Archives for August 9, 2018

It makes sense that if you have a car accident, your insurance premium could go up. What doesn’t make sense is that if you don’t have an accident, you could also end up paying more, for no reason at all.

The explanation behind such price hikes is that more and more insurance companies are adopting a practice called “Price Optimization.” This involves analyzing data on consumers to find out who will shop around and who won’t. If a computer algorithm estimates that you aren’t likely to be a savvy shopper, your premiums could likely go up.

That means that even if you are a careful driver with a great credit score, no tickets, accidents or other damage claims, you can still find your insurance premiums getting a significant hike. You can check your credit score and read your credit report for free within minutes using Credit Manager by MoneyTips. Someone down the street with the exact same driving history and profile won’t pay a penny more if the computer analysis discerns that a sudden, unexplained premium increase would send him or her shopping for a new policy.

While the idea of charging different consumers different prices for the same thing isn’t a new idea — just look at the airline industry or your nearest auto dealer — the advent of big data and consultants who crunch the numbers and refine the calculations is making it easier. According to a 2013 survey by Earnix, a software provider of price optimization products to the insurance industry, 45 percent of large insurance companies and 26 percent of all insurance companies in North America were optimizing prices.

Consumer advocates blast the practice, which they call discriminatory, because it doesn’t base the driver’s premium on the amount of risk he or she poses to the insurance carrier. According to the trade publication Insurance Journal, insurance commissioners have moved to limiting the use of price optimization in eighteen states — Alaska, California, Colorado, Connecticut, Delaware, Florida, Indiana, Maine, Maryland, Minnesota, Missouri, Montana, Ohio, Pennsylvania, Rhode Island, Vermont, Virginia, and Washington — and the District of Columbia.

In September 2015, the Consumer Federation of America called on a task force at the National Association of Insurance Commissioners that is studying the practice to recommend that states prohibit its use. According to the federation, price optimization violates state insurance laws that ban unfairly discriminatory rates.

“Price optimization is a method that uses non-risk-related information to systematically move insurance premiums away from their cost-based level. No one denies this,” the CFA wrote to the insurance commissioners. “Systematically moving prices around to reflect non-risk information causes rates to be unfairly discriminatory and illegal in virtually every state. The only conclusion that can be drawn from a review of price optimization techniques is that price optimization is illegal and must be prohibited.”

In the meantime, consumers don’t have to wait for their state insurance commission to take action. Instead, just start shopping around. According to J. Robert Hunter, a former Texas Insurance Commissioner who’s now Director of Insurance at the Consumer Federation, with just a couple of phone calls or visits to a few websites, one hour of insurance shopping can cut as much as $125 per car off your bill. Consumer Reports polled insurers in September and found that Amica Mutual and State Farm don’t use price optimization.

An even easier approach might be to make just one phone call — to your agent. Ask why your rate has gone up and what you can do to lower it. Also review your coverage to make sure you’re not paying for unwanted extras and that you’re taking advantage of discounts, such as good driver and good student deductions, or savings from bundling home and auto policies into one package.

It’s not unusual: An investor five or 10 years from retirement worries the nest egg will come up short, wants a boost over the finish line but already has a typical lineup of stocks and bonds.

So what else could fuel the afterburners? Would real estate do the job?

True believers recommend a range of possible real estate plays, from real estate investment trusts to rental-property purchases to shares in crowdfunding ventures that redo houses or buy commercial property. The risks and opportunities run the gamut.

“Among all the private investment opportunities, real estate typically outperforms other asset classes and is usually less volatile,” said Brian Dally, CEO and co-founder of Groundfloor, a firm that lends investor money to house flippers and other developers. “In addition, people are familiar with the idea of homeownership, so real estate investing isn’t overly complicated to comprehend.”

“Real estate can be a great asset class and diversification tool,” said Jeffrey Feinstein, a vice president with Lenox Advisors in New York City. “It’s typically not directly correlated to the [other financial] markets and can provide income from rentals or refinancing. Hold period is around four to 10 years, so it can be looked at as a long-term, retirement-friendly strategy.”

The median price of single-family homes hit $318,000 in the first quarter of 2018, up from $257,400 in the first quarter of 2007, overcoming the losses homeowners suffered in the Great Recession, according to Bureau of Census data.

Yet after nine straight years of real estate gains, there are mounting concerns that residential real estate is nearing another bubble, and the national average does not reflect a rise everywhere.

Feinstein also noted that the investor must be willing to keep money tied up and be able to weather real estate dips — that median dropped to 208,400 in early 2009, for example. “You don’t have access to the capital at all times, unlike a brokerage account, and there’s often market risk you can’t control,” he said.

Here is an overview of the most common ways real estate can boost your retirement income.

