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How to Save On Holiday Spending

wpid-Photo-Nov-22-2012-919-AM.jpgIt’s that time of year when Thanksgiving comes and goes and before we know it Christmas will be upon us. For many people, this time of year means the giving and exchanging of gifts to family, friends and loved ones. It also means that many people will be worried about their spending over the Holiday season; with concerns of how to budget, going over budget, or amassing unwanted amounts of credit card debit.

Here are some ideas to help keep your Holiday spending in check in order to stick to your budget and avoid the trap of credit card debt – the gift that keeps on giving.

  1. Create a spending plan and stick to it. Many individuals have a budget when it comes to what they will spend on gifts for the Holidays. However, it becomes tempting to spend in excess of this budget when we see additional gifts we’d like to give or we feel guilty that what we’ve purchased isn’t enough for the person the gift is intended for. Sticking to your budget reduces the temptation to spend money you don’t have.
  1. Consider shopping earlier in the year. Rather than wait until the last minute, consider doing your shopping throughout the year. Items can be purchased throughout the year when they’re on sale, and perhaps when emotions are less likely to influence last-minute spending.
  1. Consider saving for your Holiday gifts throughout the year. Many banks and credit unions offer a Christmas account where folks can save their money specifically for the Holidays. Then, when it’s time to purchase gifts, the money is already there, budgeted for and ready to be used for its intended purpose. Avoid department store credit card offers to finance your spending.
  1. Communicate expectations. If things are tight or your budget is small, consider explaining this to your family. In most cases, family and friends will be completely understanding of the situation and will often suggest not giving them anything at all. Conversely, they may feel relieved when you tell them the same thing – a gift isn’t necessary.
  1. Consider listening. If a friend or family member mentions that they would rather not get a gift, consider taking that comment seriously. Granted, this is difficult to do as the act of giving gifts is an expression of love and appreciation. However, consider respecting their request. Perhaps in lieu of a gift, you write a nice card or note of appreciation to them. Another idea is to make a donation in their name to a charity or organization they’re involved in or have interest.
  1. Consider combination gifting. Many times family members will pool their gift money to give a bigger gift to their loved ones. This allows family members to participate in giving, without feeling bad that they can’t give as much. Additionally, the folks pooling their money should agree on the amount each person will contribute. Those with higher incomes or who’ve done better planning should not be expected to contribute the most. It should remain equal. It also means that those with more money to give should stick to the agreed upon amount to avoid contention and ill-feelings from those who can’t give more.
  1. Giving is not quid pro quo. If you receive a gift, be thankful. If you didn’t plan on getting the person who gave a gift, consider not doing so, but perhaps send a quick note of thanks in a card or letter. This not only saves money, but also the stress of getting a gift you had no intention of giving.

Penalties for Changing SOSEPP

broken-bambooSo – you’ve begun your Series of Substantially Equal Periodic Payments (SOSEPP) from your IRA to satisfy your §72(t) requirement.  Allofasudden, something happens that causes you to make a change to your payment – either purposely or through unforeseen circumstances.  What happens? You were supposed to keep the same payment for the longer of 5 years or until age 59½. What do you do now?

.Well – first of all, we must understand the timeline associated with an SOSEPP:  once begun (notwithstanding the “one-time change” exception which you can read about here), you have to continue those periodic payments without change for the longer of five years or until you reach age 59½.

If you make a change to your periodic payments (other than the one-time change), §72(t)(4) indicates that ALL of your payments, beginning with your first payment under the SOSEPP, will be subject to 1) ordinary income tax (should have already been assessed); 2) the 10% non-qualified withdrawal penalty; and 3) interest on any unpaid tax or penalty, calculated from the date(s) of the disbursal(s) forward to the date you “broke” the SOSEPP.

This Code section should strike fear in the hearts of folks who are considering a SOSEPP.  If you think about it, the possibilities for error are numerous. Your brokerage can fail to execute a disbursement the way you directed; you forget to take your withdrawal; you mistakenly take more (or less) than your SOSEPP prescribes… And if it’s been in place for several years, you’ll owe penalties back to the beginning of the plan, plus interest.

It doesn’t take much imagination to envision a scenario where you could be in pretty deep with such an error on your plan.  The IRS has no sense of humor when dealing with these cases – not many are overturned.

 

What to Expect After the Election

womanprayingNow that the election has come and gone I wanted to send a note on what we should expect for the next four years and beyond. Really, these are no big predictions, but at times we may tend to forget our long-term goals in the hype and excitement of short term events.

  1. Expect volatility. Volatility is the norm, not the exception. Therefore, it should come as no surprise that markets will fluctuate, gyrate and generally have many ups and downs over the next four years and beyond. Think of it this way, would we expect any higher returns on our investments if markets were always calm and stable? No. Volatility is the price (risk) we pay for expected higher returns. We can diversify and maintain focus, but volatility will never go away.
  1. Expect change. As the saying goes, the only thing that is permanent is change. Do I know what that change is going to be? I don’t. And really, if anyone tells you that they can predict what change is going to happen, be very leery. Laws will change, processes will change and people will change. We have very little control over it.
  1. Expect to save, and save more. In a recent article I read the author cited a study in which retirees were asked their number one regret. No, it wasn’t that they didn’t travel enough or visit with family or friends. And no, it wasn’t spending more time recreationally. The number one regret was not saving for retirement early enough. We’ve spoken quite a bit about paying yourself first and living off of the rest. Try your best to maximize your contributions to your 401k and IRAs. For 2016 (and 2017) those maximums are $18,000 annually ($24,000 if over age 50) for the 401k and $5,500 annually ($6,500 if over age 50) for IRAs.
  1. Expect a bright outlook on your life. One of the few things we can control is our happiness and our attitude. Focus on the things that matter and worry less about the things that don’t. Life’s too short.

