February 29, 2012

401-OK

Credit: Ambro
Many people, including me, have been handed a 401(k) election form when they first started work with a new employer. It’s another form among the masses, so you quickly check a few boxes, consider the percent you think you can afford to have taken out of your paycheck, and that is that. Then a quarter passes and you’ve made a little money. Maybe a year passes and you’ve saved up some money, but your investment return looks a lot like the trajectory of an incoming meteor. Either way, most people have a lot of questions about their 401(k) that they never take the time to ask, and your 401(k) is way too important of a retirement planning vehicle to not understand what you’re doing. A friend of mine asked me for some help a few weeks ago, and I want to tell you what I told her so you, too, can hopefully make the most of your 401(k).

First, if you can possibly afford it, put in whatever percentage is required to get the maximum employer match. If your employer doesn’t match anything, that stinks; you should still contribute what you can. If they do match, take them to the cleaners! Let’s say that you make $100,000 a year, your employer will match your contributions up to 3%, and you are putting in 2%. That means you are putting in $2,000 and your employer is putting in $2,000, but if you put in $3,000 your employer would have to put in $3,000. That’s essentially a $1,000 raise right there! After you’ve forced your employer to match you, put in as much more as you can towards retirement but know there are annual contribution limits ($17,000 for 2012 if you are under 50 years old, $22,500 if you are over 50 at any time in 2012).

Second, if your employer offers different 401(k) plan types, you are going to have to make a choice between a traditional 401(k) and a Roth 401(k). Personally, I would choose a Roth 401(k) instead of a traditional 401(k) because Roth 401(k)s are taxed when you put money in, but the earnings you accumulate are tax-free when you take money out. Traditional 401(k)s are not taxed when you put money in, but the money you put in and the earnings you accumulate are taxed when you take money out. I relate this choice to scheduling getting your wisdom teeth out. By that, I mean that the taxes have to come out sometime and it’s probably going to hurt a little, but it is up to you when to schedule the procedure. Future tax rates and future investment return rates years from now will dictate what the best plan choice would have been today, but don’t get too caught up in that; what matters is that you are saving for retirement.

Third, choose investments that match your goals, risk tolerance, and stage in life. I’m going to make this way too simple:
  • I’d offer up that if you are between the ages of 20-35, you should roughly invest 80% in stocks and 20% in bonds or fixed income.
  • If you are between the ages of 35-55, you can afford less volatility and risk, so you should probably invest about 70% in stocks and 30% in bonds or fixed income.
  • If you are over the age of 55 or retired, you are probably more focused on preserving and maintaining your assets, so you should consider investing closer to 60% in stocks and 40% in bonds or fixed income.
I would also tell you that out of the stocks you invest in, I would roughly recommend 60% to be in mutual funds of large U.S. companies, 20% to be in mutual funds of small U.S. companies, and 20% to be in mutual funds of international companies, so you are nice and diversified. Please note that my very broad suggestions are simply suggestions and do not take into account what might be best for your personal financial situation. If you want more specific investment advice than that, I would be happy to help, but you probably need to be a client…

Finally, don’t touch it! Your 401(k) is for your retirement only, not for your new BMW. You should know, that with very few exceptions, 401(k) withdrawals made prior to age 59 ½ will face a 10% penalty. Now I don’t want you paying penalties, but I certainly don’t want you lessening your ability to retire at a reasonable age living the lifestyle you’ve grown accustomed to. Simply check your statements and leave your 401(k) alone. Pretend it is an angry yellow jacket or raging black bear if that helps.

I hope that the next time you get your 401(k) statement you will take a look, remember my suggestions from this post, and make your 401(k) a lot better than just okay.  

-Tom

February 21, 2012

A Little More Jingle in Your Pocket

Credit: Grant Cochrane
I had just gotten home, taken off the jacket, loosened the tie, and taken the puppy out. I walked to the mailbox not having any idea what awaited me. I was about to quickly thumb through the mail and begin my nightly routine, but something stopped me dead in my tracks: my cable bill. It had jumped almost $60 since last month! I didn’t recall ordering anything dicey or some exclusive European soccer channel, so I had either been cheated or was about to pay too much for something I didn’t need. It was this unpleasant experience that gave me the idea to do a post on six, very simple things you can do to save yourself money.

• First and foremost, your cable bill. What had happened to my cable bill was that my first-year rates had reverted to their normal rates and some movie package that I hadn’t formally rejected had been added to my services. I suggest you do exactly what my wife and I did and make a list of the channels you actually watch. We then compared that to the service offerings and were actually able to go down a package. After calling the cable company to remove the unwanted movie offering and go down a cable package, we were able to save an additional $30 a month on top of getting rid of that unpleasant $60 increase!

• Second, I also suggest you take a look at your Internet fees. Everyone loves fast Internet, but you might not actually need the latest, greatest, and most expensive “lightspeed” if you’re not into online-gaming or day trading. It’s just a suggestion, but there could be cost savings there.

