Advice for New Nesters

New NestersThey have graduated from college and have finally secured their first job. They are officially launched. Give yourselves a high five. It is what all parents dream of and sometimes fear. An empty nest with quiet solitude and, presumably, less mess and lower grocery bills. Now those fledgling adults need their own places to roost, but rents are high in Charleston or Chicago or other cities where they may have migrated. The best areas to live and work are always the most expensive. Paying rent to a landlord can seem like throwing money away. Wouldn’t it make more sense for them to buy their own nest?

The good news is that mortgage rates are favorable now and the real estate market is stronger in many areas. Real estate will likely be an asset that appreciates. There are some favorable mortgage programs for first-time home buyers. Generally, there are two categories for loans: the conventional mortgages offered by Fannie Mae/Freddie Mac and then the slightly more lenient programs offered by the FHA. There is also a kind-of hybrid program offered by Fannie Mae called My Community Mortgage that is similar to the FHA loan programs, but has income limitations based on the HUD median income in your area. Lastly, if looking in a small-town area, there is a USDA loan program that offers favorable rates, flexible lending guidelines and can offer options with no down payment. There are location and income limitations for the USDA loans, but worth looking into, if purchasing real estate in a small town. The individual banks will occasionally offer short-term “niche” loan programs, but there can be some catches with those.

The first place to start in the home-buying process is to get an accurate and current credit score and credit report for your first-time home buyer. All loan programs will require this information from the buyer and it is good for them to know where they are before starting the process. Lenders look carefully at payment history, debt ratios and employment history for young buyers. FHA loans will allow letters of explanation for credit issues and flexibility in some of the other guidelines. They can get pre-approved for a mortgage so they know exactly what amount is possible to borrow. Generally speaking, the conventional mortgages require a credit score minimum of 680. The other programs are more flexible and will individually evaluate to qualify, though 620 is probably their minimum. They can certainly start by checking with their bank on what they can do. The mortgage broker we spoke with says that they work hard to find the best available option for the borrower and to make sure that they manage the underwriting process to ensure qualification. Having options and someone to help with underwriting can be especially useful for a first-time buyer. The rates and down payment minimums might be better in a conventional loan program, but the guidelines are a little stricter. It is advisable for the new buyer to get educated and look into improving their credit worthiness, if needed.

Prior to real estate shopping, it is also recommended that the buyer have a very good understanding of their budget so they know exactly how much house they can afford. It is good to remember all the “sleeper” costs in both the purchase and ownership of a home. There are settlement costs, taxes, insurance, maintenance, repairs, HOA fees etc. that all should be considered as part of the budget. Also, have the potential new nester check out the neighborhood at different times of day to see if it meshes with their lifestyle. And be sure to test the commute to and from work… in this day and age, that can be a very big consideration for quality of life as well as resale!

There are several options for you to participate in as parents. All of the programs allow some down payment and/or settlement cost help from family members. The rules vary, but there are definitely options to provide 100% as a gift, as long as the buyer can qualify for the mortgage on their own. The lender will require proper gift letters and possible bank statements. There is also the ability to be a non-occupant co-borrower that can help with qualification, as long as the occupant can demonstrate that they can afford the payments with their income. This will affect the parents’ debt ratio and appear on their credit report. You could also purchase something and rent it to your child, possibly even with a rent-to-own contract. There are, of course, tax advantages to ownership for the young buyer and may be advantages for you, also.

DWM clients know that financial planning assistance for their children, including first time home buying, is covered as part of our Total Wealth Management process. We’re happy to help with nest-building for the entire family.

Tax Tip: Choosing the Right College Savings Plan

529This time of year, everyone is looking to find ways to avoid large tax burdens. Contributions to your child or grandchild for college savings may be a great way to plan for the future and get some tax relief right away. As a college savings tool, 529 plans are the most popular choice to maximize tax-free growth of your investment, as long as it is used entirely for qualified secondary educational expenses. An individual can contribute up to $70,000 and a couple up to $140,000 to one beneficiary in a single year, as long as they count it towards their annual gift tax exclusion over a five year period. Many of the 529 plans allow for maximum account values of over $300,000. The 529 contributions are considered an asset of the custodian, allowing for flexible financial aid qualification for the student and transfers of the funds between accounts for other beneficiaries. Each state has its own plan and investment module and many offer tax benefits for contributions by residents. If your state does not offer tax incentives, then you are free to invest in any of the top-performing 529’s in other states, as most plans do not have residency requirements to participate. DWM can help find the best direct-sold plans with low operating expenses and good allocation menus. South Carolina’s direct sold plan ranks in the top 10 and Illinois in the top 15 for the last 5 years and both offer tax incentives for residents.

