Surprises for college loan borrowers

With news from Washington, we always hear about the hot buttons and often not about the details that really affect our lives. But as in annual reports, most of the meat is hidden in the footnotes. The new 11th hour debt ceiling deal has some big surprises in it for student borrowers.

In case you missed the fine print, here’s the change. For graduate students, Stafford loan interest will no longer be waived while the student is in graduate school. Formerly, these loans did not charge interest on the principal until six months after the student graduated. As we all know, for graduate students that can take a verrrryyyy long time. Now, interest will accrue while the student is in school, and be added to payments when repayment begins. It can be thousands extra in costs for students who borrow the max. How much is this “tiny” change worth? Well, the estimate is that it will total $21.6 billion over the next two years, with the savings to be applied to maintain Pell Grants. These changes will go into effect on July 1, 2012.

Also gone is the credit for students who make on-time loan payments for 12 months. Now, all you get is a thank you—okay, probably not that either.

This change makes it even less desirable to have loans, and I still recommend borrowing as little as possible and certainly no more than what the student can expect to make in the first year out of school. The reason for this rule of thumb is that if the student is repaying with 10% of income (a reasonable figure) it will take 10 years to pay it off. As the student’s income increases, there’s some chance that a loan can be paid off early.

While I strongly believe that undergrad education should be all about acquiring a broad base of knowledge, students should keep a closer eye on career choices if they’re borrowing significantly. You don’t want $80,000 in loans as a speech or film major. However, as much as I believe in a liberal education as an undergrad, graduate school is all about specializing and it IS job training. Don’t enter that PhD program in English unless you’ve really thought through and researched what the career paths might be.

For many graduate level programs, not being offered scholarships is a pretty good indication of how much (or little) they’re really interested in you. It’s a good idea to think about WHY you’re not getting any offers. For professional school programs, less money is not necessarily an indication of how desirable you are, but employment in these fields is not the slam dunk it once was—ask any recent law graduate.

As in any financial planning issue, don’t borrow money for any investment unless you have investigated and thoroughly understand the risks involved. Start young understanding this and you’ll save yourself a lot of flimflam, whether from graduate school admissions offices or “venture capitalists” with yet another hot idea for your hard earned dollars.

Using Health Savings Accounts strategically

Nothing’s more dull than insurance, unless you don’t have it when you need it. Health Savings Accounts (HSAs) are a relatively unknown way to acquire health insurance. Cheap, tax advantaged, and great for business owners and the self employed, HSAs can make health insurance affordable again.

In brief, first you find a high deductible health insurance policy (either with your employer or on your own if you’re the employer or self-employed). Because these are high deductible, they are often quite affordable compared to traditional policies. Then, you establish an HSA savings account with a bank,  brokerage, mutual fund or other trustee, and deposit the maximum in the account: $3,050 per person covered if you or they are under 50, $4,050 if over 50. Under normal procedures, you then either use a debit card, write checks on the account, or submit bills for payment (depending on how your account provider works), up to the amount of your expenses until you reach your deductible. Once the deductible is reached, your health insurance provider covers the rest according to the co-insurance you’ve chosen. In most cases I recommend choosing a low deductible (say, $1,200 or $1,750) with 100% coverage after that, but this requires a careful look at your individual circumstances and the plans you are considering.

The beauty of HSAs is that you get to deduct the whole contribution each year EVEN IF your medical expenses are lower than your contribution. Without an HSA you can normally deduct medical expenses only after they exceed 7.5% of your income, which is some pretty big bill for many people. But with an HSA, you can spend $150 for doctors’ bills and still deduct $3,000. I like that.

Second nifty point is that not only do you get a deduction going in, but it’s tax-free coming out, as long as you use it for medical bills. Now, here’s where the strategy comes in. You don’t have to make withdrawals in the year you incur the bills. So, if you can afford to pay the bills out-of-pocket and can do a decent job of keeping careful records, you can wait until 65 to take disbursements. As long as the disbursements are for medical bills (current or previously incurred), they are tax free. So, you could accumulate bills and submit them once you retire, as you need cash.

What if you don’t keep such good records? The money can still be withdrawn after 65, but you’ll have to pay ordinary income tax if you don’t use it for medical bills. It can be a nice little account to pay for long term care insurance, prescriptions not covered by Part D, dentistry, or anything not covered by Medicare. Given all the saber rattling in Congress about reducing Medicare benefits, it might not be such a bad idea to have a health savings account in reserve.