Earlier W2 Filing Requirement in 2017

One of the new wrinkles forearlier-w2-filing tax filing requirements for 2017 is that employers must adhere to an earlier W2 filing date than in years’ past. For 2017,all W2 and W3 (employer records) must be filed with the Social Security Administration by January 31.

The previous deadline was the last day of February if the W2 and W3 forms are filed on paper; by the end of March if filed electronically.

Many employers will be caught off-guard by the earlier W2 filing requirement. I wouldn’t think it would be a problem to meet this requirement. The deadline of January 31 for distribution of employee Form W2’s has been the rule for quite a while now. The primary problem is if there are any corrections necessary. This will just cause the employer to have to amend his forms W2/W3 filings with SSA after the fact.

This earlier W2 filing requirement should not have an impact either way for most employees. Tax preparers preparing employer payroll tax forms may be a bit overwhelmed in January. This portion of W2/W3 filing is often delayed until after the employee copies of Form W2 have been distributed. Filings must now be complete by the end of January. This compresses the timeline for distribution to employees and submission to Social Security.

The IRS recently published a Reminder about this change, which was passed into law in December 2015 as part of the Protecting Americans from Tax Hikes (PATH) Act. The reminder is IR-2016-143. As part of this Reminder, IRS also notes that these changes (from the PATH Act, specifically if claiming Earned Income Tax Credit or Additional Child Tax Credit) may delay some tax refunds until after February 15, 2017.

Should I Pay Off Debt or Save for Retirement?

debt-freeeeeeeeeeeeeeeeeeee-300x300Over the last few weeks I’ve gotten quite a few questions from individuals ready to graduate college and start embarking on their first job. As is often the case, many of these individuals have varying amounts of student debt but also understand the importance of saving for retirement. Naturally, a common question is should they pay off student loans or save for retirement. Here’s my take.

As I’ve mentioned in previous posts, there are few ways to receive guaranteed returns. One of those ways is by paying down debt. This is an example of a guaranteed rate of return that is also risk free. By paying off a loan early, the interest that would have normally gone to the lender ends up in your own pocket. The good news is that the debt is retired faster, and the individual experienced zero volatility exposure compared to investing in the market.

On the other hand, what opportunity cost is the individual giving up by not investing in the market and allowing gains, dividends and interest a chance to compound over time? It’s true that the earlier an individual starts to save the more chance he or she has to take advantage of time in the market and the miracle of compound interest. We’ve all seen the examples of the difference between an individual that started investing early versus an individual getting a late start. In most cases the early investor comes out ahead.

Here are some things to consider if you find yourself in a similar situation. The first thing to do is assess your risk tolerance. In other words, are you capable of tolerating the market volatility (risk) that comes with investing outside of a risk free return? If so, investing in the market may be something to consider. In addition, are you certain you can get a higher rate of return than the interest rate on your student loan? For example, if you have a student loan interest rate of 6.8% what are your chances of getting a return higher than 6.8% in the market? The odds may be in your favor in any given year and over longer time periods, but the odds of losing money also need to be considered (and you will lose money). Paying down this debt early guarantees you 6.8% return without risk. That’s hard to beat.

Additionally, where do you plan on investing? For example, will you be investing in your employer’s 401k? Does the 401k have a match? If you have access to a 401k and your employer provides matching contributions, I would recommend saving to your 401k to the point where you receive the full matching contribution. Consider the match free money – risk free money; another rarity when investing. Once you’ve committed to saving enough to take advantage of the full employer match, consider paying extra to your student loans.

After a while, your student loans will be paid off. Good for you! However, you will have a monthly loan payment that you’ve been budgeting for quite some time. Consider keeping this monthly amount as part of your budget, and still treat it like a bill that’s due every month. Only now, you’re going to pay yourself. The good news is that you’ve already budgeted for it, but now you’re simply allocating that money to your 401k or IRA.

If you don’t have an employer match, consider saving in your 401k anyway. Aim for 15-25% of your gross income and focus on putting any extra money to your student loans. In just a short period of time, you’ll find that you’re way ahead of the game when it comes to having little to no debt and quite a bit saved for retirement. It’s simply a matter of prioritizing your money. Pay yourself first and live off of the rest.

Delayed Retirement Credits – When are These Applied?

delayed retirement credits are like marching in the snowIf you delay filing for your Social Security benefit, for each month that you delay you will earn delayed retirement credits. The increase for each month of delayed retirement credit is 2/3% (0.667%) for every month. This equates to 8% in delayed retirement credits for every year of delay. But when are these credits applied to your benefit?

As with so many Social Security-related calculations, timing is everything. With delayed retirement credits, the key is exactly when you stop delaying and start collecting benefits.

Starting Benefits Before Age 70

When you’re delaying benefits past your full retirement age (FRA), you can start receiving benefits at any age after FRA up to age 70. So, for example, if you decided to start your benefits upon the month of your 67th birthday, you’d have 8% in credits earned if your FRA was age 66. For the sake of this example, let’s say your birthday is June 15.

When you file for benefits beginning in the month of your 67th birthday, you would receive a benefit calculated as:

PIA + (PIA * 4%) = Benefit for the remainder of the year

And then, in January of the following year, your benefit will be recalculated as follows:

PIA + (PIA * 8%) = Benefit for this year

(In each year, of course the PIA is assumed to have any COLA already applied before the calculation.)

