529 Accounts and Tax Reform

In this video, we talk about the recent tax reform, 529 accounts, and how it may not be as great over the short term as people hope.

Topics:
1. Provision of the tax from allowing families to withdraw $10,000 for private tuition.
2. Tax treatment of 529 on the federal and state level.
3. States playing catch-up to the tax reform.

As always, check out collegeandretirementplan.com for more information or email me at ncarmany@thewatermarkgrp.com.

 

Planning for College and Your Expected Family Contribution

Planning for college gives families the opportunity to send young adults into the world on the best footing. Not only do these young work warriors learn technical skills to follow a career with a livable income, they also learn social skills by interacting with a new set of people. When not carried out properly, students and parents often see the end of academic careers with debt and no diploma. Creating a better understanding of how college funding works and the choices that are available help parents in the process of saving for, shopping for, and saving on the cost of college. This post will act as an introduction to saving on the cost of college, with a review of the family’s expected contribution.

First, let’s take a step back and look at the landscape as it exists today.

Google “student loan debt” and a barrage of articles and statistics fill your search results. As most families with college-bound students know, total student loan debt is well over $1 trillion. In fact, the most recent numbers show total student loan debt at $1.4 trillion (1.). In 33 out of the last 35 years, the cost of college has risen faster than the pace of inflation (as of October 2016) (2.)

The result has been an inflation rate of roughly 5% for the past 10 years. Compare this to the cost of college in Singapore over approximately the same time frame and you will see an inflation rate of 3.22% (3.) – more in line with what one would expect. Free tuition may also be available in countries such as Germany, which originally abolished tuition fees in 1971 (although it made a comeback from 2006-2014) (4.). Still, a free university education is not always as glamorous as it seems. For example, in Sweden, the government provides tuition to students, but students loans do pile up, with 85% of Swedish students graduating with debt (4.), though that debt does not compare to the growth or amount of debt US students incur.

Take a look at the cost of college and the median US household income.

Notice the growth rate of college costs and lack of growth in median family income.

Part of the American Dream is slipping farther away from parents wanting to see their children do better and from students wanting to experience a respectable standard of living. The math is simple; when the rate of change for college costs increases faster than incomes rise, more borrowing takes place, totaling $1.4 trillion.

New Trends

I hope we start waking up to the current realities and start looking at the picture with a different set of assumptions and planning techniques. The students who recently graduated or who will be graduating soon must start looking at student loans in the same way Boomers have started looking at Social Security to maximize lifetime income. However, instead of looking for ways to increase lifetime income, graduates and parents with student loans must find ways to reduce lifetime expenses.
Students in high school or middle school, and their parents, should closely examine ways to fund college. Start with the basics. (Click here for a timeline associated with the last two years of high school.)

First step

We must look at the larger, more basic formula for college as outlined below.

Cost of Attendance – Expected Family Contribution = Student Financial Need

Most families have this basic formula down. If you have a high school student, how many conversations have you had with him or her about the cost of in-state versus out-of-state tuition and public versus private university costs? Most families try to keep the cost of attendance down without focusing on other aid that may make more expensive universities competitive, in terms of cost, with public in-state institutions.
For example, if private university tuition is $50,000 and a public school costs $25,000, the easy choice (on the surface) is a public university. However, when private schools see that a student has significant financial needs, those schools will likely offer more scholarships, grants, discounts, and money to the student (assuming the college is seeking the student’s attendance).
Only 11% of private school students pay full price for their education (6.). Private universities spend $0.42 of every tuition dollar and revenue on scholarships and grants (6.). Recent years have shown record scholarships and grants issued from private universities.
In the end, the net cost to parents and students matter not the sticker price.

Learning how the formula works for a family’s expected contribution should be the second step.

What is the Expected Family Contribution, or EFC?

It seems easy to not worry about how to pay for college until the bill comes.

In simple terms, this number is the amount of money the government feels your family can reasonably contribute to funding a college education. The formula, while more complicated, is listed below:

(Parent Income + Parent Assets)/# of Children in College + Student Income + Student Assets = EFC

Parent Income – Between 0-47% of total income may be expected minus all taxes and allowances.

Parent Assets – Up to 5.6% of qualifying assets may be counted, such as brokerage accounts, college savings, and savings accounts. Assets such as the family home, retirement plans, and an asset protection allowance do not affect the EFC calculation.

Number of Children in College – If you have more than one child in college, your Student Financial Need changes because assets will cover multiple individuals.

Student Income – 50% of income over the protection allowance counts toward the family’s EFC.

Student Assets – 20% of all assets, including custodial accounts and savings accounts. As with parents’ assets, the EFC calculation ignores family homes and retirement plans. As mentioned before, students also get an income protection allowance.
(Stay tuned for another blog post discussing income protection allowances.)

Now what?

As you can see from the formula, simplicity quickly gets lost and families start ignoring the EFC part of the college funding formula. Here are the next steps for parents and students.

Parents:

1. Starting when your child is in middle school, project your income through high school and college to better understand cash flow and to examine ideal accounts to save college funds.
2. If you own a small business for which your student works, create a plan early for the student’s income to avoid a higher EFC.
3. Create a plan for the gifting of assets to the student while he or she is in college, or a few years before college. Remember that up to 20% of a child’s assets count for the EFC and that only 5.64% may be expected for a parent’s qualified assets. If Grandma and Grandpa gift stock to the kids, you may want to rethink this for a while, or Grandma and Grandpa may want to gift the stock to Mom and Dad instead. (Watch out for the annual gift exclusion amount. Talk to your tax advisor for specifics about your situation.)

