Marketplace

Safe savings for children

Question: Greetings Chris. We are HUGE supporters of Marketplace Money on Sat!

Questions for you: We have 3 children with CD's currently maturing at:

11th grader $1000 ($1041 at maturity)
8th grader $500 ($21 at maturity)
6th grader $500 ($21 at maturity)

We want an investment timeline for them that takes us to the 18 y.o. mark for each of them. What are good options for continuing short term low risk investments? We see CD rates right now which are .5 %. What low risk investment options do we have to take each of them to their 18th birthday? About 1 yr investment for our junior in high school, longer (4-7 yrs) for our other younger two children? Are CD's the best option for this time period? Thanks for help. Mitch and Jeanne

Answer: Thanks for listening. Savers sure aren't getting much of a return on their money. It's one way the government bailed out the banking system. In essence, savers are making a fraction off their deposits and the banks are earning profits by investing the proceeds in higher yielding investments, especially U.S. Treasuries. (Of course, it's more complicated than that, but not much.)

That said, it does appear that the economy is on the mend. If the recovery becomes self-sustaining you should start seeing at least slightly higher rates on savings accounts, CDs, and the like. The demand for credit grows when the economy is expanding, and that will put some upward pressure on rates. The Federal Reserve will eventually hike its benchmark interest rate, a move that will ripple throughout the fixed income market. Inflation fears will stir during the expansion, too.

Taken altogether, and assuming a double-dip recession isn't in our future, the next move in rates will be up.

At the moment I don't see you earning much on the money. One reason is you don't want to take credit risk with the money. That keeps the investment in low-yielding government-backed type securities. Another factor is you'll want to stay short-term, say, no longer than a year. That will also keep the current interest rate on the investment low. You will want to compare what you'll get from similar investments. For example, I would look at what your children will get in a federally insured one-year CD versus a one-year Treasury bill. There is no state and local government tax levy on U.S. Treasuries. You could do the same thing with 3 month, 6 month, and other maturities.

The historic record shows that high quality short-term investments like these will protect your money against the risk of inflation because when rates start climbing you'll reinvest the money at the higher rates relatively quickly.

The other quality investment to consider is savings bonds. You won't want to touch them for 5 years (otherwise you give up the last three months of interest as a penalty for early redemption).

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On a financial precipice

Question: There is a leak in my "solar equity energy". I did the "home ATM" and have refinanced myself into oblivion. I have an ARM which is at 7.5% and about to change again. My income has just been cut in half, and I'm slipping behind on mortgage and credit card payments. I owe $14k on two cards. Is a loan modification going to help me out if my income isn't where it used to be? Am I going to lose my home of 12 years? Luanne, Orlando, FL

Answer. There are no easy answers for dealing with the kind of financial predicament you're in. I don't know if you'll lose your home, but it's a risk.

I would find a qualified credit counselor to go over your finances. You can find a reputable one in your area by going to the website of the National Foundation for Credit Counseling. (Steer clear of outfits that advertise on cable and radio promising they'll slash your debt for a hefty upfront fee.) The NFCC credit counselor's have seen everything when it comes to money trouble. Hopefully, you'll be able to come up with a realistic plan that satisfies your creditors and relieves you of financial pressure.

However, it doesn't always work. Sometimes there just isn't enough money. In that case, you'll want to consult with a bankruptcy attorney. You can start looking for one at the National Association of Consumer Bankruptcy Attorneys or the American Bankruptcy Institute. Bankruptcy is how many financially troubled folks get a fresh start. In many cases the bankruptcy courts will let you keep the home. An attorney will be able to advise you of your rights--and risks.

You may want to do some research on your own about getting rid of debt of your own, what credit counseling can and cannot do for you, and when bankruptcy is a smart move. If so, look at Reduce Debt, Reduce Stress by Gerri Detweiler, Nancy Castelman and Marc Eisenson (Good Advice Press) 2009. These three veterans of the get-out-of-consumer-debt movement really know their stuff. They offer plenty of practical information.

