Financial Guides From an Accounting Professional in Charleston
Life is full of changes and surprises that affect your financial future. Please use these guides to help you make the right financial decisions.
What are the financial implications of marriage (and of divorce and remarriage)?
Those who have recently changed their marital status or who are planning such a change may have important financial and legal decisions to make. These decisions might deal with property ownership, providing for children's welfare, post-mortem planning, and day-to-day finances.
This financial guide will discuss the financial steps appropriate to a change in marital status. Because divorce is sometimes the flip side of a marriage and often the bridge between marriage and remarriage, it is covered here as well for the sake of overall context. The guide will also briefly touch on the legal issues involved; however, the variations in state law make it impossible to discuss in depth the many legal ramifications of a change in marital status.
How to Prepare Financially for a First Marriage
For the young, newly married couple, the areas of financial concern that will need to be addressed are: (1) life insurance, (2) form of property ownership and (3) money management.
When it comes to insurance needs, the basic rule is that you need enough coverage to sustain your family's present income level should you die. If you are the only breadwinner, or if you plan on starting a family soon, then you will need to purchase life insurance.
If you intend to own a residence or other property, or if you and your spouse already own property together, you will need to consider the best way for you to hold that property. Will the property be held solely by one spouse? By both spouses jointly? Because of the complex legal implications of the various forms of property ownership, you should seek legal advice about this issue.
It is important to consider carefully how your day-to-day finances will be handled. The new couple should discuss financial goals, resolve differences and establish a budget and/or saving and investment plan.
Will you have joint bank accounts, separate accounts or both? How much do you want to spend on vacations? On monthly food bills? Entertainment? Gifts? What are your long-term financial goals? Do you have a financial plan, even an informal one?
If you don't have a financial plan, now is the time to prepare one. Even if you do have a plan, your changed marital status suggests that you review it.
How to Prepare Financially for a Divorce
If you are considering a divorce, it is vital to plan for the dissolution of the financial partnership in your marriage. Such dissolution involves dividing the financial assets you have accumulated during the years of marriage. Further, if children are involved, the future support given to the custodial parent must be planned for.
The time taken to prepare and plan for eventualities will pay off later on. Here are some steps towards that end.
Take Stock of Your Situation
Make an inventory of your financial situation. This will help you to prepare in two ways:
- It will provide you with preliminary information for an eventual division of the property.
- It will help you to plan how the debts incurred in the marriage are to be paid off. (Although the best way of dealing with joint debt, such as credit card debt, is to get it all paid off before the divorce. Since this strategy is often impossible, compiling a list of your debts will help you to come to some agreement as to how they will be paid off.)
To take stock of your situation, here are the steps you might follow:
- The current balance in all bank accounts;
The value of any brokerage accounts;
The value of investments, including any IRAs;
Your autos; and
Your valuable antiques, jewelry, luxury items, collections, and furnishings.
- Make sure you have copies of the past two or three years' tax returns. These will come in handy later.
- Make sure you know the exact amounts of salary and other income earned by both yourself and your spouse.
- Find the papers relating to insurance – life, health, auto and homeowner's -- and pension or other retirement benefits.
- List all debts you both owe, separately or jointly. Include auto loans, mortgage, credit card debt and any other liabilities.
Tip: If you are a spouse who has not worked outside the home lately, be sure to open a separate bank account in your own name and apply for a credit card in your own name. These measures will help you to establish credit after the divorce.
Estimate Your Post-Divorce Living Expenses
Figure out how much it will cost you to live after the divorce. This figure is especially important for the spouse who is planning to remain in the family home with the children; it may be determined that the estimated living expenses are not manageable.
To estimate these expenses, add together all of your monthly debts and living expenses, including rent or mortgage. Then total your after-tax monthly income from all sources. The remaining amount is your disposable income.
Here are some tips for handling the credit aspects of divorce, both in the planning stages and afterwards.
Cancel All Joint Accounts
First, it is important to cancel all joint accounts immediately once you know you are going to obtain a divorce.
Creditors have the right to seek payment from either party on a joint credit card or other credit account, no matter which party actually incurred the bill. If you allow your name to remain on joint accounts with your ex-spouse, you are also responsible for the bills.
