Income Based Repayment IBR

IBR: Income Based Student Loan Repayment

Income based student loan repayment (or IBR) is one of the four income based repayment options that the federal government offers to help borrowers reduce monthly payments on their debt.  IBR is a great option if you don’t qualify for the Pay as You Earn (PAYE) program, and aren’t a good fit for the Revised Pay as You Earn (REPAYE) program.  While only available on certain federal student loans, the program is a wonderful benefit to many lower income borrowers.

 

What is Income Based Student Loan Repayment?

The income based repayment option (IBR) was originally passed by Congress in 2007, but didn’t become effective until 2009.  It’s objective was to provide a more affordable student loan repayment option to low income borrowers.  The plan improved on the preexisting income contingent repayment option (ICR) by lowering minimum monthly payments from 20% of discretionary income to 15%.

Then in 2014, IBR was revised.  For new borrowers as of July 1st, 2014, monthly minimum payments were reduced from 15% of discretionary income to 10%, and the forgiveness period was shortened from 25 years to 20.

IBR was a significant improvement over the ICR repayment option.  But today, there are two additional income driven repayment options (REPAYE and PAYE) that are a better choice for most borrowers.  But due to PAYE‘s qualification standards and REPAYE’s mandatory inclusion of spousal income, IBR remains a viable option for many others.

 

How it Works

Like all income based repayment options, IBR gives borrowers an alternative if the minimum monthly payment on the 10 year repayment plan is too much.  For example, let’s say you’re a new graduate and have accumulated $100,000 in federal student loan debt.  You’re about to start work at job that pays $50,000 per year, and the interest rate on your loans is 6%.

Continue reading

Adventures in Estate Planning: The Educational Trust Fund

Adventures in Estate Planning: The Educational Trust Fund

Helping loved ones finance the cost of education is a wonderful & long lasting gift.  But when you build this type of gift into your estate planning aspirations, the more traditional vehicles can be limiting in many ways.

529 plans and Coverdell ESAs are two of the most popular options, but the accounts can be rigid and limiting.  If your objectives are more unique, say you want to help multiple beneficiaries or include other requirements for access, you’ll need a more customized solution.

Enter the educational trust fund.  Educational trust funds give you complete control over how your gift is to be managed and distributed.  If your gifting strategy is even marginally complex, an educational trust fund might be your best option.

 

How They Work

When contributing to the 529 or Coverdell account of a loved one, you’re faced with numerous and rigid restrictions.  There are contribution limits, there are limitations on what the funds can be used for, and there are restrictions on portability and who may use the funds.  They provide a great way to save for college on a tax advantaged basis, but there’s not much room to customize.

Continue reading

Health Insurance for Retirees Under 65: How to Cope Until Medicare Kicks In

Health Insurance for Retirees Under 65: How to Cope Until Medicare Kicks In

If you’re planning to retire early, you might be wondering what you’ll do for health insurance coverage.  Medicare won’t kick in until you turn 65, and the rising cost of healthcare each year could translate to unknown monthly premiums and out of pocket costs.  This leaves you in a precarious situation if you don’t have another form of benefits.

Fortunately, the Affordable Care Act includes several rules designed to limit your costs.  For example, insurance companies may charge a 64 year old premiums of no more than three times those of a 21 year old.  The ACA also outlaws rejecting applications or charging more for preexisting conditions, and limits out of pocket costs to $6700 per year.

I’m not taking a stance on Obamacare here, but if you’re looking to retire early the road to health coverage is easier now than it was a few years back.  But despite the improvements, a major illness or  injury could still take a big chunk out of your retirement savings.  And as you probably know, the worst possible time to deplete your nest egg is immediately after you stop working.

Continue reading

Sequence of Returns: the Biggest Risk to Financial Independence & a Successful Retirement

Sequence of Returns: The Biggest Risk to Financial Independence & Successful Retirement

When you think about your retirement & financial independence, what keeps you up at night?  Is it the possibility that a market crash depletes your nest egg?  Is it inflation?  What about the cost of health care, or living too long and running out of money?