You are credited with the delayed retirement credits only once a year, in January. So when you applied for your benefit, being mid-year, you had only been credited with 6 months’ worth of delayed retirement credits by that point. Then the following January, the remaining 6 months’ of delayed retirement credits are applied.

Simon, who has a PIA of $1,000 and a date of birth of September 15, 1950, is going to delay his benefit until his age 67 and 6 months (March, 2018). His benefit for the first year (2018) will be calculated as follows:

$1,000 + ($1,000 * 10%) = $1,100

This is because as of January, 2018, he has earned a total of 15 months’ worth of delayed retirement credits. The remaining 3 months are credited to him in January of 2019:

$1,000 + ($1,000 * 12%) = $1,120

Of course, there is an exception to this rule – when you start your benefits at or after age 70.

Starting Benefits at or After Age 70

The exception to the rule is when you start your benefits at or after age 70. In this case, Social Security tosses out this notion of waiting until January to apply delayed retirement credits and applies them immediately.

So, in the case of Simon (from earlier), if he waits until age 70 to file for his benefits (September, 2020), his benefit at that point would be calculated as:

$1,000 + ($1,000 * 32%) = $1,320

And no further increases need to be applied, since all delayed retirement credits are already applied to his record.

Foresight from Experience in Planning

marriage-with-foresightWe can make a difference in our own lives if we make a simple change in our outlook. If we changed from a hindsight to a foresight perspective, many things about our society could improve dramatically. This foresight can help with retirement planning, marriage, and any major event in our lives.

I don’t mean that we should disregard history – of course not. On the contrary, we need to use history to provide us with foresight into the potential outcomes of our choices. The experiences we’ve encountered (and our friends/families/acquaintances have experienced) can help us to predict the outcome of various choices and decisions that we make in the future.

Consider these factors:

  • The divorce rate in the U.S. has been high for a very long time, causing a great deal of heartache and expense, not only for the couple but for family and friends as well. And one of the primary factors that causes a rift for young married couples is money problems.
  • The average cost of a wedding nowadays (according to this article on The Knot) is $31,213. Of course, most weddings cost far less than that, but for many folks the cost of the wedding is a very significant figure nonetheless. Often, paying the cost of a wedding can cause a young couple to go into debt before the knot is even tied.
  • The average college graduate in 2016 could expect to owe around $37,172 in student loans (per Student Loan Hero). If you assume that both members of the newly-married couple are college graduates, that amounts to nearly $75,000 in debt.
  • A “starter home” used to mean a 1 to 2 bedroom, 1 bath home at a price something on the order of one times the take home pay of a young family. Nowadays, the “starter home” has morphed into a 3+ bedroom, 2+ bath home, and the price can be as much as 2.5x to 3x the income of the family. This occurred for two reasons: the size of the average home increased dramatically; and most importantly, the amount of money that could be borrowed (as a percentage of the value of the home) increased significantly over time. Payments on mortgage loan debt have increased to an average of more than 25% of pre-tax income for folks right out of college.
  • Most people have a hard time talking openly about money. Money is one of those “taboo” subjects for most folks; conversations about money are uncomfortable. Because of this, most young couples don’t have serious discussions about finances until they start seeing problems.

Is it any wonder that divorce rates are high? A significant factor in divorces is financial issues, and the average young couple is starting out far in the hole – no wonder there are problems! Most of these young couples facing issues in their marriages can readily point out certain things that they wish they’d done differently in hindsight.

So the outcomes we see are a reaction to the factors. But what if we start using the experience of others to give foresight, to improve our own outcome? What if a young couple used the factors that can be working against the success of their marriage to try to avoid what seems inevitable?

Using Experience as Foresight for Marriage

Below are a few items to consider with your foresight:

Consider whether the wedding must be as expensive as originally planned, or as expensive as your friends’ wedding (or whatever is your gauge). Many, many long-lasting marriages were simple affairs that took place all in one church (reception in the basement). Of course you want to make the event memorable – but it doesn’t have to cost a fortune to make memories.

Make sure that you each understand one another’s debts – including what kinds of debt and how much. Have a plan for dealing with these payments, eliminating them over time. Also have a plan in place for how to keep these current if one of you is unemployed.

Instead of keeping the finances separated and only discussing money when it becomes a problem, talk about money up-front. Probably not on the first date, that might be a bit of a buzzkill, but definitely before marriage.

The accounts can remain separated after marriage if that’s a personal preference, but the couple should share the information with each other. Using this information, the couple can produce a household net worth statement. Don’t get hung up on the terminology, it’s just a report showing your assets (savings and things) minus your debts (loans and credit balances). You’ll need to do this when it comes time to get a mortgage; might as well get a head start on it.

It’s not a one-time thing, either. On a regular basis the couple should share in decision-making. Talk over things such as starting a new subscription or a membership to a fitness club, for example.

Often one member of the couple is responsible for paying the bills. This can be a mistake if the other member doesn’t have knowledge of the state of the month-to-month finances. It often makes sense to either do this together or split the responsibility (every other month, for example). At the very least, each spouse needs to know the household’s position – positive or negative cash flow. More income than expenses is positive, vice versa is negative.

The wedding example above is but one of many that illustrates the benefit of foresight. Review any major purchase, job change, retirement, or change in family similarly. Look at the potential pitfalls and use that information as foresight to guide your decisions.

I know many folks already use past experience as a guide – and kudos to those that do. But many more of us can use this change in perspective to improve our financial futures.

2017 Retirement Plan Contribution Limits

even-turtle-riders-have-limitsThe IRS recently published the new contribution limits for various retirement plans for 2017.  These limits are indexed to inflation, and as such sometimes they do not increase much year over year, and sometimes they don’t increase at all. This year for the third year in a row we saw virtually no increases contribution amounts, and the income limits increased for slightly as they did for 2016.

