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The Earliest Age You Can Withdraw Retirement Money Without Penalty

numbersQuick – what’s the earliest age you can withdraw money from a retirement account without paying a penalty? Is it 59½?

Well, if that was your answer, you are probably in the majority. That’s the general overall rule regarding withdrawal of IRA and 401(k) money. And definitely, you should be able to withdraw money from your account after that age without penalty (unless it’s in a 401(k), you’re still employed, and your plan restricts in-plan distributions). But this is much later than the real answer.

If your answer was 55, you’re in an elite group. You know about the age 55 provision that provides the ability to withdraw 401(k) funds without penalty if you’ve left employment at or after age 55. This is a good answer, but the real answer using this provision is age 54. This is because the rule specifically states that you can take withdrawals penalty-free from your plan if you leave employment “during the calendar year that you will reach age 55”. So, technically, if your birthday is in December, you could leave employment as early as January of that year (at age 54 and one month) and still be eligible for penalty-free withdrawals from your 401(k) plan (but not an IRA). This is still much later than the real answer.

So, looking at the age 55 paragraph, you might guess age 50 if you’re a public safety employee – which you would immediately adjust to age 49. This is an even younger (and clever) answer, but still not the earliest age.

The real answer is that this is a trick question. If you meet one of the exceptions noted in either the 401(k) withdrawal exceptions or the IRA withdrawal exceptions articles, you can take a withdrawal at ANY AGE without penalty, as long as you are an eligible participant in the retirement account. Technically there is no minimum age at which you could take a penalty-free withdrawal from your retirement plan!

Where To Establish Your IRA Account

Establishing and contributing to an IRA (Traditional or Roth) is pretty simple and straightforward. There are many institutions where you can establish your IRA accounts:  banks, savings and loans, credit unions, insurance companies, mutual fund companies, and brokerages.  There are pros and cons to each type of institution, as we’ll list below.  These alternatives represent the major options for opening your IRA, in no particular order.

where to establish your IRA

Institution

Pros

Cons

Banks, Savings and Loans & Credit Unions

Banks are well-known as some of the most stable and conservative institutions in our financial industry.  For many folks, this is an assurance that there is additional safety in placing funds with these institutions, and in a way, with FDIC insurance, there is additional safety. This is mitigated quite a bit with the protections provided by law to IRA accounts. Since banks are conservative, until recently, their options for investment of IRAs were somewhat limited.  Traditionally, cash-oriented investments such as CDs and money market savings were the primary means of investment within banks.  This has changed lately with some deregulation of the banks, as many offer mutual fund investments in addition to the traditional offerings.
Insurance Companies While there are many arguments about the merits (or demerits) of placing annuity investments into IRAs, this is one of the options that insurance companies bring to the table.  Annuity investments can provide a stable guaranteed income stream for retirement. A Qualified Longevity Annuity Contract (QLAC) is one example of an annuity used in an IRA. Many times the products that insurance companies have to offer have significantly higher costs than can be found in other similar investment choices.  Annual expense ratios run in the 2% plus range. The increased expenses are used to pay for the unique features (longevity insurance, for example) of the insurance products.
Mutual Fund Companies Typically the lowest-cost providers of IRAs, with a wide variety of investment offerings.  In addition, once the account is established, there often are no transaction costs for additional contributions (if the investments are no-load).  This supports the concept of dollar-cost-averaging through low- or no-cost additions to the account. Many mutual funds have minimum investment levels that make investment into the funds difficult within the IRA. This is especially true in the early years of the account when the balance is smaller.  In addition, with the exception of no-load mutual funds, there can be sales charges associated with the funds, ranging anywhere from 2% up to 5% and more.
Brokerage Wide variety of investment choices. Depending upon the brokerage, can be a very cost effective option, in terms of transaction costs. Typically have a transaction cost with each contribution, which is in contention with the concept of dollar-cost averaging, as each individual contribution, if invested immediately, can generate a transaction fee ranging from $10 to $50, depending upon the brokerage.
Self-Directed IRA Custodian These custodians provide access to more specialized and unique investment choices, such as real estate, private offerings, and tax liens. The custodian provides expertise in the form of attorneys and other advisors to assist in the diverse selection of investments within the IRA in order to maintain the legal status of the deferred account. Generally the highest-cost option of all choices due to the additional back-office support. Due to the investment choices, may be very limited in flexibility.

As you can see, there are positives and negatives to each type of institution.  You need to be comfortable with your choice of financial institution to establish your IRA, as you will likely be dealing with the company for many years in the future.  Although you could make a change (rollover your funds) to a different institution at pretty much any time within limits, making those changes can be a hassle, so it’s best to use careful consideration in your choice.

The Retirement Answer

Although I will admit that the title of this post is a bit glamorous, I wanted to share the simplicity of the message.

Typically, every morning we will sit down to eat breakfast. Meals at our house are generally jovial, with discussions ranging from which animal would win in a fight to how my kids will spend their day.

