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How Does an Early Withdrawal from a Retirement Plan Affect My Taxes?

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Image courtesy of adamr at

Oftentimes we are faced with difficult situations in life – where we need extra money to pay for a major car repair, a new roof for the house, or just day-to-day living expenses – and our emergency funds are all tapped out.  Now your options become poor: should I go to a payday loan place, put more on my credit card?  My mortgage is upside-down so there’s no home equity loan in my future, and I can’t ask my folks for a loan, I’ve asked them for too much.  Hey, what about my retirement plan?  I’ve got some money socked away in an IRA that’s just sitting there, why don’t I take that money?

It’s really tough to be in a situation like this, but you need to understand the impacts that you’ll face if you decide to go the route of the IRA withdrawal, especially if you’re under age 59½.

Any money that you take out of a retirement plan as a withdrawal will be taxed as ordinary income – just like wages, salaries, and tips.  So if you’re in the 25% marginal tax bracket, every dollar that you withdraw from your IRA or 401(k) plan (if allowed) will cost you 25 cents right off the top.

In addition to the ordinary income tax, if you’re less than 59½ years of age you’ll also be hit with an additional 10% penalty for an early withdrawal (unless your withdrawal meets one of these 19 exceptions). So now every dollar that you withdraw costs an extra 10 cents on top of the ordinary income tax.  If you’re in the 25% bracket, that $10,000 withdrawal from your IRA can cost you as much as $3,500 in extra taxes and penalties.

Bear in mind that you may be able to take a temporary loan from your 401(k) or other qualified retirement plan (QRP) if you’re still employed by that employer.  Naturally you’ll need to repay the loan, but it might be a better option cost-wise than the other choices.  Plus, if you have an outstanding loan from your QRP and you leave the employer you’ll be required to either recognize the balance of the loan as a withdrawal or pay it back to the plan immediately.

Armed with this information makes your decision points much more clear: review all of the available options mentioned above (loans from family and friends, home equity loans, payday loans, and the like) against the cost of the taxes for taking an early withdrawal from your retirement plan.  The best option may be to see about a formal loan from family, paying them a reasonable rate of interest.  But of course, your circumstances are going to dictate the best option for you.  Just go into it with your eyes wide open.

Can You Itemize? Or, Should You Itemize?

Image courtesy of Stuart Miles at

Image courtesy of Stuart Miles at

When you prepare your taxes each year, you’re faced with a decision – itemize deductions or take the standard deduction?  Most of the time it’s not a question of whether you can itemize, but rather should you itemize.

Most Anyone Can Itemize…

This is due to the fact that most anyone can itemize.  If you’ve paid state and/or local income or sales taxes, real estate taxes, or paid mortgage interest, you have deductions to itemize.  Same goes for charitable contributions.  All of these items that you’ve paid out are eligible to be deducted on Schedule A of your tax return, without a lower limit.

If you have medical expenses, these can be deductible if the total of your medical expenses are more than 10% of your Adjusted Gross Income (AGI).  For 2013 tax returns, if you’re 65 years of age or older, your medical expenses that are more than 7.5% of your AGI will be deductible.

In addition, certain job expenses and other miscellaneous expenses, such as tax preparation expenses, safe deposit box rental, and the like, can be deductible to the extent that they exceed 2% of your AGI.

If you’ve paid out any of these expenses during the tax year, you can itemize.  That doesn’t mean that you should itemize, though.

… But Should You Itemize?

So you’ve determined that you have deductible expenses and you can itemize – let’s look at reasons why you should itemize.

The initial answer is really rather simple – if the total of all the deductible items that you’ve found to put on your Schedule A is greater than your applicable Standard Deduction, then you probably should itemize.  The Standard Deduction is based upon your Filing Status (2013 figures):

Filing Status Standard Deduction Over Age 65 or Blind, per Person
Single $6,100 + $1,500
Married Filing Jointly $12,200 + $1,200
Head of Household $8,950 + $1,500
Married Filing Separately* $6,100 + $1,200
Qualifying Widow(er) $12,200 + $1,200

If someone else claims you as a dependent on his or her tax return, your Standard Deduction is the lesser of $1,000 or earned income plus $350, up to the normal Standard Deduction for your filing status.