IRAs

The annual contribution limit for IRAs (both traditional and Roth) remains at $5,500 for 2017 (third year without an increase).  The “catch up” contribution amount, for folks age 50 or over, also remains at $1,000.

The income limits for traditional (deductible) IRAs increased slightly from last year: for singles covered by a retirement plan, your Modified Adjusted Gross Income (MAGI) must be less than $62,000 for a full deduction; phased deduction is allowed up to a MAGI of $72,000.  This is an increase of $1,000 over the limits for 2016.  For married folks filing jointly who are covered by a retirement plan by his or her employer, the MAGI limit is increased to $99,000, phased out at $119,000, also up $1,000 versus last year’s limits.  For married folks filing jointly who are not covered by a workplace retirement plan but are married to someone who is covered, the MAGI limit for deduction is $186,000, phased out at $196,000; this is an increase of $2,000 over 2016’s limits.

The income limits for Roth IRA contributions also increased: single folks with a MAGI less than $118,000 can make a full contribution, and this is phased out up to a MAGI of $133,000, an increase of $1,000 at each end of the range.  For married folks filing jointly, the MAGI limits are $186,000 to $196,000 for Roth contributions, up by $2,000 over 2016.

401(k), 403(b), 457 and SARSEP plans

For traditional employer-based retirement plans, the amount of deferred income allowed remains the same as the past two years. For 2016, employees are allowed to defer up to $18,000 with a catch up amount of $6,000 for those over age 50.  If you happen to work for a governmental agency that offers a 457 plan in addition to a 401(k) or 403(b) plan, you can double up and defer as much as $36,000 plus catch-ups, for a total of $48,000 deferred.

The limits for contributions to Roth 401(k) and Roth 403(b) are the same as traditional plans – the limit is for all plans of that type in total.  You are allowed to contribute up to the limit for either a Roth plan or a traditional plan, or a combination of the two.

SIMPLE

Savings Incentive Match Plans for Employees (SIMPLE) deferral limit is also unchanged at $12,500 for 2017.  The catch up amount is unchanged as well at $3,000, for folks at or older than age 50.

Saver’s Credit

The income limits for receiving the Saver’s Credit for contributing to a retirement plan increased for 2017.  The MAGI limit for married filing jointly increased from $61,500 to $62,000; for singles the limit is unchanged at $30,750; and for heads of household, the MAGI limit is $46,500, an increase from $46,125.  The saver’s credit rewards low and moderate income taxpayers who are working hard and need more help saving for retirement.  The table below provides more details on how the saver’s credit works:

Filing Status/Adjusted Gross Income for 2017
Amount of Credit Married Filing Jointly Head of Household Single/Others
50% of first $2,000 deferred $0 to $37,000 $0 to $27,750 $0 to $18,500
20% of first $2,000 deferred $37,001 to $40,000 $27,751 to $30,000 $18,501 to $20,000
10% of first $2,000 deferred $40,001 to $62,000 $30,001 to $46,500 $20,001 to $30,750

Why Young People Need Estate Planning

2770132690_0b9558b429_m1Many young individuals and couples think that the time to start thinking about estate planning is when they’re older, or perhaps if they ever have “estates”. On other occasions, the impetus to plan may be due to a recent death of a friend or family member without an estate plan or as my friend Tom, an estate planning attorney says, “Right before they take a trip over water.”

However, many young individuals should start thinking and “doing” some estate planning right away. Before we get to specific recommendation, let us first understand what estate planning is – and, what your “estate” is.

Essentially, your estate is everything you own. This includes your home, personal property, life insurance policies, invested assets, etc. Deciding how these assets are controlled and divided in the event of your death is called estate planning. Additionally, estate planning includes who will care for your children if you die, and who may make decisions on your behalf should you become incapacitated. More complex estate planning may involve legal aspects of trusts, taxation, gifting, etc.

Dying without a will (intestate) leaves the decision of how your assets will be divided, and more importantly, the guardianship of your children in the hands of the laws of the state you’re domiciled. This can lead to individuals inheriting your assets and caring for your children that you’d rather not. To prevent this individuals and couples can take steps now in order to make sure their requests are followed.

The following documents should be considered by everyone concerning estate planning.*

  1. A Will. Executing a will ensures that your assets are distributed to those individuals you want to inherit or disinherit your assets. Additionally, a will establishes who will be guardian of your children should both parents pass away. A will also determines the executor of your estate and may establish a trust for assets in order to provide monetary support for your children.
  1. Power of Attorney for Health Care. This document names a specific individual to make health care decisions on your behalf should you become incapacitated and can no longer make those decisions on your own. Readers in the state of Illinois can find a great example of a health care POA here.
  1. Power of Attorney for Property. Similar to the health care POA, the POA for property enables an individual you appoint to make property decisions on your behalf. Such transactions include real estate, investments, banking and taxation. Again, Illinois readers can find a great example here.
  1. A Living Will. A living will states your desire to have or not to have death-delaying procedures implemented in the event of your diagnosis of a terminal condition by a health care professional (your attending physician). This document assures your wishes will be followed in the event you’re unable to actively make that decision. Another excellent example for IL readers can be found here.
  1. Beneficiary Designations. It’s important to make sure your beneficiary designations are up to date ion your life insurance policies, annuities, retirement accounts and other investment accounts.

It goes without saying that in addition to having these documents prepared and available, individuals should talk to their family or individuals they want to have these responsibilities about their wishes, requests and potential responsibilities. Personally, and as a planner, I’ve seen families argue, fight, and ultimately discontinue speaking due to lack of communication when estate planning.