A few mornings ago, however, my oldest asked me a rather interesting question. Knowing what I do for a living she asked, “Daddy, what do you have to do to retire?” My immediate response was, “That’s a great question!” At age 7, my heart swelled that she was already thinking about retirement.

Before I could give an answer she quickly quipped, “Wait. I know. You have to save enough money so that one day you can retire.” I was speechless. Pretty profound for a 7-year-old. Finally, I replied, “That’s exactly what you need to do!” Then my wife threw a rock at my already fragile ego and jabbed, “And it doesn’t take a Master’s or PhD to figure that out!”

Thanks, dear.

But really, that’s all that there is to retirement – saving enough to one day retire. I told my daughter that sadly, many people forget that the answer is really that simple, yet so hard for them to employ. I told her that many people choose to prioritize their money elsewhere and don’t think to save until it’s too late.

She then asked how old you have to be to retire. My wife mentioned that many people retire at age 65. I replied that people can retire when they want to – as it’s really how much they need to spend versus how much they have saved. I also said that if you love what you do, you may never retire.

“I’m going to save a lot of money”, she replied.

“I think that’s a great plan”, I replied.

A great plan indeed.

Traveling for Charity? You may have deductions

traveling for charityMost of us realize that donating money and goods to a charity can be beneficial on our tax returns. But did you know that traveling for charity can also be deducted? It’s true – with some limitations, of course.

When you do work for a charity, whether building houses, manning a recruitment booth, or picking up items donated, travel may be required. If you use your own personal vehicle (or your company vehicle if you own the company) your travel involved with this work can often be deducted as well.

For example, you might volunteer at your church to help with the annual winter clothing drive. Your job is to visit the homes of donors to pick up the clothing for the drive, making the donation much simpler for folks who don’t have time to come down to the church. Your mileage for driving around to the donors’ homes can be counted as a deductible out of pocket expense on your tax return for the year.

A more involved example would be if you volunteer to help build a water filtration plant for a community in a third-world country, sponsored by a qualified charitable organization. Your out-of-pocket costs for airfare, lodging, and ground transportation can be deductible if those costs are strictly related to the charitable work, and the trip is predominantly associated with the work. That is to say, your trip is not a “vacation” with a small amount of time spent working for the charity – the trip should be about the charitable work first and foremost.

The IRS recently published a Summertime Tax Tip (2017-2) that gives some broad overview information on deducting expenses while traveling for charity. The text of the Tip follows below.

Tips to Keep in Mind for Taxpayers Traveling for Charity

During the summer, some taxpayers may travel because of their involvement with a qualified charity. These traveling taxpayers may be able to lower their taxes.

Here are some tax tips for taxpayers to use when deducting charity-related travel expenses:

  • Qualified Charities. For a taxpayer to deduct costs, they must volunteer for a qualified charity. Most groups must apply to the IRS to become qualified. Churches and governments are generally qualified, and do not need to apply to the IRS. A taxpayer should ask the group about its status before they donate. Taxpayers can also use the Select Check tool on IRS.gov to check a group’s status.
  • Out-of-Pocket Expenses.  A taxpayer may be able to deduct some of their costs including travel. These out-of-pocket expenses must be necessary while the taxpayer is away from home. All costs must be:
    • Unreimbursed,
    • Directly connected with the services,
    • Expenses the taxpayer had only because of the services the taxpayer gave, and
    • Not personal, living or family expenses.
  • Genuine and Substantial Duty. The charity work the taxpayer is involved with has to be real and substantial throughout the trip. The taxpayer can’t deduct expenses if they only have nominal duties or do not have any duties for significant parts of the trip.
  • Value of Time or Service.  A taxpayer can’t deduct the value of their time or services that they give to charity. This includes income lost while the taxpayer serves as an unpaid volunteer for a qualified charity.
  • Travel Expenses a Taxpayer Can Deduct. The types of expenses a taxpayer may be able to deduct include:
    • Air, rail and bus transportation,
    • Car expenses,
    • Lodging costs,
    • Cost of meals, and
    • Taxi or other transportation costs between the airport or station and their hotel.
  • Travel Expenses a Taxpayer Can’t Deduct. Some types of travel do not qualify for a tax deduction. For example, a taxpayer can’t deduct their costs if a significant part of the trip involves recreation or vacation.

For more on these rules, see Publication 526, Charitable Contributions. Get it on IRS.gov/forms at any time.

Downside to the Age 55 Rule for 401k

downsideIn other articles we’ve covered the Age 55 rule for 401k plans – where you’re allowed to withdraw money from your 401k penalty-free if you leave employment at or after age 55. But there’s a downside to the Age 55 rule that you need to know about. We’ll cover the downside today.

When you reach age 55 and leave employment, you may be looking to use your 401k plan as your source of income needs for a few coming years. Perhaps you plan to withdraw from the 401k until you reach age 59½, when you’ll have access to other deferred money, or maybe until you reach age 62 and start receiving Social Security.

But there could be a problem in your strategy. Your 401k administrator might only allow a one-time lump-sum withdrawal from the plan! Many plans have this restriction – the reasoning being that they see the plan primarily as an accumulation vehicle, and they do not want to be in the position of maintaining long-term distributions.