Your divorce agreement may specify which one of you pays the bills. As far as the creditor is concerned, however, both you and your spouse remain responsible if the joint accounts remain open. The creditor will try to collect the bill from whomever it thinks may be able to pay, and at the same time report the late payments to the credit bureaus under both names. Your credit history could be damaged because of the cosigner's irresponsibility.
Some credit contracts require that you immediately pay the outstanding balance in full if you close an account. If so, try to get the creditor to have the balance transferred to separate accounts.
If Your Spouse's Poor Credit Affects You
If your spouse's poor credit hurts your credit record, you may be able to separate yourself from the spouse's information on your credit report. The Equal Credit Opportunity Act requires a creditor to take into account any information showing that the credit history being considered does not reflect your own. If for instance, you can show that accounts you shared with your spouse were opened by him or her before your marriage, and that he or she paid the bills, you may be able to convince the creditor that the harmful information relates to your spouse's credit record, not yours.
In practice, it is difficult to prove that the credit history under consideration does not reflect your own, and you may have to be persistent.
For Women: Maintain Your Own Credit Before You Need It
If a woman divorces, and changes her name on an account, lenders may review her application or credit file to see whether her qualifications alone meet their credit standards. They may ask her to reapply. (The account remains open.)
Maintaining credit in your own name avoids this inconvenience. It can also make it easier to preserve your own, separate, credit history. Further, should you need credit in an emergency, it will be available.
Do not use only your husband's name (e.g., Mrs. John Wilson) for credit purposes.
Tip: Check your credit report if you have not done so recently. Make sure the accounts you share are being reported in your name as well as your spouse's. If not, and you want to use your spouse's credit history to build your own, write to the creditor and request the account be reported in both names. Also, determine if there is any inaccurate or incomplete information in your file. If so, write to the credit bureau and ask them to correct it. The credit bureau must confirm the data within a reasonable time period, and let you know when they have corrected the mistake.
If you have been sharing your husband's accounts, building your own credit history in your name should be fairly easy. Call a major credit bureau and request a copy of your file. Contact the issuers of the cards you share with your husband and ask them to report the accounts in your name as well.
If you used the accounts, but never cosigned for them, ask to be added on as jointly liable for some of the major credit cards. Once you have several accounts listed as references on your credit record, apply for a department store card, or even a Visa or MasterCard, in your own name.
If you held accounts jointly and they were opened before 1977 (in which case they may have been reported only in your husband's name), point them out and tell the creditor to consider them as your credit history also. The creditor cannot require your spouse's or former spouse's signature to access his credit file if you are using his information to qualify for credit.
Tip: A secured credit card is a fairly quick and easy way to get a major credit card if you do not have a credit history. Secured credit cards look and are used like regular Visa or MasterCards, but they require a savings or money market deposit of several hundred dollars that the lender holds in case you default. In most cases, the creditor will report your payment record on these accounts just like a regular bank card, allowing you to build a good credit record if you pay your bills promptly.
Consider the Legal Issues
The best way to plan for the legal issues that must be faced in a divorce – child custody, division of property and alimony or support payments – is to come to an agreement with your spouse. If you can reach an agreement, the time and money you will have to expend in coming up with a legal solution – either one worked out between the two attorneys or one worked out by a court – will be drastically reduced.
Here are some general tips for handling the legal aspects of a divorce:
- Get your own attorney if there are significant issues dealing with assets, child custody or alimony.
- Some ways of finding a good matrimonial attorney include referrals from another professional, referrals from trusted friends, or lists obtained from the American Academy of Matrimonial Lawyers. (The address of the latter organization is listed in the last section of this guide.)
- Make sure the divorce decree or agreement covers all types of insurance coverage – life, health and auto.
- Be sure to change the beneficiaries on life insurance policies, IRA accounts, 401(k) plans, other retirement accounts and pension plans.
- Don't forget to update your will.
Tip: Those who have trouble arriving at an equitable agreement – and who do not require the services of an attorney – might consider the use of a divorce mediator. This type of professional advertises in the section of the classifieds titled "Divorce Assistance" or "Lawyer Alternatives."
Division of Property
The laws governing division of property between ex-spouses vary from state to state. Further, matrimonial judges have a great deal of latitude in applying those laws.
Here is a list of items you should be sure to take care of, regardless of whether you are represented by an attorney.
- Gain an understanding of how your state's laws on property division work.
- If you owned property separately during the marriage, be sure you have the papers to prove that it has been kept separate.
