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Avoiding Taxation of 401(k) Loan


Photo credit: jb

Hopefully you already know this – if you have a loan from your 401(k) plan and you leave employment, either on your own or if you’re terminated, the loan is considered a distribution from your plan, and therefore taxable. It’s important to note – this only applies when you leave employment.

Here’s an example:  you have a 401(k) plan with a balance of $200,000. You wish to take a loan from the plan in order to pay for your child’s college tuition – and so you take a total of $20,000 from the plan. It’s your intent to pay this off over the course of the next couple of years with the proceeds from some appreciated stock – you were delaying the sale of the stock since the stock is poised to run up quickly in the next year or so. Unfortunately, two months later your company decides to let you go – downsizing and all, you know.

Rather than calling the 401(k) loan due and payable immediately, the loan is classified as a distribution – meaning that, not only are you out of a job, you’ve got an extra $20,000 of income that will be taxed now, money that you’ve already spent on tuition. If you’re under age 55 (yes, 55, since you’re eligible to take a distribution after age 55 without penalty after leaving employment), the funds will also be subjected to the 10% early distribution penalty. Topping off the fun facts here is that you likely didn’t think to have any additional tax withheld or an estimated tax payment made, so you’ll likely get hit with a penalty for under-withholding of tax when you file.

So what can you do?

Since you have the appreciated stock (or really, funds from any other source), you can roll over the substituted funds into an IRA. The rule used to be that this had to occur within 60 days, but since the beginning of 2018, you have much longer to take care of this rollover. You can actually delay this rollover until your tax filing deadline for the year, including extensions, as you complete the rollover without penalty. This will effectively negate the distribution, and no tax or penalty will be owed.

Of course, if you sell appreciated stock you will owe tax on the capital gains – but presumably this is far less than the ordinary income tax (plus the penalties!) on the loan. If the capital gains tax is significant you’ll want to either adjust withholding for the remainder of the year and/or make estimated payments of tax in order to avoid the penalty for under-withholding. If you’ve delayed the rollover into the following year (2022 in our example), you can avoid the capital gains taxation until the end of that tax year as well.

Rounding out the example, let’s say you took the loan in January of 2021, and in March you were let go from your employer. You actually have until October 15, 2022 (yes, next year!) to fully rollover the loan balance into an IRA in order to avoid the taxation and penalties associated with the distribution. If you encountered capital gains taxes in producing the money to rollover, you could wait until as late as October of 2023 to pay that tax.

You should consider the additional impacts of taking this distribution – see the article Not So Fast! 9 Special Considerations Before Rolling Over Your 401(k) for more details on what you need to keep in mind as you make a rollover from your 401(k).

Valuation for Roth IRA Conversions

5 cents

Photo credit: jb

You’ve read all about Roth IRA conversions, and you know a lot about the questions that one must resolve in order to make one of these conversions work out for you. But have you considered how the valuation rules will impact your decision process?

Valuation of your IRA

If you have IRAs that contain both pre-tax and post-tax contributions and you’re looking to take a distribution (such as for a Roth Conversion), you know that you have to look at all IRAs in aggregate in order to determine what amount of the distribution is taxable and how much is tax-free. But when do you determine the valuation of the account?

It’s kinda tricky – and probably not what you were thinking. Your IRA balances are determined as of the end of the tax year in which the distribution occurs – so if you make your distribution in 2021, the balance as of 12/31/2021 is what is used to determine your IRA balances. This amount will include any amount that has been distributed to you in 2021, either in the form of a cash payout, or as a conversion to a Roth IRA.

For example, if you had two IRAs, one that is completely taxable (all deductible contributions and growth), totaling $20,000, and the other is made up of $10,000 in non-deductible contributions and $10,000 in growth and other deductible contributions. The total value as of December 31 is $40,000, with $10,000 being non-deductible or after-tax contributions. So any distribution you made during the tax year from either of these IRAs would be 25% tax free (since 25% of the accounts is after-tax).

Simple Enough, Right?

Well, maybe not. The problem with the valuation method comes in when you consider what happens over the course of the year – especially if you’ve made a distribution early in the year.

How about if you had the accounts mentioned above in the example, and nothing had changed as of January 15. You enact the conversion at that time… and then time goes on, and your investments perform as they might throughout the year. Then on December 31 of the current year, your IRAs are now worth a total of $50,000 – and your non-taxable portion is still only $10,000. Since this has occurred, now only 20% of your conversion will be tax-free, which may make a difference in your computations. In this case you have the comfort of knowing that your original conversion amount may have grown in value (assuming similar growth in all accounts), so the new growth since the conversion will receive tax-free Roth treatment.

And what if, after the conversion your accounts reduce in value? Adjusting our example, let’s say as of December 31 the accounts are now worth a total of $30,000. This means that a higher percentage of your conversion distribution was non-taxed, a total of 1/3 at this point. This might be to your advantage (less tax paid) but it also might mean that you’re paying tax on an amount greater than the value of your accounts – especially if your account(s) downturn continues. In a case like that, in the past you would have until October 15 of the following year to recharacterize the conversion in order to not have the tax bill on the lower amount. Unfortunately, since recharacterization has been eliminated from Roth conversions, you are now stuck with the situation as it is.

So as you can see, the timing of your conversion versus the timing of the valuation of your IRA accounts can have a large impact on the way your Roth Conversion plays out for you. Consider this information wisely as you plan your conversion strategy…

Payback When You’ve Earned Too Much

earnings test

photo credit: diedoe

In an earlier post, we talked about the Social Security Earnings Test, which is applied when you are receiving your benefit early (before Full Retirement Age) and you earn over certain limits. Briefly, in the years before the year you reach FRA, when you earn salary in excess of the limit, the Social Security Administration will withhold your benefit in an amount equal to $1 for every $2 over the specified limit. In the year that you will reach FRA, the reduction is equal to $1 for every $3 over the limit. (See the original article at this link for details on how this works.)

While a portion of your benefit is, in fact, withheld for the earnings, there is an eventual “payback”… when you reach FRA, your reduced benefit is recalculated, eliminating those months when your benefit was withheld. The recalculation is done as if you delayed filing for the number of months that your benefit was being withheld.

There’s a misconception that you actually receive back the dollars that were withheld due to your over-earning. That’s not how it works – you actually get credit back for the months when your benefit was withheld. This is much the same as how the “do-over” option works, except that you’re not paying it back to the SSA, they’re just never giving it to you.

So, for example, let’s say you took your benefit at age 62 (reducing the benefit to 75% of your PIA) and you had earnings that caused the SSA to withhold four months’ worth of benefit each year for the four years between age 62 and 66. When you reach FRA you would actually improve your benefit by 7.22% – because your reduction would be adjusted to 82.22% of your PIA.

Social Security Earnings Test


photo credit: jb

As you know, you can receive Social Security retirement or survivors benefits and continue working. If you happen to be less than Full Retirement Age (FRA) and you earn more than the earnings test, your benefit will be reduced. (Note: these reductions are not really lost, you will get credit for the withheld benefits at FRA.)

Earnings Test

If you’re at or older than FRA (age 66 if born between 1946 and 1954, ranging up to 67 if born in 1960 or later) when you begin receiving retirement or survivors benefits, you may earn as much as you like and your benefit will not be reduced. If, however, you are younger than FRA, your benefit will be reduced $1 for every $2 you earn over $18,960 (in 2021) before the year of FRA. The Social Security benefit will be reduced by $1 for every $3 you earn over $50,520 in the year of FRA, up until the month you reach FRA. These limits are adjusted every year with cost-of-living indices.

The income we’re talking about here is W2 (employee) income or self-employment income, referred to as earned income. Non-earned income, such as interest, dividends, pensions, retirement withdrawals, or rents received are not included for the purpose of the earnings test. Plus, in the first year that you start benefits, only that earned income after you’re receiving benefits is counted, on a monthly basis. Any income received before you start receiving Social Security benefits is not counted toward the earnings test.

For example, let’s say your benefit is $700 per month ($8,400 for the year) and you are 63 years old, starting benefits at 62. You work part-time and earn $22,000 during the year, which is $3,040 more than the earnings test. The Social Security Administration will withhold a total of $1,520 from your benefit ($1 for every $2 over the limit). This is done by withholding your Social Security benefit for three months, January through March of the following year – for a total of $2,100 being withheld. Beginning in April you’ll receive your full $700 benefit. In January of the next year you’ll receive $580 extra for the additional amount that was withheld above the $1,520. If you advise SSA of your income expectation in the coming year, the withholding will be done during the year of the income, rather than the following year. If your actual income differs from the expected income you reported, it will be “trued up” in January of the following year.

If this was the year you’ll reach FRA – for example in June, and your earnings through May were $52,000 ($1,480 more than the limit), $494 would be withheld from your $8,400 benefit which is accomplished by withholding your first check of the year, and the additional $206 will be refunded to you in January of the following year.

First Year

In your first year of Social Security benefits, you can earn as much as you like before you start to receive benefits. Then, for each month after you start your Social Security benefit, you are limited by the monthly amount (listed above) divided by 12. For 2021 that is $1,580 per month.

So, if you’re under FRA and worked for 8 months of the year in 2021 and started Social Security benefits in September, you can earn up to $1,520 each month (September thru December) without benefits being withheld. If you earn above that limit in any month, for each $2 over the limit, $1 will be withheld. This will occur with your first check(s) in the following year.

