Personal Finance

How to rethink cash as Fed cuts interest rates: Top financial advisors

Published

3 hours ago

October 23, 2024

The U.S. Federal Reserve cut interest rates in September, the first in a string of cuts expected at least into 2025. Earnings on cash are expected to decline as a result — likely leading investors to ask what they should do in response.

From a financial planning perspective, cash generally refers to money held in relatively risk-free assets, like a high-yield bank savings account or money market fund.

Cash is a kind of safety valve in investor portfolios, perhaps serving as an emergency fund or a reserve for near-term income needs in retirement.

Interest rates on such assets are expected to “fall closely in tandem with what the Federal Reserve does” with its interest-rate policy, said Ryan Dennehy, principal and financial advisor at California Financial Advisors in San Ramon, California. The firm ranked No. 13 on the 2024 CNBC Financial Advisor 100 list.

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Investors saw interest rates on cash rise to their highest level in years as the Fed aggressively increased borrowing costs starting in March 2022 to tame pandemic-era inflation.

For example, many money market funds are paying roughly 4% to 5% in annual interest, following a lengthy period after the 2008 financial crisis during which their rates had languished near rock bottom.

Now, the Fed has begun cutting rates to take pressure off the U.S. economy since inflation has subsided. Fed officials cut their benchmark rate by half a percentage point in September. They forecast another half point of cuts through 2024, and 1 percentage point of additional cuts in 2025.

Of course, while expected, it’s not a given the Fed will continue to reduce borrowing costs.

Gear cash to your goals, not interest rates

Investors can make some moves on the margins to boost earnings on excess cash, assuming Fed officials continue on their current trajectory, advisors said.

However, they shouldn’t abandon their overarching financial plan and put that money at an elevated risk of loss, advisors said.

“Your cash allocation really needs to be geared toward your personal financial planning goals rather than what the interest rate environment might be doing,” said Fatima Iqbal, an investment advisor and senior financial planner at Azzad Asset Management in Falls Church, Virginia, which ranked No. 58 on the FA 100.

Boneparth: What matters is the Fed will cut rates. How many will we get this year and next year?

Conventional wisdom suggests investors hold at least three to six months of expenses in cash-type holdings for emergencies, for example, Iqbal said.

This thinking shouldn’t change in light of falling rates, advisors said. In other words, they shouldn’t subject their cash to more risk if they may need it in the near term.

Additionally, cash often accounts for a relatively small portion of an investment portfolio, “so even with fluctuating interest rates, the impact to the overall strategy is minimal,” said Jeremy Goldberg, portfolio manager and research analyst at Professional Advisory Services in Vero Beach, Florida. The firm ranked No. 37 on the FA 100.

Consider locking in high rates with excess cash

That said, investors can consider reallocating any excess cash toward assets that are still relatively low risk and more likely to pay a higher return, advisors said.

That might include locking in an interest rate now in a federally insured certificate of deposit or U.S. Treasury bond, said Victoria Trumbower, a certified financial planner and managing member at Trumbower Financial Advisors in Bethesda, Maryland, which ranked No. 31 on the FA 100.

“If I have an opportunity to lock in something a little bit longer [in duration] and I’m pretty confident the client won’t want to sell it tomorrow, we’re willing to do that,” Trumbower said.

Dennehy, of California Financial Advisors, recommended a similar strategy for households with excess cash.

Rather than holding a three-, six- or nine-month Treasury bond or CD, for example, investors can perhaps consider a duration of two or five years, Dennehy said.

The virtue of such a strategy is investors would guarantee their interest rate, if they were to hold their bond or CD to its full term. Money market funds, by comparison, have a variable interest rate that will fluctuate with Fed policy, Dennehy said.

When choosing one versus the other, investors essentially make a bet on the speed and trajectory of future Fed rate cuts, Dennehy said.

“Keep in mind, for the better part of the last decade, with money market funds and high-yield savings accounts you were earning less than 1% interest,” he said. “Any amounts over 1% now is great, relatively speaking.”

Personal Finance

First-year college enrollment falls, though more students qualify for aid

Published

6 hours ago

October 23, 2024

Business Finance News

Al Seib | Los Angeles Times | Getty Images

Although more students are eligible for federal financial aid, fewer high schoolers are pursuing a four-year degree. Increasingly, college is becoming a path for only those with the means to pay for it, many studies show.

Although undergraduate enrollment is up overall, the number of new first-year students sank 5% this fall compared with last year, with four-year colleges notching the largest declines, according to an analysis of early data by the National Student Clearinghouse Research Center.

