Leave a comment

Helping Your Clients Face Their College-Financing Fears—Part 2

In part one of this two-blog series, we established that higher education is frighteningly expensive. But with a proper plan in hand, you and your clients will be better prepared to tackle college tuition bills in an organized and financially sound way.

Recently, I explored the factors that affect financial aid eligibility. In this post, I’ll provide some tax smart tips to help your clients maximize their tax benefits. (Our new research, Tackling the tuition bill, has all the details on both topics.)

While it may seem intuitive to first tap into the qualified education savings accounts when the bills come, there are a few things your clients need to consider before doing so.

Educate your Clients on Potential Tax Breaks Before They Tap 529 Accounts
Consider the AOTC for the parent, or the child. Don’t rush to deplete the 529 account in the first year, as there may be some beneficial tax credits available each year. For example, the American Opportunity Tax Credit (AOTC) is available to taxpayers who meet income eligibility requirements.

The credit amounts to the first $2,000 spent on qualified education expenses and 25 percent of the next $2,000, for a total of $2,500. Funds counted toward this credit must come from current parental income or parental-owned assets held in taxable accounts. In other words, they cannot be funds from qualified savings plans, such as 529 plans. This tax credit can be taken each year in which qualified education expenses are incurred for a maximum of four years per student. With a total benefit of $10,000 over the student’s educational career, it may be smart for eligible parents to first take advantage of this credit before spending from 529 accounts.

Note that if the parents’ income exceeds the AOTC limits, but the child is reporting income for that tax year, the child may have the option to claim the AOTC. This would require the child to file as an independent, rather than as a dependent the parent’s tax return. Although this is possible, there may be other financial implications in doing so. The AOTC is refundable up to $1,000.

See if your clients qualify for the LLC or other deductions. Some taxpayers, such as those who have exhausted the AOTC, may qualify for the Lifetime Learning Credit (LLC). This credit is worth up to $2,000 for expenses related to tuition and other qualified expenses for students enrolled at an eligible financial institution (note that for the 2016 tax year, the Lifetime Learning Credit is worth 20 percent of the first $10,000 of qualified college expenses. The LLC is not refundable). The credit can be used each tax year and applies to undergraduate and graduate school, as well as programs geared toward professional degrees or expanding job skills.

If they do not qualify for the AOTC or the LLC, the Tuition and Fees Deduction may be another option. For the 2016 tax year, this deduction can total up to a $4,000 reduction in income. Note that only one tax credit or deduction (AOTC, LLC, or Tuition and Fees Deduction) may be claimed per tax year. Keep in mind that IRS Publication 970 is a good source for more information on education tax credits and deductions. The figure below provides a brief summary of the most basic information.

vanguard-picture-1-jpg

Tax benefits may ease both tuition and tax bills.

Be Mindful of Tax-Sensitive Withdrawals
Aside from the potential tax benefits that can be received from paying for college expenses out of pocket, there are tax implications to be aware of when your clients are withdrawing from retirement accounts and taxable savings accounts to pay for college. Withdrawals from parent-owned and student-owned tax-deferred retirement accounts (such as traditional IRA and 401(k) accounts) are taxed as ordinary income. Note that withdrawals that meet the criteria of qualified education expenses are not subject to the 10 percent penalty tax. Withdrawals from parent-owned and student-owned Roth IRAs, on the other hand, can be taken tax free as long as the distribution is composed of the contributions made into the account on an after-tax basis. Withdrawals that represent earnings will be taxed as ordinary income. Note that Roth withdrawals in excess of contributions are not subject to the 10 percent penalty tax if used for qualified education expenses.

As you’re aware, care should be taken when selling assets from taxable accounts, whether parent-owned or student-owned. Realized gains will be subject to capital gains tax, but they may be offset with realized losses elsewhere.

Although the challenges of paying for college expenses may seem overwhelming to your clients, proper planning is critical to a successful outcome. Remember that bottle of smelling salts I suggested keeping at your desk in part 1 of this series? Put it away! Remember that balancing financial aid and grant considerations with tax-efficient spending strategies is a good way to help your clients start facing their college financing fears.

maria-bruno

 

Maria Bruno, CFP®
Senior Investment Analyst
Vanguard Investment Strategy Group
Philadelphia, Pa.

