Be Sure About Rental Car Insurance

This summer, whether you’re driving for business or pleasure, you may want to rent a car. If so, you’ll likely be driving an unfamiliar vehicle on unknown roads. What’s more, you’ll encounter other (perhaps many other) motorists in similar circumstances. You can’t overlook the chance you’ll be involved in an accident. 

Obviously, your first priority is to avoid injuring yourself, your passengers, and any others. Still, you’ll also want to minimize your financial exposure, so it will pay to have the right insurance in place.

Protection begins at home

Your first line of defense lies in the coverage you already have. Check your auto insurance policy and your excess liability (umbrella) policy to see what—if anything—they say about rental cars.

            Call your insurance agent to double check. If there is coverage, see if there are exclusions for rental cars. Does the coverage apply to long-term rentals or to rentals in a foreign country you may be visiting? If traveling for business, ask how that affects your coverage.

            If you feel your coverage is inadequate, your agent might be able to offer you additional insurance for car rentals. Weigh the added cost versus the extra protection you’ll get. Remember, your greatest exposure might be liability, if you injure someone while driving the rental car.

            After discussing your plans, send an email to the agent, summarizing the conversation, and have the agent respond, so you’ll have a record of what you were told.

Credit check

Besides your existing policies, you also may have coverage from your credit card issuer.

            Example 1: Howard Green rents a car and puts the charge on his Visa card. He skids off the road in a rain storm and causes extensive damage to the vehicle. Some or all of the repair costs may be covered by Visa. Indeed, if Howard has to pay a deductible amount under his personal auto insurance policy, his credit card coverage may reimburse him for the outlay. In some cases, credit card insurance can provide secondary coverage, paying claims beyond the limits of your primary auto insurance policy.

            Again, it pays to read the fine print. To determine what a given credit card will pay, enter the full name of the card and “rental car insurance” into an Internet search engine, such as Google. Be sure to be precise in designating the type of card you have (gold, platinum, etc.) because different cards from the same company may have different levels of protection. With Visa or MasterCard, there can be variations in coverage from one issuing bank to another.

            Credit card coverage can be valuable, especially if it’s included in the basic card member services at no extra charge, but it probably is not absolute. Often, this insurance applies to vehicle damage or theft, but not liability for injuries. In such cases, be sure you have other protection for any liability incurred while driving a rental car.

            Be wary of any exclusions in the coverage you receive from your credit card company. Coverage might not be available, for instance, for rentals of recreational vehicles, rentals of very expensive vehicles, rentals by students, or rentals much longer than 15 days.

            The bottom line is that you almost certainly will use a credit card when you rent a car. You might as well see which of your cards has the best suite of free car-rental benefits, in sync with your auto insurance, and use that card when you rent a car.

Counter moves

When you rent a car, the person behind the counter will ask you if you want the optional insurance offered by the company. The stated cost—often X dollars per day—may seem modest but in fact the annualized costs generally are much greater than you’d pay for standard auto insurance.

            Why would you pay for this expensive coverage? If you haven’t fully researched your insurance options, you might want to buy some coverage from the car rental company, for peace of mind. Alternatively, if you are informed about your present coverage, you might choose some of the optional choices to fill in any gaps.

            Example 2: Mindy Carter lives in New York City without a car, so she has no auto insurance. When she goes away on weekends, she rents a car. Mindy knows that her credit card covers damage and theft but not liability for injury to others. Therefore, she buys liability insurance at the car rental counter.

            Similarly, drivers with little or no collision damage coverage on their personal cars might buy this insurance from the rental company.

Even More on Rental Car Insurance

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Mixing Annuites and IRAs

According to the Investment Company Institute, 68% of households with IRAs have mutual funds in those accounts. That’s followed by individual stocks (41%), annuities (35%), and bank deposits (25%). Therefore, annuities are among the most common IRA holdings; they are also among the most controversial because many observers assert that annuities don’t belong in an IRA.

Defining the terms

To understand this seeming contradiction, you should know some terminology. Generally, the most heated debate does not involve immediate annuities, which also may be known as income or payout annuities. Here, you give a sum of money to an insurance company in return for a specified flow of cash over a specified time period, perhaps the rest of your life.

