This week, the House of Representatives passed a new proposed tax bill. I’ll cover what the new bill changes about taxes, as well as covering some new rule changes to reverse mortgages and why you probably shouldn’t consider using a reverse mortgage as part of your retirement planning.
Make It Last with Victor Medina is hosted by Victor J. Medina, an estate planning and elder law attorney and Certified Financial Planner™. Through his law firm and independent registered investment advisory company, Victor provides 360º Wealth Protection Strategies for individuals in or nearing retirement.
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Bert: Welcome to “Make It Last,” helping you keep your legal ducks in a row and your nest egg secure, with your host, Victor Medina, an estate planning and elder law attorney and certified financial planner.
Victor J. Medina: Hey, everybody, welcome back to Make It Last. I am your host, Victor Medina. I am so glad you’re enjoying this Saturday morning. It’s bright and early if you’re listening on the radio, but as you know, we also simulcast this as a podcast.
If you’re interested in listening to this show at any time that isn’t Saturday morning, you can go ahead and subscribe on iTunes or Android and just look for Make It Last with Victor Medina.
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I’m excited for today’s show. We are going to cover three subjects. A little different formats today than the way we normally do. Normally we’d cover one small topic in the first segment and then take a larger topic over segments two and three. We teach you a little bit about it and then what’s practical.
This week, we’re actually going to hit three different subjects. The three different subjects are, we’re going to cover the new GOP tax proposal. It’s a couple of weeks old now. We’re going to talk a little bit about what it means because there are some important provisions in there. A lot of things that affect retirees.
Then, in the next segment, we’re going to cover a new law about reverse mortgages. Now, on the show, I haven’t really gone into reverse mortgages. In large part because I don’t believe that they should factor into a retirement for reasons that I’ll discuss in that second segment, but I am going to cover the new law and how it might affect you if you are considering a reverse mortgage.
Then, finally, in the last segment I’m going to cover the question about should you hire a financial advisor. Many people are questioning whether or not they should have a financial advisor in their lives, specifically in retirement. We’re going to give you two good reasons about why you should consider hiring a financial advisor, especially in retirement as you make that transition.
Because we have so much to cover today, let’s jump right in and talk a little bit about the new tax proposal. The Republicans in the House essentially proposed a bill that they said is a reformation of the tax code. There are provisions in there that change the income tax rates. Inside of there, you’ll find that they have consolidated seven tax brackets down to four.
They have consolidated the 10 and the 15 percent bracket which affects a lot of people in retirement. They’ve made that 12 percent bracket. The brackets, I guess, that can be used [laughs] in the same word there, but the brackets are basically down to 12, 25, 30, and 35. They’ve eliminated the top bracket of 39.8.
There are a bunch of other provisions inside there like the elimination of the estate tax over a number of years. It starts by doubling that current exemption from $5.6 million to $11.2. I don’t know how many of our listeners have $11.2 million. My guess is not that many.
In fact, the population supports the idea that that’s a really infinitesimal percentage of the people that are out there, but they do raise the estates tax and then eliminate it over time. There are, actually, two provisions there that affect people in retirement in a pretty significant way.
One of them has to do with the elimination of the deduction for medical expenses. I’m going to tell you what that is in order for you to understand why it might impact you. Under the current law, the IRS allows for individuals to deduct qualified medical expenses when that exceeds either 7‑and‑a‑half or 10 percent of the adjusted gross income for the year.
What that means is that it comes off as a line item deduction on top when you cross that threshold. The cost to repeal that is about $10 billion per year. The way to think about that is, there’s about $10 billion worth of deductions that are taken across the US from it.
The new bill essentially eliminates the ability for individuals to deduct that. That could have very major implications for households with really high healthcare costs. The way that it works is the IRS currently allows individuals to deduct preventative care, treatment, surgeries, dental and vision care as qualifying medical expenses.
This is really where the rubber meets the road, it also qualifies your long‑term care expenses for chronically ill patients. The medical expense deduction can be used to deduct things like assisted living in nursing home expenses, even certain home healthcare. It’s a big change. There are over 8.8 million households that filed income tax returns claiming the medical expense deduction.
That’s over 19 percent of all itemized returns and 5.8 percent of all returns filed in 2015, the last tax year that we have information for. We don’t have the 2016 information quite yet. If you have high medical costs and this bill passes, this could take a significant bite out of your finances.
I mentioned before that, essentially, you have to hit these certain thresholds. Until this year, you could’ve either hit seven‑and‑a‑half percent if you were 65 and older, or 10 percent. Now, this year, it’s 10 percent, but you can only deduct that portion of medical expenses that exceeds your 10 percent of your AGI.