If your deductions amount to less than the Standard Deduction for your filing status, don’t despair.  It’s not as if being able to itemize your deductions is some sort of bonus – it’s actually the other way around.  You see, if you have more deductions when itemizing than the Standard Deduction, that means you had to pay out that money during the year.  On the other hand, if you had fewer itemized deductions (or no deductions to itemize), you’re getting to reduce your taxable income by the Standard Deduction without having to pay out that money!

Now there is at least one circumstance when you’re required to itemize your deductions, and we’ll cover that next.

Or, Do You Have to Itemize?

*If you and your spouse file separate returns with filing status of Married Filing Separately and your spouse itemizes deductions on Schedule A, you are also required to itemize your deductions on Schedule A, or take a Standard Deduction of $0.

Wrapping it up

You can always choose to itemize your deductions even if they are less than the Standard Deduction for your filing status. You only need to mark the box on Line 30 of Schedule A.  You might want to do this if it would somehow benefit your state income tax, for example.

Lastly – the only way to itemize deductions is by also filing your tax return on Form 1040.  If you choose to use either Form 1040A or Form 1040EZ, you are not eligible to itemize your deductions.  If you use tax return preparation software (or your qualified preparer does) the decision will be made for you, more than likely.

The IRS Releases Their “Dirty Dozen” Tax Scams for 2014

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Image courtesy of chanpipat at

Each year the IRS puts together a list of the tax scams that are most pervasive to taxpayers, which they refer to as the “Dirty Dozen”.  There has only been a couple of changes to the list this year, most specifically the addition of “pervasive telephone scams”, introduced as #2 on the list this year, and combining “false Form 1099 claims” (on both 2012 & 2013’s list) with “falsely claiming zero wages”.  Identity theft, which is a major issue in the tax return world, tops the list again this year after having first appeared on the list in 2013.  I’ve included the rankings for each item for 2012 and 2013 within the 2014 list below, for your reference.

This list is from IRS’ Special Edition Tax Tip 2014-08.

Don’t Fall for the Dirty Dozen Tax Scams

Every year, people fall prey to tax scams.  That’s why the IRS sends a list of its annual “Dirty Dozen”.  We want you to be safe and informed – and not become a victim.

Taxpayers who get involved in illegal tax scams can lose their money, or face stiff penalties, interest and even criminal prosecution.  Remember, if it sounds too good to be true, it probably is.  Be on the lookout for these scams.