- Be ready to document any nonfinancial contributions to the marriage, e.g., your support of a spouse while he or she attended school, or your nonfinancial contributions to his or her financial success.
- If you need alimony or child support, be ready to document your need for it.
- If you have not worked outside the home during the marriage, consider having the divorce decree provide for money for you to be trained or educated.
How to Prepare Financially for Remarriage
When considering remarriage, it is important to plan for the following:
- Whether property acquired before the marriage will be held jointly;
- How to provide for children from a previous marriage; and
- Whether a prenuptial agreement is necessary to accomplish goals related to either of these issues.
If either spouse has significant assets, it will be necessary to consult an attorney.
As for the estate planning aspects of providing for children from a previous marriage, trusts and/or life insurance are the vehicles most often used.
Tip: Be sure to update your will before you remarry to ensure that your assets will be divided among your heirs after your death in the manner and proportions you desire.
Preparing for College
Your Child's Education: How To Finance It
How can you properly fund your children's education without draining your current cash flow? What should you do if they are a few years away from college and your education fund won't be enough? How can you increase your chances of getting financial aid? What tax benefits might be available to you? This financial guide answers these questions.
With the costs of a college education rising every year, the keys to funding your child's education are to plan early and invest shrewdly. However, there are steps you can take if you get a late start. Moreover, there are a number of effective techniques for increasing financial aid opportunities and reducing taxes.
Savings and Investment Strategies
The thought of funding your child's education – the cost of which has grown at about 4 percent a year after inflation – can be staggering. However, proper planning can lessen the financial squeeze considerably, especially if you start when your child is young.
Here are some guidelines – geared to parents whose children are no older than elementary school age – for funding your child's education.
Start Saving Early
We cannot emphasize enough that getting an early start is basic to funding your child's education. The earlier you start, the more you'll benefit from the compounding of interest.
When should you start saving? This depends on how much you think your children's education will cost. The best way is to start saving before they are born. The sooner you begin, the less money you will have to put away each year.
Example: Suppose you have one child, age six months, and you estimate that you'll need $120,000 to finance his college education 18 years from now. If you start putting away money immediately, you'll need to save $3,500 per year for 18 years (assuming an after-tax return of 7 percent). On the other hand, if you put off saving until the child is six years old, you'll have to save almost double that amount every year for 12 years.
Another advantage of starting early is that you'll have more flexibility when it comes to the type of investment you'll use. You'll be able to put at least part of your money in equities, which, although riskier in the short-run, are better able to outpace inflation than other investments after time.
Find out How Much You'll Need to Save
How much will your child's education cost? It depends on whether your child attends a private or state school. In the 2008-2009 school year, the total expenses – tuition, fees, board, personal expenses, books and supplies – for the average private college are about $34,100 per year and about $14,300 per year for the average public college. However, these amounts are averages: the tuition, fees and board for some private colleges can cost more than $55,000 per year, whereas the costs for a state school can be kept under $10,000 per year.
It should also be noted in the 2008-2009 school year that on average, full-time students receive about $10,200 in financial aid per year in the form of grants and tax benefits for a private four-year institution, $3,700 per year for a public, four-year institution, and $2,300 per year for a public, two-year institution.
Don't forget to add the costs of graduate or professional school to the amount your child will need.
Choose Your Investments
As with any investment, you should choose those that will provide you with a good return and that meet your level of risk tolerance. The ones you choose should depend on when you start your savings plan – the mix of investments if you start when your child is a toddler should be different from those used if you start when your child is age 12.
The following are often recommended as investments suitable for education funds:
Series EE Bonds are extremely safe investments. For tax treatment of redemption proceeds used for college, please see the Financial Guide: HIGHER EDUCATION COSTS: How to Get the Best Tax Treatment.
U.S. government bonds are also safe investments that offer a relatively higher return. If you use zero-coupon bonds, you can time the receipt of the proceeds to fall in the year when you need the money. A drawback of such bonds is that a sale before their maturity date could result in a loss on the investment. Further, the accrued interest is taxable even though you don't receive it until maturity.
CDs are safe, but usually provide a lower return than the rate of inflation. The interest is taxable.
Municipal Bonds, if they are highly rated, can provide an acceptable return from the tax-free interest if you're in the higher income tax brackets. Zero-coupon municipals can be timed to fall due when you need the funds and are useful if you begin saving later in the child's life.