For every year thereafter (until your FRA year), the earnings test is applied on an annual basis, rather than monthly. So as long as you don’t go over the $18,960 limit (for 2021) you have no benefits withheld. As with the monthly test, for each $2 over the limit, $1 will be withheld.

FRA Year

In the year that you’ll reach FRA, there is an annual limit applied to your earnings. If you’re reaching FRA in August 2021, you are limited to earning no more than $50,520 prior to the month you reach FRA. For every $3 over that limit, $1 will be withheld.

Starting with the month you reach FRA, there are no earnings limits.

Using Capital Gains and Losses to Help With a Roth Conversion

red stapler

photo by: jb

Most of the time, when analyzing the prospect of a Roth conversion, the best outcome occurs when the tax is paid from non-IRA sources. For many folks this shoots down the entire prospect, as there is no available cash outside of IRAs to use to pay the tax on the conversion. Taking the cash from the IRA in the form of a distribution can result in a 10% penalty, which can kill the whole plan, making it far more expensive in the long run.

One source of funds that you may not have considered is within your non-IRA investment accounts – especially if you have inherent capital gains and losses (even moreso if you have carried-over capital losses that wouldn’t otherwise be utilized readily).

Offsetting Gains With Losses To Produce Cash

Here’s how it works: You sell your “loss” positions, establishing a capital loss for tax purposes. Then you can sell your “gain” positions in like amounts, giving yourself a tax-free source of cash, since the loss will offset the gain for taxation purposes.

For example – imagine that you have a $100,000 IRA that you’d like to convert to Roth. Running the numbers, you’ve come to realize that the conversion will cost $25,000 to complete. In addition to the IRA, you also hold some non-IRA money, in the form of two investments. One of these investments has an inherent loss of $20,000, and the other has an inherent gain of $30,000.

By selling out of the “loss” position completely and selling just enough of the “gain” position to offset the tax loss you’ve realized, you have effectively created a tax-free source of income in the amount of $20,000. This still leaves $5,000 if you’re planning to convert the entire amount.

After you’ve finished with your conversion activities (and after 30 days has passed so that you don’t run afoul of the wash sale rules), you can re-invest the leftover money in those same investments, keeping your allocation at least similar to what it was before.

At this stage you have three choices, assuming you don’t have an extra $5,000 laying around:

  1. You can choose to only convert a portion of your IRA – the amount that you can generate tax-free money to pay tax upon.  In our example, this would be $80,000.
  2. You can use more of the cash that you freed up from the sales of your non-IRA gain and loss holdings. After all, the tax rate on the capital gains would only be 15%, so that would keep the extra costs at a minimum.
  3. You can convert the entire amount and take distribution of the additional $5,000 to pay the extra tax. Actually you’d need to pull out $5,500 in order to pay the penalty on that amount that you’re distributing, if you’re under age 59½.

Of these three, I’d recommend option 2, which is the outcome where you complete the conversion of the entire amount without having to pay additional tax or penalty on the money that you’re using to pay the tax on the conversion. Yeah, that last sentence belongs in a museum. Happy converting!

One thing more to consider

As you consider a conversion, you need to keep in mind that the overall income tax on your return will be increasing. In general this just means you’ll have to pay more tax. More income equals more tax, simple as that, right?

Unfortunately there are other things to keep in mind. The most costly is your healthcare insurance – primarily if you’re on Medicare or an ACA (marketplace-subsidized) insurance plan. Each of these two types of healthcare insurance have income limitations that could apply as your income increases. Be sure to check on the limitations of your policy (or program) before you make the leap.

6 Steps to Start Paying Off Personal Debt Today

Today’s post is brought to you by my colleague Robyn over at A Dime Saved.

Wiping debt way with a sponge

‘A man in debt is caught in a net’ – wrote John Ray.

Molehills of personal debt build mountains of worry.

Debt is a problem. Living in debt is stressful and tiring. Constantly paying off creditors and having years of debt repayments makes many people unable to live their life fully or even celebrate significant life events. It makes them desperate for money and angry.

Debt has caused a third of all millennials, or 34 percent, to hold off on buying a home and 31 percent to delay saving for retirement. It has also affected millennials’ family structure. Fourteen percent of millennials have delayed getting married due to debt, and 16 percent have delayed having children. (Source: Poll: Majority of millennials are in debt, hitting pause on major life events (

If you are one of the many people who are struggling with mountains of debt, then you may want to start paying some of it off and starting to climb out from under the crushing pressure.

The solution is to come up with a repayment pattern that accommodates your regular savings as well as your repayment. I have compiled the following steps for you so that the road to the repayment of your debt will not be a boring one.

These tips can also be used to save money or to start changing your financial future- whether you are or are not in extreme debt.

So, here it is:…


6 Steps to Start Paying Off Personal Debt Today

Motivate Yourself

It can be very dull and depressing, waking up every morning and working hard with the sole aim of repaying the personal debt. So you need something positive to brighten your thought and instill meaning in your schedules.

If all you do is pay up your debt and mortgage, month in and month out, then all that preoccupies your mind is debt. You tend to think about nothing else. Doing that will depress you, and start focusing on the negatives of your money situation. Being depressed and stuck is not the right frame of mind to take practical and actionable steps towards paying off personal debt.

Visualize how you want your life to look and imagine what your life will be like once you get rid of your debt. Picture that and focus on that to get you motivated to start this difficult journey. Extreme frugal living is easier when you are motivated to succeed.

Pay Yourself First

Paying yourself first is essential and crucial to your financial success.  For a successful debt-payoff plan to work, you need to make sure that you won’t get back into debt. How do you do this? By ensuring that you won’t get into debt again. There is no point in paying off debt to find yourself back in the same position in a few years. Set yourself up for success by saving some money and putting money away for emergencies and for the future. Let your money start to work for you now, so you don’t fall back into debt.

This is a classic approach that I honestly urge you to adopt; you should absolutely start a savings program. Why would I start saving while I still owe others? Because if you don’t start saving for yourself and putting yourself first, then you will never get ahead. You will always be stuck in the quagmire of debt and obligation.

Create a Budget

Of the 100% that constitute your income:

You pay yourself the first 10%; this is your savings plan

55% will go to buying things you need

5% will go into your play account

20% will go to repaying your loan

10% will go for charity, or tithe, or whatever you believe it’s a right course

I know 10% to charity sound awkward to some people in debt, but believe me, it works wonders.

Make Lists and Plans

Another crucial step towards repaying your personal debt is to make a comprehensive list of all the people and organizations you owe. Then, decide who and what should get paid first. There are different theories and thoughts of which debts make the most sense to be paid off first.

Two of the most common theories are the Debt Snowball and the Debt Avalanche. It really does not matter which one you pick as long as you pick one and stick to it! If you have a particularly predatory debt or if you have a debt that particularly weighs upon you, then you should pay that one off first.

The main point is to have a clear point and guidelines of how you are attacking your debt. Know how much you owe, to whom you owe it, and in what order you are paying them back. The most basic way to succeed is to have a plan.

Make Contact

If you owe money to individuals, then at this point, you will need to talk to each of them after you have carefully mapped out the repayment pattern. Be very honest and considerate with yourself and with them. You will need to be prepared as some of them may welcome your plans and thoughtfulness, while a few others may be disagreeable and needier. You must be friendly but stick to your project.

Tell each of them to the effect that, ‘this much I can repay you each month, but no more.’ give them a timeline of when you think you will be able to repay. Write it down for them, so they know you are taking this seriously. they will respect the fact that you are attempting to pay them back clearly and logically.

Suppose you have very large loans to companies that are old or way too large ever to repay; maybe consider talking to them to discuss a settlement or an alternative payment plan. Please discuss this with a  certified financial planner in advance, as there are tax implications that you should be aware of. Many companies are willing to settle large amounts as they are willing to get some money instead of the risk of none.

Create Good Habits

Now comes the hard part. Stick to your budget and payment plan. Make sure that you never spend more than you budgeted for and always make good choices with your money. You can look for ways to make extra money that you can use to speed up your repayment plan or to cover unexpected expenses. Keep your eye on the goal: to get rid of your debt. Each dollar you save and each penny that you earn is one step closer to freedom from debt. So keep working on the program and sticking to the plan. You can do it!

Using a cash budget is an extremely effective way to stop overspending and to help you stick to your budget. Using cash makes it harder for you to overspend and helps you get in the habit of sticking to a clear budget. Try it and see if it works for you. Please don’t get too caught up in rewards and coupons and hacks: stick to the plan and work it.

The Bottom Line

Confucius said, “He who will not economize will have to agonize.” the choices we make with our money today affect our tomorrows. When we rack up extra spending today, then we are hurting our future selves. The actions we take today will have very significant ramifications on our future. Debt only grows and grows. Not taking care of debt will only hurt you later on- this is not a problem that will just disappear! Use these tips to help you get out of debt today!



The Richest Man in Babylon: Summary, Pt 9 of 9

The Richest Man in Babylon

Photo credit: jb

This article is Part Nine, the final portion of our series of the lessons from George S. Clason’s bestseller The Richest Man in Babylon. Did I just hear a collective “FINALLY!”? If you’d like to go back to the beginning and catch up on the earlier lessons, you can start with the first article in the series by clicking this link.