  1. Identity theft.  (2013: #1; 2012: not on the list) Tax fraud using identity theft tops this year’s Dirty Dozen list.  In many cases, and identity thief uses a taxpayer’s identity to illegally file a tax return and claim a refund.  For the 2014 filing season, the IRS has expanded efforts to better protect taxpayers and help victims.  Fide more information on the identity protection page on
  2. Pervasive telephone scams.  (2013: not on the list; 2012: not on the list) The IRS has seen an increase in local phone scams across the country.  Callers pretend to be from the IRS in hopes of stealing money or identities from victims.  If you get a call from someone claiming to be from the IRS – and you know you owe taxes or think you might owe taxes, call the IRS at 1-800-829-1040.  If you get a call from someone claiming to be from the IRS and know you don’t owe taxes or have no reason to think that you owe taxes, then call and report the incident to the Treasury Inspector General for Tax Administration at 1-800-366-4484.
  3. Phishing. (2013: #2; 2012: #2) Phishing scams typically use unsolicited emails or fake websites that appear legitimate.  Scammers lure in victims and prompt them to provide their personal and financial information.  The fact is that the IRS does not initiate contact with taxpayers by email to request personal or financial information.  This includes any type of electronic communication, such as text messages and social media channels.
  4. False promises of “free money” from inflated refunds.  (2013: #5; 2012: #5) The bottom line is that you are legally responsible for what’s on your tax return, even if someone else prepares it.  Scam artists often pose as tax preparers during tax time, luring victims in by promising large tax refunds.  Taxpayers who buy into such schemes can end up penalized for filing false claims or receiving fraudulent refunds.  Take care when choosing someone to do your taxes.
  5. Return preparer fraud. (2013: #3; 2012: #3) About 60 percent of taxpayers will use tax professionals this year to prepare their tax returns.  Most return preparers provide honest service to their clients.  But some dishonest preparers prey on unsuspecting taxpayers, and the result can be refund fraud or identity theft.  Choose carefully when hiring an individual or a company to do your tax return.  Only use a tax preparer that will sign your return and enter their IRS Preparer Tax Identification Number (PTIN). For tips about choosing a preparer, visit
  6. Hiding income offshore. (2013: #4; 2012: #4) While there are valid reasons for maintaining financial accounts abroad, there are reporting requirements.  U.S. taxpayers who maintain such accounts and do not comply with these requirements are breaking the law.  They risk large penalties and fines, as well as the possibility of criminal prosecution.  The IRS has collected billions of dollars in back taxes, interest and penalties from people who participated in offshore voluntary disclosure programs since 2009.  It is in the best interest of taxpayers to come forward and pay their fair share of taxes.
  7. Impersonation of charitable organizations. (2013: #6; 2012: #10) Taxpayers need to be sure they donate to recognized charities. Following major disasters, it’s common for scam artists to impersonate charities to get money or personal information from well-intentioned people.  They may even directly contact disaster victims and claim to be working with the IRS to help the victims file casualty loss claims and get tax refunds.
  8. False income, expenses or exemptions. (2013: #7; 2012: #6) Falsely claiming income you did not earn or expenses you did not pay in order to get larger refundable tax credits is tax fraud. This includes false claims for the Earned Income Tax Credit. These taxpayers often end up repaying the refund, including penalties and interest for facing criminal prosecution.
  9. Frivolous arguments. (2013: #9; 2012: #8) Frivolous schemes encourage taxpayers to make unreasonable and outlandish claims to avoid paying the taxes they owe.  The IRS has a list of frivolous tax arguments that taxpayers should avoid.  While taxpayers have the right to contest their tax liabilities in court, no one has the right to disobey the law or ignore their responsibility to pay taxes.
  10. Falsely claiming zero wages or using false Form 1099. (2013: #10 & #8; 2012: #9 & #7) Filing false information with the IRS is an illegal way to try to lower the amount of taxes owed.  Typically, fraudsters use a Form 4852 (Substitute Form W-2) or a “corrected” Form 1099 as a way to improperly reduce taxable income to zero.  The fraudster may also submit a false statement denying wages and taxes reported by a payer to the IRS.
  11. Abusive tax structures. (2013: #11; 2012: #11) These abusive tax schemes often involve sham business entities and dishonest financial arrangements for the purpose of evading taxes.  The schemes are usually complex and involve multi-layer transactions to conceal the true nature and ownership of the taxable income and assets.  The schemes often use Limited Liability Companies, Limited Liability Partnerships, International Business Companies, foreign financial accounts and offshore credit/debit cards.
  12. Misuse of trusts. (2013: #12; 2012: #12) There are reasonable uses of trusts in tax and estate planning.  However, questionable transactions also exist.  They may promise reduced taxable income, inflated deductions for personal expenses, the reduction or elimination of self-employment taxes and reduced estate or gift transfer taxes.  These trusts rarely deliver promised tax benefits.  They primarily avoid taxes and hide assets from creditors, including the IRS.

Tax scams can take many forms beyond the “Dirty Dozen”.  The best defense is to remain vigilant.  Get more information on tax scams at

Use Direct Deposit for Your Tax Refund

Image courtesy of Stuart Miles at

Image courtesy of Stuart Miles at

When filing your tax returns this year, consider using direct deposit for your refund.  By doing this, you don’t have to worry about the mail “making the trip”, and also you won’t have to make a visit to the bank to cash or deposit the refund.

On top of that, direct deposit refunds usually are deposited more quickly than a check is delivered by mail, getting you the money faster.  Among the many alternatives for the places you can have the money deposited to are virtually any bank account, as long as you have the routing and account information, as well as transferring your funds to your TreasuryDirect account to purchase US Treasury marketable securities and savings bonds.  You can also split your refund to be deposited in two or three different accounts – the account(s) need to be title in your name, your spouse’s name, or both, not someone else’s account.