*Note: We recommend consulting a competent estate planning attorney for all of the above. The documents listed are merely examples and should not be considered replacements for professional, legal advice.

2016 Retirement Plan Contribution Limits

The IRS recently published the new contribution limits for various retirement plans for 2016.  These limits are indexed to inflation, and as such sometimes they do not increase much year over year, and sometimes they don’t increase at all. This year we saw a few increases for some contribution amounts, and the income limits increased for most types of accounts after virtually no changes to the contribution amounts in 2015.

IRAs

unusual contribution limitsThe annual contribution limit for IRAs (both traditional and Roth) remains at $5,500 for 2016 (second year without an increase).  The “catch up” contribution amount, for folks age 50 or over, also remains at $1,000.

The income limits for traditional (deductible) IRAs increased slightly from last year: for singles covered by a retirement plan, your Modified Adjusted Gross Income (MAGI) must be less than $61,000 for a full deduction; phased deduction is allowed up to a MAGI of $71,000.  This is the same as the limits for 2015.  For married folks filing jointly who are covered by a retirement plan by his or her employer, the MAGI limit is increased to $98,000, phased out at $118,000, also unchanged versus last year’s limits.  For married folks filing jointly who are not covered by a workplace retirement plan but are married to someone who is covered, the MAGI limit for deduction is $184,000, phased out at $194,000; this is an increase of $1,000 over 2015’s limits.

The income limits for Roth IRA contributions also increased: single folks with a MAGI less than $117,000 can make a full contribution, and this is phased out up to a MAGI of $132,000, an increase of $1,000 at each end of the range.  For married folks filing jointly, the MAGI limits are $184,000 to $194,000 for Roth contributions, up by $1,000 over 2015.

401(k), 403(b), 457 and SARSEP plans

For traditional employer-based retirement plans, the amount of deferred income allowed remains the same. For 2016, employees are allowed to defer up to $18,000 with a catch up amount of $6,000 for those over age 50.  If you happen to work for a governmental agency that offers a 457 plan in addition to a 401(k) or 403(b) plan, you can double up and defer as much as $36,000 plus catch-ups, for a total of $48,000 deferred.

The limits for contributions to Roth 401(k) and Roth 403(b) are the same as traditional plans – the limit is for all plans of that type in total.  You are allowed to contribute up to the limit for either a Roth plan or a traditional plan, or a combination of the two.

SIMPLE

Savings Incentive Match Plans for Employees (SIMPLE) deferral limit is also unchanged at $12,500 for 2016.  The catch up amount is unchanged as well at $3,000, for folks at or older than age 50.

Saver’s Credit

The income limits for receiving the Saver’s Credit for contributing to a retirement plan increased for 2016.  The MAGI limit for married filing jointly increased from $61,000 to $61,500; for singles the new limit is $30,750 (up from $30,500); and for heads of household, the MAGI limit is $46,125, an increase from $45,750.  The saver’s credit rewards low and moderate income taxpayers who are working hard and need more help saving for retirement.  The table below provides more details on how the saver’s credit works:

Filing Status/Adjusted Gross Income for 2016
Amount of Credit Married Filing Jointly Head of Household Single/Others
50% of first $2,000 deferred $0 to $37,000 $0 to $27,750 $0 to $18,500
20% of first $2,000 deferred $37,001 to $40,000 $27,751 to $30,000 $18,501 to $20,000
10% of first $2,000 deferred $40,001 to $61,500 $30,001 to $46,125 $20,001 to $30,750

How to Tackle Debt

debt-freeeeeeeeeeeeeeeeeeee-300x300It can easily happen. Whether we’re trying to keep up with the Joneses or investing in our education, sometimes debt can add up quickly. The good news is that debt can be erased. However, sometimes what we know we need to do is different from actually doing it. Here’s a game plan to start chipping away at your outstanding debt. With time and persistence, we can eliminate debt and increase our net worth.

Let’s start with some definitions of debt. Debt is debt, but there is some that is generally better than others. Mortgage debt isn’t considered bad debt (unless you bought more house than you can afford). Additionally, student loan debt isn’t terrible (as you’re investing in human capital), but interest rates can be higher than home debt. Vehicle debt isn’t great either. Pay cash for your vehicles. Credit card debt is bad. It’s debt that has no backing, no assets. Interest on many cards is deplorable as well. Generally, it’s wise to reduce your credit card debt first (as it’s usually the highest interest) followed by student debt, vehicle debt, etc.

Start first on where you’re spending your money. With a sheet of paper, make two lists. On the left hand side, title this list “Needs”. On the right hand side, title this list “Wants”. Generally, your wants will dwarf your needs. In this step, be honest with what your needs really are. For most people the basics are going to be shelter, food (not dining out), clothing, water, and utilities.

Grab last year’s bank statement and circle or highlight all of the needs. This will be mortgage/rent, groceries, utilities such as water and electricity, insurance and needed (not excess) clothing.

Now, start on the lists of wants. But instead of making a list from the top of your head, start going through your statements and listing the “wants” as they appear from what you spent. Items such as car payment, dining out, smartphone, coffee, TV/cable, etc., should be put down on the list of wants.

From there, determine what wants you’re spending money on that can be given up in order to reduce your debt. If you find you’re spending quite a bit dining out, consider taking that money and putting it toward your debt. The key becomes prioritizing. It’s not uncommon (and in fact, it’s quite easy) to find a few hundred dollars extra every month to plow into your debt.