The Luckiest Man in Babylon

In this final chapter, Clason ties all the lessons together with the story of Sharru Nada, a rich merchant, who tells his young companion, Hadan Gula, the grandson of his business partner, the story of how his grandfather had become such a successful merchant.

In a nutshell, the grandfather and Sharru Nada had each found themselves in dismal financial straits. Learning from one another and from listening to the successful people around them, each applied the lessons we’ve discussed throughout this series. With time, effort, patience and discipline, each man gradually improved his situation. Times arose where they were able to help one another out, and eventually they became business partners, successful in every venture they undertook. (Honestly, read the book if you want the whole story – it’s a good, quick read – you’ll not regret the time spent.

The Lessons

Here are the lessons we’ve learned throughout the review of this book:

  • Part of all you earn is yours to keep. Another way to put this is: pay yourself first. Begin a savings plan with a portion of all you earn.
  • Take advice only from those experienced in the matter of your questions. Don’t ask your barber for advice on surgery, and don’t ask a surgeon for advice on building a house.
  • Take advantage of compounding of returns. Don’t spend the earnings that your savings accounts generate; reinvest your dividends.
  • Control your expenses – learn to “get by” on only a percentage of what you earn.
  • Invest with wisdom. Understand the investments that you make, and make certain that the reward is worthy of the risk in all you invest in.
  • Own your own home. This has both a financial and a spiritual benefit.
  • Invest with an eye to the long-term. Make certain that your investing activities will provide you with an income in your old age.
  • Always improve your ability to earn, either by improving your skillset in your job, or by increasing your knowledge of investment activities.
  • Learn to recognize situations when you can take advantage of “good luck”. Take action with good insight, don’t procrastinate.
  • Know when to be cautious, especially with regard to loaning money to family and friends.
  • Plan in advance for events that might cause you harm – ensure that you’re insured against disaster in all its forms.
  • Have a good advisor or advisors to help you understand all of the negative “clamor” around you. This can help you to maintain your discipline in good times and bad.
  • Having the right attitude (“the soul of a free man”) can make all the difference in your outlook on life – and therefore on the results you achieve.
  • If you find yourself in a debt situation, put a systematic plan in place to eliminate the debt, but not at the expense of your saving plans. Use organization, communication, and discipline to work yourself out of the debt hole and regain your status among your acquaintances and colleagues.

That’s the list that I’ve developed of the primary lessons from this book. I hope that if you weren’t already familiar with the book that this series has sparked an interest for you. I’d love to hear stories from anyone who has benefited from the book – as well as if you found other gems within its pages that you’d like to highlight. Just leave your stories in the comments section below.

The Clay Tablets From Babylon: The Richest Man in Babylon, Pt. 8 of 9

The Richest Man in Babylon

Photo credit: jb

This article is Part Eight in our series of the lessons from George S. Clason’s bestseller The Richest Man in Babylon. If you’d like to go back to the beginning and catch up on the earlier lessons, you can start with the first article in the series by clicking this link.

The Clay Tablets From Babylon

This chapter* is fancifully comprised of several letters back and forth between an archeologist, digging up the ruins of old Babylon, and his colleague at St. Swithin’s College of Nottingham University. (Imagine a scene from one of the Indiana Jones movies…) The subject of the letters is a collection of clay tablets that the archeologist has had delivered to the college – supposedly the record of our old friend Dabasir’s financial affairs. If you don’t recall, Dabasir was introduced to us in the previous chapter, The Camel Trader of Babylon. In that lesson, we learned that having the right attitude can take you where you want to go in life. In these clay tablets, we find the details of how Dabasir worked his way out of debt.

In the letters, the professor at St. Swithin’s is telling his colleague the archeologist that the details written on the clay tablets has opened his eyes to a new way to deal with his own financial affairs… and then in a subsequent letter he explains that the formula used by old Dabasir has, in fact changed his life.

Here is the lesson: If you find yourself dealing with a debt situation that is out of control, the only way to “fix” it is to organize your information and begin attacking the problem. Old Dabasir details on the clay tablets how he used the first rule, saving one-tenth of all his earnings, to begin building up his savings. Then, he made a list of all of his creditors, including the amounts owed. He took this opportunity to visit each creditor, explaining that he could not currently pay off the debt completely, but that he was undertaking to gradually pay off all of his creditors. He took his list of debts to show them, and explained to each that this debt would be serviced by two-tenths of his earnings, each debt in proportion.

Some of his creditors rebuked him – saying they needed all of the money returned immediately. Others were happy to hear that he was working his way out of debt. In the end, none of the creditors had any choice but to accept his offer – which he attended to religiously. Each time he earned some money, one-tenth went into his savings, two-tenths was split among his creditors evenly, and the remaining seven-tenths he and his wife used for food, clothing, and other needs.

The surprising thing, to both Dabasir and later the professor at St. Swithin’s, was that getting along on 70% of his earnings was not as difficult as he thought it would be. Soon enough, in both cases, the debts were disappearing, and the savings were accumulating. In due time, both men retired all of their debts, had increased savings, and had learned to live on much less than they earned. These are keys to financial success.

There’s no magic to it – but for some reason those particular proportions work well and provide success to anyone who undertakes such a plan. Very important to the success of this plan is to write down your debts, and to talk to your creditors to explain your plan. Don’t skip this step, as you’ll either cause problems for yourself when the creditors don’t understand, or you’ll underestimate the size of your debt. Writing it down will put you in a position to track your progress as you begin retiring the debt, as well – which can be very helpful to keep you motivated through the process. Sticking to the plan – having discipline to carry it out – is all that remains for you to succeed.

Three facets – Organization, Efficiency and Discipline – are used to resolve this problem. Organizing your debt information so that both you and your creditors understand it. Efficiency is necessary to manager your own life on only 70% of your earnings. And Discipline is required to maintain the payoff schedule, as well as the savings activity, throughout good times and bad.

One more chapter awaits, this one called “The Luckiest Man in Babylon” – and it brings many of the lessons together in one concise place.

*Note: in my current copy of the book, this interplay with the archeologist and the colleague is not included, but only the actual information from the tablets, along with Dabasir’s narrative. I left the original (to me) description intact as it helps to explain and drive home the point of the message.

The Camel Trader of Babylon: The Richest Man in Babylon, Pt. 7 of 9

The Richest Man in Babylon

Photo credit: jb

This article is Part Seven in our series of the lessons from George S. Clason’s bestseller The Richest Man in Babylon. If you’d like to go back to the beginning and catch up on the earlier lessons, you can start with the first article in the series by clicking this link.

The Camel Trader of Babylon

In chapter 8, we are introduced to Tarkad, a young fellow who has fallen upon hard times. He owes money to literally everyone he knows, and cannot even come up with enough money to buy a simple meal to keep from starving. He considers stealing some food, but his forays into theft in the past have taught him the lesson that that is not the way to go. So he finds himself hanging around outside an inn, hoping that he’ll see a friendly face among the folks coming in to dine at the inn. Instead, he finds Dabasir, the wealthy camel trader, to whom Tarkad owes a small amount of money (of course!).

Dabasir asks Tarkad for the repayment, to which Tarkad explains he has suffered much misfortune, and as such does not have the money to repay him. Dabasir rebukes his excuse, but then invites Tarkad to join him in the eating-house so that he might tell him a tale.

The tale, boiled down, is of how Dabasir had at one time been subject to slavery in his youth. Through wanton spending and living for the day, he became so heavily in debt that he could not only not pay the debts, he could no longer support his wife.  She left him and went back to live with her father.

After a time, Dabasir could find no gainful employment and took to a life of robbery. As you might expect, his success there was short-lived, and he was caught and enslaved. It might not seem so, but this is where good fortune shone on young Dabasir:  he happened to be sold to a man who required him to attend to his wife’s camels. This wife, Sira, notices that Dabasir is not like the other slaves, much the same as she was not like the master’s other wives. Sira then approaches Dabasir with a life-changing question:  “Do you have the soul of a slave, or the soul of a free man? If a man has within him the soul of a free man, will he not become respected and honored in his own city in spite of his misfortune?”

Pondering these words, Dabasir becomes determined to face up to his debts, become respected and honored, and truly live the life of a free man. Fortune worked in his favor again, as Sira helped him to escape from his slavery – but his journey back to his homeland was very difficult… many times he wanted to give up and die. Over and over he told himself that the soul of a slave would give up and allow the winds of circumstance to direct him – but a free man would stand up for himself, and through sheer determination make his way through the difficulties, to get back to Babylon and face his debtors. Of course he did, and over time paid off all of his debts, and became a respected and honored man in his own country. The details of just how Dabasir paid off his debts are covered in the next section of the book.

Lesson:  Self-pity and allowing the circumstances to direct your life are the actions of a man or woman with the soul of a slave. Taking charge of those circumstances in your life, taking action when action is needed, are the ways of a man or woman with a free soul. The only way to make yourself successful is to take on the mantle of the free man’s soul, having the courage and determination to be accountable and, eventually honored and respected.

The next chapter “The Clay Tablets From Babylon” outlines Dabasir’s specific methods for retiring his debt obligations. It is presented as if the old camel trader had written it all out on clay tablets, which have been found in the modern day.