Tapping equity in your home

The most straightforward way to fund retirement with real estate is to tap equity in a home that is all or mostly paid for. Downsizing means selling the current home to buy a cheaper one and pocketing the difference. Moving might also reduce property tax, maintenance and utility costs. For a couple filing a joint return, up to $500,000 in gains on a home sale are free of federal tax.

Currently, the Treasury Department is studying whether it can bypass congressional approval to index long-term capital gains to inflation. This means that the appreciation in an asset’s price that could be attributed to inflation would not be taxed. Homeowners whose houses have surged in value over the years could benefit from such a tax cut.

“While there may be many reasons to consider downsizing your home, a reduction in expenses is usually the top of the list,” said Kurt Rossi, CEO of Independent Wealth Management in Wall, New Jersey. “Downsizing proceeds may also allow you to pay down other debts, replenish cash reserves or even provide a much-needed boost to your retirement savings.”

Homeowners can also tap equity with a home equity loan or cash-out refinancing, which is taking out a new mortgage for more than you owe on an older one. Both approaches typically require an income to qualify and require the homeowner to make monthly payments.

To escape that, the homeowner age 62 or older can get a reverse mortgage, borrowing against the equity in the home. Instead of payments, the interest charges are added to the loan balance and paid after the home is sold by the borrower or heirs. The lender cannot force a sale or call the loan so long as the property is kept up and taxes and insurance are paid, even if the debt grows greater than the home’s value. The homeowner or heirs are never on the hook for more than the home fetches in a sale, so other assets are protected.

Proceeds can be taken as a lump sum, credit line or monthly payments and are guaranteed to continue for the borrower’s life with no income tax. Older homeowners can borrow more than younger ones, since there’s less time for the debt to grow to more than the home is worth.

But reverse mortgages can sometimes create trouble and might not be a good fit for everyone. Fees can be an obstacle, and interest, and interest on interest, can drain any equity that might otherwise be left to heirs. Also, the loan must be paid off if the borrower moves, even if it is to an assisted-living facility. As the mounting debt erodes equity, other options, such as downsizing, become less feasible. Many seniors have found themselves in trouble or at odds with children hoping for an inheritance, because they didn’t understand these loans well enough.

Steve Irwin, the executive vice president of the National Reverse Mortgage Lenders Association, said U.S. homeowners 62 and over have $6.8 trillion in home equity that can help with retirement expenses. “The numbers tell a reassuring story about housing wealth in an era when large numbers of retirees and near-retirees fear running out of money before the end of their life,” he said.

REITS

Publicly traded real estate investment trusts are like mutual funds that own commercial, residential or industrial property, or mortgage securities, instead of stocks and bonds. They pass to investors rental income, gains from properties that are sold, or payments received on loans in mortgage-backed securities.

REITS can produce capital gains, though steady dividend income is usually the main attraction. They avoid taxation at the corporate level by passing at least 90 percent of earnings to shareholders.

At the end of 2017, there were 220 “equity” REITS, and 41 mortgage REITs – with total assets of just over $1 trillion, according to NAREIT, the industry trade group.

Some REITs pay pretty well. Ares Commercial Real Estate Corp. (ACRE), for example, yields just over 8 percent.

But as with many other fixed-income investments, REIT prices can fall when rising interest rates make older investments less generous than newer ones. While this can be offset as the REIT raises rents on tenants, and as newer mortgage securities offer higher yields, there may be a lag, and experts say these assets are best for investors who can wait out the downturns and are diversified with other types of assets like stocks and bonds.

“For a passive real estate investor, the best investment would be in a publicly traded REIT index or [REIT] mutual fund with low fees,” says Jeremy Salzberg, a partner at Sugar Hill Capital Partners, a private equity real estate firm In New York City.

REITS are traded like stocks and therefore are very easy to buy and sell, a chief advantage over owning investment property directly. They are professionally managed, and since the fund owns numerous properties it is diversified. But you don’t have the control you would by owning a property yourself.

Brian Finkelstein, CEO at Broad Financial in Monsey, New York, recommends buying REITS in tax-favored accounts like IRAs, ROTH IRAs or 401(k)s to avoid annual income tax on dividends that are reinvested, and he says REITS are not especially good for investors seeking long-term growth because REIT share prices generally don’t grow very fast. Income-oriented investors can start receiving interest earnings right away, as payouts typically come every quarter.

Direct ownership

Many advocates swear that owning investment property — a business, residential building or vacation rental — is the way to go. At the modest end, it could involve renting out a spare bedroom on Airbnb or buying a vacation rental or long-term rental. At the other extreme it could be the purchase of an apartment building.