Of course, if you owe money to the IRS from past tax returns, your refund will be used to pay your debt first and foremost.  You also have the option to apply any leftover refund toward your tax obligation for the current year as well.

If your refund is less than $1 (which is highly unlikely since tax figures these days are generally rounded to the nearest dollar), you have to specifically request a refund from the IRS in writing.

Setting up direct deposit is a relatively simple activity, whether you’re using tax software or paper filing your return.  You just need to fill out the form with the appropriate bank routing and account information, and the deed is done.  If requesting direct deposit to multiple accounts, you’ll need to use Form 8888.  Form 8888 is also used to purchase paper I-series US Savings Bonds with your refund (limited to $5,000).

So do yourself a favor this year, and set up direct deposit of your tax refund.  It’s flexible, convenient, simple, and secure.

Your Social Security Benefits: Are They Taxable?

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Image courtesy of Salvatore Vuono at

If you’re receiving Social Security benefits, either for disability, retirement, or survivor’s benefits, when you file your tax return you will need to figure out if the benefits you’ve received during the prior year are taxable to you.

You’ll receive a Form SSA-1099 from Social Security sometime in the first months of the year, showing what your benefits were in the prior year, as well as any deductions that were made throughout the year – including Medicare premiums (Part B and/or Part D) if applicable, and federal income taxes withheld.

But are the benefits taxable to you?  At most, 85% of your benefit might be taxed – and it’s possible that none of your benefit is taxable, all dependent upon your total income for the year.  See this article for a detailed explanation of How Taxation of Social Security Benefits Works.  The IRS recently published their Tax Tip 2014-23, which details some facts about taxability of Social Security benefits.  The actual text of the Tip is below:

Are Your Social Security Benefits Taxable?

Some people must pay taxes on part of their Social Security benefits.  Others find that their benefits aren’t taxable.  If you get Social Security, the IRS can help you determine if some of your benefits are taxable.

Here are seven tips about how Social Security affects your taxes:

  1. If you received these benefits in 2013, you should have received a Form SSA-1099, Social Security Benefit Statement, showing the amount.
  2. If Social Security was your only sources of income in 2013, your benefits may not be taxable.  You also may not need to file a federal income tax return.
  3. If you get income from other sources, then you may have to pay taxes on some of your benefits.
  4. Your income and filing status affect whether you must pay taxes on your Social Security.
  5. The best, and free, way to find out if your benefits are taxable is to use IRS Free File to prepare and e-file your tax return.  If you made $58,000 or less, you can use Free File tax software.  the software will figure the taxable benefits for you.  If your income was more than $58,000 and you feel comfortable doing your own taxes, use Free File Fillable Forms.  Free File is available only at
  6. If you file a paper return, visit and use the Interactive Tax Assistant tool to see if any of your benefits are taxable.
  7. A quick way to find out if any of your benefits may be taxable is to add one-half of your Social Security benefits to all your other income, including any tax-exempt interest.  Next, compare this total to the base amounts below.  If your total is more than the base amount for your filing status, then some of your benefits may be taxable.  The three base amounts are:
    • $25,000 – for single, head of household, qualifying widow(er) with a dependent child or married individuals filing separately who did not live with their spouse at any time during the year.
    • $32,000 – for married couples filing jointly
    • $0 – for married persons filing separately who lived together at any time during the year.

For more on this topic visit

7 Debunked Myths About Mortgages

Guest post by Diana Fishlock for  Diana Fishlock has researched and written articles on a wide variety of subjects for newspapers in New York, Pennsylvania and Maryland. She lives near Harrisburg, PA and writes for Zillow.

Young Businesswoman Real Estate Agent in Front of HomeSecuring a mortgage can be a daunting, confusing process for first-time home buyers as well as experienced homeowners considering moving or buying a second home. There are lots of myths and misconceptions about mortgages, such as who qualifies and what makes a good one.

Myth 1: Prequalified means preapproved.

Reality: Prequalifying for a mortgage and being preapproved are two different steps. Prequalifying is a lot simpler. It requires informing a lender about debts, income and assets in a general sense. Prequalifying helps buyers loosely determine their affordable price ranges.