The Walls of Babylon: The Richest Man in Babylon, Pt. 6 of 9

The Richest Man in Babylon

Photo credit: jb

The sixth part in our series of the lessons from George S. Clason’s bestseller The Richest Man in Babylon. If you’d like to go back to the beginning and catch up on the earlier lessons, you can start with the first article in the series by clicking this link.

The Walls of Babylon

In chapter 7, the shortest chapter of the book, we are introduced to Old Banzar – who is an old warrior of times past. At this particular time, the city of Babylon is under siege, and king, along the main garrison of troops, is off on a conquest. But the city of Babylon is well-protected by enormous walls with huge bronze doors, which keep invaders out and provide a vantage point for the defenders to counterattack with burning oil, arrows, and if necessary, spears.

The citizens of Babylon are frightened out of their minds. All day and all night, they can hear the sounds of the invaders trying to breach the walls – and they see evidence of the fierce battle in the multitude of wounded soldiers being carried down from the walls.

Time and again, the citizens approach Old Banzar, who was in the best position to deliver news as a guard upon the passageway leading up to the walls, to ask if the walls will hold. Some are concerned for their own safety. Others are concerned about the safety of their families. Little children ask if they will be safe. Banzar, knowing the strength of the walls and the defenders, reassures all that the walls will hold, and the invaders will be turned back. He knows this because the walls were built at a great expense of money and human effort, specifically for this task. Due to his confidence in the defenses, the citizens are able to rest more comfortably.

Finally, after a siege of three weeks and five days, the attackers withdrew, just as Old Banzar predicted. The good citizens of Babylon can finally sigh their relief.

The lesson:  In this case there are two lessons – the first is that security is something that must be planned in advance, to fit the needs of the potential calamities that might come to us, threatening our safety. In our financial lives we plan security in many ways: through insurance for life, health, and property; with diversification of our investments; and by choosing investments with risks appropriate to our ability to absorb losses, among other things.

The second lesson comes from Old Banzar himself. Having experienced many battles upon those walls, and therefore being in the position to know that the defense was up to the task, he was able to reassure the citizens that all would be well. Much the same as the citizens of Babylon, we often hear day in and day out of the terrible things going on with the markets, the economy, and so forth. It is helpful to have an advisor or mentor, someone who knows how the “defenses” work in our times of need. This experienced person is in a position to really know what is going on, and to help reassure us that all will be well.

The next chapter is called “The Camel Trader of Babylon“, and it will help to explain how you can get yourself out of the financial ruts you may be in, to achieve financial independence.

The Gold Lender of Babylon – The Richest Man in Babylon, Pt. 5 of 9

The Richest Man in Babylon

Photo credit: jb

The fifth part in our series of the lessons from George S. Clason’s bestseller The Richest Man in Babylon. If you’d like to go back to the beginning and catch up on the earlier lessons, you can start with the first article in the series by clicking this link.

The Gold Lender of Babylon

In this chapter (chapter 6 of the book) we learn a few valuable lessons about lending money. The story is about a young man named Rodan who came into some sudden unexpected money. As you might expect, his “friends” quickly multiplied and his family became bold in their requests for loans. And, not wishing to be foolish with his money (which amounted to what he could save otherwise in fifty years!), Rodan wisely seeks the counsel of the gold lender, Mathon, due to his long experience in loaning money successfully.

One of the first things that Mathon explains is how providing assistance to another should never result in your taking on the burden yourself. In other words, were Rodan to loan his money to someone who was incapable of repaying it, he would be taking on the burden of the lack of that money. The way to alleviate this is to require a borrower to provide some sort of collateral, something of value to the borrower, to secure the loan.

In some cases the collateral is of greater value than the loan – in those cases the money lender is virtually guaranteed of the return of the principal plus interest, or the collateral can be sold to make up the money loaned. In other cases there is the promise of wages to be earned – these are also very easily assured, for the most part. In yet other cases there is nothing of value that the borrower can deliver other than the assurance of his friends and family that the loan will be repaid (the modern-day co-signer).

Mathon provides Rodan with many examples of good and bad loans he’d made throughout the years, each with similar lessons. In the end, Rodan asks the real question that he came to ask: should he loan his “found” money to his sister’s husband in order to help him get started out as a jewel merchant?

Mathon asks some simple questions: What knowledge does the brother-in-law have of the ways of trade? Does he know where to buy at the lowest cost? Does he know where to sell at a fair price?

Rodan acknowledged that his brother-in-law did not possess the skills of a merchant. And so Mathon explained again that, while it is noble to lend a hand, it is critical to make certain that you are not taking on the burden for yourself. In the case of Rodan’s brother-in-law, the purpose of the loan would likely end up in failure due to the brother-in-law’s inexperience; thus transferring the lack of funds to Rodan.

Put succinctly, when loaning money you must always have a way to ensure that it will be returned to you with interest. Whether that is in the form of collateral, the borrower’s good reputation, or the assurance of a co-signer (possibly with collateral), you must always make sure it’s a given fact that your money will be returned once borrowed.

As the parting statement from the gold lender, Mathon shows Rodan his chest full of tokens used as collateral for loans… and inscribed on the lid, very succinctly, is our lesson:

Better a little caution than a great regret.

The next installment will cover The Walls of Babylon – with some insights regarding financial advisors and protection.

The Five Laws of Gold: The Richest Man in Babylon, Part 4 of 9

The Richest Man in Babylon

Photo credit: jb

Today we’ll continue on the journey of examining the lessons of George S. Clason’s exceptional book The Richest Man in Babylon. If you’d like to start back at the first lesson, you can find it here. Today’s lesson is from the chapter entitled “The Five Laws of Gold”.

The Five Laws of Gold

This chapter starts out like a predictable prodigal son story – from the viewpoint of the son, a fellow by the name of Nomasir, who was Arkad’s son (Arkad was the richest man in Babylon, introduced in the earlier reviews). The story is related by another man who knew Nomasir.

It seems that when Nomasir was ready to make his way in the world, his father gave him a bag of gold and a clay tablet, upon which were written the five laws of gold. As you might expect, Nomasir was foolish with the bag of gold, and only after losing it all did he review the five laws closely. They are as follows:

  1. Gold cometh gladly and in increasing quantity to any man who will put by not less than one-tenth of his earnings to create an estate for his future and that of his family.
  2. Gold laboreth diligently and contentedly for the wise owner who finds for it profitable employment, multiplying even as the flocks of the field.
  3. Gold clingeth to the protection of the cautious owner who invests it under the advice of men wise in its handling.
  4. Gold slippeth away from the man who invests it in businesses or purposes with which he is not familiar or which are not approved by those skilled in its keep.
  5. Gold flees the man who would force it to impossible earnings or who followeth the alluring advice of tricksters and schemers or who trusts it to his own inexperience and romantic desires in investment.

After reviewing these laws carefully and putting them into action in his own world, sought out advice from skilled investors, and began to build his fortune. Over the course of ten years (he was to return to his father after this time) Nomasir built quite a life (as well as fortune) for himself. Upon his return to his father’s home, he paid back the original bag of gold, and then paid two more bags in exchange for the five laws.

The first three we’ve covered in the earlier reviews – save at least 10%, invest your money to compound the returns, and follow the advice of people who understand how to make money. These are foundational concepts that certainly bear repeating.

The fourth law is an expansion of the third: make sure you understand your investments. This is one of the reasons that speculative investments like cryptocurrency don’t pass muster as a good idea. Not that the very concept of Bitcoin (or whatever the coin in question is) is so difficult to understand, it’s a store of value, much the same as a euro, a dollar, or a pound sterling is. What’s not understood is why the value increases or decreases, often wildly…? The coin is still the same as it was the day (or hour, or minute) before, but somehow it’s worth more (or less) than it used to be. It’s all owing to someone else’s estimation of the current value – rather than something produced by the coin itself. Because of this I’ll continue to repeat that cryptocurrency is not an investment, any more than a dollar is an investment. And until the valuation equation stabilizes, I see no need to hold assets valued by a cryptocurrency, unless a marketplace I want to participate in requires it. (And yes, I know that some people make money by investing in various currencies, but the average Jane or Joe doesn’t have much business in that activity either.)

And now to the fifth law: we all come across fraudsters and schemers who would like to part us from our money. It’s important to be able to recognize these. It may take some time at first to gain the recognition, but soon you get to the point where you can feel the sales pitch, and you can tell it’s a fraudulent (or at best, hypersold) activity or investment. Steering clear of these things is critical to advancing your wealth safely.

Lesson:  The first three laws have been covered previously, but are always worth repeating. The last two are important to remember – keep your investing activities in the well-understood and proven realms. Much like Warren Buffett has preached, it’s important to invest in something you understand – and with the advice of those who’ve been there before.

The next section will cover the chapter “The Gold Lender of Babylon” – which provides interesting lessons for those who are asked by family members or close friends for a loan.

Meet the Goddess of Good Luck: The Richest Man in Babylon, Pt. 3 of 9

The Richest Man in Babylon

Photo credit: jb

This is the third in a series of articles reviewing the lessons found in the definitive classic, The Richest Man in Babylon by George S. Clason. If you’d like to start at the very beginning (a very good place to start!) – you can find the first article here.