My final piece of advice: Figure out how you got into this financial quagmire so that once you escape you don't fall back into debt.

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HSAs and savings

Question: My employer recently ended group health insurance and "helped" us find individual plans. They are also kicking in some money each month to help cover our new premiums. My husband and I are young and in good health, and so our new plan is actually much cheaper than our previous plan, although it covers a lot less. Our previous plan was a high deductable HSA, as is our new individual plan, so I already have an HSA account. I get paid bi-weekly, and will be receiving almost $200 more per pay check, that was once spent on health insurance. My question is, should I put all of that money into the HSA, or should I put some into the HSA and some into a regular savings account? We currently have a very small amount of savings. Thank you. I love your show! Maria, Minneapolis, MN

Answer: I've been sitting here wondering what I would do in your circumstances. I agree with you that the goal is to automatically save the $200 a month no matter what.

I don't have all the details. For instance, if your employer is putting in a good amount of money then I'd put the $200 into savings.

But what if you don't have much in the HSA? I would initially take full advantage of the tax-sheltered HSA account. The maximum HSA contribution into a special tax-sheltered savings account for family coverage in 2010 is $6,150 and for single coverage it's $3,050. There is no use-it or lose-it rule with an HSA. The money that isn't tapped to pay for medical expenses this year stays in the tax-sheltered account. It compounds over time.

My thought is for you to have a healthy (no pun intended) medical savings account. That could mean hitting the maximum contribution limit for this year, or some other number you figure makes sense. Since you already have an account and your employer is contributing it might not take very long for you to reach a sensible cushion against expected and unexpected medical expenses.

As soon as you hit your target level of HSA funding I would start sending at least half and as much as all of the $200 automatically into a regular savings account. This will then build up your emergency savings.

Does that work for you?

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Inflation protected securities

Question: I am enthusiastic about your recommendation to make TIPs a core investment. I appreciate this advice along with many other recommendations of yours during the years. All of my TIPs are in an IRA. Consequently, the TIPs are held in a mutual fund. Is your recommendation for TIPs as strong even when they are held in a mutual fund? Thank you. John, Brookfield, WI

Answer: Yes, I think owning Treasury Inflation Protected Securities or TIPS in a bond fund works as a hedge against inflation. Professor Zvi Bodie of Boston University is the leading proponent of the TIPS as a core investment for retirement savings. (I'm also a huge fan of his and I've learned a lot interviewing him over the years.) He notes that owning the bonds directly gives you greater control over the timing of when you receive your inflation-hedged cash. You're also agnostic to fluctuations in market value if you own the actual bonds and hold them to maturity. (When a bond matures you get your underlying investment back. So, if you bought a $1,000 bond with a 10 year maturity you'll get your $1,000 back in 10 years.) However, the way the U.S. Treasury rules are currently written you can't buy TIPS directly from the government for your IRA or comparable retirement savings account. You must use a broker or middleman. It's still a worthwhile cost of ownership since the commissions attached to buying U.S. Treasuries are typically very low.

Nevertheless, for many of us buying TIPS through a mutual fund is convenient. Many employer-sponsored retirement savings plans only give us the option of a mutual fund that invests in inflation-protected securities. The portfolio will be volatile reflecting changes in the market and the outlook for inflation. Since the mutual fund doesn't have a specific maturity date you're never quite sure what the payoff on your investment will be in the future. But the mutual fund TIPS investment offers a hedge against inflation.

By the way, the latest issue of the Journal of Financial Planning has an illuminating interview with Bodie on TIPS, the returns to equities, his thoughts on run-of-the-mill investment advice, and other topics. You can read it here.

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Estate taxes

Question: My mother purchased some stock in 1995 @ $25 a share, the current MV is approximately $42 plus. My mom is 85 years old and wants to sell the stock and put it into her savings account, she doesn't need the money. What would be the tax consequence if she sold it versus holding onto it and the stock becoming part of her estate? Secondly, is her age a factor? Loretta, Fairlawn, OH

Answer: Ah, you would think this would be a simple answer. I wish it was an easy one, too. But the answer is complicated for 2010 (and maybe beyond). So, I'll give you a general sense of the tax rules concerning your question. But before you do anything you will need to consult with a tax professional. That's my main piece of advice. By the end of this post you'll understand why.