Students:

1. If you work, project your income over the next few years before and while you’re in college. You may end up working more your sophomore year versus your junior and senior years. This accomplishes two items: A.) It gives you a longer timeframe for your money to compound, and B.) Because prior-year tax returns are used, a lower income will be reported on the FAFSA.
2. Be careful about receiving gifted assets. See #3 under “parents.”
3. As you plan for college, closely examine whether you will be a better candidate for merit-based or needs-based scholarships and grants.

As always, if you have any questions, use the “contact us” page to let us know what is on your mind or contact us at 317-805-0840.

Sources

1. “U.S. Student Loan Debt Statistics for 2017.” Student Loan Hero. N.p., 11 July 2017. Web. 01 Aug. 2017. https://studentloanhero.com/student-loan-debt-statistics/
2. Clark, Kim. “College Costs Hit Record High in 2016 | Money.” Time. Time, 26 Oct. 2016. Web. 01 Aug. 2017. <http://time.com/money/4543839/college-costs-record-2016/>.
3. “College Access and Affordability: USA vs. the World.” Value Colleges. N.p., 01 Nov. 2016. Web. 01 Aug. 2017. <http://www.valuecolleges.com/collegecosts/>.
4. Mithcell, Michael, and Michael Leachman. “Years of Cuts Threaten to Put College Out of Reach for More Students.” Center on Budget and Policy Priorities. N.p., 29 July 2015. Web. 01 Aug. 2017. <https://www.cbpp.org/research/years-of-cuts-threaten-to-put-college-out-of-reach-for-more-students>.

The Current Reality of Paying for College

We want the best for our children, and we seek to lead them towards lives that are better than our

Pay for college is complicated and gets many families into trouble.

own. Culturally, we accept the pursuit of the “American Dream.” We measure success in terms of a house and white picket fence, a steady nine-to-five job, and a sizeable bank account. As parents, how do we put our children in a position to achieve this dream? What if our children want something other than this dream?

These questions lead me back to the current reality. To help our kids prepare for this next exciting phase of their lives, what should we as parents be doing now? For most families, “college” is the answer. However, the reality of achieving it remains a challenge. It’s like watching a crowd pay to stand in line for a box of goods and the promise of a great future, but not knowing how long the line is or what the box contains.

The American Dream

We hear about the goods in the box being the American dream – buying a home with a white picket fence, having two children, working at a nine-to-five job, and having a sizeable bank account. These traits are measures of success. The American Dream tells us that a pension awaits us when we reach the age of 65, and that our children will get college degrees, putting them on track to have better lives than ours. Yet somehow, in some way, the dream feels out of reach.

Consider Generation X. They bear the once-shared responsibility of creating a retirement pension while caring for elderly parents and helping pay the inflated cost of college – all on stagnant wages. The financial planning community tells this generation, “Save more, work more, save for your retirement first. Kids can borrow money for college; you cannot borrow for retirement.”

What is the result? A lack of retirement savings, student loan debt that both parents and children will be working to pay off for decades, and high levels of stress and anxiety. Where can we start building momentum that helps parents and acts as a springboard for our children and communities? College planning. Here, we can start with one of Gen X’s biggest concerns. First, we must gain perspective on the current landscape.

Student Loan Bubble

One of the most disturbing clocks is the student loan clock (found at collegedebt.com). Take a moment to venture over there and wait for a few seconds. It likely feels similar to watching the national debt clock. Consider the growth in student loan debt over time with just federal student loans outstanding (3.)

Or how about the increase in parent plus loans versus federal loans to undergraduates(4.)

Several studies have shown that parents tap into their retirement accounts to help pay for college. Even as parents sacrifice their own retirement over time, we sit with $1.4 trillion of student loan debt, on which one generally cannot file for bankruptcy. Experts state that the student loan bubble is coming.

Is it coming or is it already here? In a recent article, Forbes noted that the percentage of borrowers not paying on their federal student loans within three years of graduating college has increased to 11.5% (1.). Compare this to the mortgage delinquencies from the great recession, which topped out at 11.53% in the first quarter of 2010 (2.). How can the bubble be on the way? It is already here.

For several reasons, we should not be surprised by the lack of conversation on this topic:

– The Department of Education does not penalize universities until their student loan default rates exceed 40% in one year or 30% over three years. Remember how terrible things were during the Great Recession? Universities would need to become three to four times worse in terms of their default rates before the school has skin in the game.

– Think about the fact that you cannot easily declare bankruptcy to eliminate student loans. Why would the student loan industry care much about defaults? The interest will continue accruing; it only becomes a question of when they will collect. The longer it goes, the more compensation they will receive. The interest does not stop piling up.

– Let us not forget the standard advice of the financial planning industry: Prioritize saving for your retirement. “Kids can borrow money for college, but you cannot borrow money for retirement.” Think about how we pay for advice. Most advisors or financial salespeople receive compensation from commissions and/or the assets they manage. The larger this pool of assets, the more money they make. Why wouldn’t they prefer that you and your child take out student loans instead of paying for college from accumulated assets? While this does not apply to all financial professionals, based on my experience it is most often the case. This is not always a prudent financial move. In 2015, Mark Kantrowitz wrote an article that discusses situations in which putting your retirement first does not work best.

New Mindset

Does the world seem bleak, as though all is lost? There are new and developing trends. We must

Families need a new way to pay for college and pay off existing student loans.

understand both sides of the student loan issue.

The first is students who have already graduated and are working to pay off their loans. These individuals must look and plan for their student loans using the same mindset Boomers have toward Social Security planning. As you look back on retirement income planning, not much thought was given to maximizing Social Security to increase lifetime income. However, as Boomers aged, they explored the rules and started developing strategies like file and suspend, or restricted claim to help increase lifetime income. These strategies were innovating. They became so popular that Congress had to change the rules on Social Security. In a comparative way, new planning tactics must be developed for current holders of student loans. People like Heather Jarvis and younger financial planners are leading the way.