 

Editor’s note: This post originally appeared on the Vanguard Advisor Blog. See also Part I of the series. The author gives a special thanks to her colleagues Jonathan Kahler and Jenna McNamee for their research contributions.


Leave a comment

Helping Your Clients Face Their College-Financing Fears—Part 1

Higher education is expensive—frighteningly expensive. For most parents, providing for their children’s college education is second only to retirement as their largest investment goal. But even with diligent saving, the first tuition bill may be a shock to your clients, so you may want to keep a jar of smelling salts on your desk just in case.

How can you help your clients face this fear head-on? It’s all about creating a solid plan. With a proper plan in hand, you and your clients will be better prepared to tackle college tuition bills in an organized and financially sound way. Sallie Mae recently published research titled “How America Pays for College 2016,” that reported families are paying less out of pocket for college as they take advantage of scholarships and grants. The report noted that scholarships and grants funded 34 percent of college costs in the 2015-2016 school year, up from 30 percent the prior school year.

Vanguard’s new research, Tackling the tuition bill, provides a practical framework to help you develop a plan with your clients. In this post, I’ll explore the factors that affect financial aid eligibility. (In Part 2 of this series, I’ll provide tips on how to help your clients maximize federal tax perks while also considering how to spend tax-efficiently from assets earmarked for college.)

As you know, household assets and income affect financial aid eligibility, but these sources are not treated equally, based on whether they come from the student or the parents. The graphic below summarizes the key points—income matters more than assets, and student income matters more than parental income.

2017-02-14_vanguard-pic-1

The potential impact of student and parental income and assets on financial aid.

So what does this mean? Obviously, individual circumstances will vary, but here’s a savvy strategy to pitch to your clients:

  • Spend the student’s assets first.Because student assets affect aid eligibility more than parental assets (oddly enough, 529s owned by dependent children are considered parental assets), it can make sense to spend student assets before spending from a 529 plan. Such an approach gives 529 savings more time to compound tax-free. And by spending the more heavily penalized assets early, students increase their aid eligibility in later years, when inflation may boost tuition costs.
  • Tell the grandparents to hold off.Gifts from grandparents and others are considered student income, which has the greatest impact on your student’s financial aid eligibility. As a result, consider tapping those grandparent-owned 529s in the later years of college, when they will no longer be reported or considered in financial aid evaluations.
  • Don’t drain the 529 right away.Parent-owned assets, including 529 plan accounts, have more limited impact on aid eligibility. Unless a client plans to pay for the entire degree with 529 savings, it can make sense to spend from this account strategically over the course of a student’s college career. The account can benefit from continued tax-free growth. A client may also be able to time 529 withdrawals to create opportunities for additional aid or benefits.

I realize there’s a lot for you and your clients to think about; but with a bit of knowledge of the rules and some planning, the tuition bills can be tamed. Look for part 2 of this series, in which I’ll share some tax-savvy tips for tackling tuition.

maria-bruno

Maria Bruno, CFP®
Senior Investment Analyst
Vanguard Investment Strategy Group
Philadelphia, Pa.

Editor’s note: This post originally appeared on the Vanguard Advisor Blog. The author also gives a special thanks to her colleagues Jonathan Kahler and Jenna McNamee for their research contributions.


Leave a comment

Become a Gen-Savvy Financial Planner

Cam Marston.jpg2017 FPA Retreat Speaker Cam Marston

Any business situation today—from hiring new employees to bringing on new clients—will likely involve at least two different generations, and sometimes three or four. If you feel out of touch with generations different than your own and are perhaps hesitant to work with them, Cam Marston offers this advice: understand your own generational biases first, then have empathy for others.

Marston, a leading expert on generational change and author of The Gen-Savvy Financial Advisor, is teaching people of various generations—matures, baby boomers, Gen-Xers, and millennials—how to understand each other and work together.

Marston will present at FPA Retreat, April 24–27 outside Atlanta, Ga. Register for Retreat here. Below is an excerpt of a February 2016 Journal 10 Questions interview with Cam Marston. See the original article here.

1.) What are some things financial advisers should know about successfully working with millennial clients?

First, most of them are asset poor right now; they simply don’t have a lot of resources. Second, they are very attuned to their parents. The millennials and their parents have a tight connection. A generalization is that they will listen to one another, which is an opportunity for a warm lead from baby boomer parents. Third, when you introduce yourself, put content on your website, or in any sort of promotional moment you get, you need to focus on the client and how they’ll change and benefit from working with you.