Half of the people that claim this deduction reported income of $50,000 a year or less. That can really affect people. If you think about people that are disabled, long‑term disabilities, households with those kinds of family members can deduct all kinds of expenses not covered by insurance.
That’s really where the rubber meets the road, is that your deduction here is in lieu of having insurance cover something. If you think about it, it’s not that somebody’s paying for expenses that are somehow covered by insurance. They’re deducting it specifically because it’s not covered by insurance.
For blind and deaf people, they could have deducted the cost of maintaining their service animal. People who have various kinds of prosthetic’s or high drug costs, those deductions are going to go away. Families with disabled members may find themselves drowning in medical expenses, even if you have health insurance because the health insurance doesn’t cover everything.
It’s curious that, as much as the conservative platform has been pushing people to take health savings accounts, HSAs, with high medical insurance deductibles as a way of keeping the cost of insurance down, the ability to deduct those expenses on your taxes would go away. For people that have high deductible health insurance, writing off the cost of those deductibles is no longer an option.
It flies in the face of the recommendation to take that kind of insurance. Over half of the people taking medical deductions are 65 and over. I think the number is 55 percent. If you include people that are 50 and over, right in the demographic of our listeners, their figure rises to 74 percent.
Of the people that are 50 and over, 74 percent for the people taking the medical itemized deduction are those folks. They can include unreimbursed in‑home care, assisted living, long‑term care. Even long‑term care insurance premiums are no longer deductible. Those are going to force seniors to liquidate 401ks in order to pay. Because they’re doing that, all that money is taxable.
In the past, at least the medical expense deduction offset the taxable income created by liquidating those accounts, but by liquidating those 401ks you can find yourself pushed further and further into higher tax brackets with no relief, making your money just not last as long. This bill is far from final. The CBO still has to score it. That’s the Congressional Budget Office.
They have to estimate the long‑term care cost. Then the Senate has got to introduce its version, and the two bills have to be reconciled. Of course, between now and then, lobbyists will be pressing their suits and going to visit all the congressional offices in droves in the coming weeks to make sure that their cases are heard to include or remove various elements in the legislation.
You can be sure of things like the AARPN, different patient advocacy groups will be among the lobbyists trying to move this around. We’re really not sure where it’s going to go. I did uncover another section that was going to help people if it’s being eliminated, which is the ability to deduct state income taxes off of it. We’re going to see what happens with this.
Helping people with a medical deduction is very similar to helping people affected by hurricanes. People get hit by hurricanes all the time. Same thing with catastrophic illnesses. It’s not anything that anyone can plan for. To make them pay for that by having to pay higher income taxes simply for an event that they couldn’t control, it is…I don’t know that it’s all that fair.
Victor: When we come back from the break, I’m going to cover the new law on reverse mortgages. Then we’ll cover whether or not you should hire a financial adviser. Stay tuned for more information on the GOP bill and future episodes. Stay tuned to this program, when we come back, for the next two segments. We’ll be right back.
Victor: Hey, welcome back, everybody. The first segment we talked about the new GOP tax bill. In this segment, we’re going to talk about the new rule on reverse mortgages. We are just besieged with new laws. It’s a good thing that you are a listener of this program because, that way, you can stay up‑to‑date on all of the changes going on.
Now listen, there are new rules that take effect on October 2nd that are going to raise upfront costs for home owners seeking a reverse mortgage, and they’re going to reduce the maximum loan amounts for most. The question is, “Should we even be considering a reverse mortgage?”
Now, I have to tell you my personal opinion on this. My personal opinion is that a reverse mortgage has a very small place, if any, in a retirement plan. The idea that you can liquidate your equity in a home and use that to fund retirement as a reverse mortgage as opposed to a downsizing is very difficult for me to stomach and advise.
When people ask us about it, we typically say that it’s not a great idea. Let me explain what it is, and then we’ll talk about the new law changes. A reverse mortgage is a form of a federally‑backed loan.
It’s important to know that the reason why lenders write these is because there is a federal law that insures the mortgage company against losses. The way that it works is that you take your equity in your home and you turn it into cash. In exchange for that, you don’t have to make any payments.
The first rule is that you have to be 62 or older. If you’re 62 or older and that’s your primary residence ‑‑ you can’t do it off of an investment property ‑‑ then there are some rules about the fact that you can’t move out during that process. If that’s the situation, you can apply for a reverse mortgage.