These are all common concerns I hear from people approaching their leap into financial independence.

Every now and then someone will ask me what they should be concerned about.  “What would you be concerned about if you were in my shoes?  What are my biggest risks?”

 

Average Returns & Volatility

Most of us approach retirement planning with expectations about the average returns we’ll see throughout retirement.  You’ve probably heard (maybe even from me) that the S&P 500 averages between 7.5% and 9% in annual returns – depending on the exact data set and who you talk to.  Over a 30+ year retirement, if we were to invest only in the S&P 500, we could expect an average annual return between 7.5% and 9%.  I’m confident this is true, based on the last 150 or so years of historical data in the financial markets.

As you know, this doesn’t mean that the stock market will gain 7.5% each and every year.  There will be years like 2001 and 2009 where the market falls 25%-30%.  There will also be years where it gains 25% or more.  The markets are volatileBut on average, the S&P 500 will see somewhere between 7.5% and 9% returns per year.

One of the statistical measures of volatility is called standard deviation, which is used to measure just how volatile a data set is around an average.  Since 1926, the standard deviation of the S&P 500 is about 18.5%.

Now, the image below is something you’ve seen before.  It’s a bell curve based on a normal distribution.  The simple explanation of a a normal distribution is that the results occur randomly around the mean.  In a normal distribution:

  • 68.2% of the results will fall within one standard deviation of the mean
  • 95.4% of the results will fall within two standard deviations of the mean
  • 99.6% of the results will fall within three standard deviations of the mean
  • 99.8% of the results will fall within four standard deviations of the mean

 

Sequence of Returns: The Biggest Risk to Financial Independence & Successful Retirement

What does this mean for the S&P 500?  If the S&P 500 is normally distributed and resembles a typical bell curve, annual returns will fall between:

  • -11% and 26.5% 68.2% of the time (7.5% – 18.5% & 7.5% + 18.5%)
  • -29.5% and 45% 95.4% of the time
  • -48% and 63.5% 99.6% of the time

I should note that many have argued the returns of the S&P 500 are not normally distributed, including William Egan and Nassim Nicholas Taleb.  And for the most part I don’t disagree with them.  This argument is beside the point of this post though, so for this discussion and the following examples we’ll assume a normal distribution fits the S&P 500 just fine.

Continue reading

The 17 Biggest Retirement Mistakes

I’m guessing that over the years you’ve read at least 1000 posts, articles, and ebooks on what to do before you retire.  Good retirement checklists are about a dime a dozen in the online world.  And even though most of them contain great information, you probably don’t need to review the same to-do’s for the umpteenth time.

So in this post I’ll spare you from a list of regurgitated tips you’ve seen before.  Instead, here’s a list of the 17 biggest retirement mistakes I see in my practice.  If you can avoid these issues after you stop working, you’ll be in much better shape than most retirees.

Continue reading

6 Ways to Minimize Required Minimum Distributions

6 Ways to Minimize Required Minimum Distributions

There’s a plethora of tax advantaged retirement accounts out there today.  Enough that the acronyms and numbers can get really confusing…

  • IRA
  • 401k
  • 403b
  • 457
  • Profit sharing
  • SEP IRA
  • SIMPLE IRA

Just to name a few – trust me, there are more.  The reason?  The government wants us to save for our own retirement.  And by offering an array of tax advantaged accounts, they’re incentivizing us to put money away.

But while the tax advantages are great, the government won’t let us shelter our money from taxes forever.  When you turn 70 1/2, they’ll force you start taking withdrawals called required minimum distributions, or RMDs.  If you don’t you’ll be subject to a hefty 50% penalty.

This poses quite a problem for many retirees, since each withdrawal raises their tax liability for the year.  So for those of you who want to keep Uncle Sam’s grimy mitts off of your hard earned retirement funds, here are six ways to minimize your RMDs:

Continue reading

401k RMD Rules

401k RMD Rules: A Comprehensive Guide

You’re probably familiar with the term “required minimum distributions” (or RMDs for short).  They’re the systematic withdrawals that the IRS makes you take out of an IRA after you turn 70 1/2.  But what about for 401k and other qualified retirement plans?  What are the 401k RMD rules?