Meet the Goddess of Good Luck

In this chapter, Arkad is asked by a student about how to attract good luck. It is noted that people may work side-by-side with one another, and one may have good luck while another does not.

The students are questioned about times when they had experienced good fortune to perhaps find out the way that good luck came upon them. One student found a wallet full of money – but could not reckon how to continue finding more wallets. Another noted that Arkad himself had been seen at the horse races, betting on the grays. Alas, Arkad pointed out that gaming houses and horse races, while frequent locales for witnessing the good fortune of a few, the odds are always in favor of the organizers (the house), and good luck does not flow to the game players very often.

Finally, a livestock trader speaks up about a time when he allowed good fortune to slip through his hands. It seems that he had an opportunity to purchase a flock late one night, when the owner of the flock was anxious to complete the sale and return to his home. By delaying the purchase until morning, more buyers were on the scene who were willing to pay a much higher price than was originally offered, and so the good fortune slipped by. By procrastinating his decision, the buyer lost out on a fine profit.

At this, another fellow, a trader, pointed out that he had been subjected to his own procrastination early in his career. By finally recognizing it and working against the urge to delay, he was able to cause much good fortune to come his way. By taking action, even in small ways, toward making a decision, the trader accounted that his fortunes had changed to the better.

We see these kinds of situations in our lives all the time. Maybe there’s a good opportunity to invest in a valuable piece of real estate at a reasonable price, or to buy stock when the overall market is relatively low-priced. Unless we recognize these situations and take action, even a small action, we are driving away the “good luck” that action brings to us.

This is not to say that we should fall for every pitch that comes to us. We should evaluate each opportunity closely, and take action one way or another as we see fit, especially when we seem to vascillate. As Arkad points out, too often we are dead sure about our wrong decisions and tend to procrastinate about the right ones. Over time you gradually begin to recognize these faults and overcome them. Doing so brings “luck” in the form of opportunities taken advantage of as they are presented.

Lesson: A person of action is favored by the goddess of good luck. Procrastination upon decision-making only leads to regrets. Make decisions with all the good information that you have – either for or against an action – and carry out the decision. Indecisiveness does not bring good fortune.

The next part of this review is “The Five Laws of Gold“.

Seven Cures for a Lean Purse – The Richest Man in Babylon, Pt. 2 of 9

The Richest Man in Babylon

Photo credit: jb

This is the second in a series of posts in review of the lessons found in the book The Richest Man in Babylon. The first article can be found here.

Seven Cures for a Lean Purse

Arkad, the richest man in all of Babylon, has been persuaded by the king to teach others the secrets of his wealth. The king wants all of his subjects to know how to acquire wealth, as he wishes for Babylon to be known as the wealthiest city in the world.

Arkad agrees to the scheme – he will teach his secrets to a group of citizens, who will be destined to become teachers themselves. These teachers will then go on to teach others the wisdom of Arkad, how to acquire and maintain wealth.

In this chapter, Arkad lays out the cures for a lean purse to the future teachers over the course of seven succeeding nights.

As a preface, Arkad admits to the king and later to his students that he started with nothing at all, just the same as the students. His only advantage at that point was a desire to become wealthy – plus the knowledge given to him by someone who had “been there, done that”. In other words, he started with no more advantage than any of his students have.

The First Cure:  Start Thy Purse to Fattening

Every person who has a capacity to earn a income has the ability to begin saving money. A job is a source of income, and through income is where the entire process of wealth creation begins.

As was revealed to Bansir, Kobbi and their friends in the second chapters, Arkad explains the great benefit of paying yourself first out of all income. The recommended amount is not less than one tenth (10%) of all earnings. Even though we covered this lesson in the first article, its value cannot be underestimated. This particular lesson is revisited over and over throughout the book.

There is no better way to increase savings than to regularly set aside a portion of all earnings, designated as savings. As these seemingly insignificant sums are set aside, you don’t notice them missing from your day-to-day cash flow, and before long the savings begin to mount up. Getting in the habit of saving (and therefore spending a bit less) is the foundation of any successful wealth creation plan.

In these times when many folks are nearing retirement with perhaps less savings than they need, the best way to make up the differential is to put more money aside. Many consider the benefit of taking larger risks with what remains of their savings, or somehow reducing their future expenditures, but the best (and really only, in most cases) way to get back on track is to continue regularly saving – and likely delaying retirement by a year or two from the original plan.

The Second Cure:  Control Thy Expenditures

Once you’ve begun setting aside ten percent of your earnings, you must learn to get by on only ninety percent, and the lesson here is to get by with only ninety percent, or even less if possible. Arkad explains that “what each of us calls ‘necessary expenses’ will always grow to equal our incomes unless we protest to the contrary'”.

This again is a long-held truth: if we do not examine our outlays we will always find a place to spend every last cent of our income. It is for this reason that it is often helpful to, upon receiving an increase in salary, begin by setting aside the amount of the increase into savings. After all – we were able to “get by” on our pay amount before, right? And if we have been overspending our salaries, we must split those expenses out into “necessities” and “wants”. Your “wants” can be had later when you’ve become wealthy. Remember, patience is a virtue.

For controlling expenditures, it may be necessary to enlist the help of a tracking tool of some sort, which can be as simple as a spreadsheet. By tracking your every expenditure, you gain an understanding of where all of your income is flowing to. And by understanding where your money is going, you can make decisions about which expenses are necessities, and which are simply “wants”.

The Third Cure:  Make Thy Gold Multiply

As we set aside the prescribed ten percent of our earnings, it is important to start that money working for you, multiplying your savings. Arkad describes this as causing your money to be workers for you and to have children who are workers as well, and the children of your money to have children of their own, all working for you. This is one way of describing compounding returns.

The investment of your “gold” can be as simple as a bank savings account or as elaborate as an IRA or other deferred-tax account. The point is that you are setting this money aside – make it work for you and return a dividend, and in turn put the dividends to work as well.

Of course there are many ways to invest your savings, but it is wise to invest in ventures that are assured of return. Compounding this return upon itself causes your multiplying savings to increase at an ever-quicker pace.


The Fourth Cure:  Guard Thy Treasures From Loss

Here Arkad makes a very important point: “The first principle of investment is security for thy principal.” Even though there are possible investments with large “promised” returns, these often come at a high risk to your principal – the money you’ve been saving all along. As a minimum, you need to start out with very safe investments that guard your principal, so that at any time you can get at least the amount back that you’ve saved over time.

When you have savings built up, there are many ventures that will come into your sights – some promising outrageous returns, others a fair return with less risk. As you consider your alternatives, make certain that you seek out advice from others who know and understand the venture. Use this advice as you choose investments for your savings, with the first principle of security in mind.

The Fifth Cure:  Make of Thy Dwelling a Profitable Investment

In this lesson, Arkad points out the benefit to be had by owning one’s own home. Instead of paying rent throughout the years and having nothing to show for it but a box of rent receipts, it is wise to pay roughly the same amount as your rent toward a mortgage and eventually have a paid-for home of your own. Plus, very often the value of the home appreciates over time, while you’re still making the same mortgage payment as before; rent amounts increase with the passage of the lease term in many cases.

Arkad also points out the spiritual benefits of owning a home – where you and your family can enjoy a yard and perhaps a garden, and how owning property in and of itself does good to a person’s heart.

I realize there are often good reasons to rent rather than buy. These reasons are often linked to being in a transitional phase, where you might not be staying in the same geographic area for very long, or the high entry point for home ownership in a particular area. I concede that home ownership is not a panacea for everyone, but for many it can be a very useful component of the wealth creation process.

The Sixth Cure:  Insure a Future Income

This is the lesson concerning retirement and disability income planning – or in Arkad’s words, “it behooves a man to make preparation for a suitable income in the days to come, when he is no longer young, and to make preparations for his family should he be no longer with them to comfort and support them.”

Planning for the foreseen and unforeseen is critical in your wealth creation process. You must consider those things that could occur to eliminate your income (unemployment, disability or death) and prepare yourself for those potentialities. Plus you need to think about that time of life when you’re hoping to retire from work and live off of your savings. There are many ways to prepare for these situations.

First suggested is to bury some money in the sand – of course this isn’t the best answer, although it might be partly useful. However, Arkad suggests putting money aside with the money lender (bank) and adding to it regularly, receiving rental (interest) for the loan. In time, the compounded interest and regular contributions will grow to a sizeable sum from which you can draw in old age or your family could use if you were not with them any longer.

Obviously, life insurance and disability income insurance would be products available today to cover premature death or disability, while retirement savings accounts, pensions, and annuities are available to cover the your income needs in old age. Otherwise, the “cure” is the same, just modernized with the products available in today’s world.

The Seventh Cure:  Increase Thy Ability to Earn

This last of the cures speaks to a way to increase the benefits of the other six: If you can increase your ability to earn, you can readily set aside more income toward building wealth. The way to do this is twofold… begin with industriousness and a desire to earn more. This attitude will serve you well in your current job. Working hard and taking pride in what we do doesn’t go unnoticed, and perhaps might gain you a raise for doing the same work.

At the same time, improving your skillset and knowledge of your profession will open doors of opportunity for increasing earnings. This could be at the current job or expanding out to new opportunities, or even going into business for yourself. You could start up a side-gig and augment your income in that manner as well.