I am going to focus on the tax aspect of your question. There are other issues, of course, including issues like adding to her easily tapped pool of savings to her savings to her budget needs.

Now, if she sells the stock in 2010 she could end up avoiding capital gains tax depending on her bracket. For instance, if she is in the 10% or 15% tax bracket she won't owe any capital gains tax. It's 0%. However, if she is in the 25% to 35% tax bracket the rate is 15%. That's still a low number.

The current capital gains tax rates are scheduled to expire in 2011. The rate will climb to 10% for low income folks and 20% for everyone else. (There are a few wrinkles but that's the basic idea.) The President's new budget blueprint also proposes several changes in tax law. For instance, the two top income-tax brackets (they would rise to 36% and 39.6%, from 33% and 35%, respectively). He has the dividend and capital gains tax rates at 20% for anyone earning over $250,000. But who knows what will come out of Congress.

Now, to the other part of your question: She doesn't sell the stock and it became part of her estate. You won't owe any capital gain at inheritance. To take your example, you inherit the stock at $42-plus as part of her estate and sell it for $42-plus a share. You will owe zero capital gains tax. Technically, it's called a step-up basis and it been the rule for a considerable period of time. (That said, there is a weird twist for 2010. The estate tax has expired. So, for this year alone the step-up basis is limited to a maximum of $4.3 million in an estate. Of course, that means the rule change doesn't matter for all but a very small minority of families. By the way, the estate tax comes back and the traditional step-up basis in 2011. Go figure. I can't.)

Her age isn't a factor in the capital gains equation.

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Tax exempt bonds

Question: I'm in my mid 50's and have extra money to invest after maxing out my 403b, etc., so I've been thinking of putting some in tax free state or municipal bonds. But I don't live in a financially prudent state but in New York, which is apparently going down the tubes completely if I believe what the governor is saying. Of course some other states are even worse.

Are there tax-free bonds that are designed to pay back the bondholders in some reliable way even if the state itself goes into default (e.g., a bridge that's contracted to pay its bondholders through its toll collections?) Or do people in New York, California, etc., just have to hope for the best when we buy our states' bonds? Michael, New York, NY

Answer: You're right to be concerned. The Great Recession may be over, but state and local government finances continue to deteriorate. California, the eighth-largest economy in the world, keeps treading on the edge of fiscal disaster. Nine other states aren't in much better shape, according to a recent study by the Pew Center on the States. Even after taking into account aid from Washington, state governments face a combined projected budget deficit of $350 billion over fiscal years 2010 and 2011, according to the Center on Budget & Policy Priorities.

That said, tax-exempt bonds have been doing well over the past year. (The previous year was a disaster.) One reason why individuals are snapping up munis is a widespread expectation that federal and state taxes are heading higher. Muni yields are also attractive relative to comparable Treasuries, especially for those in top tax brackets.

Still, what about those yawning budget deficits and fiscal turmoil? State government defaults are rare (Arkansas was the only state to go into default during the Great Depression). A number of states have had their debt downgraded, and more is likely to come. The default risks lies more with smaller issues and lower quality paper. However, even with high quality securities I expect a lot of volatility.

So, I would seek a measure of safety by sticking with high-quality general obligation bonds, which are backed by the taxing power of the issuer. When buying revenue bonds, which are supported by fees, investors are seeking out bonds backed by revenues from so-called essential services, with the classic examples being water and sewer bonds. And, even though you will give up some tax shelter, what about a tax exempt mutual fund that owns munis from around the country? It will diversify away some of the risk of default.

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Company match

Question: I just bought into this LLC and used all of my savings to do so. I am in the process of re-establishing my emergency fund. I also want to save for a house/property. I do not participate in the 401K with matching because I do not want to give up liquidity of my savings or take a penalty withdrawing to make a down payment for house/property. Is there a better strategy for me? 51 divorced, blah, blah.... Mark, Seattle, WA

Answer: Obviously you have a lot going on. But I wouldn't give up the company match. It's a big deal financially. The typical matching contribution in a 401(k) or comparable savings plan is 50 cents for every $1 the employee puts in, up to 6% of the employee's contribution. Of course, some companies do more and some do less.

