The Ins and Outs of Deferred Compensation Plans

If your income is greater than $400,000 a year, does making a $18,000 deferral to your company’s 401(k) retirement plan do much toward replacing your income in retirement? This less than 5% of income deferral to your retirement plan would leave you significantly underfunded to maintain your lifestyle in retirement. While you can save elsewhere through non-retirement accounts, your company may permit you to postpone receiving income through a Section 409A deferred compensation plan.

There are no IRS limits on how much compensation can be deferred; however, your company’s plan may have a limit. You could defer a bonus, incentive, or part of your salary in the present year and receive that, plus the potential for earnings on its investments, in future stated years. To do this, you must make an irrevocable election to defer compensation prior to the year in which you expect the compensation to be earned. If you’re in the top tax bracket (39.6% in 2017), this can allow you to defer income now and receive it at a later date (such as when you retire) in a lump sum or a series of payments when you expect to be in a lower tax bracket.

The major requirement to receive this deferral status is that your funds are subject to substantial risk of forfeiture. Unlike 401(k), 403(b), and 457(b) accounts where your plan’s assets are qualified, segregated from company assets, and all employee contributions are 100% yours, a Section 409A deferred compensation plan is nonqualified, and your assets are tied to the company’s general assets. If the company fails, your assets are subject to forfeiture, as creditors would have priority. Only through accepting this risk does the IRS permit unlimited contributions to this plan. If your employer doesn’t include this deferred compensation as part of the company’s general assets, making them subject to forfeiture, the deferred compensation becomes taxable immediately, plus a 20% penalty and interest. A potential reason for this requirement of substantial risk of forfeiture is to incentivize executives and business owners to maintain the health of the company, and to ensure they don’t inappropriately withdraw too much of its resources, and then try to leave. (more…)

The Benefits of Consolidating Dormant Retirement Plans

Like most people, you’ve probably switched jobs at some point in your career. If you’ve done this a few times, you may have several outstanding retirement plans, like a 401(k), 403(b), etc. In the flurry of paperwork between leaving your former employer and starting a new job, you should have been given the option to either leave the retirement plan as-is (default), transfer it to an individual retirement account (IRA), move it to your existing employer retirement plan or cash it out. If these plans aren’t consolidated after each job change, whether to an outside rollover IRA (or Roth IRA if you made after-tax contributions), or to your current employer retirement plan, they can start to accumulate and become more of a frustration later to deal with.

Consolidating your retirement plans has several benefits:

Investments align with the asset allocation your financial plan recommends 

When you enroll in a new employer’s retirement plan, they ask how you’d like to invest the proceeds. You may not have even made a choice and were put into the default investment option. In the past, the default option was the stable value or money market fund, which is not designed to help you grow your assets; instead, it preserves the value with minimal interest. Nowadays, the default options are target date retirement funds that at least have a more diversified breakdown of assets between stocks and bonds.

Importantly, your financial plan may require that your investments be more aggressive (stocks) or conservative (bonds) than how your dormant retirement account is invested. Regardless of the account’s size, you want all of your investments functioning in a cohesive manner, as that investment allocation will drive the long-term returns necessary to achieve your financial goals. (more…)

Affordable Care Act – the Subsidies

Due to the 2016 presidential election, parts of the Affordable Care Act described below may change. The current rules will likely stay in place through 2017. We’ll provide updates as they occur.

When an employer provides health insurance, you receive tax advantages that you don’t get when purchasing health insurance on your own. All the premium costs – whether paid by the employer or employee – are excluded from taxable income (both income tax and FICA taxes).

By contrast, individual health insurance you purchase on your own is paid for with after-tax dollars. These payments don’t receive the same tax advantages, so purchasing $1 of health insurance on your own is more expensive than purchasing $1 of health insurance through your employer plan

To address this, the Affordable Care Act (ACA) created a tax credit for individuals who purchase health insurance through the ACA marketplace. The credit is available to taxpayers earning up to 400% of the poverty level in the current year. For a household of two, that limit is $64,080 in 2017. A taxpayer’s income for this calculation is adjusted gross income (AGI), plus tax-exempt interest and any Social Security that was excluded from taxable income. So a married couple with no kids who earn $50,000 in 2017 would qualify for a tax credit if they had to purchase their own health insurance.

Because tax credits aren’t calculated until the end of the year, you have to pay your health insurance premiums all year in order to get money back when you file your taxes after the end of the year. This is where subsidies come in. (more…)

When It Makes Financial Sense to Get a New Car

For some, a car is simply something that gets you from point A to point B, and there’s no reason to get the newest or most luxurious car. The challenge of holding onto a car for 10 plus years, though, is that you reach a point where you need to either continue putting money into the car for repairs, or look to buy a new car. Today’s cars are built to run 150,000 to 200,000 miles or more, but repairs and maintenance start to creep up when you pass the 100,000-mile mark. Considering that the average age of cars on the road now is about 11.4 years, many car owners are in this situation.

According to Edmunds, if the cost of repairing the car is greater than either its value, or one year’s worth of new car payments, then it’s time for a new car. If the repair is half the value of your car, though, then it makes sense to do the repair.

To find your car’s value, start by finding your car’s year, make, and model on Kelley Blue Book, Edmunds or NADA Guides. Evaluate how long the repair can extend the life of your car. Don’t forget to check for recalls on your vehicle to avoid paying for repairs that the dealership will repair for free.