For preapproval, a buyer must submit to the lender much more detailed information, including a financial history. The lender then verifies the borrower’s debt-to-income ratio before agreeing in writing to loan a specific amount. Preapproval indicates to home sellers that a buyer is approved by a lender and serious about making a purchase.

Myth 2: Buyers should choose the mortgage lender with the lowest interest rate.

Reality: The annual percentage rate (APR) is a better measure of the cost of a mortgage because it includes not only interest rate, but points and other fees. With all of the high costs of buying a home, owning a home and maintaining the property, it’s important to consider all the costs.

Myth 3: Buyers should always choose the lender who offers the lowest APR.

Reality: There are other important factors too. It’s important for buyers to look at lenders’ costs and fees, which can add up quickly. But borrowers should opt for well-known, reputable lenders. Buyers should ask friends and neighbors for recommendations on lenders they used for buying or refinancing homes. They can also read online reviews of lenders on Zillow Mortgage Marketplace. Reviews include information on which lenders were easy to work with, available to answer questions and clear and respectful with their responses.

Myth 4: Salary is the most important factor to lenders. 

Reality: While lenders like to work with borrowers who earn large salaries, they’re looking for the whole package with the lowest risk. Lenders factor in debt, credit ratings and both financial and work histories. A borrower with a big paycheck but numerous loans and a history of job-hopping isn’t as attractive to lenders as the patient saver who stayed at one job for years. Lenders also want to see someone who made a habit of saving money, not a person whose parents made a big deposit right before it was time to buy a house.

Myth 5: Bigger downpayments are always better.

Reality: Putting 20 percent down is great for buyers with loads of cash on hand, but these days many people can secure favorable mortgages with 10, 5 or even 3.5 percent down. With interest rates low, some homebuyers prefer to use as little cash as possible for a downpayment and opt instead to keep a bigger nest egg for buying furniture and appliances or maintaining a safety cushion.

Myth 6: Refinancing is a smart decision.

Reality: Refinancing is not always the best decision. Refinancing a mortgage to pay a lower interest rate or consolidate loans can be a very good idea. Refinancing is not the right choice for homeowners who don’t plan on staying in their houses for many years, or those whose credit has depreciated. Any savings realized from lowering the interest rates for homeowners planning to move soon may be eaten up by the lender’s closing fees. Homeowners with poor credit risk getting higher interest rates on their refinances.

Myth 7: Homeowners should pay off their mortgages as soon as possible.

Reality: Although outright homeownership is a major achievement, homeowners should be in less of a rush to pay down their principals if they have more expensive debts to pay. Homeowners should pay off their highest-interest rate debts first, which usually means credit cards. Interest on a mortgage is also tax deductible, while credit cards and car loans are not. Paying off a mortgage ahead of schedule is beneficial to avoid some interest payments but should be evaluated on an individual basis.

Mortgage shopping can be a long, frustrating process without the right information. Smart homebuyers who can separate myth from reality can secure the best mortgages available, saving money and inconvenience by locking in a great rate with a reputable lender.

How Much Do I Need to Save?

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Frequently I’m asked by folks how much they need to be socking away for retirement. Many people I talk to are concerned about having enough (a very common concern I would say among most people) for retirement and fear running out of money.

As much as I would love to give them a rock-solid answer and as much as they want a definitive answer, the true answer is that it depends – on a number of factors.

  1. 1. How much do you plan to spend in retirement?

This question can be difficult to answer especially if you’re young and can’t contemplate nor even come close to an estimate of what expenses will be in retirement. For others, this may be more readily a number to come up with especially if one is close to retirement or in the peak accumulation years of their careers which is usually later in life.

  1. 2. How much do you plan to give in retirement?

For many folks there is a desire to give away some or all of their wealth at retirement. This could range from a few thousand to several billion dollars (we’re talking Warren Buffett and Jim Blankenship wealth here). Naturally, the amount saved and accumulated over the working years needs to be greater than simply an amount needed to survive or enjoy retirement.

3. What assets have you currently saved and accumulated?

If you’re younger you’re not looking at much, but here’s the good news: time is on your side. You have much longer until retirement but you also have the advantage of compounding returns as well as the potential of your human capital (your earnings over your lifetime) compounding as you advance in your career. If you’re middle aged or older aged, there’s a chance you have a home you may potentially downsize from or perhaps you’d consider a HECM reverse mortgage. As you age, you have less human capital the closer you get to retirement, but hopefully that’s been replaced with financial capital (what you’ve saved while working).