I would participate in the retirement savings plan at work at least up to the match. Even financial planners and market forecasters that expect years of low returns and bad markets ahead of us would agree with that. The "match" is where much of the return comes from in a retirement savings plan.

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Better rates on savings

Question: Like many conservative "investors" I long for the days when CD rates were higher than 1% or less, when the government wasn't trying to manipulate me into the all too risky stock market which demonstrated in the last decade that it is not to be trusted as a secure repository for retirement savings. The "free market economy" serves those at the upper income levels, not those of us who want to live without spending precious time on keeping track and understanding basic concepts of the abyss of the investment world. It just does not interest me, and the past two years have shown how unreliable, indeed, destructive risk can be. My question is, is there a movement to promote a return to CDs offering higher interest rates? Thank you for the voice of reason you present on public radio. Brigitte, Amherst, New York

Answer: I'm not aware of any movement to promote a return to higher yielding savings accounts or certificates of deposit for the everyday saver. And you're right to upset over how little interest you're getting on your savings. One factor is the dampening effect of the Great Recession and the subsequent anemic recovery. Another force is inflation is essentially non-existent with demand down sharply and unemployment at double digit rates. But to a large extent today's low rates reflect how savers bailed out the banking industry. In essence, you make a fraction on your savings and the banks earned profits by investing your deposits in higher yielding investments, especially U.S. Treasuries. (Of course, it's more complicated than that, but not much.) Bailouts stink. It's just that the alternatives are even worse.

It's a reasonable bet that over the course of the next year or so you'll get an opportunity to earn more on your savings. The economy does appear to be on the mend. And if the recovery becomes self-sustaining you'll start earning at least somewhat more on savings accounts, CDs, and the like. The demand for credit grows when the economy is expanding, and that puts some upward pressure on rates. The Federal Reserve will eventually hike its benchmark interest rate, a move that will ripple throughout the fixed income market. Inflation fears will stir during the expansion, too. Taken altogether, and assuming there isn't a double-dip recession in our future, the next move in rates will be up--at least a bit.

What are some safe savings alternatives to CDs? I would look into federally insured online savings accounts since they typically pay a better rate than their brick-and-mortar peers. You could also look into buying short-term Treasury bills from the federal government at treasurydirect.gov. You won't pay any commissions. There is no credit risk with Treasuries. There is no state and local government tax levy on U.S. Treasuries. The historic record shows that short-term Treasuries will protect your money against the risk of inflation. To be sure, you won't make much interest but when rates start climbing you'll be able to reinvest the money at the higher rates.

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Paying for culinary school

Question: My daughter got a Sallie Mae loan to go to culinary school. She was 27 so did not get the special low rates for younger students, rather got a variable rate that can fluctuate between 10% and 17%. Her loan was for $48,000 and for now, it looks like it will be a $650/mo. pay back for 15 years, starting in another 4 months. Is there another, better way perhaps, to finance this burdensome loan? Where should we look? Who should we trust? Cynthia, Shreveport, LA

Answer: It looks like your daughter took out what's called a "private student loan." Not everyone agrees with me, but I don't think private student loans should be called student loans at all. It suggests that they're similar to federally-sponsored student loans and that isn't the case. Federal loans (both subsidized and unsubsidized) offer borrowers a great deal of built-in financial flexibility with repayment terms. (Of course, you'll end up paying more for your education if you take advantage of the options.) The same isn't true with private student loans. In essence, it's a straight-forward consumer loan with monthly minimum payments that have to be met.

To be sure, there are a few avenues for nicking away at payments. For instance, most lenders will offer a better rate with a co-signer (but that's usually a bad idea for the co-signer.) Borrowers often get a small interest rate reduction for setting up automatic monthly payments. Lenders do have the discretion to change the terms if the borrower is in troubled straits, but it's their call, not yours. That's pretty much it.