Fourth, millennials are easiest to work with in groups. They tend to like to be in groups of two, and three, and four. When calling on them or holding events, you want to make sure they come in pairs or in threes because they will much more likely show up than an individual who doesn’t know anyone at the event. So schedule opportunities for small groups of millennials to gather and hear your proposal or your information.

2.) What about Gen X clients?

The apex consumer in Generation X today is the Generation X female. And when she is a mother of a young child, her decision-making and referral authority is unparalleled. Our society has given mothers of young children the ability to tell people what to do, what to buy, and where to shop in a way we’ve never seen before. So if I’m an adviser and I’m engaging a Generation X female with young children, I must treat her very, very well, because her ability to refer people to me is enormous.

Secondly, if she is married with young children, she is more often than not the CFO of her household. As much as the husband may act like he is the decision-maker, when the two of them are alone, she will determine whether I get the business or not, and she still has the power to refer. So when I’m dealing with Generation X, I’m keeping a keen eye out for the influence of the Generation X female. And my prediction is the millennial female will be exactly the same with a power of 10.

Know that the Generation-Xer is a “stalker.” Before ever meeting you in a business environment, they will have gone online and done a good bit of research on you. So to prepare for doing business with a Generation-Xer, make sure your online first impression is sparkling and squeaky clean.

3.) What are some things that financial advisers should know about successfully working with baby boomer clients?

A distinction needs to be made between leading and trailing baby boomers.

Leading baby boomers, born 1946 to 1955, are the oldest portion of the baby boomers. Population-wise, they’re a smaller segment of the boomers, but their attitude is unique in that we appeal to the older baby boomers with messages of: you’ve worked hard, you’ve paid your dues, you deserve the fruits of your labor. The systems of the nation, Social Security, etc., were set up to reward you for the hard work you’ve done; let’s help you enjoy that through retirement planning.the-gen-savvy-planner

The younger baby boomers, born 1956 to 1964, are the more populous section of the generation. The great recession of 2008 hit them hard. They are of the age that many of their children should have been getting a toehold in their careers when 2008 came around, but due to the economy those younger boomers had to continue to supplement some of their children’s needs.

Bottom line, those younger boomers wear a brave face, but inside they are horrified at their retirement prospects. They haven’t saved enough. Their defined benefit plans have been frozen, eliminated, or were never offered to them. They’ve not taken advantage of the 401(k) plan—they realize in hindsight—the way they should have.

The adviser needs to go to the trailing baby boomers and give them a message of hope. Not a message of entitlement, or you deserve it, or you’ve worked hard, but a message of hope that is timely and personalized, which is: “There is still time to get you to this goal. We can create a plan that matches your need.”

Schulaka Carly_resizedCarly Schulaka
Editor
Journal of Financial Planning
Denver, CO


Leave a comment

Financial Planning Priorities for New Parents

Everyone in my life is having kids. And, as the fee-only financial planner in my community, I’ve frequently been asked: “How do I set up a 529 college savings account?”

It’s a good question. But, as another adviser used to say, “it’s the wrong question.” While opening a 529 college savings account is usually a good idea, it’s very low on the list of financial planning priorities. Why ins’t a 529 college savings account a big deal?

Without a 529, attending college is still possible via either student loans and/or work-study programs. Moreover, there is even the chance that higher education might be free in the future, or that your client’s child determines that college isn’t right for them. Either way, not having a 529 doesn’t mean a catastrophic life event for you client.

I’m not saying don’t create a 529 account. I’m just saying that a client’s attention, energy and time are extremely limited—especially if they’re a new parent. So, if a client only has so much time in his/her hectic schedule, focus on the financial planning moves that will make the biggest impact.

What Planners Need to Emphasize for New Parents
A Will. While having a conversation with a client about their own mortality may not be easy, our profession knows that this subject is very important. Parents of minor children definitely need a will. In the will, it is critical to designate the names of the godparents in the instance that both clients pass simultaneously in an untimely manner.

luskin-1-jpg

To illustrate the importance of a will, consider a worst-case scenario: Without a 529 account, a client’s child may have to resort to student loans to finance his/her education. Without a will, a client’s child may end up in a state-run orphanage. Of those two scenarios, which single issue is most dramatic—and which issue should receive the highest priority in terms of prevention as you advise new-parent clients?