Doing this exercise accomplishes a few things. First, it reduces your debt and builds your net worth. It also changes your habits and priorities. It forces you to think about your spending and whether or not a contemplated purchase will add any value to your life. It also provides guaranteed, risk-free returns. By eliminating debt you are saving a ton of money in interest payments, effectively giving that return to yourself instead of a creditor.

Finally, it changes your habits. The good news is that once the debt is paid off, you can still treat the payments you were making as a bill. Only now, you’re going to pay yourself first. For example, let’s say you’ve been making an extra $400 payment to pay off your vehicle or credit cards. Once they’re paid off, take that $400 and put it in your emergency fund, IRA or 401k. And keep making the payments. The good news is that you’ve already budgeted for it, only now the money goes in your pocket.

Roth 401k – Is It Right for You?

up-to-5-people-wonder-about-roth-401k-a-dayMany employers are now offering a Roth 401k option in addition to the traditional 401k option. And with this new choice comes many questions: What is the benefit? Is a Roth 401k a good idea for me? How can I choose between the traditional 401k and the Roth?

Benefits of Roth 401k

Much like a Roth IRA, the Roth 401k can provide you with tax-free income when you retire. This benefit comes to you in exchange for no tax deduction when you contribute your funds to the Roth account.

Contributing money to a traditional 401k account results in a reduction from your income for the year. Then when you withdraw money from the account in your retirement, you will have to pay tax on the money withdrawn. This is the primary difference between the traditional 401k and the Roth.

Another benefit of the Roth 401k is that when you retire (or leave the job) you can rollover the money directly to a Roth IRA – this will eliminate RMDs from ever being required on the account, once the account has been held for 5 years.

Making the Choice Between Traditional and Roth 401k

So, knowing the benefits of a Roth 401k you may wonder if a Roth 401k is right for your situation. This is not a simple answer, as with many investing and savings activities. It all depends on two primary factors: your applicable tax rate now, and the tax rate in the future.

Your applicable tax rate now is important because if you choose a Roth 401k you’ll be paying taxes on the income you are deferring into the account. On the other hand, if this same money was going into a traditional 401k account you would avoid tax on the money deferred.

So if your current applicable tax rate is high, there is much value in deferring tax on some of your income. With a lower (or zero) applicable tax rate then the benefit of deferring tax on contributions is reduced or eliminated.

Looking into the future, if you anticipate that your tax rate in retirement is going to be lower than your tax rate today, then the traditional 401k is likely your best option. This is because you are deferring income at one rate and then paying tax another lower rate in the future.

On the other hand, if you anticipate higher taxes in the future (and who doesn’t?) then the Roth 401k might make more sense. This is due to the fact that, by using the Roth 401k you can pay taxes today at your lower rate and then later withdraw those funds at a zero tax rate.

Tax-Loss Harvesting: It’s Never Too Late

Tax-loss harvesting is a tax move that can help with your income tax burden when you’ve experienced a loss with your investments.  Briefly, this is where you have a taxable account, holding stocks, bonds, or mutual funds and the market declines leaving your holdings in a loss situation.  Once you sell the holding, you have realized the loss, which enables you to take advantage of the tax laws and deduct those losses, first against any gains in your account(s), and then at a rate of $3,000 per year against ordinary income.

This is similar to the famous move that Mr. Trump (and I would be shocked if Mrs. Clinton never took a loss against future taxes) used to avoid future income taxes. This was recently discovered in Trump’s tax records and made out to be a fatcat loophole – at least by the media – when actually anyone can take advantage of it. In fact, it’s likely that if you have non-IRA investments you’ve probably taken advantage of this rule yourself.

As an example, say you purchased a mutual fund for $10,000 last year.  Over the course of this year, your mutual fund’s value reduced to $5,000.  If you sold the holding, you would have a loss of $5,000.  Using the tax law to your benefit, you are able to reduce your ordinary income by $3,000 for the current year and carry over the remaining $2,000 for writing off against the following year’s income.

It is important to note that the loss is first used to offset any capital gains you may have realized before you can use it to reduce ordinary income. Continuing the example, if you also sold investments in the current year that had capital gains of $2,600, your net capital loss for the year would be $2,400 ($5,000 minus $2,600). This would allow you to take the capital gains with zero taxes (just like Donald!) and also reduce your ordinary (wage) income by the remaining $2,400 of net capital loss.

Tax-loss harvesting is the action of realizing a loss in order to utilize the loss as a reduction against your other gains and ordinary income. You may not have chosen to sell the losing investment at that particular time for any other reason, but the benefit of tax-loss harvesting caused you to take the action.

taxes-by-x_jamesmorrisThe good news is that you can sell any loss positions (and let’s face it, who doesn’t have a loss position?) that you currently hold and then take this reduction of up to $3,000 in ordinary income for your current year’s taxes, which you’ll file next April.  It’ll be a nice surprise for you (if you’ve forgotten about it) when you get ready to file.

Not available to an IRA

This is one of the many benefits of holding at least a portion of your investments in non-qualified or non-IRA accounts.  Because in your IRA or 401(k) plan, losses you sustain are of no tax consequence.  Likewise, gains that you experience, along with the funds that you “hid” from taxes in earlier years, will be taxed at ordinary income tax rates – which are presently higher than the capital gains rates assessed against your taxable account gains.  And I don’t expect that the ordinary income tax rates are set to decline appreciably at any time in the near future, given the deficit spending being introduced at an alarming pace these days.

Multiple Income Streams

minimize taxesThis post is primarily geared toward younger individuals just starting out after college or from graduate school. However, the information can be used by anyone looking to boost income in order to increase retirement savings, pay off debt earlier or simply to put them in a better position financially.

