stocks do very well over the next year, the client will have a portfolio with more risk than appropriate one year later. Research helps us identify how far the portfolio can drift from our original allocation before we need to rebalance and move back to the original allocation.

Third, research helps client performance by identifying the most tax-efficient ways to invest. There are some investments we only hold in taxable accounts, and some we only hold in tax-deferred accounts, like IRAs. We will also use Roth IRA conversions for some clients, and research helps us identify when that is appropriate and how much to convert.

While we believe that you can’t rely on past performance, as stated in the question, we use research to develop our best estimate for the expected return and volatility for a portfolio (such as a 50% stock portfolio that is rebalanced appropriately). These expected return and volatility numbers are used when we create a financial plan and help clients identify if they are on target for meeting their goals.

Finally, we rely on research to help identify the best investments to use when creating client portfolios, which takes us into our next question:

Do you still rely exclusively on Dimensional (DFA) funds?

Our research department looks at all investments to find the best options for our clients. We do use DFA for all of the stock and some of the bond holdings in our MarketWise portfolios, which make up about 80% of Merriman accounts. DFA has consistently proven to be the best option, and we use their funds much more than any other investment.

DFA’s funds are broadly diversified. Also, they don’t try to pick individual companies that are expected to outperform the market. However, because they are not index funds, they have some additional flexibility that helps to lower costs and increase returns.

DFA also relies on academic research to identify types of stocks that are likely to perform better over the long run – specifically value and small-cap stocks. DFA slightly overweights these stocks, and slightly underweights stocks with the opposite characteristics.

Our research department is constantly evaluating various investment options. For now, the combination of tilting toward small and value stocks, broad diversification without being tied to an index, and low fees have consistently made DFA the best option for many of our portfolios.

Tax Benefits that Come with Raising Kids

We all know the cost of raising a child is significantly higher than any tax benefit you may receive. Every dollar you save on taxes counts, especially when you have more than one child. Whether it’s through tax deductions, exemptions or special tax-advantaged accounts, taking the necessary steps can help reduce the cost of raising a child.

Dependent exemptions

On a 2016 tax return, your spouse, any dependents and you receive a personal exemption that reduces your taxable income by $4,050 each. Let’s say you’re in the 28% marginal tax bracket and receive four exemptions for your spouse, two kids and you. This leads to a tax savings of $4,356 [($4,050 x 4 exemptions) x 28%]. When you start a family, make sure to adjust the tax withholding from your paychecks to include the correct number of exemptions. This reduces the tax withholding, thereby increasing your paycheck to account for the additional exemptions.

Child tax credits

For each dependent under age 17, you may be eligible to receive up to a $1,000 tax credit for each child. Credits are better than deductions and exemptions as they directly reduce the taxes you owe versus reducing your income that’s subject to tax. The credit amount starts to get phased out at income levels of $110,000 on a joint return, $75,000 for an unmarried individual and $55,000 for married filing separately. The credit is reduced by $50 for each $1,000 your household income exceeds these income levels, so it’s completely phased out at $130,000, $95,000 and $75,000, respectively. This credit is also partially refundable, meaning that in some cases, the credit may give you a refund, even if you do not owe any tax. This is also known as the additional child tax credit.

Consider a married couple with two children under age 10 and a household income of $108,000. This puts them near the start of the 25% marginal tax bracket after subtracting the standard deduction and exemptions. So the $1,000 credit for each child in the 25% marginal tax bracket provides for $8,000 ($2,000 / 25%) of income not to be taxed. Another way of looking at it is that this couple would owe $2,000 more in taxes if their dependents were age 17.

Dependent Care Flexible Spending Account (FSA)

The $5,000 that can be contributed to this special account is not subject to payroll taxes, federal taxes and most state taxes. It’s a reimbursement account for qualified childcare expenses for dependents up until age 13. This FSA can be used to pay for daycare, nanny services, summer day camps and many more. Make sure to spend the money in the account by year end as it’s a use it or lose it situation, where any leftover balance is forfeited. However, your plan may offer a grace period extension that could allow you to use the unused funds within 2 months and 15 days after the plan year ends. Unfortunately, dependent care FSAs are only available through employer benefits plans.