“It is startling to see such a substantial drop in freshmen, the first decline since the start of the pandemic,” Doug Shapiro, the National Student Clearinghouse Research Center’s executive director, said in a statement.

“But the gains among students either continuing from last year or returning from prior stop outs [or temporary withdrawals] are keeping overall undergraduate numbers growing, especially at community colleges, and that’s at least some good news,” he said.

The declines in first-year student enrollment were most significant at four-year colleges that serve low-income students, the report also found. At four-year colleges where large shares of students receive Pell Grants, first-year student enrollment plummeted more than 10%.

More students qualify for federal financial aid

The new Free Application for Federal Student Aid is meant to improve access by expanding Pell Grant eligibility to provide more financial support to low- and middle-income families.

As a result of changes to the financial aid application, more students can now qualify for a Pell Grant, a type of aid awarded solely based on financial need.

New data from the Department of Education shows that 10% more students are on track to receive Pell Grants this year, including 3% more current high school seniors.

But overall, the number of Pell Grant recipients is down significantly. In fact, the number of Pell Grant recipients peaked over a decade ago, when 9.4 million students were awarded grants in the 2011-12 academic year, and sank 32% to 6.4 million in 2023-24, according to the College Board, which tracks trends in college pricing and student aid.

Federal aid is not keeping up with costs

Also, those grants have not kept up with the rising cost of a four-year degree. Currently, the maximum Pell Grant award rose to $7,395 — after notching a $500 increase in the 2023-34 academic year.

Meanwhile, tuition and fees plus room and board for a four-year private college averaged $58,600 in the 2024-25 school year, up from $56,390 a year earlier. At four-year, in-state public colleges, it was $24,920, up from $24,080, the College Board found.

Experts have continuously warned that ongoing problems with the new FAFSA have resulted in fewer students applying for financial aid, which could also contribute to declining enrollment.

“The changes from FAFSA simplification were supposed to increase the number of Pell grant recipients. This was before all of the chaos ensued,” said higher education expert Mark Kantrowitz.

FAFSA rollout bugs and blunders: Here's what you need to know

Last year, 45% of college applicants reported frustrations with the process and 12% said they ultimately chose a community college, technical school or other alternative because of their FAFSA experience, according to an exclusive look at Jenzabar/Spark451′s upcoming college-bound student survey. The higher education marketing firm polled more than 5,400 recent high school graduates in September.

Rising college costs and ballooning student debt balances are still a major concern, causing more students to question the return on investment, experts also say.

“There is growing skepticism and paranoia about the value of a degree,” said Jamie Beaton, co-founder and CEO of Crimson Education, a college consulting firm.

Meanwhile, the number of students pursuing shorter-term accreditations is growing rapidly, with enrollment in certificate programs up 7.3%, according to the National Student Clearinghouse Research Center.

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Personal Finance

Tax benefits of health savings accounts make them worth considering

Published

8 hours ago

October 23, 2024

Business Finance News

Fg Trade | E+ | Getty Images

Health savings accounts have become popular workplace perks with significant tax-advantaged investment opportunities — but many Americans have no idea how they work.

About 26 million people had an HSA at the end of 2023, according to Devenir, a research and investment firm based in Minneapolis. Assets in these accounts reached about $137 billion by this June, and are expected to grow to $175 billion by the end of 2026.

“We definitely are seeing growth in the number of people who sign up,” said Todd Katz, executive vice president of group benefits at MetLife. Strong market performance has also spurred growth of the investments in HSA accounts, helping to boost balances.

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Still, 50% of U.S. adults don’t understand how HSA’s work, according to a survey by Empower, a financial services company. Only 34% of employees with access to an HSA have enrolled in the benefit, and just 24% who have enrolled have funded their accounts, according to MetLife’s U.S. Employee Benefits Trends Study conducted in September 2024.

That can be an expensive miss: HSA benefits are “unmatched, really, relative to Roth IRAs or 401(k)s,” said Christine Benz, director of personal finance and retirement planning at Morningstar. “You just don’t see tax benefits like that.”

Here’s what to know about HSAs, and how to take advantage:

Tax benefits of health savings accounts

HSAs are tax-advantaged accounts for health expenses. Funds roll over from year to year, and the account comes with you if you change jobs. HSA money can also be invested.

To be eligible to contribute to a health savings account, an individual must be enrolled in a high-deductible health plan, or HDHP. For 2025, the Internal Revenue Service defines that as any plan with an annual deductible of at least $1,650 for an individual or $3,300 for a family. The maximum out-of-pocket expenses for an HDHP are $8,300 for an individual or $16,600 for a family.