So, for example, Steve retires from his job at age 56, knowing that he can take withdrawals from his 401k plan without penalty. So when he maps this out, he needs approximately $50,000 from his 401k plan each year. He needs this amount until he reaches age 62, when he’ll start taking his Social Security and drawing his pension.

When Steve contacts the 401k administrator to set this up, he learns that the plan only allows a lump sum distribution! This means that Steve would have to take a distribution of $150,000 to get him to age 59½. Of course this would result in significantly more tax than Steve anticipated, but there’s not much else he could do, other than going back to work. (It should be noted that not all 401k plans have this restriction – many will allow multiple withdrawals, but many do restrict withdrawals to a one-time lump sum. Check with your plan administrator as you devise your strategy.)

If he rolls over the 401k plan to an IRA, the Age 55 rule no longer applies. However, Steve has another option that can help the overall tax situation, by staging his withdrawals.

Staging Withdrawals

If Steve took the entire lump sum of $150,000 from his 401k in one year (rolling over the rest of the account to an IRA), the tax would be approximately $32,070, since he’s single. If he was married, the tax would be approximately $23,778. But, since he only needs $50,000 in the first year, he could withdraw that $50,000 for a tax cost of approximately $5,940 ($3,448 if he was married). The remaining 401k would be rolled over into an IRA.

Then in the subsequent years, Steve could take “early” withdrawals of $50,000 each year, paying the 10% penalty. His total tax each of the two following years (his age 57 and 58) would work out to $10,940 per year (or $8,448 if he was married). So his total tax for the three years amounts to $27,820 – a savings of $4,250. If he was married the total tax would have been $20,344, saving $3,434 by staging. However, any way you look at it, this is costing an extra $10,000 in penalties, so it’s not the boon you thought it would be (if your plan is restricted like this).

Often, the best option to deal with this downside to the Age 55 rule is to come up with some other source of income during the intervening years. A part-time job could be the answer, helping Steve through the couple of years before he reaches age 59½. Or perhaps one of the other exceptions to early withdrawal could apply for a portion of his income needs. At age 59½ he could have the entire amount rolled over into an IRA and he’d have unfettered (unpenalized) access to the money in any amount.

How to Get Your Social Security Statement

One of the requests we make when doing retirement or Social Security claiming plans for clients is for the clients to bring in their Social Security statements. As many readers are aware, these statements can be retrieved online from the Social Security website. Below is a step by step process to retrieve your statement online.

  1. Go to https://secure.ssa.gov/RIL/SiView.do
  2. Click on “Create an Account” and agree to the Terms of Service
  3. Enter your personal information on the following page
  4. You will be required to answer questions related to your identity and background (be careful – answering these questions wrong will require you to call or go into the local office)
  5. Set up your account with a username and password.
  6. You should then be able to view and retrieve your statement, earning history, etc.

If you’re leery of giving your personal information online, you can go into your local Social Security office and verify your ID by showing a valid photo ID.

If you’re not wanting to set up an online account, there are some other means to retrieve your statement. You can request a paper statement by going here. Additionally, if you’re age 60 or older you’ll receive your paper statement in the mail three months before your birthday – if you’re currently not receiving benefits nor have access to your account online.

How to Save Even More

owe taxesIn the past, we’ve written about how to save more money by paying yourself first, saving 15-25% of your gross income, or saving just 1% more in order to have enough to retire comfortably, send a child to college, or other goals requiring capital needs.

Saving money via payroll deductions, automatic contributions to IRAs and 401ks, and directly into piggy banks (for kids and adults alike) can be considered ways to save money directly. However, there are some ways to save money indirectly – and convert that money into direct savings towards retirement, college, or other financial goals.

  1. Turn the lights off (shut the door, close the refrigerator)! This phrase still echoes in my head from when I was younger. My parents could frequently be heard telling me to turn lights off in my bedroom or in the house if I wasn’t going to be using them or needing them. Now, I catch myself telling my own kids to remember to turn lights off – explaining to them that every month, mommy and daddy have to pay to use the lights power that we need. Being frugal with your utilities means having more in your pocket; it adds up. And if you’re one of those folks who argues that it’s not a big deal leaving lights on because you have energy efficient bulbs, think of the following. Would you leave your car running in the garage or at work just because it gets good gas mileage?
  2. Don’t grocery shop hungry. When I was in college I can remember several times I would go grocery shopping when I hadn’t eaten for quite some time. This usually ended up with me buying a lot of food (ramen) I didn’t need, wasn’t very healthy, and either ended up getting wasted or sat in my pantry for a long time. One of the best times to go grocery shopping is when you’re full, and after you’ve made a list of the items you need. Being full reduces the risk of buying “with your eyes” and helps keep you focused on only the food items you need. It will also prevent you from buying junk food which is typically the body’s response to satisfy cravings when you’re hungry.
  3. Take inventory of your spending. A good way to track needless spending is to get your last three month’s bank statements and go over them with a fine-toothed comb. On a separate sheet of paper write down two columns – wants and needs. Carefully write down the items that are needs (generally food (not dining out), shelter, water, etc.) and those that are wants. This exercise allows you to take inventory of what you’re spending money on – and is generally free from bias since you’re looking at your spending in the past. Get rid of items you don’t use or need such as magazine subscriptions, TV subscriptions, dining out, etc. The wants and needs are relative to you – only you can be the best judge of what is a need and want.