The flip side involves preventing student loans from being an issue. This means that as college education consumers, we must change the way we save for, shop for, and save on higher education. Most of the time, financial services will tell you to save for college (provided you have taken care of your retirement first), but it will not tell you how to save on the cost of college. Those individuals who talk about how to save on the cost focus on getting scholarships. However, there are other ways, like smart shopping, making the schools compete for your student’s attendance, and using the tax code to create “tax scholarships.”

Next Step with College Funding

– If you face the first scenario, study the innovators who specialize in student loans. If you are a do-it-yourselfer, check out Heather Jarvis’ site: http://askheatherjarvis.com/. For those who are delegates or validators, check out the screening tool on the XY Planning Network and look for advisors who specialize in student loans.

– If you are a parent of a high school student seeking some level of education beyond high school, look for advisors who specialize in the financing of college funding, not just the filing of the FAFSA or CSS and finding scholarships. I’m talking about using the tax code to create “scholarships,” having universities compete for your attendance, coordinating contributions from family members to avoid negative impacts on aid, helping coordinate distributions from accounts, developing a smart borrowing plan, and helping families explore ways to cover any college funding shortfall. To see what this process can look like, follow this blog over the next few months.

– Check out my other college funding articles.

Give me a call at 317-805-0840 or email me at ncarmany@thewatermarkgrp.com to discuss you will pay for you student’s higher education.

Sources

  1. Friedman, Zack. “Student Loan Defaults Rise – What To Do Now.” Forbes, Forbes Magazine, 6 Oct. 2017, www.forbes.com/sites/zackfriedman/2017/10/06/student-loan-default/#1f1cc56928de.
  2. “Delinquency Rate on Single-Family Residential Mortgages, Booked in Domestic Offices, All Commercial Banks.” FRED, St. Louis Federal Reserve, 27 Nov. 2017, fred.stlouisfed.org/series/DRSFRMACBS.
  3. Eisenhart, Maddie. “Student Debt Is Going to Be A Huge Problem for Millennial Marriages | A Practical Wedding.” A Practical Wedding: We’re Your Wedding Planner. Wedding Ideas for Brides, Bridesmaids, Grooms, and More, 17 May 2016, apracticalwedding.com/student-loan-debt-relationships/.
  4. Mitchell, Josh. “The U.S. Makes It Easy for Parents to Get College Loans-Repaying Them Is Another Story.” The Wall Street Journal, Dow Jones & Company, 24 Apr. 2017, www.wsj.com/articles/the-u-s-makes-it-easy-for-parents-to-get-college-loansrepaying-them-is-another-story-1493047388.

Important Dates for College Planning

College affects the daily lives of Gen X parents, either through children who have just graduated from college with student loan debt or through children who will soon be attending college. As their careers become settled and they earn higher incomes, parents with toddlers also focus on college. The idea of funding college moves up their list of goals.

As an industry, financial planning still has room to improve in terms of college planning. While financial services communicate the dates for retirement planning, the opposite seems true for college planning. Here, we discuss many of the dates and explain a few of the ideas associated with college planning.

FAFSA and Associated Timeline

FAFSA is an acronym for Free Application for Federal Student Aid. Parents and students complete this form every year to determine eligibility for financial aid. From the information listed on this form, an Expected Family Contribution is established to help fund the student’s education. For this article, students and parents should know that to file for the 2017-2018 academic year, the FAFSA must be filled out by June 30, 2018. However, the earlier you file, the better your chance of qualifying for grant, scholarship, and work-study money (1). Ideally, you would have filed on October 1, 2016, for the 2017-2018 school year.

Families should complete the FAFSA as close to October 1 of their senior year of high school.

States and colleges have their own deadlines for the FASFA filing (1). You can find the date by visiting FAFSA.edu.gov (2). The dates will not necessarily agree with the federal deadline already discussed. For example, Indiana’s deadline for the 2017-2018 academic year was midnight on March 10, 2017

When checking your desired university’s deadline, make sure you define the deadline. Is it submission of the FASFA or the date when it has been processed (2)?

As you can see, the FAFSA-related dates complicate the situation. The simplest action is to file your FAFSA form as close to October 1 when the application opens for the academic year in the following calendar year. In other words, for the 2018-2019 academic year, file the FAFSA on October 1, 2017. Many states and universities give out money on a first-come, first-served basis.

College Application Deadlines

While families stress about the financial aid they may receive, it is easy for them to forget about the college application deadline. As with the FAFSA, a few deadlines may apply to you. The result of not applying on time may lead the university to not even look at your application (3).

First, understand that the college application can be an early application or regular application. Colleges divide early application into early action or single choice early action. For purposes of this article, send an early application to the university during the first semester of the student’s senior year of high school, typically October to mid-November (3, 4). Early acceptance announcements may occur from November to early February (5).

Universities typically accept regular applications between January 1 and February 1. Students who plan to fill out a regular application should have letters of recommendation and essays completed by mid-November. Students should receive acceptance letters by mid-March or April (4).

SAT and ACT Tests

The ACT and SAT tests cause strike fear in many high school students. A high score means getting into the student’s dream college … or so many think. Many colleges now take a holistic approach to admissions and look at civic engagement, secondary student activities, and work experience as factors influencing admissions. However, the ACT and SAT are still important factors in the admissions process.