The terms of the loan are clearly laid out at the Sallie Mae website. You can always talk to Sallie Mae and see what they can do. But looking at the loan terms it doesn't appear that there is much she can do to reduce the financial burden. Other student loan lenders will offer essentially the same terms, too. My only suggestion is if she ends up struggling financially perhaps you could help her out a bit until she gets the kind of job her degree has qualified her for? And hopefully going to school and taking on the loan opens up the kind of career opportunities she wants.

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Save for car

Question: I am saving up for a new car. I put away, above and beyond the normal expenses on my current vehicle, fifty cents for every mile I drive, I currently have about $4,000.

A few of my friends have said, "You're crazy. You have good credit, a Credit Union that will give you a good rate, and your car has 200,000 miles on it. Buy one next year with a big down payment and you'll be fine and you'll save on maintenance and gas." Or even that for the good of my credit I should take out a loan for half the car regardless of how much I actually have saved.

Personally I think I can get another 50,000 miles out of my poor ugly little car and that would mean, provided nothing goes seriously wrong where I have to dip into savings, that I'll have almost $30,000. Enough to buy any reasonable car on the market or even my dream vehicle, a Prius. Is saving up the full amount for a vehicle purchase excessively scrupulous? Matthew, Denver, CO

Answer: Bravo! I don't think you're being excessively scrupulous. You're creating financial freedom of choice for yourself.

I've interviewed Jack Gillis a number of times over the years. He's published the consumer-oriented Car Book for almost three decades now. I always learned something from him about cars and ownership. He always recommended a car maintenance and car replacement savings strategy along the lines that you're pursuing. Of course, we'd both say that very few people have the discipline to do it. You do.

What's more, you have a goal: To own a Prius or at least a hybrid.

So, don't pay attention to the financial advice of your friends and I wouldn't take out a loan simply to boost my credit score. However, if you keep on saving the loan versus cash decision will be your choice. When it comes time to retire your current car for your dream car the best financial move at the time may be to pay all cash. But you might want to take out a small auto loan if there's an investment opportunity you'd like to take advantage of or you'd like to keep more savings on hand because you're worried about losing your job. The bottom line is that it will be your choice.

Energy tax credits

Question: I was told when I had 13 new energy efficient windows installed that I was eligible for a tax credit of 1500 dollars, even though the total price was only about 2300 dollars installed. My question is this a rebate that I will get 1500 dollars back to me from Uncle Sam or will I just get a credit of 1500 dollars towards any amount that I might owe to Uncle Sam? Love your program by the way! Tania, Dayton, OH

Answer: The tax credit is for up to $1,500. Technically, it's called a "non-refundable" credit. That means you can't get more money back in tax credits than your federal tax liability. Whether Uncle Sam ends up writing you a refund check or reducing your tax liability depends on your tax situation. The federal government's website Energy Star offers information about the energy efficiency tax credits.

I've lifted these examples from the FAQ section that goes toward your question:

Say your Adjusted Gross Income (AGI) is $50,000, your tax liability is $10,000 (before you apply tax credits), and you've had $12,000 withheld from your paychecks. In this scenario you could claim up to $10,000 in tax credits. If you are eligible for the entire $1,500 tax credit, then your tax liability ($10,000) would be reduced to $8,500. Since you already had $12,000 withheld, you will get a tax refund of $3,500 ($12,000 - 8,5000 = $3,500).

If your AGI was $50,000, your tax liability $10,000 (before tax credits were applied), and you had $8,000 withheld from your pay checks, you would still have the ability to claim up to $10,000 in tax credits. If you are eligible for the entire $1,500 tax credit, your tax liability ($10,000) would be reduced to $8,500 and you would owe the government $500 at the end of the year ($8,000 already paid in taxes - $8,500 tax liability = $500 final payment).

Check it out.