Life insurance. You likely don’t need me to convince you that life insurance is important for new parents. The point here is that term-life insurance is infinitely more important than funding a 529 college savings plan. Household breadwinners need to designate their spouse as primary beneficiary with godparents (outlined in the will) designated as the contingent beneficiary.

luskin-2-jpg

Illustrating a worse-case scenario to your client is the best way to effectively communicate the value of prioritizing life insurance over college funding: it’s more important that a client’s child has food on the table, clothes on his/her back and shelter over his/her head for ages up to approximately 18, rather than money for college.

Disability Insurance. In the context of financial planning moves for new parents, a disability insurance policy plays a pretty similar role as life insurance: providing money to fund a child’s lifestyle when your client (the parent) is no longer able to do so. For this reason, it’s much more important than a 529 plan, with a disability insurance policy providing money for food, clothes and shelter.

Prioritize Financial Planning Needs for New Clients

So, while having a college savings account is certainly a “nice-to-have,” it’s not a make-or-break financial planning move. A 529 college savings account is simply not that important. What is very important for parents (or prospective parents) are a will, life insurance and disability insurance. Address those three items FIRST, and then work with clients to open up a 529 college savings account.

jon-luskin

 

Jon Luskin
Fee-only Financial Planner and Fiduciary
Define Financial
San Diego, Calif.

Editor’s note: Find more of Luskin’s blogs about personal financial planning for employees of Deloitte at UncleDmoney.com.


Leave a comment

Educate Yourself About Complex Products

Regulators have been focusing on complex products for many years and we don’t anticipate a shift anytime soon.

Here are just a few regulatory references relating to complex products with one thing in common across all of them—education! It would be wise to familiarize yourself with them.

  • NASD Notice to Members 03-71 (Non-Conventional Investments) reminds members offering non-conventional investments of many obligations to include training advisers regarding the features, risks and suitability of these products.
  • NASD Notice to Members 05-26 (New Products) encourages firms to consider the complexity of a new product during the vetting process—whether the complexity would impair investor understanding of the product, and how complexity would affect the marketing and sale of the product. The notice highlights practices employed by some firms that NASD believed others should consider to comply with their various suitability obligations, avoid conflicts and plan for appropriate training and supervision. Every firm should ask and answer certain questions before a new product is offered for sale, including:
    • Does such complexity impact suitability considerations and/or the training requirements associated with the product?
    • Will the product necessitate the development or refinement of in-firm training programs for advisers and their supervisors? If so, how and when will the training be provided?
  • FINRA Regulatory Notice 12-03 (Heightened Supervision of Complex Products) identifies characteristics that may render a product “complex” for purposes of determining whether it should be subject to heightened supervisory and compliance procedures, and provides examples of appropriate procedures. The notice clearly states that advisers who recommend complex products must understand the features and risks associated with those products. The adviser should be adequately trained to understand how a complex product is expected to perform in normal market conditions as well as the risks associated with the product.

How Do Complex Products Impact Commission Structures and Regulatory Requirements?
Certain complex products may involve a higher commission structure than less complex products. Regulatory requirements place a heightened focus and obligation on the adviser when recommending such products and that may justify the higher commission.

As discussed within part one of the Exemption FAQs released by the DOL and preamble to the BIC Exemption of the DOL Conflict of Interest Final Rule, firms can pay different commission amounts for broad categories of investments based on neutral factors, such as the time, complexity and level of expertise associated with recommending investments within different product categories.

During a recent webinar hosted by AI Insight, Marcia Wagner of The Wagner Law Group, stated, “Providing evidence of training for the distribution of more complex investment alternatives would support a finding that level of expertise was an appropriate neutral factor.”

Regardless of the training policy you and your firm may have, if it is not adequately followed and documented, it didn’t happen.

michael-kell

 

Michael Kell
Vice President
Program Management and Business Development
AI Insight
Worthington, Ohio
 


Leave a comment

Do We Rely Too Much on Risk Tolerance Questionnaires?

When you meet a new client you want to know three things: their return objective, their time horizon and their tolerance for risk. You may want to know other things too, but these are the big three.

Calculating a return objective is pretty straightforward. The same is true about time horizon. You gather some facts, make some assumptions and ask the client to think about some things they probably haven’t thought much about. But, in the end, the calculations are pretty simple.