Tip: Be sure to convert the tax-free return quoted by sellers of such bonds into an equivalent taxable return. Otherwise, the quoted return may be misleading. The formula for converting tax-free returns into taxable returns is as follows:
Divide the tax-free return by 1.00 minus your top tax rate to determine the taxable-return equivalent. For example, if the return on municipal bonds is 5 percent and you are in the 30 percent tax bracket, the equivalent taxable return is 7.1 percent (5 percent divided by 70 percent).
Stocks contained in an appropriate mutual fund or portfolio can provide you with a higher yield at an acceptable risk level. Stock mutual funds can provide superior returns over the long term. Income and balanced funds can meet the investment needs of those who begin saving when the child is older.
Deferred annuities provide you with tax deferral, but the yield may not be acceptable because of the relatively high cost of these investments. Further, amounts withdrawn before you reach age 59 1/2 may be subject to a 10 percent premature withdrawal penalty.
If You're Caught Short
If you have insufficient savings for your child's education when he or she is close to entering college, there are ways to generate additional funds both now and when your child is about to enter school:
- You can start saving as much as possible during the remaining years. However, unless your income level is high enough to support an extremely stringent savings plan, you will probably fall short of the amount you need.
- You can take on a part-time job. However, this will raise your income for purposes of determining whether you are eligible for certain types of student aid. In addition, your child may be able to take on part-time or summer jobs.
- You can tap your assets by taking out a home equity loan or a personal loan, selling assets or borrowing from a 401(k) plan.
- You (or your child) can apply for various types of student aid and education loans (discussed below and in InfoSources).
Tip: Sources of student aid and education loans should be exhausted before other types of loans are used, since the former make better sense financially. In some cases, however, a home equity loan can be advantageous because of the deductibility of interest.
Sources of Financial Aid
Here is a summary of the possible sources of financial aid. The types of aid and tax implications change frequently, so consult your financial advisor for specifics when you're approaching the time to seek financial aid.
Grants, the best type of financial aid because they do not have to be paid back, are amounts awarded by governments, schools and other organizations. Some grants are need-based and others are not.
Pell grants are federal aid based on need.
Tip: Don't assume that middle class families are ineligible for needs-based aid or loans. The assessment of whether a family qualifies as "in need" depends on the cost of the college and the size of the family.
- State education departments may make grants available. Inquiries should be made of the state agency. Employers may provide subsidies.
- Private organizations may provide scholarships. Inquiries should be made at schools.
- Most schools provide aid and scholarships, both needs-based and non-needs-based.
- Military scholarships are available to those who enlist in the Reserves, National Guard, or Reserve Officers Training Corps. Inquiries should be made at the branch of service.
Tip: Try negotiating with your preferred college for additional financial aid, especially if it offers less than a comparable college.
Loans may be need-based, and others are not. Here is a summary of loans:
- Stafford loans (formerly guaranteed student loans) are federally guaranteed and subsidized low-interest loans made by local lenders and the federal government. They are needs-based for subsidized loans; however, an unsubsidized version is also available.
- Perkins loans are provided by the federal government and administered by schools. They are needs-based. Inquiries should be made at school aid offices.
- Parent loans for undergraduate students (PLUS) and supplemental loans for students are federally guaranteed loans by local lenders to parents, not students. Inquiries should be made at college aid offices or by calling 800-333-4636.
- Schools themselves may provide student loans. Inquiries should be made at the school.
Work-Study is a program that is federally funded and based on the family's financial need. The student works on campus and receives partly subsidized pay. The receipt of work-study funds does not affect the level of "need" for purposes of need-based grants and loans.
To make a thorough investigation, you should fill out the financial aid application, which you can obtain from the school's financial aid office. You will have to provide tax returns. The amount you are determined to be eligible for depends on your income, the size of your family, the number of family members currently attending college, and your assets.
How to Increase the Amount of Financial Aid
Here are some strategies that may increase the amount of aid for which your family is eligible:
- Try to avoid putting assets in your child's name. As a general rule, education funds should be kept in the parents' names, since investments in a child's name can impact negatively on aid eligibility. For example, the rules for determining financial aid decrease the amount of aid for which a child is eligible by 35 percent of assets the child owns and by 50 percent of the child's income. Example: If your child owns $1,000 worth of stock, the amount of aid for which he or she is eligible for is reduced by $350. On the other hand, the amount of aid is reduced by (effectively) only 5.6 percent of your assets and from 22 to 47 percent of your income.