These are just some starting points to use. After considering these actions, take the money you’re not spending and direct it to your retirement, college savings, or emergency fund. Better yet, ramp up your savings to these accounts first (pay yourself first) and then figure out a way to live on the rest. By doing this first, you force yourself to get rid of things you don’t need and can quickly change your mindset to remember to shut off lights, close doors, etc. It’s amazing how frugal and efficient you can be when the money is no longer there to waste – you’ve made it a priority to put it elsewhere – where it will go muc

Public Safety Employee Retirement Plan Withdrawal at Age 50

public safety employee age 50For certain types of workers, specifically someone employed as a public safety employee, there is a special exception to the normal distribution rules. For a public safety employee, retirement plan withdrawal can begin without penalty as early as age 50, rather than age 55 or 59½.

Public Safety Employee

The list of public safety employees includes government or municipal firefighters, police, and emergency medical service employees. Recent expansion of this definition was put in place to include federal employees who work in certain public safety professions. These additional classifications include federal law enforcement, customs and border protection officers, federal firefighters, air traffic controllers, nuclear materials couriers, and members of the US Capitol Police, Supreme Court Police, and diplomatic security special agents of the Department of State.

This provision has been put in place to allow for an earlier withdrawal from the workforce by these individuals. These professions often exact a toll on the worker that results in a shortened career span versus other occupations.

Separation from Service on or after age 50

In order to take advantage of this provision, the worker must be employed in the public safety profession and leaves service upon reaching age 50 or at any point after that age. This allows the individual to make withdrawals from retirement plans without penalty prior to age 59½. Otherwise, unless another exception applies to the retirement account, any early distribution from a retirement plan would result in a 10% penalty applied to the distribution.

The age 50 exception applies to all government-based retirement plans, including defined benefit and defined contribution plans. This exception does not apply to Individual Retirement Arrangement (IRA) plans.

So, if Patricia, a firefighter who has a 457 retirement plan, a pension from her county, and an IRA, decides to retire at age 51 she can withdraw funds from the 457 and begin receiving payments from her pension without penalty. She cannot take distributions from her IRA (unless another early-withdrawal exception applies). Tax will be owed on any normally-taxable distributions from these accounts.

In addition, if Patricia rolls over her 457 plan into an IRA or another employer’s retirement plan, she loses the age 50 distribution exception. This exception only applies to her original retirement account.

Home Equity is Not a License to Spend

vacation homeMany homeowners find themselves in a beneficial position a few or many years into their mortgage. As their payments continue, their mortgage balance gradually lessens and generally their home equity increases.

It may be tempting to view this increase in equity as a license to spend. In other words, individuals may be tempted to start spending on wants versus needs and no longer delay gratification.

A few arguments can be made in favor of using your homes equity in order to make purchases. Such arguments include home remodels, purchasing vehicles, taking vacations, and paying for college. Additionally, some may argue that if interest rates are low, one could use home equity and invest in the stock market – profiting from the spread of market gains and the loan interest. Further augmenting these arguments is the fact that the interest on a home equity loan may be tax deductible.

Let me give a few arguments against using your home’s equity to make purchases. Regarding home improvements – why not save the money needed to make the improvements without a loan? These improvements can be done over time and do not diminish your net worth. The same argument is true with vehicles and vacations. Save money to purchase vehicles (preferably used) and take vacations. And if you can’t afford the vehicle or vacation – don’t purchase it. Or better yet, think of a way to find cheaper transportation (bike, carpool, public) or take a cheaper vacation.

To combat the argument of using home equity to invest in the stock market, let me make one thing clear – market returns are not guaranteed. While there is the possibility to earn more that the interest rate on the equity loan, there is also the risk of losing money, yet still owing on the loan.

It makes very little sense to acquire debt, just to acquire more stuff. Additionally, real estate prices/valuations are no guarantee. A home owner could take out a home equity loan, and see the market value of the home drop (just like the stock market). In which case the home owner is upside down – owing more money that the home is worth. This can create dire circumstances should the home need to be sold.

One argument I do favor regarding home equity is when considering a reverse mortgage. Reverse mortgages allow homeowners to tap the equity in their home in order to supplement their retirement income. While reverse mortgages may be ideal for some, it’s important to do your due diligence. More information on reverse mortgages can be found here.

I think the key point is to delay gratification, and working diligently to keep increasing net worth. Use home equity to build and increase wealth, not diminish it.

5 Questions to Ask Your Advisor

If you’re contemplating hiring a financial planner or advisor or if you’re currently working with one, here are some fair and important questions you may consider asking him or her.