            Deferred annuities are a different story. With these investments, the money you contribute can grow inside the annuity contract. Different types of deferred annuities offer various ways that the amounts invested can grow over the years. Regardless of the method or the amount of accumulation, earnings inside the annuity aren’t taxed until money is withdrawn.

            Critics of holding deferred annuities inside an IRA say that they are redundant. Any investment inside an IRA is tax deferred or tax-free (with a Roth IRA), so you don’t get any tax benefit by investing IRA money in a deferred annuity. Why pay the costs that come with a deferred annuity when you get the same tax deferral with mutual funds or individual securities or bank accounts held inside your IRA?

            Because there might be advantages as well as drawbacks. Deferred annuities offer various guarantees, which might include certain death benefits and certain amounts of cash flow during the investor’s life, regardless of investment performance. These guarantees may be a valid reason to include a deferred annuity in an IRA, some annuity issuers and sellers contend.

            Among different deferred annuities, death benefits and so-called “living benefits” vary widely. Some can be extremely complicated. If you are interested in a deferred annuity, our office can explain the guarantees in the contract, so you can make an informed decision.

Verifying value

Another thing to consider when deciding whether to hold a deferred annuity in your IRA, is that these annuities must be valued for purposes such as Roth IRA conversions and required minimum distributions (RMDs). This also will arise if you already have such an annuity in your IRA. The reported value of the annuity contract may not be the appropriate number.

            Example: Sarah Thomson invests $50,000 of her IRA money in a deferred annuity that offers several investment options. After this outlay, Sarah’s investments decline, so her annuity account is now reported at $40,000. Sarah decides this reduced value would generate a lower tax cost on a conversion to a Roth IRA.

            However, Sarah’s deferred annuity also contains a rider guaranteeing to pay her a certain amount per year for the rest of her life. Such a rider has some value, which Sarah must include in valuing the annuity inside the IRA if she does a Roth conversion. The same problem will arise when Sarah must take RMDs. Sarah’s best course of action may be to ask the annuity issuer for help with the valuation because insurers typically have actuaries and software designed to perform these intricate calculations.

            Holding an annuity in an IRA raises many issues that don’t arise with other choices. There may be advantages, but you should proceed cautiously.

Annuity Payback Time

Variations of immediate annuities include the following:

·       Fixed ­period annuities. Here, you receive definite amounts at regular intervals for a specified length of time.

·       Annuities for a single life. These contracts provide you with definite amounts at regular intervals for life. The payments end at your death.

·       Joint and survivor annuities. Usually acquired by a married couple, the first annuitant receives a definite amount at regular intervals for life. After he or she dies, a second annuitant receives a definite amount at regular intervals for life. The amount paid to the second annuitant may or may not differ from the amount paid to the first annuitant.

Making Expense Accounts... Accountable

Business owners who work for their company typically have expense accounts; the same usually is true for many employees. If your company has what the IRS calls an accountable plan, everyone can benefit from the tax treatment. The company gets a full deduction for its outlays (a 50% deduction for most dining and entertainment expenses), while the employee reports no taxable compensation.

            A company expense plan judged to be nonaccountable, on the other hand, won’t be as welcome. It’s true that the company can deduct 100% of the payments it makes for meals and entertainment, but it also will have to pay the employer’s share of payroll taxes (FICA and FUTA) on the expense money paid to employees. The employees, meanwhile, will report those payments as wages, subject to income and payroll taxes.

In that situation, the employee can include employee business expenses (minus 50% of those for meals and entertainment) with other miscellaneous itemized deductions, but only miscellaneous deductions that exceed 2% of adjusted gross income can be subtracted on a tax return. Taxpayers who owe the alternative minimum tax can’t get any benefit from their miscellaneous deductions.

                       

Key factors

In order for expense accounts to get favorable tax treatment, they should pass the following tests:

·       Business purpose. There should be an apparent reason why the company stands to gain from this outlay. An employee might be going out of town to see a customer or a prospect, for example.