As a best practice, students should take one or both tests a couple times starting their junior year of high school. Students can take test several times throughout the year. The best time to take the tests will depend on your needs; typically, a study time of at least 40 hours is recommended for ACT and SAT preparation (6). Depending on class load, extracurricular activities, and scheduling, a student may take one to four months to prepare. Some do not recommend starting too early because the student may forget some of the material.

For general planning purposes, start with two months of lead time for test preparation and then adjust your schedule as the date gets closer.

Parents and College Planning

For parents, college planning will involve time spent reviewing and analyzing assets, as well as cash flow for account contributions.

College Savings Accounts

Parents typically save money in one of three types of accounts for college.

Custodial account- Money placed in this account is the child’s  asset(s). A custodian, typically a parent, oversees and invests the money. Contributors do not face deadlines for but funds will be considered higher on the list for college funding. The account also has a greater effect on funding expectations versus, say, a 529. The upside to a custodial account remains the flexibility with which the funds may be taken out. The money must be used for the benefit of the student. On a side note, some states require that the money is turned over to the child (i.e., the custodian is removed) once the child reaches the age of majority – a situation some parents do not favor. No tax advantage may be realized in funding these types of accounts.

Coverdell Educational Savings Account- This type of account is also known as the Educational Savings Account, or ESA. It focuses mainly on college with a cap on the contribution limit of $2000 each year until the student reaches the age of 18. The contributions are not tax-deductible but grow tax-free as long as the money is used for qualified expenses. Contributions can be made until the due date of the contributors’ return (April 15) without extensions (7). Income limits apply to the account. Individuals may contribute if their modified adjusted gross income is below $110,000 ($220,000 for married filing jointly) (7).

529 College Savings Account- The most popular college savings account is the 529. The deadline for most 529 contributions is December 31. However, seven states allow contributions up to mid- to late April for the previous tax year. These seven states are Georgia, Iowa, Mississippi, Oklahoma, Oregon, South Carolina, and Wisconsin (8). Many states offer a deduction or credit for account contributions. Please see your advisor for details related to your specific state.

Tax Returns

As we know, April 15 remains a dreaded date for most Americans, as tax returns are normally due. The date does adjust every once in a while, when April 15 falls on a weekend and to accommodate Emancipation Day (normally on April 16), which celebrates the end of slavery in Washington, D.C.

Some parents do not complete their taxes on time and file an extension. When this happens, the taxpayer must complete the filing by October 15. Filing an extension affects the FAFSA. Parents need to send a copy of the 4868 (extension form) with the FAFSA. Often, the university wants copies of W-2’s and a signed draft of your tax return. The institution may offer a temporary extension on the financial aid award until the FAFSA has been updated and completed.

 Shifting Income

Strategic planning for recognizing income or shifting it from one year to another may have an effect on your capacity to receive aid. In the same way, parents may look at shifting income for other reasons; many of the same tactics apply.

Gifting appreciated stock is one example which shifts income from a parent in a high tax bracket to a child (who sells the security) in a lower tax bracket at a young age. Parents need to gauge how this income shift affects financial aid. The focus should be on the income allowance and trying not to exceed it.

Understand that your income from this year will not affect aid for two years. For example, in the new changes on the FAFSA filing, the form asks for the “prior prior year’s” tax information. A 2015 tax return will become the basis for the 2017-2018 academic year.

Avoid recognizing large amounts of income through retirement account distributions or exercising stock options or capital gains. Offset capital gains with losses.

All the activities listed above normally have a deadline of December 31 at the close of the tax year. Please see your tax advisor for specifics about your situation.

If you have questions or would like to talk more about your student’s college funding, use the “contact us” section to let us know what you would like to discuss and when you are available.

Sources:

  1. Nykiel, Teddy. “When Is My FAFSA Deadline.” NerdWallet. N.p., 13 Sept. 2016. Web. 19 June 2017. <https://www.nerdwallet.com/blog/loans/student-loans/fafsa-deadline/>.
  2. “Student Aid Deadlines.” Student Aid Deadlines – FAFSA on the Web – Federal Student Aid. N.p., n.d. Web. 19 June 2017. <https://fafsa.ed.gov/deadlines.htm#>.
  3. Services, University Language. “College Application Deadlines at US Colleges and Universities.” The Campus Commons. N.p., n.d. Web. 19 June 2017. <https://www.universitylanguage.com/guides/us-university-and-us-college-application-deadlines/>.
  4. Services, University Language. “Early Application: Applying to US universities early or regular decision.” The Campus Commons. N.p., n.d. Web. 19 June 2017. <https://www.universitylanguage.com/guides/early-application-applying-to-us-universities-early-or-regular-decision/>.
  5. Blank
  6. Zhang, Dr. Fred. “SAT / ACT Prep Online Guides and Tips.” How long before the SAT should you study and prep?: 3 Factors that Affect the Hours. N.p., n.d. Web. 19 June 2017. <http://blog.prepscholar.com/how-long-ahead-of-the-sat-you-should-begin-studying-and-prepping>.
  7. “Coverdell ESA Contribution Limits & Deadlines.” 2016 and 2017 Coverdell (ESA) contribution limits and deadlines. N.p., n.d. Web. 19 June 2017. <https://newdirectionira.com/ira-info/contributions/coverdell-esa>.
  8. Flynn, Kathryn. “7 States Where You Can Still Claim a Prior-year 529 Plan Tax Deduction.” Savingforcollege.com. N.p., 21 Feb. 2017. Web. 19 June 2017. <http://www.savingforcollege.com/articles/6-states-where-you-can-still-claim-a-prior-year-529-plan-tax-deduction-915>.
  9. “Office of Student Financial Aid.” IRS Tax Transcript FAQ | Office of Student Financial Aid – University of Wisconsin–Madison. N.p., n.d. Web. 19 June 2017. <https://finaid.wisc.edu/557.htm>.

