Old Adages Die Hard: What Worked in the Past May Not Work Today!

More people are renting (not buying) houses, particularly millennials. The old adage that “paying rent is foolish, own your house as soon as you can” is no longer being universally followed.  Lots of reasons: cost of college education, student debt, relative cost of houses, flat wages, more flexibility and others.  Today we 327 million Americans live in 124 million households, of which 64% (or 79 million) are owner-occupied and 36% (or 45 million) are renter-occupied. In 2008, homeownership hit 69% and has been declining ever since.

It starts with the increasing cost of college.  Back in the mid 1960s, in-state tuition, fees, room and board for one year at the University of Illinois was $1,100.  Annual Inflation from 1965 to now has been 4.4% meaning $1,100 would have increased 10 times to $11,000 in current dollars.  Yet, today’s in-state tuition, room & board at Champaign is $31,000, a 28 times (or 7.9% average annual) increase.  Yes, students often get scholarships and don’t pay full price, but even a $22,000 price tag would represent a 20 times increase.

It’s no surprise that in the last 20 years, many students following the old adage “get a college education at any price” found it necessary to incur debt to complete college.  Today over 44 million students and/or their parents owe $1.6 trillion in student debt.  Among the class of 2018, 69% took out student loans with the average debt being $37,000, up $20,000 each since 2005.  And here is the sad part: according to the NY Fed Reserve, 4 in 10 recent college graduates are in jobs that don’t require degrees.  Ouch. In today’s changing economy, taking on “good debt” to get a degree doesn’t work for everyone, like it did 50 years ago.

At the same time, houses in many communities have increased in value greater than general inflation.  Elise and I bought our first house in Arlington Heights, IL in 1970 when we were 22.   It was 1,300 sq. ft., 3 bedrooms and one bath and cost $21,000.  I was making $13,000 a year as a starting CPA and Elise made $8,000 teaching.  Today that same house is shown on Zillow at $315,000.  That’s a 15 times increase in 50 years. At the same time, the first year salary for a CPA in public accounting is now, according to Robert Half, about $50,000-$60,000. Let’s use $60,000.  That’s less than a 5x increase.  Houses, on the other hand, have increased at 5.6% per year. CPA salaries have increased 3.1%.  The cost of living in that 50 years went up 3.8%. Wages, even in good occupations, have lagged inflation. Our house 50 years ago represented about one times our annual income.  Today the average home is over 4 times the owners’ income.  That makes housing a huge cost of the family budget.

In addition, today it is so much more difficult to assemble the down payment. We needed 20% or $4,200; which came from $3,500 savings we accumulated during our first year working full-time and a $700 gift from my mother. A “starter” house today can cost $250,000 or more.  20% is $50,000, which for many is more than their first year gross income.  And, from that income, they have taxes, rent, food and other expenses and, in many cases, student debt, to pay before they have money for savings. Saving 10% is great, 20% is phenomenal.  But even at 20%, that’s only $10,000 per year and they would need five years to get to $50,000.  No surprise that it is estimated the 2/3 of millennials would require at least 2 decades to accumulate a 20% down payment.

Certainly, houses can become wealth builders because of the leverage of the mortgage.  If your $250,000 house appreciates 2% a year, that is a 10% or $5,000 increase on your theoretical $50,000 down payment. But what happens when real estate markets go down as they did after the 2008 financial crisis?  The loss is increased.  Many young people saw siblings or parents suffer a big downturn in equity 10 years ago and are not ready to jump in.

Furthermore, young people who can scrape up the down payment and recognize the long term benefits of home ownership, may not be willing to commit to one house or one location for six to seven years.  With closing costs and commissions, buying, owning and selling a house in too short a period can be costly and not produce positive returns.

Lastly, many people want flexibility and don’t want to be tied to a house. They want flexibility to change locations and jobs.  They want flexibility with their time and don’t want to spend their weekends mowing the grass or perform continual repairs on the house. In changing states like Illinois, with a shrinking population and less likelihood of significant appreciation, their house can be a burden.  For them, renting provides them flexibility and peace of mind.

It’s no surprise then that the WSJ reported last week that a record number of families earning $100,000 a year or more are renting.  In 2019, 19% of households with six-figure income rented their house, up from 12% in 2006.  Rentals are not only apartment buildings around city centers, but also single-family houses.  The big home-rental companies are betting that high earners will continue renting.