In financial planning we often talk about risk management as one of the bricks to the foundation of any solid financial plan. Generally, when we say risk management we think of auto, home, life, disability and other insurance coverage in addition to an emergency fund. Another area of “insurance” would be creating additional or multiple income streams as a hedge against losing an income source due to downsizing, termination, etc. If none of the aforementioned negative events occurs, then the extra income can be used to bolster retirement savings, reduce debt, or save extra for college. The point is that if one job dissolves there are other income streams providing cash flow.

The question then becomes how to find these additional income streams or “pipelines”. One of the easiest would be to simply find another part-time job, preferably doing something you enjoy. This could be working at your child’s school as an aid, waiting tables an earning extra money in tips, or simply working hourly on the evenings or weekends at a local business.

Individuals may also consider starting their own business, part-time, to generate additional income. One area to look is as an offshoot to what the individual is currently doing. For example, if the individual is a teacher, they may also find it enjoyable to do consulting to teachers and schools in a particular area of expertise. Another example would be an accountant finding extra work from January through April doing tax returns. The main idea here is to leverage an individual’s current knowledge and expertise into another income stream. The learning curve is less onerous. From a tax perspective, the IRS allows certain deductions if you have a legitimate business and expenses.

One word of caution: be careful of starting a business that relies on the individual working hard to make someone else money (i.e. multi-level or network marketing organizations). Often these types of “businesses” recruit naïve individuals to sell their products and recruit others to the sales “pyramid”. Generally, those making any substantial income are those at the top of the pyramid (i.e. the founders).

Should you consider exploring another income source, feel free to contact our office and we’d be happy to answer questions and provide insight as to the particular path you choose to take.

SOSEPP & How a QDRO Affects It

In addition to the 72(t) exception available for folks with a QDRO (see this post), there is also the question of how a QDRO impacts an established Series of Substantially Equal Periodic Payments (SOSEPP) – which, as we know, once established can only be changed one time.

separati-en-casa-near-divorce-by-mirko-macariAlthough not definitive, below are summaries of three Private Letter Rulings (PLRs) that seem to suggest first of all that making the distribution is not subject to the 10% penalty when a QDRO or divorce decree is involved, pursuant to the regulation in Code section 72(t)(4)(A)(ii).

Private Letter Rulings for SOSEPP

1) The transfer to a taxpayer’s spouse pursuant to a divorce decree of 50% of each of three separate IRAs owned by the taxpayer from which the taxpayer had already begun receiving “substantially equal periodic payments” did not result in a modification where the taxpayer’s spouse was two years younger and would commence receiving similar payments such that the total of periodic payments to the taxpayer and his spouse subsequent to the division would be substantially equal to the periodic payments received by the taxpayer prior to the division. PLR 9739044

2) In PLR 200027060, the IRS rules that a spouse after the divorce, that  received a portion of the client’s IRA accounts that were being used to fund a SEPP,  didn’t need to continue the payments since it was a transfer under Code section 408(d)(6). What about the client – did all the payments have to be continued out of what remained of his accounts?

2a) Later in PLR 200050046 (with similar facts) the IRS ruled in favor of the taxpayer. “The reduction in the annual distribution from IRA 1 to Taxpayer A beginning in calendar year 2001, prior to Taxpayer A’s attaining age 59 1/2 , and assuming Taxpayer A has not died and has not become permanently disabled, will not constitute a subsequent modification in his series of periodic payments, as the term “subsequent modification” is used in Code section 72(t)(4), and will not result in the imposition upon Taxpayer A of the 10 percent additional income tax imposed by Code section 72(t)(1) pursuant to Code section 72(t)(4)(A)(ii).

In other PLRs, it has further been ruled that the IRA owner may reduce the 72(t) payment amount by the same percentage as the reduction in the overall account by distribution to the former spouse.  This is the case for a QDRO granting a division of a qualified plan or a divorce decree granting a division of an IRA when the SOSEPP has already been set up.  In these cases, the former spouse who receives the proceeds from the IRA or qualified plan was not required to continue a 72(t) payment plan – the funds could be rolled over into an IRA, or left in the plan as is.

It is also important to note that the RMD (Required Minimum Distribution) for the year of the transfer is still dependent upon the previous end-of-year balance in the account – and could be adjusted for the following year if a favorable PLR is reached for the case.

Tax Benefits for Job Hunting

5 santasThe IRS recently published their Summertime Tax Tip 2016-24, entitled “Looking for Work May Impact Your Taxes”, with some good tips that you should know as you go about job hunting.  The text of the actual publication from the IRS follows, and at the end of the article I have added a few additional job-related tax breaks that could be useful to you.

Looking for Work May Impact Your Taxes

If you are job hunting in the same line of work, you may be able to deduct some of your job search costs. Here are some key tax facts you should know about when searching for a new job:

  • Same Occupation.  Your expenses must be for a job search in your current line of work. You can’t deduct expenses for a job search in a new occupation.
  • Résumé Costs.  You can deduct the cost of preparing and mailing your résumé.
  • Travel Expenses.  If you travel to look for a new job, you may be able to deduct the cost of the trip. To deduct the cost of the travel to and from the area, the trip must be mainly to look for a new job. You may still be able to deduct some costs if looking for a job is not the main purpose of the trip.
  • Placement Agency. You can deduct some job placement agency fees you pay to look for a job.
  • First Job.  You can’t deduct job search expenses if you’re looking for a job for the first time.
  • Time Between Jobs.  You can’t deduct job search expenses if there was a long break between the end of your last job and the time you began looking for a new one.
  • Reimbursed Costs.  Reimbursed expenses are not deductible.
  • Schedule A.  You normally deduct your job search expenses on Schedule A, Itemized Deductions. Claim them as a miscellaneous deduction. You can deduct the total miscellaneous deductions that are more than two percent of your adjusted gross income.
  • Premium Tax Credit.  If you receive advance payments of the premium tax credit, it is important that you report changes in circumstances –  such as changes in your income, a change in eligibility for other coverage, or a change of address  –  to your Health Insurance Marketplace.  Advance payments are paid directly to your insurance company and lower the out-of-pocket cost for your health insurance premiums.  Reporting changes will help you get the proper type and amount of financial assistance so you can avoid getting too much or too little in advance.