A NEW INVESTING FRONTIER: Crowdfunding

The traditional investing world is shrinking as younger workers face the hurdle of saving for retirement, servicing student loans, buying homes, and starting families. The shrinking isn’t in the

Understand how crowdfunding works

number of available choices (like mutual funds or exchange traded funds) but in the number of publicly traded stocks. The number of publicly traded companies decreased roughly 46 percent from the middle of 1996 to the middle of 2016 (1).  Crowdfunding may change how we invest.

Let’s look at one of the broadest domestic indices, the Wilshire 5000. In August 2016, the index had 3,607 stocks, while in 1998 it had 7,562 (2). Ironically, the number of public companies outside the United States has risen by roughly 8,700 since 1996 (2). The lower number of public stocks today can be attributed to the fact that large companies are merging or failing to meet listing requirements, and fewer companies want to go public (2).

WITH FEWER PLAYERS, WHAT DOES IT MEAN?

As the Wilshire example shows, this is happening now. Consequently, on the larger company side, equities like Apple play a more important role in the markets. Remember when Apple was not a major player for the top position in the S&P 500? Today, the stock occupies roughly 3.5 percent of the S&P 500 and over 11 percent of the NASDAQ 100. An article from CNBC discusses how this may negatively affect the popular trend of passively investing in index-based instruments (3):

“Some have gone a step further, arguing that passive investing leads already-overvalued stocks to become even more overvalued, as new money is allocated on the basis of existing (relative) sizes.”

For active mutual fund managers, a shrinking pool may mean holding onto well-known names longer than they would have otherwise. This point demonstrates the influence on mutual managers and investors as the number of stocks decreases. Less flexibility exists for mutual fund managers because money is leaving the arena and there are fewer stocks in which to invest.

This movement plays out like a game of musical chairs, in which the companies are the chair and the investors (including the fund managers) are trying to grab a seat. In our case, the number of investors does not decrease as the number of chairs becomes smaller. We end with people sitting on each other’s laps.

What is an investor to do?

You should continue with a normal course of saving and investing regularly, but you will need to make a few adjustments.

  1. Pay attention to your holdings. Know what you own and how to use it in your portfolio.
  2. Notice where you save money. How much goes into your 401k versus IRAs or Roth IRAs? Do not forget about your emergency savings. IRAs at large firms like Schwab, Vanguard, or TD Ameritrade typically have more investment choices than does a 401k. The point is to make sure you have the flexibility to access the best investments.
  3. Be ready to change as the financial markets change. Two movements are taking place that may change our investing landscape. The first is socially responsible investing, which has captured much press recently. The second change stems from crowdfund investing or the private equity movement.

What is private equity?

Private equity covers many types of investments, though its main characteristic involves not listing on a public exchange like the New York Stock Exchange or the NASDAQ. Private equity typically involves an investment in a non-listed business. Profit, management, and other traditional metrics matter, as they do with a listed business, but you do not have the reporting requirements of listed companies.

Some analysts propose that investing in private equity forces people to become “real investors” because of the lack of liquidity and the longtime horizon needed for the investment to provide returns. Private equity may also include bonds or other forms of debt.

Most closely associated with private equity is the venture capital firm, or VC. VC firms invest mostly in small companies or startups they believe have growth potential.  The institutions receiving the money typically do not have access to enough traditional funding through banks, public markets, and other places. Most of the investments are high risk. Consequently the terms of VC funding do not follow a traditional path.

A new and growing way to access private equity involves raising money through crowdfunding.

What is crowdfund investing?

Think Kiva, Kickstarter, and Go Fund Me; these are popular examples of crowdfunding. It is like a public version of Shark Tank. People put their ideas out there and potential investors can pass,

Understand how crowdfunding works

invest, or sometimes become actively involved in the presented opportunity. One of the key features of crowdfunding is that it allows securities to bypass federal securities laws (4).

Crowdfunding sprang into action with the JOBS Act of 2012, signed by President Barack Obama. The idea behind the act had the “SEC to write rules and issue studies on capital formation, disclosure, and registration requirements” (5). It opened the door for more participants to fund companies or investments that were previously available only to accredited investors.

Who are accredited and non-accredited investors?

In simple terms, accredited investors are high-net-worth or high-income individuals who have access to private investments that do not have to be registered with the Securities & Exchange Commission (SEC). To become an accredited investor, one must meet one of the following criteria:

– Have a net worth greater than $1 million. This value cannot include the value of one’s personal house.

– Have an income of greater than $300,000 for couples (or $200,000 for individuals) for the two previous years. Also, the couple (or individual) should expect to meet the criteria in the current year.

A non-accredited investor does not meet the needs listed above. As we can imagine, accredited investors make up a small percentage of the population. This is where the JOBS Act enters the picture with crowdfunding.

What are the rules for crowdfund investing?

In a press release dated October 30, 2015, the SEC outlined four areas for rules and regulations for crowdfunding, which include (6):

  1. Capital limits on funds raised by the company.
  2. Disclosure requirements on issues of specific information for the security offered.
  3. Investment limits on the amount investors buy.
  4. Framework for broker-deals and funding portals that engage in crowdfunding.

A brief summary of each area

Capital Raising Limits– Companies may not raise more than $1 million through crowdfunding in a 12-month period. Some companies, such as non-US companies and Exchange Act reporting companies, will not be eligible for crowdfunding campaigns.