Yes, the world has changed greatly in the last 50 years and it will keep changing.  When I look back, I realize we baby boomers had it awfully good.  The old adages worked for us. But today, buying a house is not the “slam dunk” decision we had years ago, nor is a college degree.  The personal financial playbook followed by past generations doesn’t add up for many people these days.  It’s time for a new plan customized for new generations and that’s exactly what we do at DWM.

It’s beginning to “cost” a lot like Christmas!

 

6th-year-holiday-costs-2.jpg

 

It’s beginning to “cost” a lot like Christmas! It’s a fun play on the popular holiday song, “It’s beginning to look a lot like Christmas”, originally written by Meredith Wilson in 1951. Though times have certainly changed since the 1950s, the spirit of gifting and giving during the holidays has always remained the same. According to the National Retail Federation, the average American spends an average of $1,000 during the holiday season!

It’s not uncommon, as we approach the holiday season, that you might find yourself feeling grateful, compassionate and more charitable than any other time of the year. Now is the time people eagerly give to their loved ones and generously give back to those in need. Here’s a look into new and exciting ways people are giving and gifting in 2018:

529 College Savings Plans

As the total student loan debt in the U.S. approaches the $1.5 trillion mark, 529 college saving plans have grown in popularity. Unlike ordinary gift checks, a 529 savings plan can an act as an investment in a child’s future that has the ability to grow, tax-free, for the use of qualified educational expenses (K-12 tuition included under the new tax law). While college savings may not be the most riveting gift for a young child to receive at the time, the potential to alleviate the future burden of student loans, all or in part, will be one gift they won’t soon forget.

Custodial Investment Accounts

There are two main forms of custodial investment accounts, UGMA (Uniform Gifts to Minors Act) and UTMA (Uniform Transfers to Minors Act) accounts. They are virtually identical aside from the ability of UTMA accounts to hold real estate. Custodial accounts can be a great way to teach children about investments while limiting their access to investment funds. Depending on your state, access to custodial accounts is limited to minors until the child has obtained ages 18-21.

In 2018, individual gifts are limited to the annual $15,000 gift-tax-exemption limit ($30,000 for married couples). Family and friends can contribute directly to custodial accounts of another person. If these accounts are properly titled as retirement accounts, such as a Custodial Roth Account, contributions must be made indirectly, limited to $5,500 for 2018, and the donee must have earned an income equal to or greater than the contribution made.

Charitable Gifts

Did you know you can complete charitable gifts in the name of a friend or family member and still capture the tax deduction? Assuming you itemize, funds given to charity can come from any taxable account (or qualified, see below) of your choosing and may list a donor of your choosing. For example, one can give to St. Judes Children’s Hospital using their own personal funds, receive a tax deduction for doing so, and list the donor as someone other than themselves, like a grandson or other relative. So long as you can prove the funds used came from you, i.e. your name is listed on the account used, you should receive a deduction for these forms of charitable contributions.

There are several ways to give back to charity, one of the more tax efficient ways is by way of Qualified Charitable Distributions (QCDs). This is an alternative to Required Minimum Distributions (RMDs) that you are required to take from your IRA upon obtaining age 70 1/2. A QCD allows you to give a portion or all of the amount that you otherwise would be required to take from your IRA to charity. The benefit of doing so is to exclude these funds from your taxable income. This process can be especially beneficial if, under the new tax reform, you will be using the new increased standard deduction, $12,000 for individuals and $24,000 for married filing jointly, as opposed to itemizing.

There are many forms of giving. Integrating both charitable giving and family giving can be an intricate part of your overall plan, and it doesn’t always have to “cost you an arm and a leg.” Ensuring your gestures are both sustainable and tax-efficient are good questions to ask. At DWM we are always looking for new ways to give back to our clients and friends by assisting in these areas. Please, never hesitate to reach out to us in regards to new ways to give back to your family, friends and charitable organizations.

College Funding Solutions

Last night, our Palatine team at DWM performed a presentation for the parents of students attending Quest Academy, a private K-12 school right here in Palatine, IL. The focus of the night was putting a spotlight on two important topics, tax reform and college savings. We’ve covered the effects of tax reform quite a bit in blogs from the past few weeks, so we wanted to focus in on the savings portion of the presentation for our blog this week.