·       Verification. Employees should submit a record of their expenses, in order to be reimbursed. Lodging expenses require a receipt, as do other items over $75.

            In order to reduce the effort of dealing with multiple receipts, employers are allowed to give employees predetermined mileage and per diem travel allowances. Substantiation of other elements besides amounts spent (time, place, business purpose) is still required. If the amounts of those allowances don’t exceed the amounts provided to federal employees, the process can be considered an accountable plan. (Excess allowance amounts are taxable wages.) Per diem rates can be found at www.gsa.gov/portal/category/104711.

            Example: XYZ Corp. asks a marketing manager, Jill Matthews, to take a two-day business trip to Atlanta to demonstrate new products. The federal rate for Atlanta (lodging, meals and incidentals) on the federal per diem website is $189 per day. As required by the XYZ accountable plan, Jill accounts for the dates, place, and business purpose of the trip. XYZ reimburses Jill $189 a day ($378 total) for living expenses; her expenses in Atlanta are not more than $189 a day. In this situation, XYZ does not include any of the reimbursement on her Form W-2, and Jill does not deduct the expenses on her tax return.

·       Refunds. Employees must return any amounts that were advanced or reimbursed if they were not spent on substantiated business activities.

·       Timeliness. Substantiation and any required refunds should be made within a reasonable amount of time after the expense was incurred. Those times vary, but IRS publications indicate that substantiation should be made within 60 days, and any employee refunds should be made within 120 days.

            For a plan to be accountable, reimbursements and allowances should be clearly identified. They can be paid to employees in separate checks. Alternatively, expense payments can be combined with wages if the distinction is noted on the check stub. Our office can help you check to see that your company’s employee expense plan is accountable, and, thus, qualifies for the resulting tax treatment.

Supreme Court Bolsters Beneficiary Rights

A 2013 decision by the U.S. Supreme Court illustrates the importance of updating beneficiary forms regularly. If you don’t, your desired heirs can lose a valuable asset.

            This case, Hillman vs. Maretta, had its genesis in 1996, when Warren Hillman married Judy Maretta. Warren was a federal employee, so he named Judy as the beneficiary of his group term life insurance policy. The couple was divorced after two years, and Warren subsequently married Jacqueline. Warren and Jacqueline were still married in 2008 when Warren died; that life insurance policy’s death benefit was nearly $125,000.

            As it turned out, Warren had never changed the beneficiary designation on the policy. Thus, Judy received the death benefit, and Jacqueline went to court to get the money from Judy.

State versus federal

The case took place in the state of Virginia, which has passed a state law saying that a divorce or annulment revokes a beneficiary designation relating to death benefits. That sounds like it should have settled the matter, but Warren’s life insurance policy was created under the Federal Employees’ Government Life Insurance Act (FEGLIA), a federal law, and the U.S. Constitution states that federal law will trump state law when there’s a conflict.

            Nevertheless, Jacqueline still had a card to play. Virginia has another law saying, in essence, that if death benefits are turned over to a former spouse because of such a conflict, that former spouse is liable for the amount in question, payable to the person who otherwise would have collected. Thus, Jacqueline (Warren’s widow) sued Judy for the amount of the insurance proceeds.

Court conflicts

Did federal law override state law, giving the life insurance benefits to Judy? All parties agreed that was the case. But did the second Virginia law prevail, allowing Jacqueline to ultimately collect the death benefits from Judy? That was the question dividing the Virginia courts and bringing the matter to the U.S. Supreme Court.

            In 2013, the Supreme Court decided Hillman vs. Maretta in favor of Judy, the former spouse and the designated beneficiary. “FEGLIA establishes a clear and predictable procedure for an employee to indicate who the intended beneficiary shall be,” the Supreme Court noted, so federal employees have an “unfettered freedom of choice in selecting a beneficiary and to ensure the proceeds actually belong to that beneficiary.” State law can’t overturn that federal law’s intent, the Court ruled.