  1. Are you a fiduciary? Being a fiduciary means that the adviser must legally act in your best interest. While not an absolute guarantee that the advisor will never act otherwise, most advisors who are fiduciaries embrace the responsibility – they want to be fiduciaries. Any other answer then yes to this question means you need to keep searching for an advisor who is.
  2. How are you paid? Generally, three different answers will follow. It will either be fee-only, fee and commission, or commission. If the advisor says fee-based or salary, you’ll want to dig deeper. These two responses don’t say how the compensation is derived. More importantly, you want to know how you will pay the advisor. And if you’re curious, exactly how much. Fee-only means the advisor is compensated directly from you, the client via hourly, retainer, or asset under management fees. Fee and commission is a combination of asset or hourly fees and commissions from product sales. Commission is derived from the sale of products. If the advisor is unsure – move on.
  3. What value do you provide relative to the money you’re paid? Like the questions says, this is relative. Cheap to one person may be expensive to another. Regardless of how much is paid, make sure you’re receiving value. If you’re unsure, ask the adviser to write it down for you. Good advisors may well be worth the money you pay – and then some.
  4. What are your credentials? Ask your advisor what credentials and education they have obtained to be able to work with you and your situation professionally. Many advisors have designations and some will also have degrees specific to financial planning. Degrees specific to financial planning include bachelor’s and Master’s degrees in financial planning or services, consumer finance, wealth management, and family economics among others. Specific designations to financial planning include the CFP® and ChFC®. The CFP® is considered the gold standard in financial planning designations.
  5. What conflicts or potential conflicts of interest exist? If the advisor only gets paid if you’re sold a product, that’s a conflict. If they only get paid if you move assets to their firm, that’s a conflict. Conflicts are everywhere. They should and need to be disclosed – preferably in writing. Ask your advisor how he or she will mitigate or avoid conflicts of interest. If the conflicts are incongruent with your beliefs and values, find an advisor that is a better fit. It’s important to note that just because there’s a conflict does not mean the advisor is wrong or unethical.

Hopefully these questions will help provide a baseline to start the conversation with your advisor. Surely more will arise in your conversations, and that’s to be expected.

Interaction of Survivor Benefits with Your Own Benefits

interactionSocial Security Survivor Benefits can be a critical lifeline for surviving spouses. The interaction of survivor benefits with your own benefits can be a bit confusing though. Does starting to receive one benefit affect your future amount of the other benefit? How about vice-versa? There’s a lot written about the topic in Social Security’s POMS manual, but it becomes very simple after you study it a bit.

The interaction of survivor benefits with your own benefits can be played out in one of two ways: either you take your own benefit first and the survivor benefit later; or vice versa, taking the survivor benefit first followed by your own benefit. We’ll look at each of these methods and review the interaction of survivor benefits with your own benefits.

Note: in our examples, we are assuming that the survivor benefit has been calculated correctly per the late spouse’s circumstances. See How is the Social Security Survivor Benefit Calculated? for more details on the calculations. It’s also important to understand that there is a difference between Survivor Benefits and Spousal Benefits. Survivor Benefits are only available once your spouse has passed away, while Spousal Benefits are only available during his or her lifetime.

Survivor Benefits First

In this case, you will be filing for your survivor benefit first, and then filing for your own benefit at some point in the future. You might do this if you’re under FRA when you become eligible for the survivor benefit and wish to delay filing for your own benefit until later. Or you want to delay your own benefit until it’s maximized at your age 70. Generally speaking, the only way this would make sense is if your survivor benefit is something less than what your own future benefit can be.

Filing for your Survivor Benefit has zero impact on your own benefit in the future. Receipt of the Survivor Benefit in prior years (from filing for your own benefit) isn’t even noted when you file for your own benefit later.

For example, Robin, a widow age 62, has a survivor benefit coming to her that would amount to $1,000 at her present age. Her own benefit will be $1,500 when she reaches FRA (at age 66 and 4 months), or it could grow to $1,950 if she waits until she reaches age 70.

Robin can take the survivor benefit right away and collect $1,000 per month for the next several years, and then file for her own benefit (at any point). There will be no reduction to her own benefit from her “early” filing for the survivor benefit.

Own Benefits First

This is the reverse of the above situation: you are filing for your own benefit first, and then later filing for the survivor benefit. This occurs when the survivor benefit will be something more than your own benefit – and of course the amount would be maximized when you reach FRA. In the meantime you are collecting your own benefit until you decide to file for the survivor benefit.

Jack is a surviving widower, age 63. He has a benefit based on his own record that will pay him $900 per month now, at his current age. He also has a survivor’s benefit that will pay him $1,200 per month if he waits until FRA to file for the survivor benefit.

When Jack files for his own benefit, it is reduced from the amount that could be paid to him if he waits until FRA, a total reduction of $225 (his FRA amount would be $1,125). When he later files for the survivor benefit, SSA does a calculation to determine the amount of benefit he will receive:

The reduced retirement benefit is subtracted from the total survivor benefit. That difference will become the survivor portion of the benefit, and the individual will also continue to receive his or her own benefit. The two are added together.