Let’s just look at some numbers. Say you’re 50 years old, you establish an HSA and keep it going for the next 15 years. Say also that interest rates stay pretty junky for that whole period (unlikely) and you only make 4% a year with 3% inflation. When you start collecting Medicare you’ll have about $65,000 in that account, and potentially much more if you can cover a spouse or children (the account holder keeps the money even after the children “age out”). Withdraw $3,000 a year to cover, say, long term care insurance and it’ll last for about 25 years. Or take larger withdrawals and let your other portfolio(s) grow. Again, it requires some individual planning, but it’s not such a bad thing to have an extra $65,000 for tax free income.

The gap between your deductible and what you can save is just such a good deal I’m surprised it hasn’t been targeted for budget cutting measures. Maybe it’s because, so far, so few people use it. Save the whole thing and enjoy the deduction and tax-free compounding. Be one of the smart ones.

Caveat: there are a lot of details on this. There’s an IRS publication 969 that sets out all the rules, but I’d be happy to talk over HSAs with you at any time.

 

Market Turmoil–here we go again

You remember the last time, right? For me, it’s actually which last time–the tech bust in 2002, the October crash in the 80s, the flash crash, the hyper-inflation during the Carter administration?–and since I’ve been around long enough, I’ve heard at least a dozen times, “This time it’s different”. Uh, no, it’s not. It’s still scary. The market will always be unpredictable. In your investing life you can absolutely count on several dramatic crashes. You will see your net worth and investment value take plunges worse than an unmoored elevator.

My nomination for dumbest guy on the planet was interviewed in the Wall Street Journal this morning. Apparently, he was watching the ticker when Apple stock took a plunge, so he sold a chunk. But according to the WSJ, when it began rising later in the afternoon, he was off line and missed buying it back on the upswing, for which he was regretful. Dumb as a box of rocks. Has this idiot never seen the advice to sell high and buy low? Sadly, he has had plenty of company in the last few days.

For about a year now, I’ve heard people bemoan how they shoulda’, coulda’ bought in March, 2009 (instead of going to cash or bonds, as most did) and what a great stock market run up they therefore missed. And so what is the average investor doing since Monday? Going to cash and bonds. I don’t know why people can’t get this right–maybe it’s the same as learning to steer into a skid–just too much against instinct.

What you should be doing right now is laughing at the market. If you follow the advice of your friendly neighborhood financial planner (me!) you’d have an appropriate asset allocation plan in place–a diverse basket of investment types, including a cash emergency fund, stocks, bonds, real estate, and internationals. And some of them would be sinking like a stone. In fact, I can pretty much guarantee that your net worth has dropped in the last few days. No one can diversify out of all market risk and in our very interdependent world, it’s next to impossible to find investments that are negatively correlated. But diversification can limit and protect that risk as much as is possible in a turbulent world. If the zombies arrive at the gates, nothing will help. Short of that, my guess is that the U.S. government and Apple computer (along with a lot of other cash heavy companies) aren’t going bust anytime soon.

Unfortunately, what’s good for the individual bill payer and investor isn’t exactly what’s good for the economy right now, but do it anyway. Economists want us to spend right now. But in periods of uncertainty, individuals paying individual bills need to cut those and hang on to their dough. So probably you should put off the world tour, the brand new car, or the McMansion purchase for now, unless the family chariot is up on blocks.

Don’t sell your investments and go to cash. In fact, put any investment cash into whatever part of your asset allocation is doing the WORST, that’s called rebalancing or buying LOW, which is what you’re supposed to be doing, right?

I don’t recommend any significant investment in individual stocks in a prudent investment plan, but I know some of you like to dabble anyway (okay, I do too, but only a little). If you’re going to do this, I highly recommend Better Investing’s recommended methods of evaluating investments (they used to be NAIC–National Association of Investment Clubs) and if you follow it, you already have a wish list of stocks you’d like to own. Well, take a look–maybe they’re “on sale” right now.

That’s really it–sit tight, turn off the tube, get off the internet, and try to calm down. With a decent asset allocation plan, you’ve done all you can to influence the universe. And if you don’t have a plan, well, ahem, you need a financial planner. I’ll look forward to hearing from you. But take a deep breath, okay?