            Not every case will come down in favor of a former spouse. ERISA, a federal law covering retirement plans, gives a current spouse certain rights to death benefits from an employer’s retirement plan, unless that right has been formally waived. Nevertheless, beneficiary conflicts can be time consuming, expensive, and stressful, especially if large amounts are at stake. Regularly updating all beneficiary forms can spare your loved ones from fighting what might wind up being a losing battle.

Paired Plans

• ·       In most 401(k) and similar plans, an amount left by a participant who has not received benefits will automatically go to the surviving spouse.
• ·       If a participant wishes to select a different beneficiary, the spouse must consent by signing a waiver.
• ·       This waiver must be witnessed by a notary or a plan representative.

Time to Trim Stocks?

In 2013, the benchmark Standard & Poor’s 500 Index returned more than 32%, and the average domestic stock fund was up more than 31%, according to Morningstar. Major domestic stock market indexes are at or near record levels, as of this writing. Since the nadir of the financial crisis in early 2009, stocks have enjoyed a powerful five-year run.

 Is it time to move out of stocks, or at least trim your holdings?  Most commentators advise against trying to time the market. There’s no way of knowing if we’re at the top of the market, as we were in 2000 and 2007, or if we’re just beginning an 18-year bull run like the one we enjoyed from 1982 to the 2000 peak.

Rebalancing act

Market timing may not be recommended, but many financial advisers favor the concept of rebalancing your portfolio. Here, you determine an asset allocation to suit your investment goals and your risk tolerance. If your actual allocation departs from the plan, you’ll act to get your investment mix back on the chosen path.

            Example 1: Megan Harris has a basic asset allocation of 65% stocks and 35% bonds. After a few years of a bull market, Megan’s $400,000 portfolio is $300,000 in stocks (75%) and $100,000 (25%) in bonds. To rebalance, Megan would sell $40,000 of stocks and buy $40,000 of bonds. This would bring her to $260,000 in stocks (65%) and $140,000 in bonds (35%).

            Note that Megan will still have a substantial amount invested in stocks, so she will continue to profit if stocks perform well. At the same time, she will have less exposure to a possible stock market reversal.

            The Megan Harris example is extremely simplified. Today, many financial advisers advocate a portfolio that’s diversified among multiple asset classes. Megan might hold international and domestic equities, large company and small company stocks, high grade and lower quality bonds, real estate securities, commodities and so on. Each asset class will have an allocation, and periodic rebalancing can keep the mix on track.

Tax tactics

One advantage of continual rebalancing is that it encourages investors to sell after assets have appreciated and buy other assets that are currently out of favor. Long term, that can be a formula for successful investing. It’s also a formula for realizing taxable gains. Some astute planning can reduce the tax bill, though.

            One approach is to rebalance by executing your asset sales in a tax-favored retirement plan such as a 401(k) or an IRA. Then, any gains on the sale won’t be taxed right away. By building up a substantial amount in such an account and holding a blend of asset classes in there, you’ll increase your ability to rebalance without triggering taxes.

            Another tax reduction method is to sell assets from a large holding within your portfolio, acquired at different times. Specify the shares you’d like to sell, choosing those with the least tax impact.

            Example 2: As in our previous example, Megan Harris wants to rebalance her portfolio by selling $40,000 of stocks. She sells $15,000 of stock funds held inside her 401(k), avoiding a current tax bill, but Megan would like to sell another $25,000 of stocks in her taxable account.

            Megan holds a large position in mutual fund ABC, which she has amassed over several years. She wants to reduce her exposure to this fund, so she sells $25,000 worth of fund ABC in her taxable account. When instructing her broker to make this sale, Megan specifies which shares to sell, choosing those that (a) have declined since her purchase or (b) have relatively small paper profits. Among the gainers, Megan focuses on the shares that have been held more than one year and, thus, qualify for the favorable tax rate on long-term capital gains.

             Yet another way to reduce the tax on rebalancing gains is to build up a bank of capital losses by periodically selling assets that lose value after you buy them. Such capital losses can offset taxable capital gains.