So in Jack’s case, the survivor portion of his benefit will be $1,200 minus $900 ($300). So Jack will receive one check each month in the amount of $1,200, which is made up of his own benefit ($900) plus the survivor portion ($300).

The bottom line

The bottom line is this: in either case, starting one benefit early has zero impact on starting the other benefit at a later date. So – if you find yourself in a position where you’re widowed and eligible by age for your own benefit and a survivor benefit you should definitely look into starting one or the other benefit. It’s likely that if you don’t do this, you’ll be leaving money behind that you should have received.

Frugality Versus “Buying on Sale”

loanI wanted to write a brief note on the difference between being frugal and frugal spending. I think it really boils down to the mindset of the individual. Frugality, in my opinion, is making smart purchases when necessary, and forgoing purchasing altogether if not. I also believe that frugality is making purchases that reduce the need to spend more in the future (i.e. buying a quality product for more money in order to reduce or eliminate repair expenses in the future).

Frugal spending, on the other hand, is buying something simply because it’s on sale or cheap – regardless of need. For example, many times we see items in the store advertised as “buy one, get one half off” or “2 for $5.00”. It can be easy to fall into this trap of buying these items and leaving the store feeling good about having saved money. Sometimes we may even think that because we bought two items and one was half priced, that we saved money. This only makes sense if we needed the two items to begin with.

Let’s take a look at the “buy one, get one half off” deal. This may make sense frugally if you truly need two of the items. Otherwise, if you only need one, purchasing the other for half price is still wasting money. The other argument is buying something simply because it was on sale. Again, if the item isn’t needed, then you’re saving zero money, and in fact, wasting money buying the item even if it’s on sale. In other words, if an item is normally priced $30, and you buy it on sale for $20 but don’t need it, you’ve still wasted $20. You haven’t “saved” $10. The fact that it was on sale is irrelevant. It simply makes you feel better for spending less. In this example, it’s only $10.

But, ten bucks is ten bucks.

As items get more expensive, this concept only grows larger. Bigger purchases just mean you’re wasting more money, not saving more. This applies to housing, cars, and even buying in bulk at the warehouse store. The good news is that we can start on the smaller items and build our self-discipline from there. By practicing frugality, we can lean to resist the urge to spend, even if it’s on sale.

Higher Education Expenses Paid From an IRA

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Another way to pull funds from an IRA  without having to pay the 10% penalty is to use those funds for Qualified Higher Education Expenses (QHEE).  This comes up quite often, as parents are faced with the issues surrounding the dueling requirements of retirement saving and paying education expenses for the young ‘uns.

We’ve been talking about the components of Internal Revenue Code Section 72, and specifically here we’re talking about §72(t)(2)(E).  In this portion of the code, the provision is made for an IRA owner to withdraw, without penalty, amounts “not to exceed the Qualified Higher Education Expenses for the tax year”.

So, you may ask, what is a QHEE? Essentially, this includes tuition, fees, books, supplies, and equipment required for enrollment or attendance at an eligible educational institution.  Also included are expenses for special needs services incurred by or for special needs students in connection with their enrollment or attendance.

Room and board also qualifies, but only to the extent that it is not greater than the educational institution’s allowance for room and board, or the amount that the institution actually charges for room and board.  In addition, with the passage of the ARRA 2009, computing equipment and services (including internet service) can be included as QHEE.

Who is the student? For the purpose of this provision, the student can be the IRA account owner, her spouse, eligible children (generally dependents), and grandchildren.

Amounts withdrawn must be no more than the QHEE for the tax year, reduced by any additional tax benefits applied: 529 or Coverdell ESA account withdrawals; QHEE covered by HOPE or Lifetime Learning credits; or any grants or scholarships received.

How to De-clutter Physically and Financially

Throughout our lives we acquire things. This can start at an early age when we were given things as gifts and of course, the childhood tendency to collect and save many of the items that we came across.

As we mature into adults, the desire or habit to continue to hold onto things may still linger. This leads to garages, basements, closets, bedrooms, and even storage facilities full of stuff. It can also creep into our financial lives – as we acquire different savings accounts, retirement accounts, or purchase things that continue to be automatically deducted from our bank account (a monthly subscription to a gym, perhaps).

Decluttering can have a profound effect on our behavior. It can help lower the stress of trying to keep track of so many things. It can also free up time to enjoy the things in life that are important to us. Finally, it can make a big difference financially when we focus on things we need, and allocate our money to priorities that will benefit ourselves and others.

Here are some ideas that may help should you decide that decluttering may be beneficial.