Inflation protection

Question: If I am concerned about the possibility of inflation, which alternative to choose; TIPS, I-Bonds, or Floating Rate Notes? I am not an expert and just started reading about this issue. Thank you in advance. John, Philadelphia, PA

Answer: You might want to add Worry Free Investing by Zvi Bodie and Michael J. Clowes to your reading list. They have the best explanation around for the logic of investing in Treasury Inflation Protected Securities (TIPS), I-bonds, and the like over the long haul. You can download it here.

One of the biggest risks faced by savers is that inflation will erode the value of their money over time. Even small rates of inflation, say, in the 1% to 3% range, reduce the purchasing power of savings. Many economists reasonably fear that inflation could go much higher than that following the extraordinary actions the Federal Reserve took to bail out the banking system and avoid a depression.

I'm a fan of TIPS and I-bonds. When it comes to floating rate notes (which covers a large universe of securities) I would stick with short-term Treasury bills. You don't have to worry about default risk and the historic record shows that T-bills perserve the value of your dollar against the ravages of inflation. You don't make much, but you don't lose it either.

TIPS are really the long-term savers' friend. They come in 5, 10 and 20 year maturities. TIPS offer a fixed interest rate above inflation, as measured by the consumer price index. An additional advantage of TIPS is that they protect against deflation--a decline in the overall price level--by offering a "deflation floor" that protects principal value during deflation.

TIPS have two main drawbacks. The first is that Uncle Sam requires owners of TIPS in a taxable account to pay income taxes on your inflation-adjusted gains before getting any of the inflation-adjusted money at maturity. The easy way to invest in TIPS and avoid the tax problem is to own them in a tax-deferred retirement savings account, such as a 401(k) or IRA. The other problem is that for a variety of legal and regulatory reasons you can't buy TIPS directly from the U.S. Treasury for your retirement savings account. You have to pay a broker to do it for you. It's worth it, however

Taxes aren't an issue with I-bonds, the federal government's other inflation-protected security. These 30-year inflation protected savings bonds allow money to compound tax-deferred until they are cashed in. There are no commission costs when buying or selling them. I-bonds redeemed before the 5 year mark forfeit the 3 most recent months' interest, but after 5 years that there is no penalty at redemption. The only drawback to I bonds is that you can't buy very much at a time. Savers can purchase $10,000 worth a year--$5,000 online from the Treasury and $5,000 in paper bonds bought at a bank.

Medical deduction

Question: Last year, I had an FSA, and was reimbursed for all sorts of medical expenses - contact lens solution, cough syrup, condoms - without a prescription. Without an FSA this year, can I deduct those expenses just like doctor bills? (i.e., if they total 7.5% of my income.) I also paid COBRA for 9 months. Is any part of that premium deductible? Sarah, Gray, ME

Answer: A Flexible Savings Account or FSA makes it easy to pay for all kinds of medical expenses. The risk is if you don't use all the money within a year you lose it.

Now, when it comes to medical expenses and the tax code the bar is high before deductions kick in. My main advice is check with a tax professional. But from the way you phrased your question the answer may be yes.

To take advantage of the medical deduction you need to itemize. Other common itemized deductions include the interest on home mortgages and charitable contributions. Your itemized deductions should be greater than the standard deduction.

Your COBRA payments are deductible, but many people find it hard to actually take the deduction. The reason is that total medical expenses, including premiums, co-pays, deductibles, medication and the like must exceed 7.5 percent of your adjusted gross income.

Roth conversion tax schedule

Question: If I convert my traditional IRA's in 2010 do I have the option of paying the tax in just the first year or must it be spread over the next 2 years? Thanks. Fred, Plano, TX.

Answer: When you convert a traditional IRA into a Roth in 2010 you get to choose whether to pay the 2010 tax bill in full or to include the conversion amount as taxable income in 2011 and 2012. The option to spread it out over two years is a one-time tax perk on conversions. But you don't have to go that route.

Of course, the choice adds an additional layer of complexity. For instance, should you pay the tax tab in full or over two years depends on whether you believe the money you make off the delayed payment will offset the risk of a higher tax bill.