          

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Business Owners Get More Bang From Flex Plan Bucks

Although all the effects of the Affordable Care Act (ACA) are still unclear, it’s likely that health insurance costs will continue to increase in the future. Business owners may require greater health plan contributions from participating employees. In addition, this health care law already has made it more difficult for individuals to deduct medical outlays: For most taxpayers, only expenses over 10% of adjusted gross income (AGI) are tax deductible, versus a 7.5% hurdle under prior law. (The 7.5% rule remains in place through 2016 for individuals 65 and older and their spouses.)

            In this environment, business owners stand to benefit substantially by offering a health flexible spending account (health FSA). These plans allow employees to set aside up to $2,500 per year that they can use to pay for health care expenses with pretax dollars.

            Example 1: XYZ Corp. offers a health FSA to its employees. Harvey James, who works there, puts $2,400 into the plan at the beginning of the year. Each month, $200 will be withheld from Harvey’s paychecks, and he’ll owe no income tax on those amounts.

            Going forward, Harvey can be reimbursed for his qualified medical expenses that are not covered by his health plan at XYZ. Possible examples include health insurance deductibles, copayments, dental treatments, eyeglasses, eye surgery, and prescription drugs. Such reimbursements are not considered taxable income. Thus, Harvey will pay those medical bills with pretax rather than after-tax dollars.

Health FSAs and the Affordable Care Act

Under the ACA, there are limitations on an employer offering a health FSA to their employees. Standalone health FSAs can only be offered to provide limited scope dental and vision benefits. An employer can only offer a health FSA that provides more than limited scope dental and vision benefits to employees if the employer also offers group major medical health coverage to the employees.

Additionally, an employer can make contributions to an employee’s health FSA. However, under the ACA, the maximum employer contribution the plan can offer is $500 or up to a dollar-for-dollar match of the employee’s salary reduction contribution.

Ultimately, these additional new rules can affect whether an employer can offer a health FSA and the amount of any optional employer match.

Employer benefits

A health FSA’s benefits to participating employees are clear. What will the business owner receive in return? Chiefly, the same advantages that come from offering any desirable employee benefit. Recruiting may be strengthened, employee retention might increase, and workers’ improved morale can make your company more productive.

            There’s even a tax benefit for employers, too. When Harvey James reduces his taxable income from, say, $75,000 to $72,600 by contributing $2,400 to a health FSA, he also reduces the amount subject to Social Security and Medicare withholding by $2,400. Similarly, XYZ Corp. won’t pay its share of Social Security or Medicare tax on that $2,400 going into the health FSA.

Counting the costs

However, drawbacks to offering an FSA to employees do exist. The plan, including reimbursements for eligible expenses, must be managed. Many companies save headaches by hiring a third-party administrator to handle a health FSA, but there will be a cost for such services.

            In addition, companies offering health FSAs to employees should have enough cash to handle a large demand for reimbursement, especially early in the year.

            Example 2: Kate Logan also works for XYZ and she chooses to contribute $1,800 to her health FSA at the beginning of the year: $150 a month, or $75 per each semimonthly paycheck. Just after her first contribution of the year, Kate submits paperwork for a $1,000 dental procedure. XYZ might not have trouble coming up with $1,000 for Kate, but there could be a problem if several employees seek large reimbursements after making small health FSA contributions.

Using It, Losing It

Employers also should be sure that employees are well aware of all the implications of health FSA participation. For years, these plans have been “use it or lose it.” Any unused amounts would be forfeited at year end.

            Example 3: Mark Nash participated in an FSA offered by XYZ several years ago. He contributed $2,000 but spent only $1,600 during the year. The unspent $400 went back to XYZ.

            In 2005, the rules changed. Now, if the FSA permits, participants have until mid-March of the following year to use up any excess. If XYZ had adopted this optional grace period, Mark Nash would have had an extra 2½ months to spend that leftover $400 on qualified medical costs.

            Yet another change occurred in late 2013—a $500 option. Under this provision, FSA plans can be amended to allow each employee a carryover of up to $500, from one year to the next. Plans with this $500 carryover provision cannot allow a grace period as well. If your company now has an FSA with this optional grace period, it will have to amend the FSA to eliminate the grace period in order to add the $500 carryover provision. 