A saving, spending and investment account, HSAs offer three ways to save on taxes.

“You’re able to put pre-tax dollars into your health savings account. As long as the money stays within the confines of the HSA is it is not taxed,” said Benz, the author of “How to Retire.” “And then, assuming that you pull the funds out and use them for qualified health care expenses, those funds aren’t taxed either. So you earn a tax break every step of the way.”

In 2025, eligible individuals can contribute to a HSA up to $4,300 or $8,550 for family coverage.

‘You need to run the numbers’

High-deductible health plans may have lower monthly premiums than other plans, but it still could be hard for many people to come up with the cash to meet the deductible on a hefty medical bill.

Experts say making the most of an HSA’s tax benefits generally requires covering current health costs out of pocket, if possible, so the HSA investment funds can grow for future use. That’s not easy to do, either.

Also, if you take money from your HSA for a non-medical expense, you have to pay federal income tax and a 20% tax penalty on the money withdrawn. Accountholders age 65 and older can avoid that penalty, but will still pay income tax.

There’s a lot to think about, so experts say take the time to weigh the pros and cons of the options.

A new report from Voya Financial finds 91% of working Americans pick the same health plan from the year before. But experts say it can pay to crunch the numbers.

“If you’re somebody who has to go to the doctor all the time, you know you’re going to meet your deductible, you probably want to go with a copay plan, but you need to run the numbers,” said Carolyn McClanahan, a physician and CFP based in Jacksonville, Florida. She’s a member of CNBC’s Financial Advisor Council.

Benz agrees, adding that “successfully using the high deductible plan very much rests on taking advantage of that health savings account.”

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Personal Finance

2025 child tax credit, earned income tax credit terms

Published

24 hours ago

October 22, 2024

Business Finance News

Momo Productions | Digitalvision | Getty Images

Child tax credit for 2025

The refundable portion of the child tax credit — a tax break parents can take for qualifying children — will be $1,700 for 2025, which is unchanged from 2024. That figure represents how much families may claim even with zero tax balance on their tax returns.

The maximum child tax credit of $2,000 per child under 17 is available to parents with up to $400,000 in modified adjusted gross income if they are married and filing jointly, or under $200,000 if they are single. Those figures are also unchanged from 2024.

Notably, the terms of the current child tax credit are set to expire at the end of tax year 2025. At that time, the child tax credit is scheduled to drop to a maximum $1,000 per child.

However, lawmakers on both sides of the aisle have touted proposals to make the credit more generous.

The new changes for 2025 are standard adjustments for inflation to make it so taxpayers don’t face higher tax liabilities, according to Alex Durante, economist at the Tax Foundation. The terms still reflect the Tax Cuts and Jobs Act of 2017.

“But the year following, 2026, families should be expecting to see higher tax liabilities unless Congress votes to extend these tax provisions that were implemented in 2017,” Durante said.

Earned income tax credit for 2025

A tax credit for low- to middle-income individuals and families — the earned income tax credit, or EITC — will have higher maximum amounts in 2025.

The earned income tax credit helps qualifying individuals and families reduce the amount of tax they owe, while also potentially providing a refund, according to the IRS.

In 2025, the maximum EITC amount will be $8,046 for qualifying taxpayers with three or more eligible children. That is up from $7,830 for tax year 2024.

The maximum amount available for qualifying taxpayers with two eligible children will be $7,152, up from $6,960 in 2024; one qualifying child, $4,328, compared to $4,213 in 2024; and no qualifying children, $649, up from $632 this year.

To qualify for the tax credit, individuals and families must be under certain thresholds for adjusted gross income — defined as total income excluding any eligible deductions.

In 2025, the maximum AGI to qualify for the EITC for married couples with three or more children will be $68,675, up from $66,819 in 2024; and for single, head of household and widowed filers with three or more children will be $61,555, adjusted from $59,899 this year. The EITC is also subject to phaseout thresholds.

Taxpayers are also limited to how much investment income they can have in order to qualify for the earned income tax credit. In 2025, that threshold will go up to $11,950, up from $11,600 in 2024. If investment income is above $11,950 in 2025, taxpayers will not qualify for the credit.

Adoption, gift tax exclusion changes

Other changes announced by the IRS may also affect families.

The maximum adoption credit for a child, including those with special needs, will apply to qualified expenses of up to $17,280 in 2025, up from $16,810 in 2024.

The annual exclusion for gifts will go up to $19,000, up from $18,000 in 2024. If taxpayers give $19,000 to each of their children in 2025, the annual exclusion will apply to each gift.