College costs are rising, with no end in sight. Tuition prices for public and private universities increase yearly by approximately 4-8% consistently, which put them right up there with housing and gas prices as the leaders of inflation (though college costs experience much less volatility then either of the others). Per Figure 1, we can see the effect of this inflation, with tuition at an in-state public university costing parents over $100,000 over the four years of collegiate study. With inflation rates as they are, these numbers are only going to get larger.

Tuition

Figure 1: College Tuition Costs

So, as we presented last night, how can parents of children expect to be able to pay these high price tags?

Luckily, there are several different options available to parents and children alike that can help offset the huge costs of college. These different solutions vary from federal financial aid, merit-based scholarships, savings, and loans.

Let’s start with federal financial aid. The path to being awarded federal financial aid starts at the same spot for each family, the Free Application for Federal Student Aid, commonly referred to as the FAFSA form. This document helps many domestic colleges determine how much, if any, federal aid your child should be allotted. To determine this, the FAFSA form interprets your financial situation based on their calculated Expected Family Contribution (EFC), or essentially how much money the parents of a student will be able to contribute to their child’s college tuition. To determine the EFC amount, many factors including the family’s taxed and untaxed income, assets, and benefits (such as unemployment or social security) are evaluated. Retirement assets are not considered in this calculation. For example, any money held in an IRA or 401k plan will not be counted towards the EFC, since those funds cannot be used for college tuition. However, money held in a checking or brokerage account will factor into the EFC when calculating federal financial aid. One important caveat to this is that any funds held in the student’s name will be weighted more heavily towards the EFC calculation than those assets held in the parent’s name. For a quick reference, please see Figure 2 below, which gives an approximate federal aid allotment based upon your EFC and the number of children you have.

EFC

Figure 2: https://www.forbes.com/forbes/welcome/?toURL=https://www.forbes.com/sites/troyonink/2017/01/08/2017-guide-to-college-financial-aid-the-fafsa-and-css-profile

Another college funding solution is the use of merit-based scholarships, which are awarded by the schools themselves, based on a student’s academic, athletic, music, or other merits. If a student shows exceptional talents, colleges are likely to offer these students grants in order to entice them to coming to their college. These scholarships tend to be offered for at least four years of college depending on their eligibility, and can often be a hefty sum of the tuition costs (some being the full amount)! Besides the colleges themselves offering these scholarships, there are various online sources that have private funding that is given out to students who apply to them. We have done some research on these websites, and have included some of the most popular ones at the bottom of this blog. Please feel free to check them out with your student!

One of the major college funding methods that students and their parents utilize is through savings. Besides holding assets in a bank or brokerage account to pay for their child, parents have some other ways of saving money specifically for college funding that can be great resources also for tax purposes! One of the best of these vehicles is a 529 plan. In Illinois, we like the Illinois Bright Start and Bright Directions 529 platforms, and in South Carolina, our team likes the Future Scholar 529 platform. What these programs offer is a method for holding college funds and investing them, allowing for compounding tax-free growth! By contributing to these accounts, taxpayers can annually take advantage of a $10,000 state tax deduction ($20,000 for married couples) for Illinois, and can utilize the $15,000 dollar gift tax exclusion on the transfer as well, helping to lower the taxes for the parents, and save a lot of money for their child quickly. In comparison, South Carolina offers an unlimited state deduction for all contributions to a 529 plan. In conjunction with this, in all states parents are able to take advantage of a “Five-Year Forward” funding method, which allows for up to $150,000 to be contributed to a 529 plan in one year, and as long as no extra contributions are made in the following four years, the entire amount qualifies for five years of the gift-tax exclusion, a fantastic strategy for savings and estate planning, for parents and grand-parents alike! As part of the recent tax reform, the government has expanded the use of these plans to allow parents to use these funds to pay for K-12 private schooling, though this could prohibit the use of the state tax deduction, which is still a grey area. Stay alert for more updates on this particular change.