To illustrate the tax savings, consider a couple living in California with taxable income of $250,000. Their marginal tax rate is 33% to federal, 9.3% to California and 7.45% to payroll taxes (Social Security and Medicare), leading to an overall marginal tax rate of 49.75%. The $5,000 contributed to a dependent care FSA effectively saves you $2,488 on taxes for expenses you would be paying normally with after-tax dollars.

Child and dependent care tax credit

If your employer doesn’t offer a dependent care FSA, or you have more than one child, you may still be able to qualify for a tax credit to cover part of the costs for daycare. The maximum amount of expenses you’re allowed to claim is $3,000 for one child or $6,000 for two or more children. You can use 20% to 35% of these expenses to get a tax credit, depending on your income. If your income is $43,000 or more, then you can use 20% of these expenses. There’s no limit on income for claiming this credit. read more…

Key Benefits Decisions to Make When Joining a New Company

When switching jobs, it can seem overwhelming to review all of the documents related to your new company’s employee benefits. These plans include choices for medical, dental, vision, retirement, life and accidental death and dismemberment, short-term and long-term disability and many other additional benefits that may be useful.

With all of these options to navigate through, combined with the anxiety of starting a new job, it can help to focus on making a few key decisions.

Retirement plan

You don’t want to leave free money on the table, so enroll in your company’s 401(k) plan as soon as you are eligible, and set your contribution percent (deferral rate) to at least the minimum required to receive the full employer match. This may mean contributing 6% to receive the employer match of 3%.

If you don’t start out deferring at a rate above the matching percent, let’s say 3% to 6%, then try to increase your deferral rate by 1% every 6 months to increase your retirement savings. You can also make a plan to increase your contribution rate when you receive any raises.

If you’re given the option between a Traditional (pre-tax) and Roth (after-tax) 401(k), consider your age and income level, and whether you’re already contributing to an outside Roth IRA. The employer match will always be to the Traditional 401(k) portion, so you can decide whether your contributions are pre-tax or after-tax for your portion. If you think your tax rate will be much higher in retirement than it is now, Roth 401(k) contributions make sense. Sometimes splitting your contributions 50/50, where 50% goes into the Traditional portion and 50% goes into the Roth portion, is the perfect medium. This way, you receive a tax deduction for half of your contributions now, while the other half is contributed after taxes and can be withdrawn tax-free in retirement.

Health care plan

Some companies give you multiple health care plans to choose from, while others give you just one option. These options may include an HMO, PPO, POS, or high-deductible health plan (HDHP) paired with a health savings account (HSA). If you’re deciding between an HMO, PPO or POS, make sure you’re comfortable with the in-network doctors available to you and your family, as well as the level of deductibles and out-of-pocket maximums. It doesn’t make sense to choose the least expensive health plan if you can’t afford the deductible.

If it’s available, select the high-deductible health plan paired with an HSA. It can provide the best overall value of any health plan available. If the total of your and your employer’s contributions reach the maximum you can contribute, then you receive a unique tax advantage because payroll taxes, federal income taxes and most state income taxes won’t be deducted from these contributions. They grow tax free, and withdrawals can be made tax free for qualified out-of-pocket medical expenses, including dental and vision. And, unused funds in the account are not forfeited at the end of each year like with a flexible spending account, so you can invest and allow these funds to grow.

More information about the benefits of using an HSA can be found by reading my article, A New Perspective on Health Savings Accounts.

Life insurance and accidental death and dismemberment

It’s a good idea to have life insurance that’s 10 times your income, especially when you have young dependents to provide for. Group plans may not let you go higher than 5 times your income, so acquiring the remaining coverage through an individual term policy may make sense.

Be aware that group life insurance through work is contingent upon your employment at the company, so if you are no longer working there, you may experience a loss of coverage. An individual term policy would avoid this, but may be more expensive than group benefits.

Even though the chance of having an event where accidental death and dismemberment (AD&D) pays out is slim to none, it’s still a worthwhile benefit if it doesn’t cost more than a few dollars a month. Most benefits plans sign you up for it automatically.

Short-term and long-term disability

Usually you’re automatically enrolled in short-term and long-term disability benefits. However, if you’re given the choice, select the option where you can pay these premiums with after-tax dollars, versus pre-tax dollars from your paycheck. These premiums are often less than $25 to $30 each pay period, and are paid pre-tax, meaning not subject to tax. Paying for these premiums after tax permits you to receive benefits tax-free if you ever need to file a claim. Since these premiums are small and have minimal tax consequences, receiving tax-free benefits if you have a claimis substantially more favorable.