While they largely resemble IRA RMD rules, 401k plans have a few subtle but important differences.  And since many people these days are staying at their jobs beyond 70 1/2, it’s a situation that more and more people find themselves in.

To help you navigate the waters, here’s a comprehensive guide to 401k RMD rules, which also applies to 403b, 457, and other qualified plans.

Continue reading

Active vs Passive Investing

Active vs Passive Investing: The Debate Continues

Active vs passive investing.  The debate over which is strategy is superior has raged on for what seems like an eternity.  And even though passive investing, or indexing, has become so popular of late, millions of investors still prefer a skillful active manager over a robotic index fund.

Whichever side of the argument you fall on, you have a decision to make when it comes to managing your portfolio.  Here’s some background on both strategies, and a summary of some mainstream research on the topic.  If you can put this research to use, you’ll be far better off than most investors.

 

Active vs Passive Investing

 

Indexing

When you think of the term “stock market,” what comes to mind?  Most people visualize walls of computer monitors, people yelling into phones and running around frantically, and papers being thrown in the air.   But as you know, the actual market is just the place where securities are traded every day.  And today it’s largely run by computers across several semi-quiet trading floors in New York.

But what does it mean when we say the market is up or down 50 points?  Rather than track the trades of every single stock trade (there are millions, by the way), it’s far easier to create a proxy, or index.  Simply put, an index is a group of securities used to represent a specific portion of the market.

The most prolific index is the S&P 500, which represents large cap stocks in the United States.  As you know, there are a ton of large publicly traded companies in the U.S. – far more than 500.  To represent the performance of the entire group, the S&P 500 takes the largest 500 of them based on market capitalization (number of shares in existence times the market price of each share).

There are thousands of different indexes out there beyond the S&P 500.  Some are built to track specific asset classes, while some are used to track sectors or investment styles.  For example, in addition to the S&P 500, Standard and Poor’s has an index that tracks just the technology sector in the U.S., and another that tracks large cap value stocks in the U.S.

 

Passive Management

As you probably know, indexing is an investment strategy.  The objective is to invest in an entire asset class by purchasing every single security in the index.  If you wanted to invest in large cap U.S. stocks, you could select an index like the S&P 500 or the Dow Jones Industrial Average and buy an equal number of shares of each stock in the index.

Logistically, it’s far more cost effective to buy index funds than it is to buy every security.  But the strategy is the same.  In both formats, your portfolio is invested without preference to individual securities.  This broad based, diversified investment strategy is known as passive management.

 

Active Management

As you also know, many MANY investors prefer to pick individual securities.  Rather than invest in every security in an index, active managers make investment decisions on individual securities within the same universe.  Their objective is to invest in the stocks that will outperform the index, and avoid the stocks that won’t.

In other words, active managers have an opinion about the future performance of every single security in a given universe.  Passive managers don’t.  Instead, they buy one of each.

Hiring an active manager can be expensive.  In order to develop these opinions, active managers must “grade” each security effectively.  This takes a significant amount of time, resources, expertise, and skill.  Far more than what’s necessary in an indexing strategy – which is why actively managed funds are more expensive than index funds.

Continue reading

Fixed Annuity Pros and Cons: 10 Things You Need to Know

Annuities are incredibly popular instruments for retirement planning.  They come in all shapes and sizes, and while having more options can be a good thing, it can also be very confusing.  For that reason, fixed annuities are a popular way to guarantee income without wrestling with a complicated and expensive product.  Even so, buying an annuity is a major decision.  To help you weight both sides, here are 10 fixed annuity pros and cons:

 

Fixed Annuity Pros and Cons:

 

Pros:

1) Guaranteed Returns

Since fixed annuities pay you a set amount of interest (like a CD), your returns are guaranteed.  This is very useful if you’re concerned about stock market risk as you approach retirement.