Reasons to consider a new car (more…)

Private College 529 Plan Explained

istock_000010843373xsmall_croppedWhen it comes to saving for your family’s college education, a 529 plan is one of the best savings vehicles out there. Its high allowable contributions, tax-free growth and withdrawal for education expenses, as well as the control the owner can exercise over the account without it being included in their estate, make this a unique investment. The more common type of 529 plan is a state sponsored offering that includes a number of different mutual funds to invest in stocks and bonds. With this type of 529 plan, you have the opportunity to receive excess investment returns and growth of principal; however, there’s also the risk of losing money, like with any other stock or bond investment.

With the Private College 529 Plan, families can prepay tuition that can be used up to 30 years later at today’s tuition rates. The tuition certificates can be redeemed at one of the nearly 300 participating private colleges. These include schools like Stanford, Seattle Pacific University and Pacific Lutheran University, and the list keeps growing every year. The difference between the Private College 529 Plan and state prepaid tuition plans like the Washington Guaranteed Education Tuition (GET) program is that it has far more participating schools, and it’s not tied to a state’s budget or operations. The program can spread investment risk across all of the participating schools throughout the country.

How does it work?

Similar to prepaid tuition programs, you’re buying tuition certificates or units that are guaranteed for up to 30 years after the purchase date at all participating private colleges at the time of purchase. You don’t need to select a private school to attend up front, but you can choose five sample colleges to determine your child’s progress toward covering the tuition cost at those schools. Unlike traditional 529 plans that can pay all costs for college, this plan can only be used to pay for tuition and fees and any other required fees for enrollment.

Tuition certificates must be held for at least 36 months before they can be redeemed to pay for tuition. So if you buy a certificate when your child is a high school senior and they’ll be attending a private college the following fall, they’ll have to wait until their senior year of college to redeem the certificate for a full academic year. (more…)

Your Credit Score Explained

You might want to open a new credit card to receive a bonus for signing up, or reduce the number of credit cards in your wallet with an annual fee, but opening and closing credit card accounts can impact your credit score. The question is, just how much does it impact your credit score, and is it worth sweating?

Most banks and credit lenders use FICO, which is the most common type of credit score. FICO scores range from 300 to 850. The score is based on the credit files of the three national bureaus – Experian, Equifax and TransUnion – with the following breakdown:

  • Payment history 35%
  • Amounts owed 30%
  • Length of credit history 15%
  • New credit 10%
  • Types of credit used 10%

Payment history (35%)

This makes up the largest component of your score, which makes sense because your payment history demonstrates your ability to make payments on time. Even if you cancel a credit card, the payment history on that card will stay on your credit report for 10 years after the day it was closed. Positive credit data, created by otherwise using the card for purchases and making payments, stays on your account indefinitely.

If you’re just making minimum payments, it still counts as paying your credit card as contractually agreed, so that alone doesn’t hurt your credit score. If you find yourself forgetting to make payments, though, consider adding calendar reminders.

Amounts owed (30%)

Also known as debt burden, this category measures how much you’ve charged in relation to your overall available credit. This can be called your credit utilization rate, and it’s best to keep it lower than 20% of overall limit. Credit bureaus use three other metrics in addition to the credit utilization rate, including the number of accounts with balances, the amount owed across different types of accounts and the amount paid down on installment loans.

Canceling a credit card that has a high limit can hurt your credit score because it impacts your utilization rate. One way to remedy this is to ask for a higher credit limit to make up for the overall decrease on a remaining credit card. Be careful not to close credit cards before a big purchase like a home or a car, because you want your credit score to be as high as possible to get the most favorable interest rate and terms available.

Having a credit utilization rate of over 30% can hurt your credit score. If you’re just making minimum required payments, it’s likely that you’re also using more than 30% of your available credit, and the balance keeps increasing due to interest building up rather than being paid down.

Length of history (15%)

As your credit history ages, it can have a positive impact on your credit score. The two metrics tracked include average age of accounts and the age of your oldest account. It can be said that the oldest credit cards are the best credit cards for your credit score. This also takes into account how long other types of credit (auto, student, mortgage, etc.) have been established.

Closing a credit card may reduce the average age of accounts. Opening a new credit card will also reduce your average age of accounts, which hurts your score. The ideal age of credit card accounts is eight years or older.

New credit (10%)

Recent searches (also called hard inquiries) into your credit history, such as when you apply for a new credit card, can hurt your credit score. Hard inquiries also occur when a lender is evaluating whether to extend credit to you for an auto loan, student loan, business loan, personal loan or mortgage. Keep these inquiries to a minimum.

A soft inquiry, which occurs when opening a new brokerage account or part of a new employer’s background check, does not impact your credit score.

Types of credit used (10%)

This includes installment (auto loan), revolving (credit card), consumer finance (high interest rate, short-term loans like from Payday loans) and mortgages. Having a mix of different types of credit helps your score. This is based on the number and mix of accounts. If a loan is paid off recently, it will eventually be removed from your history.

The creators of the FICO score have an online credit score estimator you can use. Lastly, if you’re looking for a new credit card or you want to better understand the benefits of your existing credit cards, visit NerdWallet for comparison information.