- Reduce your income. Income for financial aid purposes is generally determined based upon your previous year's income tax situation. Therefore, in the years immediately prior to and during college, try to reduce your taxable income. Some ways to do this include:
- Defer capital gains.
- Sell losing investments.
- Reduce the income from your business. If you are the owner of your own business, you may be able to reduce your taxable income by taking a lower salary, deferring bonuses, etc.
- Avoid distributions from retirement plans or IRAs in these years.
- Pay your federal and state taxes during the year in the form of estimated payments rather than waiting until April 15 of the following year.
- Since a portion of discretionary assets is included in the family's expected contribution from income, reduce discretionary assets by paying off credit cards and other consumer loans.
- Take advantage of vehicles which defer income, such as 401(k) plans, other retirement plans or annuities.
- Detail your financial hardships. If you have any financial hardships, let the deciding authorities know (via the statement of financial need) exactly what they are, if they are not clear on the application. The financial aid officer may be able to assist you in explaining hardships.
- Have your child become independent (if feasible). In this case, your income is not considered in determining how much aid your child will be eligible for. Students are considered independent if they:
- Are at least 24 years old by the end of the year for which they are applying for aid,
- Are veterans,
- Have dependents other than their spouse,
- Are wards of the court or both parents are deceased,
- Are graduate or professional students or
- Are married and are not claimed as dependents on their parents' returns
How To Reduce Taxes
As noted above, education funds should generally be kept in the parents' names because of financial-aid considerations. However, in specific cases, it may be better to keep the investments in your child's name since the tax rate on the income will be less than if they are held in your name. Professional advice should be sought in making this decision.
In the past, parents would invest in the child's name in order to shift income to the lower-bracket child. However, the addition of the "kiddie tax" mostly put an end to that strategy. Now, investment income over $1,900 for 2009 ($1,800 for 2008) of children under the age of 19 (or 24 if a full-time student) is taxed at the parents' rate. (This threshold is indexed annually for inflation.) Once the child reaches age 19, however, all income is taxed at the child's rate. Of this $1,900, one-half probably won't be taxed due to the availability of the standard deduction while the other half would be taxed at the child's rate.
Note: These rules apply to unearned income. If a child has earned income, this amount is always taxed at the child's rate. If you decide to invest in your child's name, here are some tax strategies to consider:
- You can shift just enough assets to create $1,900 in taxable income to an under-19 child.
- You can buy U.S. Savings Bonds (in the child's name) scheduled to mature after your child reaches age 19.
- You can invest in equities that pay small dividends but have a lot of potential for appreciation. The income earned when your child is under 19 will be minimal, and the growth in the stocks will occur over the long term.
- If you own a family business, you can employ your child in the business. Earned income is not subject to the "kiddie-tax," and is deductible by the business if the child is performing a legitimate function. Additionally, if your business is a sole proprietorship and your child is under 19, then he or she will not pay social security taxes on the income.
Note: The Kiddie Tax does not apply if the earned income of a student over age 18 exceeds half of the child's living expenses. Living expenses include food, housing, clothing, medical, dental, education and other necessary costs of support. Students over 18 are considered independent from their parents if they provide more than 50 percent of their own support.
There are also a number of tax incentives that you might be able to take advantage of. Please see the Financial Guide: HIGHER EDUCATION COSTS: How to Get the Best Tax Treatment.
Tip: Reporting the kiddie tax on the child's return using the required Form 8615 calls for showing the parents' taxable income. A parent reluctant to show that item to a teenager may instead report the child's investment income of the parent's return, on Form 8814. But this is not allowed, and the Form 8615 route must be followed, where the child has taxable earned income, as many teenagers would.
Dealing with Your Bank
Choosing A Professional
Getting a Loan
Buying & Maintaining A Car
Planning Your Estate
Coping with Major Illness
Improving Your Retirement
Becoming a Parent
Developing a Financial Plan
Improving Your Credit
Planning For Retirement
Buying & Selling A Home
Making Charitable Contributions
Getting Divorced or Becoming Widowed
Coping with Death of a Loved One
Handling Other Situations