In closing, here in Arkad’s words are several more items to consider in increasing your earnings capacity as well as your self-respect:

Many things come to make a man’s life rich with gainful experiences.  Such things as the following, a man must do if he respect himself:

He must pay his debts with all the promptness within his power, not purchasing that for which he is unable to pay.

He must take care of his family that they may think and speak well of him.

He must make a will of record that, in case the Gods call him, proper and honorable division of his property be accomplished.

He must have compassion upon those who are injured and smitten by misfortune and aid them within reasonable limits.  He must do deeds of thoughtfulness to those dear to them.

And lastly, to cultivate thy own powers, to study and become wiser, to become more skillful, to so act as to respect thyself.

The next article will deal with the chapter “Meet The Goddess of Good Luck“.

The Richest Man in Babylon: Pt. 1 of 9

The Richest Man in Babylon

Photo credit: jb

I’m re-re-reading a classic, George S. Clason’s The Richest Man in Babylon. As a result, I’ve decided to re-do and refresh my review of the lessons in the book (last updated in 2009) – not a book review, mind you, but going through each of the lessons in the book in its entirety. There are nine parts to my review, and I’ll be releasing a new part every week over the coming 8 weeks.

What’s very interesting about this book is that the lessons aren’t anything new. Perhaps it’s fanciful to assume that these very conversations were being had in ancient Babylon, but the basic lessons have been around for ages and they still apply! Yes, there may be new tax legislation all the time, and from time to time a groundbreaking product may take the stage, but all in all the way to gather and maintain wealth is unchanged throughout the centuries…

The first installment of these lessons takes place in the the first two chapters: The Man Who Desired Gold, and The Richest Man in Babylon.

The Man Who Desired Gold

This first chapter sets the stage for the rest of the book; we are introduced to a chariotmaker, Bansir, and his friend Kobbi, a lyre-player. These two fellows are talking together as modern-day friends might, commiserating about their shared plight. Each man has spent his entire life working, working, working, but they have nothing whatsoever to show for it. Kobbi finds Bansir sitting on a wall daydreaming, rather than finishing the chariot that is half-made in his workshop. He asks Bansir for a loan, since it appears that he must have plenty of money due to his lack of industry.

Bansir tells his friend of his dream, where he had all the money he desired, enough to spend on everything his heart wanted. But he awoke, and found himself still in his dire condition, living hand-to-mouth, with no savings, and no investments to provide him with an income.

Sharing the dream, both men wonder aloud how it is that some people eventually move beyond the situation that they find themselves in. They’ve hoped all their lives that hard work alone would be enough to magically transform their lives to ones of leisure. (to borrow a phrase “So how’s that working for you?”)

As they talk they come to the realization that most men are born into similar circumstances – they even observe a line of slaves being driven to work carrying water to the king’s gardens, noting that they could just as easily have traded fortunes with any one of them. Likewise, they discuss the great fortune of their old friend Arkad, who is known as the richest man in Babylon. How is it that Arkad has such a great fortune, yet they have nothing at all?

Together, they finally decide that the way to learn how to provide themselves with a fortune is to talk with their friend, Arkad, the rich merchant.

Lesson: To start yourself on the way to riches, it is important to learn from others who have experience in acquiring riches.

The Richest Man in Babylon

So Bansir and Kobbi, among other friends in similar situations, go to ask their friend Arkad, the richest man in Babylon, to share the secret of his great fortune. They point out that they all started in the same place – they played together as children, and attended the same schools. How was it that Arkad became the richest man in Babylon?

In answer, Arkad shares his story…

As a young man Arkad was, in fact, in the same boat as Bansir, Kobbi and the others – working, working, working, and never getting anywhere financially. Through his job he happened to become acquainted with a money lender, Algamash, who Arkad decides to ask the same question being asked of him now – how did he become a rich man?

Algamash provides Arkad with the first lesson:  part of all you earn is yours to keep. This is that age-old saying that we’ve all heard often – Pay yourself first. It’s simple enough, but if you don’t take it to heart, make it a part of your every action, and put it into practice you won’t know the vast benefit of such a habit. As Arkad learned, paying oneself a tenth of everything he earns teaches a man to live just as well with the remaining 90% of his earnings. He didn’t even notice the difference.

Later on, as Arkad has gotten into the habit of putting away that tenth… we learn the second lesson. Arkad built up a bit of money and decided to take the advice of his friend the brickmaker, to invest in some gemstones. Algamash points out the folly of taking advice from a brickmaker about gemstones, as Arkad painfully learns by losing all of his savings. Why should he take advice about gemstones from a brickmaker? Lesson two from Algamash: take advice only from those that are experienced in the matter of your questions. 

After a time, Algamash returned again to check on Arkad. He had learned from his mistake and invested on the advice of a shieldmaker who dealt in bronze, and by lending him funds Arkad had earned nice dividends. When asked what he had done with the earnings from his savings, Arkad proudly told Algamash about the feast he had given, the clothing he had purchased for his wife, and his plans to buy a donkey for himself to ride upon. At this news Algamash admonished Arkad – “If you take the children of your gold and make the children produce children, you’ll enjoy many a rich banquet without regret.” The third lesson: take advantage of compounding of returns.

Once Arkad had learned and applied the lesson of compounding returns (making the children of your money to produce children of the children), he had mastered the secret of increasing his wealth. Upon learning this, and knowing that his heirs had not learned these lessons, Algamash offers Arkad a job, managing some of his properties. In return, Algamash makes Arkad a partner in the profits, and the heir of a portion of his fortune. And the rest is history.

Some of the young men in Arkad’s audience believe that he was very lucky to happen onto Algamash, and for Algamash to fortunately agree to share his wealth. But others in the group realized that it wasn’t luck – it was a deep understanding of these lessons that produced Arkad’s “luck”. If he hadn’t become Algamash’s partner, some other opportunity would have presented itself, or at the very least the application of the lessons would have continued the gradual advance of Arkad’s fortune.

In our next installment, we’ll review the lessons of the next chapter –  Seven Cures for a Lean Purse.

When To Apply for Social Security Benefits


Photo credit: jb

As you might expect, the answer to the title isn’t cut-and-dried… it’s different for each individual, depending upon your circumstances. There is no magical “best age” for everyone. It’s important to understand the impacts and consequences of choosing to apply at different times in your life.

As we’ve discussed in other articles in this blog, when you apply for benefits before your Full Retirement Age (FRA) your benefit will be reduced. The amount of the reduction is dependent upon the amount of time between the date you apply and your FRA – earlier application results in greater reduction in benefit.

The opposite holds true for delaying your application for benefits after your FRA:  the more you delay, up to age 70, the more your benefit will increase. At age 70, the benefit no longer increases, so it doesn’t (in general) profit for you to delay receipt of benefits after that age.

Actuarial Results

The Social Security Administration has a bunch of really smart actuaries working for them, and these actuaries have determined the perfect mix of “average life expectancy” versus the reductions or increases. The result is that if you’re the average person who lives to the average life expectancy, it doesn’t matter much when you begin receiving your benefit. It will always work out the same.

Note: I don’t profess to know how the actuaries do this.  I have heard that it involves a trip to a cemetery at midnight and the possible sacrifice of a chicken. But, I can’t confirm, deny or divulge my sources on that.

Factors to Consider

You should consider several things as you make your Social Security filing decision – especially since many of us expect to live longer than the “average”, or at least we hope to. Statistics tell us that about one of every four people age 65 today will live past age 90. One of ten will live past age 95. So if your family history tends to run past the occasional octogenarian, you should certainly weigh longevity into your equation. For most choices of delaying receipt of benefits, the break-even ranges between the approximate ages of 78 to 82. (By “break-even”, I mean that filing at any particular age results in roughly the same lifetime benefit as of those approximate ages, 78-82. This break even is based solely on one individual, not including spousal or other dependents’ benefits.)

In addition to longevity, consider the impact that your choice could have on your family. Whenever you choose to apply for benefits will lock you into that amount as your benefit base for the rest of your life. And that benefit base impacts your surviving spouse’s benefit, plus the timing on a spousal benefit while you’re still alive. The benefit base can also impact other members of your family that might receive benefits based upon your earnings record.

It is important to note that it’s possible to make a change to your choice – using the “Do Over” tactic, so you’re not completely locked in when you make a choice.  But for many folks this may be out of reach. Note: the “do over” has been limited since this article was originally written, to only allow the reset within the first 12 months of filing.

Other factors that you need to consider as you make your decision are:  whether you plan to work in retirement, whether you have other retirement income sources, and your anticipated future financial needs and obligations.

Another Way to Increase Your Benefit

I mentioned earlier that your application for benefits locks you into a base benefit amount for the rest of your life. That’s not entirely the case – if you continue to work while receiving benefits, you’ll continue accruing credit for your earnings. If you have earlier years on your record with low (or no) earnings credits, your benefit could increase over time. In addition, you can suspend benefits once you reach FRA which could allow you to increase your base benefit at that point in your life as well.

However, working during your retirement (before FRA) could have the impact of reducing your benefit, depending on how much you’re earning. This is partly made up for when you reach FRA, but it’s important to know so that you can plan for the Social Security benefit reductions from working.