Disclosure Requirements (as taken from the October 30, 2015 press release)-

  • The price to the public of the securities or the method for determining the price, the target offering amount, the deadline to reach the target offering amount, and whether the company will accept investments in excess of the target offering amount;
  • A discussion of the company’s financial condition;
  • Financial statements of the company that, depending on the amount offered and sold during a 12-month period, are accompanied by information from the company’s tax returns, reviewed by an independent public accountant, or audited by an independent auditor. A company offering more than $500,000 but not more than $1 million of securities relying on these rules for the first time would be permitted to provide reviewed rather than audited financial statements unless financial statements of the company are available that an independent auditor has audited;
  • A description of the business and the use of proceeds from the offering;
  • Information about officers and directors as well as owners of 20 percent or more of the company; and
  • Certain related-party transactions.

In addition, companies relying on the crowdfunding exemption must file an annual report with the Commission and provide it to investors.

Investor Limits– Investors are divided into two groups: income or net worth below $100,000, and those above $100,000.

  • Permit individual investors, over a 12-month period, to invest in the aggregate across all crowdfunding offerings up to:
  • If either their annual income or net worth is less than $100,000, the greater of:
  • $2,000 or
  • Five percent of the lesser of their annual income or net worth.
  • If both their annual income and net worth are equal to or more than $100,000, 10 percent of the lesser of their annual income or net worth; and
  • During the 12-month period, the aggregate amount of securities sold to an investor through all crowdfunding offerings may not exceed $100,000.

Broker-Deal and Portal Framework– Some funding platforms should register with the Commission a new Form Funding Portal and be registered with FINRA. Additional requirements taken from the same press release are as listed below:

  • Provide investors with educational materials that explain, among other things, the process for investing on the platform, the types of securities being offered, the information a company must provide to investors, resale restrictions, and investment limits;
  • Take certain measures to reduce the risk of fraud, including having a reasonable basis for believing that a company complies with Regulation Crowdfunding and that the company has established means to keep accurate records of securities holders;
  • Make publicly available on its platform the information a company is required to disclose throughout the offering period and for a minimum of 21 days before any security may be sold in the offering;
  • Provide communication channels to permit discussions about offerings on the platform;
  • Provide disclosure to investors about the compensation the intermediary receives;
  • Accept an investment commitment from an investor only after that investor has opened an account;
  • Have a reasonable basis for believing an investor complies with the investment limitations;
  • Give investors notices once they have made investment commitments and confirmations upon or before completion of a transaction;
  • Comply with maintenance and transmission of funds requirements; and
  • Comply with the completion, cancellation, and reconfirmation of offerings requirements.

The rules would also prohibit intermediaries from engaging in certain activities, such as:

  • Providing access to their platforms to companies that they have a reasonable basis for believing have the potential for fraud or other investor protection concerns;
  • Having a financial interest in a company that is offering or selling securities on its platform unless the intermediary receives the financial interest as compensation for the services, subject to certain conditions; and
  • Compensating any person for providing the intermediary with the personally identifiable information of any investor or potential investor.

Could crowdfunding change the way we invest?

One of the most noteworthy trends in crowdfunding right now focuses on impact investing and socially responsible investing. As we look forward, though, crowdfunding may solve the problem posed earlier about the declining number of publicly traded securities.

Perhaps we will see a trajectory in packaged products similar to the ETF or mutual fund for the smaller investor. This would create economies of scale while providing diversification and reducing business risk.

Where do I look for crowdfund investing opportunities?

Here is a link for portals regulated by FINRA: https://www.finra.org/about/funding-portals-we-regulate

Next steps:

  1. Educate yourself on crowdfund investing. As with other risky investments, the potential to lose money exists. Make sure you have the capacity to lose the money. If not, crowdfund investing is likely not suitable for you.
  2. What are you looking for as an investment? Is it to have an impact locally or “own a dream business” like a brewery without the stress of running it?
  3. Talk to a knowledge advisor on the topic. Be careful when engaging in this conversation, as many “advisors” are really salespeople. Ask how the advisor receives compensation. If the advisor receives commissions, he/she is a salesperson.

Check out this related article on investment performance.

Sources:

  1. https://finance.yahoo.com/news/jp-startup-public-companies-fewer-000000709.html
  2. https://seekingalpha.com/article/3995691-number-public-companies-shrinking
  3. http://www.cnbc.com/2017/05/17/four-tech-heavyweights-make-up-a-huge-share-of-the-sp-500.html
  4. https://www.sec.gov/spotlight/crowdfunding.shtml
  5. https://www.sec.gov/spotlight/jobs-act.shtml
  6. https://www.sec.gov/news/pressrelease/2015-249.html

 

Overconfidence with Finances and Sailing

Helping GenX parents plan for college and retirement.

317-805-0840, ncarmany@thewatermarkgrp.com

Topics:

Overconfidence With Finances and Sailing
1. How we get ourselves into trouble
2. Common financial moves
3. Get help

This post compares a day out on the water sailing to common experiences people encounter with their financial lives.  The root for many of these difficulties reflect behavioral.

Planning a Sabbatical

The Dream Life

How often do you find yourself comparing your life with those “living the dream?” We constantly fill our time with these thoughts. Buy this product and your life will dramatically improve. Take this action and your life will have no worries. One evening while watching TV or one morning while on your way to work, count how many times you hear this message.

Eventually, we buckle to this Chinese-water-torture-style marketing. Even when the messaging does not convince us to buy, we still compare our lives to those living the dream. For example, consider how our society reveres Hollywood stars, the wealthy, and the powerful. We look at them and tell ourselves, “If only I could have this, my life would be complete.” These lives play out with leisure and are full of happiness. Or at least, this is what we think.