4. How much do you plan on earning over your lifetime?

This is the $64,000 question – although I will say be careful with thinking that more money means more savings. Just by the numbers if a person makes more they have the ability to save more, but it’s true that the more someone makes the more they spend. I have seen very simple, frugal folks that turn out to be the millionaires next door and I have seen dual six-figure spouses live paycheck to paycheck and worry. A key point is this – when you start saving – save a percentage and as you get raises, continue to live like you did when you had nothing. It’s amazing how fast your wealth will build.

Next week we’ll cover some different equations (for all you math lovers – you know who you are!) that show some examples but for now – a good rule of thumb is to start with 10% of your gross income (what you make before taxes) and gradually move toward 20%. In theory as you make more you should be able to easily save more – especially if you’re expenses stay as they were before your income increased. Good in theory, but hard for many folks to do.

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Education Tax Benefits

Locke's Some Thoughts on Education

Going to college can be a stressful time for students and parents. Some of the costs of your education can be offset by tax credits and reductions to income.  These credits and reductions can be complicated, so it takes a bit of coordination to keep things straight. 

More than one education tax benefit may be taken in one year, but generally the expenses must be segregated from one another in your reporting.  In other words, you couldn’t take two tax benefits based upon the exact same education expenses, with some exceptions.  For example, you can use most qualified expenses for the tax credits and apply the expense toward eliminating the 10% penalty on IRA distributions at the same time.

Generally though, most tax benefits for education can only be applied once to each expense.  Only one of the following credits may be used per student in any given year: American Opportunity Tax Credit, Lifetime Learning Credit, or Tuition and Fees Deduction.  If you have enough students with the appropriate circumstances, it is feasible that you could use all three types of benefit in a single tax year.

Listed below are the three primary tax benefits and the specifics around them:

  • American Opportunity Tax Credit.  This credit can be up to $2,500 per eligible student. The AOTC is available for the first four years of post secondary education. Forty percent of the credit is refundable. That means that you may be able to receive up to $1,000 of the credit as a refund, even if you don’t owe any taxes. Qualified expenses include tuition and fees, course related books, supplies and equipment.

    There are income limitations on this credit. Generally, your Modified Adjusted Gross Income must be less than $80,000 (if single) or $160,000 (if married) to claim the full credit. The credit is phased out above those levels and eliminated at $90,000 and $180,000 respectively.

    The AOTC is not allowed if you file Married Filing Separately, or if you are claimed as a dependent on another taxpayer’s return. In addition, the credit is not refundable if you are under age 24 and are essentially dependent upon your parents (that is, they are alive) and you are unmarried. If you are under age 18 none of the credit is refundable.

  • Lifetime Learning Credit.  With the LLC, you may be able to claim up to $2,000 for qualified education expenses on your federal tax return. There is no limit on the number of years you can claim this credit for an eligible student. The credit is 20% of the first $10,000 of education expenses for the student.

    This credit has income limitations as well. If your Modified AGI is less than $53,000 (single) or $107,000 (married filing jointly) the credit is fully available. The phaseout occurs at $63,000 and $127,000 respectively. Again, you are not allowed to use this credit if you file Married Filing Separately, or are the dependent of another taxpayer.

  • Tuition and Fees deduction. This benefit provides a reduction in your Adjusted Gross Income of up to $4,000 for modified AGI less than $65,000 (single) or $130,000 (married filing jointly), or $2,000 if your modified AGI is above those limits but less than $80,000 or $160,000 respectively. Above those limits the deduction is not available. Like the other benefits, the Tuition and Fees deduction is not available if filing MFS or you are the dependent of another taxpayer.

    One difference with this deduction is that you can include course materials in the deduction only if purchased directly from the educational institution (other benefits allow any source of purchase of course materials).

  • Student loan interest deduction. Other than home mortgage interest, you generally can’t deduct the interest you pay. However, you may be able to deduct interest you pay on a qualified student loan. The deduction can reduce your taxable income by up to $2,500. You don’t need to itemize deductions to claim it.
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