When you get the reverse mortgage, first of all, there are some rules to how you qualify for it. For instance, you have to take a pre‑education program. You have to go in and be educated on it. It’s a click‑through. You don’t have to take a test at the end demonstrating superior knowledge. This is actually a point of contention for me because this is a sophisticated financial instrument.
The way that it works has the potential to really devastate somebody’s retirement, if they don’t understand it. The idea that someone can go, especially someone who is a senior, who is very nervous about where retirement is going to lead…They’re latching onto this reverse mortgage as a Louie. It’s a life preserver, and they’re thinking about it as a way to save their retirement.
For instance, there’s no requirement in the education that you go visit with a competent financial advisor to have them tell you whether or not it is appropriate. The education is all self‑driven. It’s just a way of covering law suits later because people were claiming that they were hoodwinked by reverse mortgage brokers.
The education requirement is a way of saying, “Well, we gave him an opportunity to come and learn on their own.” Folks, you’ve been with me now for over half a year and heard me rail about financial advisors who hoodwink their clients by selling them products that are inappropriate. Guess what? It’s right there in the mortgage business as well.
When it comes to reverse mortgages, the commissions that are available for that are nearly as attractive as those for life insurance products. When it comes to whether or not somebody should be buying a reverse mortgage, there’s a bunch of people within that industry that are there just to make money.
If they can convince you to do a reverse mortgage, they can make a lot of money off of that, even if it’s not in your best interest. A reverse mortgage broker has got no fiduciary obligation to make sure that it’s the right thing for you. In fact, most of the times, they don’t know the financial advisement from financial…I don’t know. The point is that they don’t have an idea.
They don’t have an idea whether or not it should fit in part of a financial plan. They’re there to sell you a product. The idea that you take this education course and, all of a sudden, you’re ready to make your own decisions on that, it’s folly. It doesn’t help. In any event, you’ve heard me. Great, I railed on that for two minutes. [laughs]
The way the reverse mortgage works so that we can eventually get to the new law is that the interest charges on the mortgage…You’re going to borrow money. You can take that money, by the way, in a lump sum. You can take that money as monthly income for life or you can use it as a line of credit. Those have been the three ways that it’s gotten done. You can select any of those three.
The interest charges on the loan are added to the debt that you’ve taken out, which doesn’t have to be paid off until you die or you no longer use that property as a primary residence, either because you’ve moved out or because you sell it.
As long as you keep up your taxes, insurance, the maintenance on the home, the company that lent you the money can’t call the loan and they can’t ever recover more than the home gets in a sale, even if the debt is larger as a way sort of protecting your other assets.
To protect the lenders against this kind of loss, the federal government had some limitations on the program. They’re going to limit the amount that you can borrow, and they maintain an insurance fund with premiums paid by you, the borrower. Which is HUD, by the way. HUD is looking to shore up this insurance fund.
The way that it works is that, as of October 2nd, the maximum loan amount is reduced. It used to be that an applicant might have been able to borrow 60 or 70 percent of the property’s value. They are going to get something less. The exact amount is going to vary by borrower because the limits are based on your age and the loan rates as well as the property value.
As you get older, you can borrow more. If you’re younger, you borrow less because the interest would accrue over that long time. Now, if you’re on death’s door, it’s the last year ‑‑ actuarially speaking ‑‑ they’re going to let you borrow the maximum amount because you don’t have a lot of time for interest to accrue.
Based on the property value and what the loan rates are, your number, what’s called a Principle Limit Factor or a PLF, that’s going to change. It’s going to be reduced. Second, HUD used to charge an upfront insurance premium as part of the cost based on the amount that you took out.
If you borrowed less than 60 percent of the maximum, then they’d only charge you half of a percent. Let’s illustrate this. Let’s say that there was a $200,000 home and the maximum you could have borrowed was $150,000, about three‑quarters of it. If you only borrowed 60 percent of that or less, so if you only borrowed $90,000 or less, you used to pay half a percent of a fee.
The way that would work on half percent, you pay about $450 in order to get that up and running. All right, good. If you took more than 60 percent, you would pay two‑and‑a‑half percent. Basically, it meant that you would always try to take 60 percent of the maximum or less.
If you took $90,001, you’d go two‑and‑a‑half percent against that and you’d basically be taking out about $2,200. It’s a big difference between $450 and $2,200. Now, under the new rules, the fee is two percent for everybody. To take out a reverse mortgage is two percent ‑‑ two percent, two percent. Two percent of what you borrow.