Mark Painter, founder of EverGuide Financial Group in Berkeley Heights, New Jersey, said, “The best way to magnify real estate returns to boost your retirement is the use of income-oriented real estate and leverage. He recommends borrowing at least half the cost of the investment property. That would add some risk but double any profit on the amount invested.

Borrow half of a $500,000 purchase, for example, and a 10 percent gain in property value would be a 20 percent gain on your initial investment. But the same math means a 10 percent price decline would be a 20 percent loss of invested capital. And borrowing means shouldering loan payments, which can erode annual earnings and be tough on a retiree with limited income.

A good property, he said, would earn at least 6 percent a year on the investment, as rents and other income exceed costs like mortgage, maintenance and taxes. “Real estate is all about location, location, location, and if you can find a property that has good cash flow — at least 6 percent — then buying an individual property is the best bet and can help you weather any pitfalls that may face real estate as a whole.”

Investors can avoid annual tax by setting up a limited liability company within a self-directed IRA, including a feature called checkbook control to streamline transactions, Finkelstein said. “That means that there is no middleman to go through in order to access your retirement funds,” he says. “If you want to buy real estate with your IRA, just write a check to the seller. If you want to buy supplies for renovations, just write a check at your local hardware store. … Having access to your self-directed IRA via a checking account allows you to effectively cut out the fees and the aggravation of third-party processing.”

Among the chief benefits of direct ownership is having control. But that can also mean doing a lot of work and having many eggs in one basket.

Crowdfunding

In recent years a number of firms have started to offer investors chances to buy shares in specific real estate ventures, such as flipping individual homes or fixing up business space through crowdfunding platforms like Groundfloor, with a minimum investment of $100, or RealtyShares, with minimums as low as $5,000, depending on the project.

The investor can select from among a list of properties vetted by the investment firm, with estimated income and capital gains disclosed on the website but not guaranteed. It is an alternative to finding an investment property yourself, and the investor need only buy a small share of an individual project, making it possible to spread your money among various projects to reduce risk.

“Crowdfunding involves the pooling of funds by a group of investors into a real estate project,” explains Ralph DiBugnara, president of Home Qualified, a website for real estate investors. “Investors earn money first through rental income and then ultimately when the property sells. Originally these platforms were only offered to experienced investors, now they have been expanded where anyone can get involved.”

While REITS leave the property selection to the fund managers, crowdfunding allows investors to pick and choose themselves, he says. But he notes that crowdfunding investors are often required to commit their money for five years or longer, which could be a problem if a better investment came along or the market turned sour.

“It is very new and untested,” DiBugnara says. “So we don’t have a lot of historical data and it will be a while before investors can really analyze long term returns.”

These platforms vary widely in how they screen potential investments, in terms like minimum investments and procedures for making withdrawals, so experts urge investors to look carefully at rules and track records, and to avoid putting too many eggs in one basket.

The majority of Americans are not setting aside enough money in emergency savings to cover a significant unexpected expense, according to a new survey from CIT Bank. That’s a problem, because nearly half of American households were faced with emergency expenses in the past year.

“More than one in four U.S. consumers do not save for unexpected events such as a home repair or health expense,” said Ravi Kumar, head of Internet Banking for CIT Bank in a press release. “Another quarter of consumers report saving less than 5% of their monthly household income for emergencies.”

It’s important to have an emergency fund.

How are people paying?

Experts generally recommended that your emergency fund be large enough to cover three to six months of your household expenses, but those numbers aren’t set in stone. If you have a job where your income is not stable, for example, or a health insurance plan with a high deductible, it might make sense to have an even larger cushion.

But as numerous other studies have confirmed, the failure to save steadily has left a large majority of Americans far shy of those targets. Earlier this year, just 39% of respondents to a Bankrate survey said they had savings sufficient to to cover a $1,000 surprise expense. And that leaves people in a tough position when trouble arises.

“Family and credit cards top the list of resources Americans rely on for financial support instead of utilizing a savings account for emergencies,” Kumar said.

Americans say they are willing

While we’re largely coming up short on the “preparing for the unexpected” front, the majority of the 1,100 American adults surveyed by The Harris Poll for CIT did say they would be willing to make some sacrifices to build their emergency funds.

Over half (56%) said they were willing to dine out less, 47% said they would give up online subscriptions, 41% were willing to give up gym memberships, and the same number said they would sacrifice vacations.

Those good intentions don’t quite square with how people actually act. For example, 44% called saving for vacation a low priority, and 25% said it wasn’t a priority at all. In reality, while they may not see the savings aspect as important, the spending happens anyway: 77% of those surveyed shell out for vacations each year, and a majority of those spend up to $5,000 on them.

As a predictable result, nearly three in ten (29%) respondents said they have taken “extreme actions to pay for a vacation, including taking out a bank loan, going into debt, cleaning out a savings account, borrowing money or maxing out a credit card.” That’s essentially the opposite of sacrificing to build an emergency fund.