 

2) Guaranteed Income

This is probably the most popular feature of fixed annuities.  You hand money to an insurance company via a fixed annuity, and in return the insurance company pays you consistent income for the rest of your life.  Your income doesn’t fluctuate due to stock markets, interest rates, or whether your rental property is leased for the month.  It’s guaranteed and reliable.

The only reason the insurance company might fail to pay this income is if they went out of business.  And even though many of us are skeptical about big companies in the financial industry, insurance companies are very unlikely to go bankrupt.  They are regulated by individual states, each of which requires them to keep a great deal of cash on hand to pay their liabilities (far more than bank reserve requirements).  Even though fixed annuities aren’t insured by the FDIC, the likelihood that you won’t receive promised retirement income is extremely low.

Continue reading

Fundamental Indexing: An Overview

Fundamental Indexing: An Overview

Fundamental indexing, or “smart beta” is an investing buzz word you might have heard before.  It’s an investment strategy similar to index investing, and was introduced about ten years ago.  Since then the strategy has grown to become rather popular.

Generally, when it comes to new and popular investment strategies I run for the hills.  I learned early on that “this time it’s different” are incredibly dangerous words in the investing sphere.

But even though fundamental indexing is a newer strategy, I believe it merits an allocation in a well diversified portfolio.  This post will explain what fundamental indexing is and why I think you should consider using it.

Before diving into fundamental indexing, let’s take a look at where traditional indexing came from.

 

Indexing History

Back in the early 1900s there wasn’t much of a market for stocks.  If you wanted to invest in stocks you had to buy physical certificates from someone who had them on hand.  In the big metropolitan areas like New York there were plenty of people wheeling and dealing these certificates (this is how the New York Stock Exchange started).  But even if you could piece together a decent selection, building a well diversified portfolio was overly difficult.

Then in the late 1920s, the first mutual funds appeared.  Established by Massachusetts Investors’ Trust, investors could buy shares of a diversified investment fund managed by a professional for the first time.

The mutual fund market expanded through the 50s and 60s, and by 1970 there were nearly 250 open ended mutual funds available to investors.  These 250 funds were a far easier way for most people to invest, and billions poured into them from around the globe.

They weren’t without their shortcomings though.  The trouble with mutual funds was that investors were forced to put blind faith into an investment manager’s stock picking ability.  The mutual fund manager may be skilled, or they may not.  And since very few investors could have a face to face or phone conversation with a mutual fund manager, many were not completely sold on the idea.

 

Enter Index Investing

Then in 1971 Wells Fargo Bank started the first index fund.  It was a novel idea.  Rather than trust a stranger to manage your money, you could invest in an index fund that simply replicated a given universe of securities.  S&P 500 index funds simply bought all 500 stocks in the S&P 500.  All the research & analysis a mutual fund manager would undergo to pick superior securities was stripped from the equation.  And since investors didn’t need to pay a mutual fund manager’s salary, index funds were far less expensive.

This was the very idea that John Bogle used to build Vanguard into a massive investment company.  He believed that investors are far better off investing in an index than they are purchasing actively managed mutual funds that attempt to outperform an index.

Bogle also believed that active investment managers were unable to pick outperforming securities (and avoid underperforming securities) on a consistent basis.  Those who did were simply lucky.

The Active vs. Indexing Debate

The debate between which strategy is superior is fierce, and will probably rage on for eternity. Proponents of active management contend that in the long term, skillful mutual fund managers are still able to outperform index investing.  This might be because they are particularly adept at analyzing securities or the market, or because they have some other type of advantage.

Like Bogle, those arguing in favor of indexing claim that managers who outperform an index do so only by luck, and there is no mutual fund manager alive who can consistently outperform their benchmark index. Therefore it makes no sense to incur the additional cost of active management.

Over the last decade or so, the evidence has pointed toward indexing.  Fewer and fewer mutual funds are outperforming their benchmarks.  And along with more low cost investing options, billions of dollars have flown out of actively managed and into index funds in each of the last 10 years.

Continue reading