On that $90,000 example, you’re going to pay $1,800, whether you took $89,999 or $90,001. There’s no break for people that are making maybe a little bit of a smarter decision. In addition to doing that, I guess there’s some upside, which is the HUD reduced a separate annual insurance premium to half a percent of the debt from 1.25.
It used to be 1.25 that you had to take out as an insurance. That’s down to half a percent, a swing of 0.75. For mostly everybody, the increase, the two percent, was double that. They’re going to have to pay more.
Since the premium was generally added to the debt that you owed rather than paying from the assets, the reduction in separate insurance means that your debts going to grow more slowly leaving more equity.
Basically, here’s how it’s going to shake out. For most people, experts, including this one, agree that the reverse mortgage is now less appealing. For the people that are taking it as a line of credit, tapping it in emergencies is less attractive because you’re going to have to use that credit line. You have to pay the premiums of that credit line whether or not you use it.
Now, if you took it as a lump sum, you pay your percentages and you move on. A lot of people took that as a standby line of credit just as a way to insure against catastrophic losses. That’s going to go down and go away as something that’s attractive to do because you have to pay the premiums whether or not you borrow the money.
Victor: I’m going to go back to my first thing, which, as I said is, for most people, reverse mortgages don’t make sense. We might do a follow‑up show on reverse mortgages. If people are interested, drop me a line about that. If you’re considering it, my professional advice, don’t. Consider something else. It’d be very rare in circumstances in which we recommend it.
All right, when we come back we’re going to go with our last segment, which is, “Should you be hiring a financial adviser?” We’ll give you two reasons to consider why that might be a little bit different than what you think in terms of investment management. It Ain’t That. When we come back we’ll talk about that. Stick with us here on Make It Last.
Victor: All right, welcome back to Make It Last. We’ve been talking about the new GOP tax bill, and then we talked about reverse mortgages. Now, let’s talk about whether or not you should consider hiring a financial adviser.
Now, listen. You know I’m a financial adviser as well as an estate planning attorney. You’re going to listen to this segment saying, “Of course, he’s going to say, ‘Hire a financial adviser.'”
Listen. Of course, I’m going to say, “Hire a financial adviser.” [laughs] I just am. I think you should be getting professional counsel no matter what the circumstances are. I go for professional counseling for things like property and casualty insurance. I don’t know everything there is to know about that. I hire a professional to get that done.
I rely on a professional because it’s folly for me to think that I am going to know everything about it. What do they say about the attorney that is his own lawyer? He’s got a fool for a client. I think it’s the same thing in most of these professional settings. There’s just too much to know these days.
In any event, I’m going to make the case for why you should consider it. I think there’s two reasons beyond investment management, but let’s knock out investment management first. A lot of people look at the cost of a financial adviser. Most of the top ones are making their money as a fee of your assets under management. That’s the fiduciaries.
The people who are the product sales folks. The people that are selling you something, they make a commission off of what you buy. They make a commission of the mutual fund. They’re not working as a fiduciary. They’re still making money, but they’re [laughs] compromised in their advice.
Let’s just stick, right now, to the world of people that aren’t compromised in their advice by conflicts of interest and actually are looking out for your best interest. Even they are going to charge an amount because they’ve got to make a living. We all got to make a living. That’s usually a percentage of your assets under management.
That percentage can range depending on how much you have with that adviser. When we get to trying to figure out whether or not it’s worth it, some people look at the returns as a way to gauge whether or not they’re making more money. If I’m going to pay you one percent, one‑and‑a‑half percent annually, are you going to be making more than that?
Some conclusion that people reach from time to time is, “Well, I can invest and, by the way, I’ve been reading all of this stuff about index funds. If all of the education says go into an index fund, I’m just going to go straight to an index fund and I don’t need an adviser in order to help me.” There are a couple of reasons why you’re going to want to rethink that position.
The first is that most people are incapable of judging whether or not the index that they are in or the investment they’re in is smart or good. Just because something is labeled as an index doesn’t necessarily mean that it’s right for you. We’ve had stories of people that are 75 percent in an S&P index fund and another 25 percent in another index fund, and they think that they’re well diversified.
An index is not diversification. It’s a representation of a small sliver of investments. If you look at that and are like “Well, I’m totally diversified. I’ve got my index funds,” no. All you’re doing is tracking another index. That might be right or wrong, but you may not be represented in the asset classes that you should be represented as part of a diversified portfolio.
There’s a way to be in the eight asset classes to make sure that you’re properly represented. By the way, keep re‑balancing that as it moves in and out. While index is a way of getting representation in a particular asset class, it is not way of being diversified per se.