For more on job hunting refer to Publication 529, Miscellaneous Deductions. You can get IRS tax forms and publications on IRS.gov/forms at any time.

In addition to all that…

It’s important to know that you have some other job-related tax breaks which you can take advantage of…

Moving Expenses – if you move to a new home for your employment, either a new job or just being transferred in your current job, you might be able to deduct your moving expenses if:

  • the move is closely related to your start of work in the new location
  • your new work location is more than 50 miles farther away from your old home than the distance from your old home to the old work location.  In other words, if your old workplace was 7 miles away from your old home, your new workplace must be at least 57 miles away from your old home.
  • you must continue to work in the new location for at least 39 weeks during the 12 months after the move.  If you’re self-employed you must also work in the new job for 78 weeks during the 24 months following the move. (There are exceptions for disability, layoff, transfers, and other situations.)

You may include the cost of transportation and storage of your household goods for up to 30 days, as well as travel and lodging from the old home to the new home (only one trip per person).

Unreimbursed Employee Business Expenses – certain expenses related to your job that are not reimbursed by your employer can be deducted.  Some examples are:

  • Dues to professional associations and chambers of commerce if work related and entertainment is not one of the main purposes of the organization.  Any part of the dues that is related to lobbying or political activities is not deductible.
  • Educational expenses related to your work.  These expenses must be required to maintain your current job, serving a business purpose of your employer, and not part of a program that will qualify the taxpayer for a new trade or business.
  • Licenses and regulatory fees.
  • Malpractice insurance premiums.
  • Office-in-home expenses (subject to quite a few qualifications)
  • Phone charges for business use (but not the cost of basic service for the first phone in a home)
  • Physical exams required by the employer
  • Protective clothing and safety equipment required for work, as well as tools and supplies required for your job
  • Uniforms required by your employer that are not suitable for ordinary wear
  • Union dues and expenses

This is not an exhaustive list – you can find more information by going to the IRS website at www.IRS.gov.

Photo by Richard Croft

The Third Most Important Factor to Investing Success

out_at_thirdPreviously I wrote about the Most Important Factor and the Second Most Important Factor to Investing Success. Continuing this streak I’ll give you the third most important factor to investing success: Leave it alone.

To recap: The most important factor is to continuously save and add to your nest egg over your career; the second factor is allocation – make sure you’re investing in a diversified allocation that will grow over time.

The third most important factor to investing success: Once you’ve started investing, leave it alone. Resist the temptation to sell off the component of your allocation plan that’s lagging; the reason you have a diversified allocation is so that some pieces will lag while others flourish, and vice-versa.

Reallocate your funds from time to time (once a year at most) to match your allocation plan, but that’s all the fussing you should do with your investments. Leave it alone.

No Loans

In addition to resisting temptation to fiddle with the investments, don’t take out a loan from your account. Even though this may seem like a good alternative to other loan sources, your best option is to disregard the 401k loan as an alternative altogether. Taking a loan puts you behind the eight ball – having to pay back the loan will likely take over your ability to save consistently (Factor #1) and will have a portion of your funds allocated to a loan instead of your growth allocation (Factor #2).

How to Pay Off Students Loans and Save for Retirement

Businessman juggling fruit

Businessman juggling fruit

Very often in my classes I get asked the question “What should I do first, pay off student loans or save for retirement?” My goal is to give some perspective on approaching these two very important issues.

Generally, holding student loans and making the minimum payments can lead to an unnecessary amount of interest being paid. For example, if an individual has a student loan at 6%, then that loan is earning 6% but for the lender not for the student. Many individuals find themselves wanting to pay off their student loans as quickly as possible.

On the other hand, recent college graduates are also faced with the decision to save for retirement.  Many of them have heard that it is wise to start saving when they are young in order to let compounding work its magic. However, many individuals are confused as to which situation they should take care of first.

Here’s my take. If an individual has a 401k with employer matching, then it makes perfect sense to save to the maximum possible in order to receive the full the employer match. The employer match is essentially free money and is a guaranteed return on the employee’s deferral. If an individual does not have an employer match, they could still consider saving a percentage of their income – say 15% to start.

Once that is done, the individual can accelerate payments to their student loans. Essentially, the individual is earning a guaranteed rate of return equal to the amount of interest on the loan. I don’t know about you, but a 6% guaranteed return without risk is extremely difficult to achieve elsewhere. The beauty of this plan is that once the student loan is paid off the individual can take the money that was being allocated to the loan and reallocate to the retirement savings. Individuals finding themselves maxing out their 401k should consider contributing to an IRA once that happens.

Finally, a key to making this work is making the payments automatic.  Saving to a 401k is automated easily since the deferrals are coming directly from the paycheck. However, accelerating student loan payments is less convenient.  That being said, an individual can set up automatic payments through their bank to be made at periodic intervals (say, monthly) to their loan in order to put this on autopilot. Individuals may also consider allocating pay raises and bonuses to chip away at the loan.

This is one way an individual can take care of two priorities early in her career. The key will be to make these priorities above and beyond the temptations of everyday wants such as dining out or cable TV. More information on student loan payback options can be found here. 

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