Before the 529’s were created, the investment choice for many was the Uniform Gift to Minor Acts (UGMA) or Uniform Transfer to Minors Act (UTMA) custodial accounts. These plans offer the advantage of allowing for non-qualified educational expenses without penalty. For example, if you want to use the funds to buy a car for your teenager. The UGMA/UTMA accounts also offer a full range of investment options with the ability to choose allocations and make changes as you would with any other investment account. There is also no limit on the maximum contribution amount. UGMA/UTMA accounts are taxed on their growth and mandated by the rules of the “kiddie tax”. This tax provision allows for the first $1,000 of unearned income of the minor to be tax-exempt and then the second $1,000 is taxed at the young account holder’s lower tax rate. Any gains from investment growth, dividends or interest above that $2,000 unearned income limit will be taxed at their parent’s higher tax rate. This tax provision affects all account holders under 19 or dependent full-time students between ages 19-23.

So what happens if you are the custodian for a UGMA/UTMA for a minor child or grandchild and you want to move it to a 529? 529’s can only accept cash deposits so the account will have to be liquidated and the custodianship terminated. The irrevocable provisions of the beneficiary arrangement in Uniform Minor acounts, however, must still be maintained, even in the 529. The 529 will ask for the source of the funds, and, if coming from a UGMA/UTMA, some 529 plans will register it as a Custodian 529. This simply means that the beneficiary rules designate the account holder be given control of the asset at age 18. The same Uniform Minor laws apply regardless of what kind of account these funds transfer to because the original asset was in an irrevocable account. Funds cannot be transferred or used by siblings or other family members without a penalty.

Is it prudent to move the funds into a tax-exempt 529? The biggest consideration are the taxes created by the liquidation of the UGMA/UTMA account and/or the annual taxes owed by the minor during its operation. After evaluating the potential gains to be made during the life of the account, you must consider what the tax on those gains will be. You can choose to liquidate the account in pieces over time or all at once, depending on the tax burden created. The tax must be paid at some point, so perhaps sooner rather than later will prevent it from increasing. Another choice is to leave the assets where they are and put any additional contributions in a new 529 for the beneficiary. This will avoid causing a taxable event while creating a beneficial 529 account. There may be a tax benefit to transferring the funds into a state-sponsored 529 plan because of tax breaks offered by some states, like South Carolina and Illinois. The tax owed on the gains may be offset by the tax incentives offered. You will have to weigh the implications of the long-term tax-saving benefit of transferring into a 529 against the tax burden created by liquidating the account.

While it’s true that the 529 is an excellent college-saving tool, there can be advantages to using the Uniform Minor accounts as well. And a conversion of a UGMA/UTMA account to a 529 can be a complex decision. At Detterbeck Wealth Management, we can help you evaluate your situation to determine the best option.

Student Debt: On the Rise Big Time

Student Loans

Student debt is accumulating at an alarming rate for a large number of people. According to a recent study by The Federal Reserve Bank of New York, student debt is approaching $1 trillion, making student debt the second largest after mortgage debt. The study estimates that 43% of 25-year-olds had student debt in 2012. We are meeting young clients with loans in excess of $200,000.

This immense level of debt is creating a drag on the economy. With such a large burden, a recent graduate is less likely to start a business, buy a house, or even start a family.

What has led to these high levels of student debt? Contributing factors include: increasing tuition rates, income levels that do not line up with the amount of debt, states funding cutbacks and the notion that all Americans need a college education. Tuition rates have increased to astounding levels; it’s not uncommon for a graduate school’s tuition to exceed $40,000. Yet, the Center for College Affordability and Productivity reported that around 48% of college graduates are in jobs that do not require a four-year college degree. The amount of a recent graduate’s loan can play a major role in the career decision that person makes when considering monthly repayments.

Many recent graduates are spending between 10 -25% of their income in student loan repayment. There are three new repayment programs that adjust the monthly payments to reflect the borrower’s adjusted gross income and ability to pay. They also provide a forgiveness of any unpaid principal at the end of the loan repayment period. However, these programs are only available to recent borrowers with federal loans and borrowers must meet a number of criteria to qualify for these programs. Additionally, unless the borrower works for the government or non-profit companies, the forgiven balance will be included as taxable income.

When the cost of attending school and the high interest rates for federal loans (6.8%) are combined, the remaining balance can be the same or larger than the original loan amount, even after 25 years of payments. This means that the borrower paid more interest than the original loan was for, and will now have tax consequences on the remaining balance. Also, unless the borrower can prove he or she is physically unable to work and there’s no chance he or she will be able to earn money, student loans will not be discharged in bankruptcy.

DWM is here to help plan a successful financial future for clients of all ages; even those with a seemingly unmanageable amount of student loan debt. Taking advantage of the repayment programs available to a client is just a part of the plan. Make sure you know all the rules for repaying the loans and follow those rules to the letter. Continue to invest in your retirement plan and don’t be afraid to have that Tuesday latté. With strategic financial planning from DWM, that student loan burden can be paid off and out of your life for good.