How can you get more of these features in your life?Enter the sabbatical. Often, we associate a sabbatical with the college professor who takes time off to study or travel the world. However, many companies provide a sabbatical as an employee benefit. Charles Schwab is one example. For every five years of qualified service to the company, the employee receives one paid month off. The employee may still use his or her normal vacation during the year as well. As you can see, this allows for many possibilities.Still, most companies, primarily small ones, cannot provide this benefit, which keeps the sabbatical at bay.

How about those people who have the dream life?

Take two sailing stories, for example.

Brian Trautman and his crew produce the popular YouTube series “SV Delos” and have had many favorable life experiences. Brian was a software engineer who worked 70-hour weeks (2.) He notes in his blog, “My priorities were a lot different then and I lived to work rather than worked to live (2.)” Bitten by the sailing bug, Brian developed a four-year plan to travel the world that involved reading as many sailing blogs and as much sailing material as he could. The four-year plan included Australia as a destination and a budget to get there.

Once the sailing fund emptied, the crew had to find ways to pay for their adventures. In a popular blog post, Brian lists four of their early practices for continuing the journey.

  1. Brian would work remotely a few hours each day on IT projects (3.)
  2. The crew would work as hard as it could in the off-season, saving money to fund the next season (3.)
  3. Everyone paid his or her own way, including family and friends who visited (3.)
  4. They took advantage of moneymaking opportunities whenever and wherever they could (3.)

Brian also notes that part of the success of the Delos journey originates from the frugal nature of sailors. “… (C)ruisers are incredibly cheap. Imagine the cheapest person you know, then double their level of cheapness. Most cruisers are still even cheaper than this, and for good reason. The majority of people are trying to stretch every cruising dollar- just like you.”

The cost of this lifestyle is great, not necessarily in money terms, but in terms of opportunity by missing time spent with family and friends. Brian notes that if the journey wasn’t this way, it wouldn’t be worth it.

The second sailing story focuses on SV LaVagabonde. The crew of LaVagabonde, Riley and Elayna, are world cruisers like the crew of the Delos. To fund his adventure, Riley notes, “For eight long years, I worked offshore on oil rigs and in the mines of Western Australia, saving every dollar possible to be able to afford a halfway-decent Yacht (5.)” Riley also spent significant time studying where to buy his boat. He found that Europe was much cheaper than Australia.

Here are a few tips from Riley and Elayna to keep things moving.

  1. Research a place before you go.
  2. Let others be generous towards you. You both may enjoy it.
  3. Try to find an internet cafe or library instead of a restaurant.

For purposes of a sabbatical, not only will this help you save money if you are traveling, but it also points out the implied benefit of using the free services you may have access to use.

Today, both crews are gaining support through Patreon, a website through which fans can contribute to supporting a group in creating videos, music, and webcomics (4.) They are doing what they love and are giving back by sharing videos that have turned a sabbatical into a new way of life.

Examine the why for your sabbatical

Taking time off work is valuable in terms of preventing burnout and getting to spend time with family and friends. However, taking extended time away from work does not necessarily make for a sabbatical. Rather, it becomes an extended vacation. A sabbatical requires a cause or purpose for taking time off from work or your current life. The second differentiation between a sabbatical and a vacation is the cost. If the cost is not high, you may be justifying an extended vacation. Think again about the cost our sailors have paid in missed time with family and friends.

The purpose of a sabbatical typically shows up in a person’s core values in the form of goals and objectives. Yoursabbatical.com notes, “The most meaningful sabbaticals are planned ones – with specific goals and objectives designed to benefit both you and your company.” Do your core values show up in your reasoning for the sabbatical?

Sabbatical benefits

A workforce experiences many benefits from sabbaticals. For starters, when an employee takes a sabbatical during a recession, the company can reduce expenses while the employee takes the time to pursue a lifelong dream. Also, the company may be able to save enough money to avoid layoffs during an economic downturn (6.) While management and executives are away taking their own sabbaticals, someone will need to step into the empty role for a short period of time. There is value in creating impromptu training for the next worker who may occupy the role (6.)

Beyond the benefits to the company, sabbaticals provide an important intercultural financial practice – learning what it’s like to spend the money you saved. Unlike most Americans, who have a spending problem, those who save for decades often develop the habit of reducing their spending while still collecting cash. While such an action is noble, retirees often experience a strong urge to not spend in retirement. They forgo life-changing opportunities. The benefit of a self-funded sabbatical is that it gives you the experience of enjoying your money along the way. Later, when you cannot work or officially retire, spending the money does not become an issue. The biggest benefit involves the fact that saving and planning habits have already been settled. You get to enjoy “retirement along the way.”

How younger workers may use a sabbatical

Millennials have gained a reputation for changing jobs often. Gallup.com noted in an article last year that about 50 percent of Gen Y planned on staying at their current employer (7.). Sixty percent were open to new opportunities (7.) The article also pointed out that only 29 percent of Millennials are emotionally and behaviorally engaged with their jobs or companies.

The reasons for these frequent job changes are not discussed here but are brought up to explain the opportunity that exists in the practice of changing jobs often. The self-funded sabbatical may be a perfect opportunity for this generation to find more happiness and fulfillment while highlighting the financial behaviors discussed above. However, when planning a self-funded sabbatical, it is important to avoid missing any important benefits, like vesting (the schedule of how long an employee must work at a company before the employer’s match becomes the employee’s property) of company matching on 401(k)s. Sometimes, the vesting period lasts up to six years.

Delaying a traditional retirement may be a setback for younger workers who plan on taking several sabbaticals during their professional careers. Time away from work may result in periods of not saving money or, worse yet, dipping into savings earmarked for senior years.

However, while some non-Millennials aren’t willing to even consider the idea of a self-funded sabbatical, younger workers may be willing to take on this risk that may require working later in life. In fact, there are several benefits to working after the age of 65.