• Third, think about your phones. Many people don’t use their landlines anymore, as the only people who call are telemarketers. Consider ditching the landline and enjoying the savings. Also, smartphones are amazing, but they can be expensive. Do you really need an app for taxis, an electronic candle flickering, or a productivity calculator? Cell phones are much better now than they were three years ago, but what were you paying for your cell back then? Just saying…

• My fourth idea is simply list shopping. Making a list before shopping helps you not forget what you came to purchase and helps you resist the temptation to impulse buy something you do not need. 

• If you enjoy bottled water over tap water, my fifth suggestion is to buy a filter. Bottled water is good for you and helps prevent open-cup spills, but the cost of one bottle at a time can get more expensive than you might think. Sure a filter is a little pricey upfront once every six months or so, but in the long run, it will save you money versus the daily bottle(s) of water.

• Finally, my wildcard sixth suggestion: razors. Razors are a fairly expensive, periodic purchase for both men and women alike. While I can’t postpone or slow my beard growth, I can tell you to dry your razor after each use. According to an article I read in my dentist's office several weeks ago, the leftover water and the absorption that follows is what speeds up the damage to and dulling of razors. If you take the extra five seconds to dry your razor after each use, it evidently can last three times as long. That would mean you would have to purchase razors a third as often as you currently do, and you would also save some cash!

Hope this helps. Feel free to share more simple cost saving strategies that have worked for you.

-Tom

February 16, 2012

Don't Forget...

Credit: renjith krishnan
In light of my most recent post, I heard from some people that prepare their own taxes that they wanted me to do a post on commonly forgotten tax deductions. Well I will be happy to, but before I start in on some frequently missed deductions and common tax misconceptions, let me quickly address preparing your own tax return.

Believe me, I am not getting a kick-back from any firm for saying this, but you really should let a CPA prepare your taxes. I know you can save a little money by doing your taxes yourself as opposed to paying a tax preparer, but do you know how much financial and emotional pain one mistake on your taxes could cause?  It’s easy to make a mistake on your taxes because the tax law is complicated and it's always changing. For example, according to the IRS’s own commissioner, there have been more than 3,500 tax law changes since 2000! If, in spite of my warnings, you still want to prepare your own taxes, please at least consider letting a CPA review your taxes every few years. This ensures that you aren’t missing out on any potential savings or inadvertently doing something wrong that will come back to you in a few years, with interest.

Well, I’m off my soap box. Here are some tax tips for you to consider as you get ready to file your 2011 federal taxes:

• If you paid any state income taxes during the year or paid any prior year’s state income taxes in 2011, they are potentially deductible for federal tax purposes. That being said, if you received a state income tax refund last year and itemized your deductions on your 2010 federal income tax return, all or part of the refund may need to be included on your 2011 federal income tax return.

• If you took out a first mortgage or refinanced after January 1, 2007, and are paying private mortgage insurance, you could be able to deduct that expense.

• If you got married at any point during 2011, you and your spouse are eligible to file together under the more tax advantageous Married Filing Jointly status for 2011.

• If you paid interest on a qualified student loan, you could be able to deduct up to $2,500 in interest.

• If you moved more than 50 miles away from your old home and your old job, there are many moving expenses such as transporting expenses, shipping expenses, and travel costs that you could potentially deduct.

• If you were out of work or looking for a new job in 2011, you could be able to deduct some of your expenses for resume critiques or paying a recruiter as long as the job-search was within your particular field.

• If your medical and dental expenses for you and your family exceeded 7.5% of your adjusted gross income, you could be able to deduct those expenses. After December 31, 2012, that threshold becomes 10%!

• If you made charitable contributions of $250 or more of cash, goods, or services, you must receive a substantiated acknowledgment from the qualified organization in order to potentially claim the deduction. If you made total non-cash contributions of more than $500, you have to fill out an additional form, Form 8283 to go with your tax return.

• If you rented a safety deposit box, you could be able to deduct the expense if you used the box to store taxable, income-producing documents such as stock certificates or savings bonds.

• If you had investment expenses, such as financial advisor or investment fees, you could be able to deduct those costs.

• Finally, remember you can still make your 2011 contribution to your traditional IRA or Roth IRA as long as you do so by April 17, 2012. Making your 2011 contribution to a traditional IRA before April 17 is one of the few ways you can potentially generate a deduction in 2012 that counts for 2011.

Please note that many of the potential deductions I have listed come with caveats and additional requirements, and some of them face adjusted gross income thresholds of 2% or more. In fact, I could write individual blog posts on many of the items listed above by themselves! That’s why I have included so many links that take you to additional details you should consider before you claim an item as a deduction. I hope this post helps you as you prepare your 2011 taxes, but if you are uncertain about something I have written or provided a link to, I would once again suggest you find a tax advisor.

By the way, tax preparation fees can also be deductible.

-Tom

February 14, 2012

What Your CPA Does Not Want You to Know, or Do They?

Credit: Arvind Balaraman
There is nothing like the smell of tax season - the satisfaction of receiving all those end-of-year contribution thank-yous, the joy of seeing how much mortgage interest you can deduct, the feeling of a crisp 1099 in your hand... Personally, one of those “Tax Masters” commercials always makes me chuckle.