Online savings

Question: Responding to "@78 yrs of age, ...best place to put a mortgage payout beside the coffee can in the garden." [That part was a joke.] I am not nearly as well off as J.L. in Seattle, WA, having spent my earning years as an English professor, but I am happy with the savings rates offered online. I'm now in Ally, but I tell anyone who's interested to go to Bank Rate and look at the banks sorted by savings rates. It takes only three days' turnaround to have as much or as little transferred to my local bank branch. Do you agree, or do you have a better idea? Rebecca, St. Simons Island, GA

Answer: Right now, staring out my office window at the snow covering the ground all I can think about is how wonderful it must be to walk around St. Simons Island. Okay, enough on the reverie. The question and answer you're referring to was posted on Dec. 23, 2009. I think checking out savings rates at Bankrate.com is fine. As readers of Getting Personal know I like federally insured online savings accounts. The rates are typically better than the offerings of their brick-and-mortar peers.

Roth conversion

Question: I understand it will be possible to convert an IRA to a Roth IRA without penalty in 2010. Will it be possible to convert any part of the 403b, into which I continue to contribute, to a Roth IRA? Tom, Rochester, NY

Answer: Some older employees will have the opportunity to convert part or their entire employer-sponsored retirement savings plan into a Roth. If you are over 59½ and still working at your company, you can withdraw the money in your employer's 401(k) plan, 403(b), and the like without penalty and place it in a Roth. However, your company's pension-plan documentation must allow for such an "in-service" distribution (while you're still employed).

Of course, that's only the first hurdle. You still have to figure out whether conversion from an employer-sponsored plan into a Roth is a smart move. By the way, the best Roth conversion calculator I've come across was recently created by Henry Hebeler at analyzenow.com. Check it out.

Long term care insurance

Question: I am a 32 year old married female. I am an only child and do not plan on having children. I am interested in purchasing LTD insurance (in addition to what I have through work, as it is not something that is offered through COBRA) and long term care insurance. How do I go about doing this? I am hesitant to go to an insurance agent as selling something might be their first priority, should I go to a financial advisor? A lawyer? Thank you! Sarah, Minneapolis, MN

Answer: I'll look first at long-term care insurance and then disability coverage.

The case for long-term care insurance is compelling. A year in a nursing home runs an average of some $50,000. It can easily run $30,000 or more a year to live in an assisted living center with professional care. Home care is even more costly. Yet Medicare and regular health insurance policies don't cover these astronomical costs.

Problem is, the case for buying long-term care insurance isn't as compelling. It's a complicated product and it's expensive.

I'd approach this with a skeptical frame of mind, especially at your age. I would be surprised if you needed additional LTCI at age 32 unless there is something in your family's medical history that is cause for worry or concern.

By the way, group plans are a good way to own LTCI. For more and more employees it's part of their benefit package. You don't have to worry about losing your group long-term care insurance policy at work if you leave or lose your job. By law, if it's a group policy you can convert it at the same prevailing cost to an identical individual plan.

It's true that your insurance premiums will be low if you buy LTCI at your age compared to someone 62 years old. But you'll be paying premiums for a long time since most folks don't face the risk of entering a nursing home until their 80s.

Perhaps most important, is this the best use of your "safety net" money? There are a lot of demands on our money. When it comes to creating your financial safety net retirement savings, disability insurance, life insurance, and an emergency fund are more important than LTCI. It's really a question of resources and priorities.

The U.S. Department of Health and Human Services offers a portal into all kinds of information about LTCI. For a more skeptical point of view you could check out this Consumer Reports analysis of LTCI here.

Now, let's turn to long-term disability insurance. It's important, perhaps the most important insurance outside of health for someone like you. It's really paycheck protection, or more accurately, partial paycheck protection.

You already know this, but just to make sure that everyone understands the basics of the product, disability insurance replaces a portion of your income if you can't work because of an illness or injury. A typical group plan policy is cheap as part of an employee's benefits package, costing the employee nothing to a few dollars a month. An employer's policy usually replaces up to 60% of salary.