“CIT’s study shows that many Americans can do more to ensure their lifestyles and savings priorities are aligned,” said Kumar.

What can you do?

It’s time for many Americans to face reality. Just because it’s not raining right now does not mean a rainy day will never come. In fact, it’s close to coin-flip odds that you’re going to be “surprised” by a big expense in any given year.

Given that, everyone ought to analyze their budget and their savings. If you don’t have the recommended three to six months worth of expenses set aside, now’s the time to take the steps needed to build that cushion. That’s likely to require making some of those spending cuts mentioned above. It may also make sense take on a second job or side gig.

Considering the odds, it’s a bit naive to describe our acute personal financial crises as “unexpected expenses.” You can and should expect that some costly trouble is bound to come up, even if you can’t predict the particulars in advance. You can make those events less traumatic if you prepare. It’s your choice: Act in advance, and have more flexibility to manage your financial strategy the way you choose to, or wait, and wind up forced into more painful choices when those surprise bills come due.

Owing money in retirement isn’t ideal — but most people do.

Seventy percent of U.S. households headed by people ages 65 to 74 had at least some debt in 2016, according to the Federal Reserve’s latest Survey of Consumer Finances. So did half of those 75 and older.

Paying debt usually gets more difficult on a fixed income. Mortgage debt, especially, can be a huge burden in retirement. Retirees may have to withdraw larger amounts from their retirement funds to cover payments on debt, which can trigger higher tax bills and increase the chances they’ll run short of money.

People have the most options to deal with debt if they create a plan before they retire, financial planners say. Refinancing a mortgage, for example, is usually less of a hassle while people are still employed. It’s also typically easier to generate the extra income that may be needed to pay off debt.

“It is much easier to keep working for another year or two than to try and come back into the workforce when they are older and the employer needs have changed,” says Linda Farinola, a certified financial planner in Princeton, New Jersey.

Here are three loans to consider before you stop working:

Refinance (or recast) your mortgage

Certified financial planner Rebecca L. Kennedy of Denver would prefer that clients pay off their mortgages before they retire. But paying off a mortgage may not be feasible or advisable, especially if it would mean taking a lot of money from a 401(k), IRA or other account.

“Often the majority of the assets are pretax so it would require a much larger withdrawal to net the after-tax amount needed,” Kennedy says.

People also could consider downsizing to eliminate or reduce mortgage debt, Farinola says.

For retirees determined to stay put, refinancing or “recasting” the loan can lower payments, says Serina Shyu, a certified financial planner in Atlanta. While refinancing requires taking out a new loan, with substantial fees, recasting means keeping the same loan, but using a lump sum to pay down the balance and lower the payments. Recasting is offered by some but not all lenders and may not be good idea if the lump sum would come from retirement accounts.

Another option, if the mortgage balance is less than half of the home’s market value, is using a reverse mortgage to pay it off. Reverse mortgages allow people 62 and older to tap their home equity without having to pay the money back until they move out, sell the house or die.

“For many, that is a very viable way to increase cash flow,” says Chris Chen, a certified financial planner in Waltham, Massachusetts.

Consolidate your debt

Credit card debt indicates people may be living above their means. That’s not something that tends to get better when incomes drop in retirement, Farinola says.

“I find that if people cannot pay off debt when they are working, they certainly cannot when they retire and the cycle just continues,” she says.

People with good credit scores, and sufficient discipline, can use 0% balance transfer offers to consolidate and pay off their credit card debt. Those who need more time to pay off debt might consider a personal loan with a fixed interest rate and fixed payments. If it would take over five years to pay off the debt, however, their debt load may be unmanageable. In that case, they should talk to a credit counselor and a bankruptcy attorney to better understand their options.

Open a home equity line of credit

A home equity line of credit is like a credit card that allows you to borrow against the value of your home. If that sounds dangerous — good. It should.

HELOCs shouldn’t be used for frivolous spending, but they can be a good backup to an emergency fund. HELOCs also can fund home repairs or long-term care.

A HELOC probably isn’t a good option for people who aren’t disciplined about their spending. HELOCs have another big pitfall: Payments on any borrowed money can spike after an initial interest-only “draw period” ends, usually after 10 years.

Another product, a reverse mortgage HELOC, costs more to set up, but payments are optional. Some financial planners recommend reverse mortgage HELOCs as a potential source of cash in market downturns. The retiree can draw on the HELOC rather than selling stocks in a bad market, and pay the money back — or not — in good markets.

“The key advantage is ability to choose if and when to make payments, and ability to access a growing line of credit,” says Tom C.B. Davison, a certified financial planner in Columbus, Ohio.