What about risk tolerance? How do you measure it? Can you calculate it at all?

It doesn’t take long to see that there are really two very different varieties of risk tolerance. One is objective and the other is subjective.

The objective variety is easy to understand. If I arrive at my retirement age with more money than I need to live comfortably, my goal should be to take as little risk as possible while maintaining the purchasing power of my assets. Objectively, I have no need to take risk.

On the other hand, if I arrive at my retirement age with significantly less money than I need, objectively I should have a higher risk tolerance. I need to take risk to reach my goal.

This objective type of risk tolerance determination has nothing to do with my internal feelings, attitudes or beliefs about risk. It is all driven by my goals and my time horizon.

Now let’s look at subjective risk tolerance. This is what risk tolerance questionnaires purport to measure by asking questions about our predisposition toward, and comfort level with, risk.

Some questionnaires synthesize our answers into a risk score. Some even use our risk scores to determine our investment strategy. Our comfort with risk drives which portfolio we receive.

These questionnaires assume that our risk tolerance is like an organ in our body that can be “seen” through an X-ray or MRI. The questionnaire is the tool that discerns risk tolerance.

This view is not consistent with the research on risk tolerance. A person’s tolerance for risk is hard to capture and harder to quantify precisely. You may get a general sense of a person’s comfort with, and capacity for, risk-taking, but assigning a meaningful risk score is impossible.

In addition, risk tolerance is fluid not fixed—it changes over time. Today’s bold adventurer is tomorrow’s timid soul. It is also situational. A skydiver may be conservative with her money.

The research also suggests that we are notoriously bad at assessing our own risk tolerance. Getting a sense of our risk tolerance by asking us produces unreliable results.

If we are not good at assessing our own tolerance for risk and that tolerance changes over time, what good is a questionnaire that produces a precise risk score at one moment in time?

A more difficult question is, “why is risk tolerance even relevant?” If a client needs to be aggressive in order to reach his goals, should you put him in a conservative portfolio just because he has a low risk score? The answer seems obvious. Risk, alone, should not drive strategy. Sometimes being a little uncomfortable is a necessary side effect of investing.

A discovery questionnaire can help an adviser solicit important information from a client and stimulate discussion to develop insights about the client’s goals, experiences and attitudes. But substituting a mechanical scoring system, backed by questionable science, for the judgment of an experienced adviser is a step backwards for our industry and ill serves our clients.

scott-mackillop

 

Scott MacKillop
CEO
First Ascent Asset Management
Denver, CO

 


Leave a comment

FPA Events: FPA Retreat 2017

chateau-elanOnce again, Chateau Elan outside Atlanta, Ga., is the quintessential setting for effortless engagement and organic networking at Retreat 2017.

For those who have not had the pleasure of attending Retreat, this deeply relational event focuses as much on the art of being an intuitive financial planner as it does the science of best planning practices. Maybe even more so. Of course, attendees receive world-class, peer-to-peer learning that elevates their professional effectiveness. That has been the goal of Retreat from the start 37 years ago. But, ask any regular attendee, and you’ll hear the real reason they return year after year—for the human interaction, the mentoring and the stories that so often teach us the lessons that remain with us for a lifetime.

Additionally, Retreat plays a vital role in connecting the next generations of planners. As conventional standards for achieving success in business give way to such interpersonal capabilities as engaging and inspiring others, Retreat will be the bridge for an ongoing interchange of expertise, experience and insights that connect the generations and foster authentic relationships within the FPA family.

MentorMatch has been hugely successful in addressing the needs of newer practitioners through connection with experienced advisers who help shorten the learning gap significantly for their mentees. Likewise, mentors find that the learning goes both ways as they build relationships with young planners whose skillsets are different from their own. Something intangible rubs off on us in the company of an older and wiser generation. And who can deny the surge of energy and innovative ideas we pick up from the younger crowd.

It is win-win. And those involved in the program enjoy sharing the benefits and rewards of the experience, whether they’re on the receiving end of a mentor’s sage advice and generous support or paying it forward as they walk with younger planners though the challenges of building a successful practice. In the end, we are all reminded of what matters mos—and why we do what we do as financial planners and advisers.

Space is tight so grab your spot not! Visit fparetreat.org for more information and to register.