The Social Security Administration has online Social Security benefit calculators that will help you to estimate your benefit amounts at various ages, which can help you in your decision-making process.

Double, Double, Toil and Trouble

double the fun

Photo credit: jb

Avoiding Double Tax on an Inherited IRA

Did you know that if you don’t pay close attention, you could be paying tax a second time on an inherited IRA – if the original owner’s estate paid estate tax. You won’t find much about this at the IRS’ website… but nonetheless, it’s a fact that you can (and should!) avoid this double tax.

In the current (2021) estate tax exemption environment, this provision doesn’t apply to very many people. After all, the estate tax exemption is $11,700,000 for 2021 – and although it’s not impossible to breach that amount, it’s a significant number. Presumably if you are in that situation you will have many advisors to help you navigate the potential tax issues, but it never hurts to understand how it all works. Plus, there’s always the possibility, even likelihood, that the estate tax exemption will be reduced in the not-too-distant future.

Following are a couple of examples that explain how the IRD deduction works, so that you can avoid the double taxation problem.

First Example

You have become the sole beneficiary of your father’s $500,000 IRA.  According to the records for the account, all of the contributions were deductible contributions (more on this later).

When your father passed away, his total estate was worth $12 million – the IRA that you will inherit, plus an additional $11,500,000 in other assets. At the time of his death in 2021, the estate tax exemption was $11.7 million, leaving $300,000 taxable to the estate. Without the IRA, the estate would have been completely non-taxed. At the current 40% rate, your father’s estate has paid $120,000 in estate tax.

This creates your Income in Respect of a Decedent (IRD) ratio: the tax attributable to the distribution divided by the size of the IRA. Dividing $120,000 by $500,000 equals 24%. This is an important number, make a note of it!

If you took the entire distribution all at once, you would have available the entire IRD deduction of $120,000.  However (and – there’s always a however in life, right?) what happens when you take the distribution over many years, like the 10 possible years of IRA distribution these days?

If you began withdrawing $50,000 per year from the account, each year you could deduct $12,000 (24%) from the distribution – reducing the taxable income to $38,000*. If you continued withdrawing that same $50,000 every year, the same deduction would be available to you – but only until you used up the original $120,000. In this case, it would be 10 years (not counting growth).

If you took different-sized distributions, each distribution would be eligible for the 24% deduction, up to the point where the full $120,000 has been used up.

Of course, over time the IRA has the opportunity to grow, so you’ve likely got quite a bit left in the account as you reach the end of the 10-year distribution period. Each distribution after the credit has been used up will be completely taxable as ordinary income.

Second Example

For a very quick look at a second example:

Same circumstances as before, except that the rest of the estate was worth $12 million, so that the overall estate is valued at $12.5 million when your inherited IRA is included. Total estate tax paid is $320,000 (40% of $800,000). Of that $320,000, the tax attributable to the IRA is $200,000. So your IRD ratio is 40%, the same as the tax – $200,000 divided by $500,000. In this example, every distribution that you take from the account receives a deduction of 40%, until the $200,000 has been used completely. Any distributions after the credit has been used up will be taxed as ordinary income to you.

It’s important to note that I used the 10-year distribution period for these two examples since that is the current “default” distribution period. The IRD rules are the same not matter what your distribution period is – you just have a different time period over which you may use the IRD deduction. In other words, SECURE did not change how IRD taxation and deduction work.

H/T to reader SS for pointing out my math error in the original. Thanks!

Bonds and Bond Funds

Roth conversions

Photo credit: diedoe

There is a question that often comes up when discussing investment strategies, especially for an astute investor who has done some research on various kinds of investments. Specifically the question often is: why would we choose a bond fund or a bond index fund versus purchasing a specific bond (or several bonds)?

Bonds in General

To answer the question, we have to start with a basic understanding of bonds in general. A bond is a loan – either to a corporation, the US government (or a foreign government), a state, or a municipality, among others. For this loan there are very specific terms, which include:  maturity of the bond (how long it exists), the coupon rate (what amount of income it provides), whether the bond is “callable” – meaning, if circumstances change and the issuer wants to pay off your bond early, is that allowed?

If you had a bond with a corporation that was worth $1,000, had a maturity of 30 years, and pays you $60 every year, your yield is 6% ($60 divided by $1,000). Here’s where it starts to get complicated though:  when you purchased the bond, you likely didn’t purchase it for $1,000 – the purchase price is discounted due to the fact that you won’t get your money back for 30 years, so the price might have been something like $900.

If nothing changes, you will receive your annual $60 payment for the next 30 years, and then you’ll receive the $1,000 value of the bond. However (and there’s always a however in life, right?), if you decided after 15 years that you wanted to get your money out of the bond, you would sell it on the secondary market – but not likely for $1,000, or even for the $900 that you paid. If nothing else has changed (current rates are the same, credit risk of the corporation is the same, etc.) then this bond is likely worth somewhere between your purchase price and the redemption value of $1,000.

If other things have changed, this bond could be worth much more than the $1,000 or much less than the $900 that you paid. Let’s say that interest rates had dropped off for new issues of similar bonds, to a new rate of 3%. Obviously your locked-in 6% is worth much more to a new investor coming to the market, so your bond might bring $1,100. Vice versa is true if rates had climbed – your bond could be worth less than you paid for it. In either case, if you don’t sell the bond, at maturity it will still be worth $1,000, the face value.

Likewise, if the company that issued the bond was facing hard times and their creditworthiness was in question, the value of the bond would decrease to reflect this situation, and vice versa if things had improved for them.

Adding to this, if the bond happens to be callable (which many are), if a situation arose wherein the company could obtain loans at a more favorable rate after, say, 18 months of your purchase, they would pay you the value of the bond and end your loan with them. This would leave you having to purchase another bond at the new, prevailing lower rates.

Bond Funds

So, armed with the knowledge of individual bonds, we can now define a bond fund. A bond fund is an investment vehicle that owns many bonds. There are many types of bond funds, some defined by the maturity (or duration, a term related to maturity), some defined by creditworthiness of the bond issuers, and others defined by the governmental entity that issues the bonds. We won’t get into specifically discussing all these types of funds at present, just suffice it to say that all of these types (and many more) exist.

Since a bond fund holds many bonds, the result that the bond fund receives is the aggregate of all of the bonds it is holding. So, if the majority of the bonds in the fund are experiencing price increases (perhaps due to a market-wide decrease in rates for new bonds), then the price of the fund will increase.  If nothing changes, the yield for the fund (in dollar terms) will remain the same.

But most bond mutual fund managers are constantly buying and selling their holdings. One bond may show a hefty increase in value, prompting the manager to sell it for a gain, replacing it with a less-costly bond that achieves a similar yield. Or maybe the manager is looking to the future and believes that a particular bond’s value could increase due to circumstances that will improve the creditworthiness of the issuer, and so the manager might purchase that bond.

All this buying and selling make the contents of a bond fund fluctuate quite a bit over time, but the manager always pays close attention to the price of shares in his fund – if not enough new money is flowing into the fund to maintain the present price level, the manager may take some moves with his holdings that have the effect of keeping his fund’s price stable or growing slightly. If a major event occurred that the manager didn’t foresee, such as a dramatic market-wide increase in rates for new bonds, the price value of his fund could drop – or vice versa for a drop in rates for new bonds.

Bond managers are always managing their fund to maintain a stable price level and yield, but they can’t always make the right predictions. Sometimes the value of a fund will drop off because the manager misinterpreted some signal on the forefront, or a major holding in the fund declines in creditworthiness.

Bond Index Funds

Bond index funds aren’t managed actively, but rather (like all index funds) they track a specific index, and as such hold bonds representative of that index. When the index’s makeup changes (bonds are added or removed), the index automatically makes those changes. This takes the decision-making process out of the fund, so a fund manager won’t make a mistake (or a big winner) decision that results in a dramatic drop-off in value (or a dramatic rise in value).

So, if you are holding a bond index that always invests in medium-term bonds (maturity of 5-7 years), the bonds in the index will be constantly changing as bonds mature and new bonds are added to the mix. But in general you’ll experience much less volatility with the index fund, as you are taking that “forecasting” risk out of the picture.

An example of the “steadiness” or lack of volatility in a bond index can be seen with the Vanguard Total Bond Market Index (VBMFX). Over the many years of this index fund’s existence, the price has fluctuated from a low of $8.92 (the only time this fund was ever below $9, in 1987) to a recent high of $11.78. This fund fluctuated approximately 25 to 30 cents on either side of the $10 range up until about 2010, and over the past 10+ years has fluctuated about 75-80 cents on either side of $11. All the while providing a steady 3% to 4% yield annualized over the past 10 years.

Risks Associated with Bonds

Credit Risk. The issuing entity, whether it’s a corporation or a governmental entity, brings the risk that they could go bankrupt. With governmental entities this is less common, but it still occurs… and actually going bankrupt isn’t the whole risk, either. As the ratings agencies (Moody’s and Standard & Poors, primarily) review the issuing entity’s results and earnings forecasts, the rating of the bond can be changed. As this rating changes, the value of the bond may decrease or increase, depending upon which way the rating changed, since a new buyer of the bond may be more or less inclined to want to purchase the newly-rated bond.