Lastly, there are loans. Most students and parents have come to a modern consensus that student loans are extremely hard to pay off, and as of 2018, student loan debt does indeed sit at approximately $1.5 trillion, so whenever loans are taken, it is extremely important that parents take into account how these will be paid off. There are many different options when it comes to taking these loans as well, including federal versus private loans (government vs. banks), and deferral timings (“subsidized” start payments once graduated, “unsubsidized” start payments immediately). Some important aspects of loans to look at when researching them is to ensure that they have no application fee, a soft hit on credit pulls, and no fees for paying off loans early, so you get out with the least interest accrued as possible.

All in all, paying for college is a daunting task for any parent and student. However, by planning early and utilizing the many different methods of funding, both can find peace of mind and focus on the challenges presented in reaching a higher education, and less on how they are going to pay for it.

If you have any questions on any of the above information, please do not hesitate to reach out!

Scholarship resources to check out:

bigfuture.org
cappex.com
fastweb.com

Now’s the time to plan your 529!

Summmerrrtttime!  Every day in the summer at our office here in Charleston, we are regaled with the carriage tour drivers’ versions of this famous song from Porgy & Bess.  We end up having that song stuck in our head a lot of the time!  Already the ads for back to school sales are appearing and it reminds us that, while the “livin’ is easy” right now, the hustle of getting kids ready to head back to school isn’t far away.  We hate to interrupt your summer fun, but it is a good idea to get ready for college tuition payments no matter what age those students are!

We wanted to highlight the particular advantages of using 529 plans for funding your education purposes, as it is the most cost-effective way to manage the expenses of higher education.  Enacted in 1996, Section 529 of the Internal Revenue Service Code allows an account owner to establish a plan to pay for a beneficiary’s qualified higher education expenses using two types of plans – a pre-paid tuition program or the more popular, state-administered college savings plan.  The beneficiary can be a family member or friend or an owner can set up a 529 account for their own benefit.  Anyone can then donate to the account, regardless of the owner or beneficiary.  Funds can be deposited and used almost immediately (need to wait 10 days) or can be invested and grown until needed.  Surprisingly, according to a Wall Street Journal article recently, only 14% of Americans plan to use 529s to pay for college.

Although there is no allowable federal tax deduction for 529 contributions, the income and gain in the account are not taxable, as long as they are used for qualified education expenses.  These qualified expenses include tuition, room & board, books and, in a 2015 legislative change, payments for many technological expenses like a computer, printer or internet access, even if not specifically required by the educational institution.  The costs for off-campus housing can also qualify, as long as the amount used matches the average cost of resident-living at your university.  Many states, like SC and IL, also allow a tax deduction for 529 contributions to in-state plans.  Another recent legislative change allows for an increase from one to two annual investment selection changes per year, unless there is a rollover and then a change can be made at that time.  This gives the 529 owner a little more benefit, flexibility and control over their accounts.

When funding 529 accounts, we recommend that our clients not fund more than 50% of the total cost of estimated expenses for the education of their student before the student selects and starts college.  One nice feature about 529 plans is that they are transferrable to a sibling or other close family member, if a student doesn’t use or exhaust their entire 529 account.    However, you don’t want to overfund an account and then have some leftover.  Only the gains in the account are taxed, but there is a 10% penalty on the account if the funds are withdrawn and not used for qualified education expenses.  Another reason for not overfunding is that there are many scholarships available – you may have an accomplished science whiz or an amazing athlete that earns scholarship money.  Once final amounts of tuition requirements are determined, 529 account owners can make necessary additional contributions to take advantage of tax benefits.

There are many scholarship opportunities available for those who take the time to look and apply.  Checking with the high school guidance counselor, local civic groups or community organizations about scholarships or awards opportunities can give your high school student some hands on involvement in paying for their own education!  All high school seniors should also fill out the annual FAFSA (Free Application for Federal Student Aid).  There are many opportunities for earning money for college and nothing should be ruled out.

We know that using 529 accounts is the least expensive way to pay for college.  Research shows that the most expensive way to pay is by taking out student loans or paying out of pocket as the student needs it.  At DWM, we want to help you strategize how to save for and pay for any education expenses that you may have before you, no matter when those costs are expected.  We can help you evaluate the various state plans and the investment options in the 529s and calculate an appropriate annual or lump sum amount of savings.  We will be glad to help make your summertime livin’ easy and carefree!  Okay, now back to summer fun…already in progress!