            In addition to explaining all of the rules on possible forfeitures, employers offering an FSA should be sure their employees know about a possible impact on Social Security benefits. As mentioned, FSA contributions aren’t subject to Social Security; those contributions aren’t included in official compensation, for Social Security purposes. Employees should know that reduced compensation today might reduce Social Security benefits tomorrow. Companies that spell out all the FSA implications to workers may reduce misunderstandings and future complaints.

Mixing IRA Distributions With Social Security

Many workers save for the future in a 401(k) or another employer sponsored retirement plan. Contributions avoid income tax, and the same is true for investment earnings inside the plan. Often, 401(k) participants roll over the money to a traditional IRA after they retire, which extends the tax deferral.

Many people try to keep their IRAs intact as long as possible, continuing tax free buildup inside the plan.

Example 1: Alice Wells retired at age 62. To make up for her lost earnings, Alice draws down her taxable accounts, so her IRA can keep growing untaxed. Alice’s plan is to wait as long as possible before taking distributions from her IRA. (She’ll have to take at least the required minimum distributions from her traditional IRA after age 70½.)

However, once she retires, Alice finds that she is still short of cash flow. She can start to receive Social Security retirement benefits as early as age 62, so Alice puts in her claim to get the additional monthly income. 

Lower brackets are likely

Alice’s strategy, as described, is followed by many seniors. That is, they take Social Security early and eventually tap their IRA. That may not always be the best approach.

What might indicate taking a different route? Taxes, for one thing. The value of tax deferral depends on your tax bracket. The higher your bracket, the more putting off the IRS makes sense.

Suppose Alice typically was in a 28% or 33% tax bracket during her working years. In 2014, those brackets cover single taxpayers with about $90,000 to $400,000 of taxable income after deductions. Deferring income tax while she worked saved Alice 28 cents or 33 cents on the dollar.

Now that she’s retired, Alice’s taxable income is sharply reduced. In our example, Alice can tap her IRA for cash flow and keep taxable income below $90,000, which would put her in the 25% bracket. At 25 cents on the dollar, tax deferral isn’t as valuable as it was during her working years. On the other hand, taking IRA distributions and paying 25% tax isn’t as painful as it would be in a higher bracket.

Indeed, many retired couples are in the 15% bracket now, which goes up to nearly $75,000 of taxable income, after deductions. Such couples will owe even less tax on IRA distributions.

A plumper pension

There’s another reason to consider reversing the plan to take Social Security early and IRA distributions late. The longer you wait to start Social Security, the larger your monthly benefits will be.

Example 2: Suppose that Alice Wells has an earnings history that would qualify her to receive $2,000 a month at 66, which Social Security considers the “full retirement age” for people now in their 60s. If Alice starts Social Security at age 62, she’ll get only 75% of that benefit: $1,500 a month, plus cost-of-living adjustments (COLAs), for the rest of her life.

On the other hand, Alice can wait as late as age 70 to start Social Security. That would increase the monthly payment from her full retirement age by 32%, from $2,000 to $2,640 a month, plus all the COLAs along the way.

 Not counting COLAs, waiting from 62 to 70 will increase Alice’s annual benefit from $18,000 a year to $31,680 a year, which she’ll receive for the rest of her life.

Once Alice starts to receive Social Security, those much larger payments may reduce the amounts she’ll need from her IRA. If that’s the case, Alice will be substituting Social Security dollars, which are partially taxed under current law, for traditional IRA distributions, which usually are fully taxable.  

    

Building up Social Security benefits might have another appeal for married couples. When the first spouse dies, the survivor will receive the decedent’s Social Security payments, if they are larger than the benefits the survivor had been receiving. Thus, waiting to start Social Security may provide extra cash flow for a surviving spouse.

This plan to tap your IRA early and wait to start Social Security will help some people but not others. Calculations involve each individual’s health and work history as well as some complicated navigation through the tax code. When you are ready to make your decision, our office can help you determine a course of action likely to maximize cash flow and income security as you grow older.