Interest Rate Risk. I mentioned this earlier, but this is the situation where the bond you hold has a rate of, for example, 5%, and the rates on new bonds is higher, perhaps 6%. This would cause the value of the bond you’re holding to drop. This isn’t a problem if you plan to hold the bond to maturity, but if you need to cash it in early, you might lose money on the deal. Of course, on the other end of the spectrum, if the rates on new bonds decreased to 4%, your bond would be worth more if you cashed it in. But again, this situation might also subject your bond to be called by the issuer, leaving you in a lurch with no bond.

Inflation Risk. This is similar to interest rate risk, except that this is where general economic growth might cause the value of your bond to decrease. If inflation picked up to a point where your bond was only just keeping pace with inflation (such as a 4% bond and inflation at 4%), then of course new bonds being issued would have a higher rate, and as such your bond’s value would drop. Again, not a problem if you’re holding the bond to maturity, but would be a problem if you needed to cash it in early.

Characteristics of Bonds, Bond Funds, and Bond Index Funds

The chart below describes the major characteristics of individual bonds, managed bond funds, and bond index funds. Hopefully this will help you to understand the benefits of one type of bond investing versus the others for your individual situation.

Individual Bonds Managed Bond Fund Index Bond Fund
Maturity Definite. Individual bonds have a specific maturity date when you will receive the face value of the bond. Indefinite. The fund will indicate an average maturity of all bonds held in the fund, but there is no specific maturity date. The benefit is that your fund will always have the same average maturity, whereas a bond’s maturity is always declining.
Holdings Known – you should be able to list out your individual bond holdings at any time. Generally known but a specific list of bonds held at any point in time is not available. The index is generally available and the approximate holdings can be listed.
Volatility May have significant fluctuation in price over the life of the bond, although value at maturity is always known. Generally less volatile than stocks but depending upon maturities and interest rate fluctuations, can have some volatility. Minimal volatility as compared to Managed Bond funds.
Liquidity Generally liquid (depends upon the bond) but may have to accept a much lower value than face value, or delay liquidation to maturity. Very liquid, with a ready market.
Income Regular, known quantity coupon payments are made on a semi-annual basis. Interest income may fluctuate with changes to the underlying portfolio. However, bond funds generally make interest payments on a monthly basis, rather than semiannually (as with individual bonds).
Diversification Must purchase many individual bonds to achieve diversification. Diversification is achieved via the ownership of the fund, as well as by owning more than one fund with different classifications. (see Entry Point for additional information)
Entry Point Individual bonds are generally priced at $1,000, however, many brokerages have minimums for purchase of $10,000 or greater. Most funds have very low entry points, often between $1,000 and $3,000. Same as Managed Funds, although ETFs can lower the entry point even more.
Default Risk This will vary by the credit quality of the bond. Varies by credit quality of the class of bonds in the fund, but limited by diversification.
Interest Rate Risk Exists but declines as bond nears maturity. Exists and sensitivity to interest rates depends on portfolio of holdings.
Expenses Purchase and sale will involve sales charges that are typically hidden in the purchase/sale transaction; no maintenance or annual costs. Annual fees are present, and may have front-end or back-end sales charges. Annual fees are present but usually lower than Managed Funds. Sales charges are not typical.
Management An individual bond will not have an inherent professional manager. You may hire a professional manager to help you manage a portfolio of bonds. Active professional management. Passively managed.
Reinvestment No reinvestment of dividends. Reinvestment is usually a feature of these funds. Reinvestment is usually a feature of these funds.

The Bottom Line

So, we started this discussion to answer a question: why would you choose a bond fund or an index bond fund over investing in an individual bond? Hopefully discussion above has helped you to understand the benefits of one type of investment over another. The bottom line for me is – unless you have a pretty large sum of money to invest in bonds, in excess of a couple hundred thousand dollars, it costs an awful lot of time and money to build, diversify, and manage a portfolio of individual bonds. There is one important overriding factor that may cause some wary investors to choose individual bonds: the principal guarantee at maturity.

The convenience of mutual funds for their low entry point, instant diversification, reinvestment of dividends, and moderately stable value makes the choice pretty simple for most folks. Managing individual bonds is cumbersome, can be costly, and can cause liquidity problems (depending upon the term of the bonds).

Indexed bond funds reduce the volatility associated with managed bond funds, plus they generally have the lowest overall cost structure of all options out there (especially ETFs). It is for this reason that index bond funds are the overall best choice for most investors, and therefore index funds and ETFs are the bond investment option that I most often recommend.

The Formula for Success


Photo credit: jb

Financial professionals sometimes get wrapped up in the overly-complex – retirement projections, Monte Carlo analysis, trust and estate planning, and complicated portfolio design. It often comes to mind that we need to stop and remember what the most important concepts are in successful financial planning, and that can be boiled down to a very simple Formula for success.

This is important because, as individuals, we are doing a poor job of creating success for ourselves. Recent reports have shown that our overall savings rate (for Americans, anyhow) is essentially far lower than it should be. That is to say, we’re mortgaging our futures at a regular rate, month over month, with nothing being put back for the aggregate rainy days that are coming.

The Formula for Success

The basic, stripped down Formula for success is as follows (and don’t be surprised if this is boringly familiar):

Save a significant amount (10% to 20% of everything that you earn), live debt-free, and invest your money in low cost diversified investments with a long term view.

Following this simple Formula has provided many folks from all walks of life with a comfortable retirement, pretty much without regard to the ups and downs of the markets. The Formula can work for anyone of any means – without the need for complicated projections, analyses, or any of the other fancy services that financial professionals provide.

That’s not to say that there is no value in those additional services – tax savings, estate protection, and portfolio optimization do provide powerful benefits, but not as much until your net worth has increased to a substantial size. Following The Formula is the first step, the foundation of financial success.

What This Means

For the person just starting to put a real plan in motion, it really isn’t hard to get The Formula to work for you – the biggest roadblock is instilling the discipline into yourself to follow it. It could be as simple as working together with your spouse, each of you holding the other accountable for maintaining the plan; in fact it’s essential that both of you are on the same page. But often it is necessary to get some help.

Even though this process seems simple, it is at the earliest stages that guidance is most useful to keep you on track. The process requires you to analyze your monthly expenses and income, consider your debt situation and any savings plans already in place, and then develop and work your plan to apply The Formula to your situation. Guidance can be vital as you work through the process and can be critical to keeping you focused and on track.

If you don’t already have an advisor to help you to develop and work your plan, you should strongly consider getting one. Many fee-only financial planners (but not all) can provide hourly service to help with just such a plan – you can search for this sort of advisor on the internet: and are the best places to start.

The Point

So, the point of all this is – as Americans we have done a terrible job of preparing for our futures, but it’s never too late to start. No matter where you are in the spectrum of potential financial success, putting The Formula into place (if you haven’t already) will improve your situation. If enough of us do these simple things and stick to the plan, a brighter future will be in store for all of us.

Should You Take or Postpone Your First RMD?

required minimum omelet

Photo credit: jb

In the first year that you’re required to start taking Required Minimum Distributions (RMDs) from your IRAs and other retirement plans, you have a decision to make:  Should you take the RMD during the first year, or should you delay it to the following year?

The Rule

This decision comes about because of the special rule regarding your first RMD:  In the year that you achieve age 72 (used to be 70½), you don’t have to take the first distribution until April 1 of the following year. For each subsequent year thereafter, you’re required to take your RMD by December 31 of the year… so this first year provides you with the opportunity to plan your income just a bit.

Generally it’s a better idea to take the distribution in the first year, with just a few reasons that you might reconsider:

  • If your income is considerably higher in the first year than it will be in the following year, you might want to delay the distribution, recognizing the income the following year when your tax bracket is lower. This situation might come about if you’ve delayed retirement until age 72, so you’d potentially have much more income in that year than the following year.
  • If taking the distribution would have an adverse impact on your Social Security, causing a higher amount to be taxed in the first year (versus the second year), you might want to delay the distribution. Again, this might be due to retiring during the year you reach age 72 making your income higher during that year.
  • Other MAGI limited provisions may impact your decision as well – but these are too varied and specific to the individual to list here.

Reasons to NOT Delay

The downsides to delaying receipt of the first year’s RMD: delaying the distribution to the following year will cause a double-shot of RMD to be recognized as income in the second year. In addition, the two RMDs in one year will be unnecessarily complicated: Each has a different deadline (April 1 for the delayed RMD, December 31 for the regular RMD); each is calculated on different account balances (the delayed one is based upon the balance of December 31 of the year before you turned age 72, the regular RMD is based upon the balance one year later); and each is calculated based upon your Table I value for different ages (the first is based on age 72, the second on age 73).

All of these differences increase complexity which increases the possibility of confusion and opportunity for making an error, so unless you have a very compelling reason (such as those listed above) it’s probably in your best interest to go ahead and take the first distribution in the first year – when you reach age 72.

Note:  Bear in mind that this planning doesn’t apply to inherited IRAs and the RMDs – only to your own regular distributions from your own IRA. 

In addition, if you have a 401(k), 403(b) or other employer-oriented retirement plan instead of an IRA, your first year for distribution might be later than age 72. This occurs if you were still working for the company and are not a 5% or more owner of the company. This only applies to current employers’ 401(k) plans – if you’ve left a company your 401(k) plan will follow the age 72 start rules.

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