Employee stock purchase program

If your employer offers an employee stock purchase program (ESPP) where they allow you to buy their stock at a 10% to 15% discount during stated periods in the year, considering enrolling with up to 10% of your paycheck. To avoid concentrating too much risk in your company, i.e., human capital plus financial capital, it makes sense to sell this stock as soon as possible to pocket the after-tax gain from the discount and any appreciation to help diversify. That 10% to 15% discount is considered compensation and taxed as ordinary income. Additional profit is taxed as short-term or long-term capital gains depending on how long you end up holding the stock.

Other popular benefits like legal aid, group long-term care insurance and identity theft protection can also be valuable benefits, but make sure you aren’t already receiving these benefits through another source. Group long-term care insurance is becoming more common, but it’s worth shopping around to make sure you’re getting a favorable rate. Also, one caution about group long-term care is that the insurance provider doesn’t have to get permission from the state regulators to raise premiums like they do for individual policies.

When evaluating benefits, we recommend contacting an advisor to review your options.

Teaching Kids About Cash and Credit

As we get to know our clients, we always ask about the goals they have for their children and grandchildren. Over and over we hear a variation on a theme: I want them to have enough to do something, but not enough to do nothing. How do we go about teaching our kids and grandkids the value of a dollar, while giving them opportunities to have fun and enjoy what financial freedom can give? Moreover, how do we teach them about credit and borrowing money in a way that will encourage them to only spend what they have, and no more? We’ve found some useful tools to help young people learn the skills of budgeting and spending wisely, both with cash and credit.

Debit Cards

To teach your teenager about spending, consider the American Express Serve prepaid debit card. The card requires no credit check or minimum balance, and has minimal fees. Parents can set up an account in their name, called a “Master Account,” and from there create up to four subaccounts for children aged 13 or older. Your child is issued a personal debit card with access to the funds in their subaccount, which can be used at merchants that accept American Express, as well as ATMs. They can also request funds from you, as well as send funds back from their account to yours.

Parents can view their child’s transaction history and set spending limits. Parents and children both have access to budgeting tools through American Express to see transactions divided into categories, or view each category as a percentage of their total spending. This is a great way to give kids power over how their allowance is spent, while being able to oversee spending and encourage good habits. These prepaid accounts can’t be overdrawn, offering another safeguard, and they do not affect the cardholder’s credit history.

Consider contacting your local credit union to see if they offer similar products with no fees.

What About Credit?

One of the best ways to teach your kids about credit, while also helping them build their credit history, is a secured credit card. Many major banks offer secured credit cards, which come with many of the same perks and services as traditional credit cards. Cardholders deposit funds into a checking or savings account. That deposit is then put on hold by the bank and used to secure the credit line on your credit card. iStock_89087687_XSmallA $300 deposit, for example, would become equivalent to a $300 credit line. The held funds continue to earn interest in the depository account, but can be spent using the secured credit card. Minimum payments are due monthly, and balances carried forward each month accrue interest charges just like with a traditional credit card. Balances and payments on a secured credit card are reported to the three credit bureaus, so making on-time payments is just as important.

After holding a secured card and making regular purchases and payments for a year, many banks will reassess the cardholder’s credit and, if strong enough, free up the funds used to secure the card, converting the account to a traditional card issued on credit. This type of card offers kids the ability to take time to learn about using credit cards, including the importance of making payments on time, as well as the process of billing cycles, interest charges, and spending only what they can afford to pay off each month. Some secured cards even offer rewards like traditional cards.

For something more traditional, college-age kids may consider the Discover it® for Students Card, which offers credit tracking and a reward for a good report card. A GPA of 3.0 or higher each school year will earn you $20 in rewards, and certain categories earn up to 5% cash back throughout the year. This card is also a great option for college kids who might be spending a semester studying abroad, as it charges no foreign transaction fee. Be sure to remind your student that while they may not see a fee for using their card abroad, they may still get less-than-favorable exchange rates on currency when using any credit card in another country. Lastly, in the event the card is misplaced, your student can freeze the card using an on/off feature accessible online and through the mobile app.

Cash and credit are both important tools for young people to feel comfortable using, and offering kids the freedom and responsibility to use them from an early age can make a huge difference in how careful they are with money down the road.

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