Now, it isn't unusual for highly compensated employees to buy supplemental coverage. Sometimes it's offered through the employer. You can also buy an individual policy that will boost your coverage by an additional 10% to 20%. If you think you need more disability coverage I would shop around and get quotes from various life insurance agents and companies.

If you still want more guidance, I would consult with a fee-only financial planner. The reason is that you want a planner that can look at whether or not buying additional LTCI and LTD makes sense for you as part of your overall finances.

Which debts to pay off first

Question: I am hoping you can help me with a question my husband and I have. We currently have an extra $1200.00 that we would like to pay towards either his student loan or our second mortgage and we are at odds over which one to apply it to in order to make it most useful. Here is the situation.

2nd mortgage.

5 years ago we purchased our home with a 80-15 loan. The 15% is on a 2nd mortgage and was for 30,000.00 it was on a 5 year arm at 9.0% interest. We recently refinanced that 2nd mortgage because the 5 years was up. the current interest rate is 7.5% on a new 5 year arm and the current balance is $26424.66. The required payment is about $245.00 per month and we pay $300.00.

Student loan.

My husband has a student loan left and the balance is $11549.66 with a interest rate at a fixed 6.0%. The required payment per month is $145.64 and we pay $200.00

Now my thought was that since the student loan has less of a balance we should take the $1200.00 and pay towards that even though the interest rate is less that way we could get one of the two bills paid off faster and then take the $200.00 we pay each month on the student loan and apply it to the 2nd mortgage. My husband however feels that since the interest rate on the 2nd mortgage is higher we should take the money and pay towards the thus saving money we would pay on interest. My thought is though they are both tax deductible and I would like to eliminate one bill completely. Could you please help us! Which of the two will get us the best results. Thanks, Susan, St. Cloud, MN

Answer: Fact is, you can't lose whichever choice you make. You're getting rid of debt. That's the bottom line.

I agree with your husband that interest rates and interest savings matter. And you're right to think that eliminating a debt is wonderful. You can run the numbers at a website like dinkytown.net.

Still, I always like to look at risk when mulling the trade-offs in a situation like this. However small, there is greater risk attached to a second mortgage than a student loan (assuming the student loans are federally-sponsored and not private ones). I would focus on getting rid of the second mortgage.

Here's my reasoning: There is a great deal of flexibility built into student loans if you hit a rocky patch. You can defer student loans. You can go into forbearance. You can choose a different repayment option that reduces your monthly outlay. Yes, any of these choices will increase the overall cost of your husband's college education. But it's easy find financial relief in a pinch.

The same isn't true with second mortgages, home equity loans, and home equity lines of credit. And in recent years second mortgages have been a real source of financial stress and money trouble. Your home is at risk if for some reason you fell behind on your second mortgage. Interest rates could be higher in 5 years, too.

These are fine distinctions, however. You'll be better off financially no matter what at the end of the day. Congratulations.

Roth conversion

Question: I heard your segment about converting to a Roth IRA recently and was wondering if it was possible to convert a Beneficiary IRA to a Roth IRA? Thanks for the great show! John, Chicago, IL

Answer: You would think this would be an easy question to answer, right? It isn't. Like so many of the rules surrounding IRAs the answer is a mystery wrapped in an enigma requiring the help of a CPA to untangle. It's a disgrace.

That said, here is the basic outline. If you're the spouse and it's an inherited IRA you can convert it to a Roth. (Whether you should is a separate question). That's pretty straight-forward. But if the IRA beneficiary isn't the spouse it can't be converted into a Roth. However, new guidelines allow a non-spouse beneficiary of an inherited retirement savings plan like a 401(k) (but not an IRA) to convert it into a Roth. But the employers plan must permit the maneuver and many don't. I am not making this up. Really. Now you know why my bottom line is consult with a pro unless the beneficiary is the spouse.

Investopedia has a good and more detailed description of the rules here.

One other thing: I've read a number of clever ways to get around the restriction surrounding non-spousal inherited IRAs and Roth conversions. My own sense is that they aren't worth the cost and effort. Keep it simple is my motto (well, one of my mottos).