While I may no longer be a tax preparer, I remember those days and I thought I would give you some tips for this tax season from a former insider. Here are some suggestions that will help your taxes get prepared more quickly, more accurately, and maybe even for less money. 

1. Form of Delivery- If you are delivering your tax information to your accountant in any fashion other than in a PDF file, a file folder, or one of those nice, brown envelopes with a metal clasp, STOP! I have been given shoe boxes, I have been faxed enough paper to kill the Redwood Forest, and I have been given scribbles on the back of a Krispy Kreme napkin. As a preparer, it could take me hours to organize someone’s tax information before I could even get started on the real tax work! I can tell you from experience that if you give your accountant a pile of junk in a box, it will stay on the bottom of his/her pile, and when they do decide to start your work, they will bill you for every single second that it takes them to reconstruct your last year’s paper trail.

2. State of Organization- You should definitely organize the information you provide your accountant. A pile of nicely folded documents facing the same way can still take valuable preparation time if they are not in some type of logical order. I would suggest organizing your items by type. Perhaps W-2s, interest statements and other 1099s, and then additional income items like rental property information or realized security gains/losses. Where most people increase their tax prep bill is the pile of itemized deduction-related materials they provide. All I ask is that you sort your charitable contribution statements from your property taxes from your medical bills. I know it takes time, but accountants can charge a lot by the hour nowadays!

3. Completeness- Accountants can only prepare a tax return as completely and accurately as the information you give them. If you are missing a 1099 from an account you had last year and still have this year, or some other piece of information you know about, don’t give your CPA anything yet. The more times your accountant has to ask you for additional items and pick up and put down your work, the longer his/her clock runs. If you never provide that missing piece of information, your return won’t be accurate and that is actually on you! Accountants are only responsible for accurately preparing a return based on the information you provide them. Worse than anything, your accountant may be required to report rental income without a related expense or not report a charitable deduction without substantiation solely because your information is not complete.

4. Responsiveness- Finally, be responsive to your accountant. Your CPA is not auditing you; your CPA works for you for crying out loud! Your CPA should want to help you file an accurate and timely return with as little tax liability as possible. In order to help them help you, make sure you completely address your accountant’s initial information request and quickly respond to any follow-up questions.

These suggestions will hopefully make this tax season a lot less painful for you and your accountant. There may not be any tax savings from these suggestions, but if you follow my advice and your tax preparation bill goes up, I would suggest finding a new accountant.

-Tom

February 07, 2012

To Refinance or Not to Refinance, That is the Question

Credit: jscreationzs
One of the most common questions I get from clients is whether or not they should refinance an outstanding mortgage. As is the case with most financial advice, it depends. It depends on how much lower the potential rate is than the current rate, it depends on what type of mortgages or lending instruments we are talking about, and it depends on fees and closing costs. Let me quickly walk you through the decision-making process as I would a client.

The first items I would want to know from a client are their current interest rate and the rate of the potential new mortgage. If the difference between the two interest rates is not more than one percent, the conversation will usually stop there. This is because any small monthly payment benefit you might receive from that refinance flyer you got in the mail will most always be immediately negated by administrative fees and closing costs that you must pay. In addition, anyone who has been through a closing knows that the whole process is usually a stressful hassle with a cost in sweat and tears in addition to dollars.

The second items I would want to know from a client are what type of mortgage they are currently in and what type of mortgage they would be potentially refinancing into. Basically I would be checking to make sure the client is not thinking about refinancing into another 30-year mortgage when they are already 10 or 20 years into their current 30-year mortgage. The lower interest rate of the refinanced mortgage would not matter because the overall costs would be increasing due to the longer period of interest rate compounding. In English, 3.5% over 30 years is not necessarily better than 4% over 15 years. I would then take the opportunity to talk to the client about how comfortable they are with increasing their monthly payments. Refinancing into a shorter term mortgage is sometimes more beneficial than even the lower interest rate. This is because a 15-year mortgage roughly requires a monthly payment of only 25% more than a 30-year mortgage and allows you to build up equity in your home twice as fast!

Based on the client’s responses, I would then raise a few other questions such as:

- How is your credit now since the last time you got a mortgage? If it has gotten worse, refinancing probably does not make sense. You’re not going to get as favorable terms as you did the first time!

- How much equity do you have in your home? If you have to borrow more than 80% of the value of your home, you’re not going to be getting the best rates. You should probably wait until you have finally reached that 20% down threshold, and then consider refinancing.

- What are your closing costs? I’ve mentioned this already, but you really do need the specifics before you refinance because many items, such as recording fees, title fees, appraisal fees, attorney fees, points, and transfer taxes, could come into play. These one-time payments alone can make your decision for you about whether or not it is a good idea to refinance.

With interest rates at historical lows over recent years, refinancing has been very popular. Refinancing has been a very good financial strategy and has helped many of my clients, but you can actually make things worse for yourself and cost yourself more money in the long run if you do not consider things carefully.

-Tom