  1. Ask yourself, how often do you use/enjoy your stuff. A good rule of thumb is that if it hasn’t been used in 6 months to a year – get rid of it. This includes items such as clothing, kitchenware, clothes, toys, etc. Of course, there will be some exceptions such as holidays decorations, etc., but those items can add up as well.
  2. Ask yourself if it’s a need or a want. Asking this question can help you focus on whether it’s necessary, or if you could realistically do without. This may help when contemplating getting rid of monthly subscriptions or infrequently used items such as cable TV, gym memberships, magazine/newspaper subscriptions, etc.
  3. Could someone else benefit more from the items? This past winter I looked in my closet and saw that I had five different jackets, of which I only wore two. Talk about a first world problem! Some jackets, along with other items not needed anymore, were donated to charity.
  4. Consolidate accounts. During our lives we have different jobs, get married, divorced, etc. This can lead to having multiple retirement, savings, credit cards, and other accounts. If possible, consolidate those accounts into as few as possible. This will allow you to focus on fewer accounts, and more easily manage your money since it’s in fewer places.
  5. Go paperless. This eliminates the clutter of paper statements filling up your file cabinets and attics. If you can, try to get online billing for bills and make your savings and investing automatic – through bank draft or paycheck deductions to your retirement. Think of this rhetorical question: How many people would save for Social Security if they had to physically write a check?
  6. Donate your items, don’t try to sell them. Except in very rare cases, trying to sell your stuff will only lead to hanging onto it longer – and creating more of a mess and clutter. And while you’re at it, skip the garage sale (both having and going to). From an economic standpoint, you’re much more financially better off if you donate your stuff and take the tax deduction. I’ve seen individuals put in over 30 hours of time setting up, monitoring, and working a garage sale to make only $100 or so. And in most cases, most stuff doesn’t sell and it’s donated anyway or worse, goes back into storage. What’s your time worth?
  7. Delay gratification. Much clutter and build-up of items we don’t use can be attributed to impulse buying. Avoid the temptation to buy on impulse. Infomercials, advertisements, and our peers are constantly bombarding us with the urge to buy more stuff. Take a few moments to gather your thoughts and ask if you really need the item you’re about to purchase. Is your money best utilized elsewhere (saving for retirement, college, emergencies, charity)? Paying yourself first helps delay gratification. By paying yourself first and making your retirement and other financial goals priorities, it leaves less money (and temptation) to spend on clutter.

What to do When You Owe Taxes

owe taxesFor all your good intentions, you’ve found yourself in a position where you owe taxes to the IRS that you can’t pay right away. All is not lost, there are ways to deal with this situation that can be helpful if you can’t pay. The IRS has several methods you can use to arrange a plan to pay the IRS taxes that you owe over time.

The most important part is to not ignore the situation, you need to take action and make arrangements. If you ignore it, like most things, your situation will only get worse, costing you more in interest and penalties.

Recently the IRS published a Special Edition Tax Tip 2017-09 which details what you can do in this situation. the actual text of the Tip follows below:

Tips for Taxpayers Who Owe Taxes

The IRS offers a variety of payment options where taxpayers can pay immediately or arrange to pay in installments. Those who receive a bill from the IRS should not ignore it. A delay may cost more in the end. As more time passes, the more interest and penalties accumulate.

Here are some ways to make payments using IRS electronic payment options:

  • Direct Pay. Pay tax bills directly from a checking or savings account free with IRS Direct Pay. Taxpayers receive instant confirmation once they’ve made a payment. With Direct Pay, taxpayers can schedule payments up to 30 days in advance. Change or cancel a payment two business days before the scheduled payment date.
  • Credit or Debit Cards. Taxpayers can also pay their taxes by debit or credit card online, by phone or with a mobile device. A payment processor will process payments.  The IRS does not charge a fee but convenience fees apply and vary by processor.

Those wishing to use a mobile devise can access the IRS2Go app to pay with either Direct Pay or debit or credit card. IRS2Go is the official mobile app of the IRS. Download IRS2Go from Google Play, the Apple App Store or the Amazon App Store.

  • Installment Agreement. Taxpayers, who are unable to pay their tax debt immediately, may be able to make monthly payments. Before applying for any payment agreement, taxpayers must file all required tax returns. Apply for an installment agreement with the Online Payment Agreement tool.

Who’s eligible to apply for a monthly installment agreement online?

  • Individuals who owe $50,000 or less in combined  tax, penalties and interest and have filed all required returns
  • Businesses that owe $25,000 or less in combined tax, penalties and interest for the current year or last year’s liabilities and have filed all required returns

Those who owe taxes are reminded to pay as much as they can as soon as possible to minimize interest and penalties. Visit IRS.gov/payments for all payment options.

IRS YouTube Videos:

Traditional IRA v. Roth IRA – Compare & Contrast

What’s the difference between the two types of IRAs?  And what is similar?

compare-contrast-by-suvodeb-croppedYou probably know a little bit about this subject – like one IRA is deductible on your income taxes, and the other one has some kind of tax benefit… but the differences are hard to understand, and can be even harder to explain!  Below are the major differences between the two, followed by the similarities.  This discussion is liable to be useful as you consider which kind of IRA is best for you (and both could be best for you, at different times in your life).

Differences Between Traditional IRA and Roth IRA

Deductibility is a feature of the Traditional IRA (Trad) that is not available in the Roth IRA (Roth).  What this means is that, subject to the limits we discussed here, you may be able to deduct the amount of your contribution to your Trad from your Gross Income in the year of the contribution.  When the Traditional IRA was originally introduced in 1974, the deductibility feature was not included.  This was added in 1986, and is one of the primary reasons that Trads have remained as popular as they are to this day.  At the time of the introduction of the deductibility feature, very few companies offered 401(k) plans so the Trad offered one of the only tax shelters available to nearly every taxpayer.