In fact, there are some index funds that [laughs] are actively managed based on the fact that they’re tracking an index that is active in what it’s doing. You’ve got to figure out whether or not you have overlap in the indices, whether or not there’s gaps. What about international representation? The domestic market isn’t the only market out there.
I don’t know, you may want to think about that again. [laughs] You’re not as good looking, charming, or as good a driver as you think you are. It’s the same thing when it comes to investing abilities. Put that issue aside because I said that I would. I think there’s two additional reasons that you might want to think about working with an adviser. Basically, taxes and spouses.
Many retirees have got two or more different kinds of savings accounts. They’ve got a taxable account that may represent after tax savings. They’ve got tax deferred accounts. They might have Roths. They might be factoring IRAs, pensions, Social Security. Essentially, they’re looking at lots of different buckets. Each of those buckets are taxed differently.
Ensuring that your nest egg lasts as long as you do ‑‑ tag line for Make It Last ‑‑ it’s probably the biggest financial challenge that you face in retirement. Figuring out how to tap these various assets in the most tax‑efficient way is crucial to doing that. No matter what the tax code is ‑‑ go back to segment one ‑‑ there are going to be income taxes that are going to be due.
The Federal Government has to collect their income taxes. Those tax rates are going to change over time and they’re going to be impacted by what assets you pull out of which account. Making sure that you do that efficiently is a total value of an adviser because they can tell you where to pull from.
The small amount that they charge versus the additional taxable income is a tremendous return on investment. If they save you from going from the 25 percent bracket to the 30 percent bracket, that five percent on new money on what’s in there, that’s pretty valuable. That goes in every year, so you can do smart planning for that. Then the other reason is…I don’t want to play against gender lines.
This isn’t really about male/female, but, typically, there are spouses where one is involved in the finances and one is not. They’ve allocated resources amongst [laughs] themselves, but who’s going do what? One of the spouses says, “I want to be responsible for the money.” The other person says, “Great. Go for it. Just tell me when we don’t have any.” Usually there’s a financial savvy spouse.
Maybe that financially savvy spouse has been managing funds just fine in their investments successfully over their entire working career, but there’s a chance that that financially savvy spouse dies before the non‑financially savvy spouse. Working with an adviser is a way of being able to transfer that knowledge over and to have somebody smooth that stuff over.
I can’t tell you how many clients come to our estate planning practice and are really enthusiastic about our client maintenance program where we see them every year because it gives the opportunity for the entire family ‑‑ both spouses, sometimes the kids ‑‑ to get to know an adviser who can help them transition from one generation to the next from one spouse dying.
It could be that the person who’s financially savvy is actually driving that. It’s not actually the non‑financially savvy person that’s saying I need help. It’s the financially savvy person saying, “Look, I’ve taken care of this for this long, and I know that part of my responsibility is to continue to take care of this going forward.
“I want you in my family’s life to make sure that that happens well. I’m willing to give up control and responsibility for the decision making on investments and financial planning in order to make sure that I have an adviser that can help me transition from me being around to me not being around, being the financially savvy person.”
I would look less at the concept of fees. I think fees are a fluid way of evaluating an adviser. Sometimes you get a lot more for somebody that charges slightly more. You going to want to look and not just to go bargain‑basement shopping.
Getting an adviser in and having them help you manage taxes as well as being there for your family throughout those transitions and making sure that things are being well planned for throughout that time are two great values for having an adviser.
Look at that. We are done with the show for today. I want to thank you for joining me here on Make It Last. We publish our show every Saturday. If you like the show, share it with a friend. Let them know about it.
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That’s it for this week. We’re going to join you next week, and we’re going to keep covering these important topics. I want to thank you for joining us.
Victor: This has been Make It Last helping you keep your legal ducks in a row and your financial nest egg secure. We will see you next Saturday. Bye‑bye.
Bert: The forgoing content reflects the opinions of Medina Law Group, LLC and Private Client Capital Group, LLC and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment or legal advice, or a recommendation regarding the purchase or sale of any security, or to follow any legal strategy.
There is no guarantee that the strategies, statements, opinions, or forecasts provided herein will prove to be correct. Past performance is not a guarantee of future results. Indices are not available for direct investment.
Any investor who attempts to mimic the performance of an index would incur fees and expenses, which would reduce returns. All investing involves risk, including the potential for loss of principle. There’s no guarantee that any investment plan or strategy will be successful. We recommend that you consult with a professional dedicated to your needs.