-Living longer. An Oregon State University study found that “working past age 65 could lead to longer life, while retiring early may be a risk factor for dying earlier.”

-Employer benefits. You may be able to get health insurance, paid vacations, and other traditional benefits.

– Reduced withdrawals from your portfolio. Because you are earning income, the needed withdraws from your other assets should lessen

– Social. Many people do not realize the importance of interacting with peers. This keeps our minds engaged and can increase happiness.

Mechanics of a self-funded sabbatical

Let us assume that you have completed the process of determining why you want a sabbatical and you agree that you can use this self-created benefit as you advance in your career. Now it’s time to figure out the funding. To complete this, we need a fictional case study to explain the math. Our example will not consider taxes and other important things like health insurance. This is where the benefit of working with a Certified Financial Planner may be realized.

Consider Jan, who is in her early 30’s and has been moving from job to job every few years as she climbs the corporate ladder. Currently, she makes $65,000 a year and would like to take a one-month sabbatical to help a not-for-profit take care of disadvantaged youth. Jan is considering taking this sabbatical in either 36, 48, or 60 months and is interested in determining what she needs to save each month to carry out this goal.

If Jan will need $5000 for use in 36, 48, or 60 months she will have 35, 47, or 59 months to save while she works. Jan will have access to different vehicles to save the money, like CDs, bond mutual funds, stock funds, and money market funds. Jan likes to play it safe and isn’t willing to subject her savings to variations in the stock or bond market. She will be using low-yielding instruments like CDs or money market funds. Jan can save the following amounts every month to amass her $5000.

Time to Sabbatical Required Monthly Savings

60 months-$84.75

48 months-$106.38

36 months-$142.86

If Jan has some flexibility and reasonable outlays, she should be able to accomplish her goal of saving $5000. Even if she runs a tight budget, Jan will likely be able to cut out a low-value cost to live her dream experience.

Let’s take the example a step further. Assume Jan spoke to a friend who recommended she invest the monthly contributions into moderate-risk items like bond mutual funds and a small portion into blue-chip stocks, creating a return of three percent yearly. How would Jan’s required monthly savings change?

Time to Sabbatical Required Monthly Savings Earning 3%

60 months-$ 78.75

48 months-$ 100.39

36 months-$ 136.87

As you can see, the power of compounding reduces Jan’s needed monthly contribution. The longer the time until she takes the sabbatical, the larger the benefit from letting the money work. Either savings plan will make Jan happy. The money and regular action of saving are simply the means to the end of Jan being able to work with the disadvantaged children. Both plans are doable.

On a side note, you may even be able to include some of your work benefits, like unused vacation time, to fund the sabbatical. Although this makes the calculation more complex, working it into the picture may reduce your needed monthly savings. However, you may be forgoing the use of vacation time along the way.

How does a self-funded sabbatical affect long-term savings?

Jan’s savings will put her on track for her sabbatical, but she cannot forget about the long-term picture. She will somehow need to make up the missed savings for the month when she will not be working. With moderate increases in her long-term savings (on top of the savings required to fund the sabbatical), she will be able to keep her retirement plan on track as well. Jan can increase her retirement account savings by one of the following amounts to make up for the month she will not be working.

Time Until Sabbatical Required Increase in Monthly Retirement Savings

60 months 1.69%

48 months 2.12%

36 months 2.85%

 

Next steps

If you plan on working self-funded sabbaticals into your career, make sure you follow the correct steps.

– Identify the why behind your sabbatical.

– Decide how long you want to wait before taking the sabbatical.

– Figure out your monthly savings requirement and the adjustment to your retirement savings plan.

– Start saving and investing.

– Enjoy the sabbatical.

Should you have any questions or concerns, please feel free to contact me at 317-805-0840 or ncarmany@thewatermarkgrp.com.

 

Sources:

1.h”What Are Sabbaticals?” What Are Sabbaticals? | yourSABBATICAL. YourSabbatical.com, n.d. Web. 19 June 2017. <http://yoursabbatical.com/learn/employees/>.

2. Trautman, Brian-trautman. “How do we afford to sail? (Part 1)–By Brian.” SV Delos. SV Delos, 02 Mar. 2017. Web. 19 June 2017. <http://svdelos.com/2014/01/how-do-we-afford-to-sail-part-1-by-brian/>.

  1. Trautman, Brian-trautman. “How do we afford to sail? (Part 2) -By Brian.” SV Delos. SV Delos, 02 Mar. 2017. Web. 19 June 2017. <http://svdelos.com/2014/01/how-do-we-afford-to-sail-part-2-by-brian/>.
  2. h”How can we help you?” Types of questions. N.p., n.d. Web. 19 June 2017. <https://patreon.zendesk.com/hc/en-us/articles/204606315-What-is-Patreon->.
  3. “How I Bought The Yacht and Afford to Sail.” Sailing La Vagabonde. N.p., n.d. Web. 19 June 2017. <http://sailing-lavagabonde.com/money-money-money/>.
  4. “Facts and Figures.” Facts and Figures | yourSABBATICAL. N.p., n.d. Web. 19 June 2017. <http://yoursabbatical.com/learn/>.
  5. Gallup, Inc. “Millennials: The Job-Hopping Generation.” Gallup.com. N.p., 12 May 2016. Web. 19 June 2017. <http://www.gallup.com/businessjournal/191459/millennials-job-hopping-generation.aspx>.
  6. Schlesinger, Jill. “Working past age 65 has many benefits.” Chicago Tribune. N.p., n.d. Web. 19 June 2017. <http://www.chicagotribune.com/business/success/savingsgame/tca-working-past-age-65-has-many-benefits-20160714-story.html>.