Tax treament is another major difference between the two kinds of IRA.  The Trad’s distributions are always taxable (if not rollover distributions) as ordinary income, while the Roth’s distributions are always tax-free (as long as they meet the requirements, such as after age 59½).  What is also very different about the two is that your contributions to a Roth are always available for withdrawal at any time for any reason – tax free.  The growth in the Roth (interest, dividends, capital gains) would be taxed and subject to penalty if withdrawn for an ineligible reason, though.  The Trad does not have such a provision.

Required distributions are the final major difference covered here.  The Trad has Required Minimum Distributions (RMDs) that must begin at the owner’s age 70½, while the Roth has no requirement for distribution.  In other words, the Roth IRA never needs to be distributed during the IRA owner’s life, while the Traditional IRA must be distributed beginning at the owner’s age 70½.

Similarities Between Traditional IRA and Roth IRA

Income requirement. A component of the requirements of both the Trad and the Roth is that the holder (or the holder’s spouse) must have earned income in the year of the contributions.  The income must be at least equal to the total of all IRA contributions for the year.  This includes two additional types of contributions: spousal contributions and non-deductible contributions.

Spousal contributions are allowed for both the Trad and the Roth, and they essentially allow a spouse with income to contribute to the IRA (either variety) of the spouse who either does not have income, or whose income is below the maximum available contribution for the tax year.  The contributions are limited, however, to the total of both spouses’ earned income for the tax year.

Earned income, for the purposes of IRA contributions, includes wages, salaries, tips, commissions, self-employment income, or alimony (or separate maintenance payments).  Not included as earned income are earnings and profits from property (rental or royalty), interest income, dividends, pensions, annuities, deferred compensation (such as 401(k) distributions), certain non-participatory partnership income, and capital gains.

Non-deductible contributions to a Traditional IRA are allowable when your MAGI is above the limits (described here).  In essence, if your income is too high to make either a Roth contribution or a deductible Trad contribution, you are allowed to make a non-deductible contribution of up to the maximum amount allowable for the year into your Trad IRA.  These contributions are after tax, and so when distributed there will be tax only on the growth that has occurred on that contribution.  Non-deductible contributions are a way to defer tax on the growth of funds in an account, and are also available as a spousal contribution.

Tax Year Specification. Trad and Roth contributions must be made for a specific tax year.  That is, since there are strict limits on the amounts that can be contributed, you must specify the tax year of the contribution to your IRA.  You are generally allowed to contribute for a tax year beginning on January 1 and ending on the tax due date for the year (generally April 15 of the following year).  In other words, for 2017, you may make your 2017 contribution to your IRA at any time between January 1, 2017 and April 17, 2018.

The same deadline applies to establishing the account as well.  You can even file your tax return early, indicating a contribution to your Trad IRA (and deducting it from your gross income) before you make the contribution!  Just make sure that you do go ahead and make the contribution… the IRS has very little sense of humor about things like that!

Penalty for withdrawal applies to ineligible distributions from either type of account.  A 10% penalty will be applied to any distribution from an IRA of either variety that is not specifically allowed under §72(t), above and beyond the ordinary tax that would be applied to the distribution.

Save Money with an Energy Audit

loanWhen we hear the word audit it’s often associated with a negative connotation. However, an audit does not necessarily have to be a bad thing – especially when it can save you some money. I’m talking about having an energy audit done at your home or business.

What an energy audit can do is let you know how much energy and utilities your home is using as well as let you know how much energy and utilities your home may be wasting. Of course, wasted utilities means wasted money. Let me give you an example from my perspective.

About 5 years ago my wife and I decided to have an energy audit done. We called our local utility provider and inquired about the specific programs that were available. Our utility company was more than willing to point us in the right direction and they recommended a third-party contractor that was qualified to do an energy audit.

The good news is that if we had the audit done and made the suggested improvements to our home, the utility company had a program where there would cover some of the costs of the improvements. We decided to have the audit done.

A few weeks later, the audit company came and did the audit. They ran an analysis of our home energy use, water use, etc. They also provided some free tips as well as some free items to help right away. These included sink aerators to reduce the water flow from our faucets and showers. I also went around and replaced all of the light bulbs with energy efficient bulbs.

Next came an estimate of the work that needed to be done. While the bill was a bit high, we did remember that our utility company would help with some of the costs. We agreed to have the improvements made. The improvements included insulating our basement and crawl space as well as blowing insulation into our attic. This increased the R-value substantially and we could feel the difference almost immediately (this was done during one of the hottest weeks on record).

Here’s the best part. When we did the break-even on the costs, it would take just over 3 years for the cost of the improvements to be paid for by the annual savings in utilities. Now, the improvements have not only paid for themselves, but the difference in savings allows us to allocate that money elsewhere (to retirement or college savings). Our home is much more comfortable in the summer and winter months, and we’re saving money.

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