10 Financial Pointers for Young Professionals Coming out (or about to come out) of College

Cut It     

Happy New Year!  I know that I have been busy, but I do come bearing gifts (of wisdom).

Graduating from college is a big deal.  Not just for the education obtained, but for the commitment of focusing oneself for 4-5 years on a goal.   All of those years of taking courses, managing your time, balancing assignments of varying priority, dealing with emergencies, and making it to the finish line.  It’s definitely more than an academic endeavor.  College in many ways shows prospective employers that you are ready to take on the rigors and responsibility that come with real work in the real world.

In my contemplation of graduates, I thought that it would be cool to share a few financial words of wisdom as they prepare to venture out into the real world.  Here are my ten pointers for young professionals coming out of college:

1. Save 25-35% of your net pay. You never had the money before, so you will never miss it.  Start building your war chest of savings now, because it will come in handy later.

2. If you have student loans, use every disposable dime (after saving per #1) to pay it off.  I’m serious.  Get rid of those loans.

3. INVEST money in 1-2 custom-made suits, custom-made shirts, some high-quality shoes, and a nice coat. It will cost some serious money, but if you are on the lookout for deals (i.e., finding a quality tailor, looking out for yearly deals from stores like NORDSTROM, tagging along to a friends and family event at a luxury retailer, etc.), you will be amazed by the money that you can save. There will be times when you need to look like you have a million bucks. Be ready.

4. Start developing a Secondary source of income. Start off with a Stock Dividend Fund, a Municipal Bond or Treasuries. Then, consider investing in an investment or rental property. Invest in a business or restaurant. Whatever. The point is, you will do yourself a favor by growing a source of income that is NOT from your job. Don’t be a slave to a paycheck.

5. Sign Up for Match – As in your 401(k) Match.  Since your income is expected to be relatively low, here’s a retirement savings trick that I would recommend – Contribute to your 401(k)/Roth 401(k) just enough to secure the company’s match (which is free money), stop contributing after that and max out a ROTH IRA. Many employer Retirement Savings Plans have mediocre investment options at best and are full of hidden fees. Having a Roth IRA allows you to build assets that you can control with many cost-effective, high performing investment options.

6. CASH rules EVERYTHING around me (CREAM).  If you can’t pay for it with cash (and I’m not referring to your savings), don’t buy it. Credit is not an extension of your income. It is BORROWED MONEY.  Nothing is sadder than seeing a young adult paying on a credit card balance for clothes that he/she bought a year ago, or for a trip that you took two summers ago. Learn to live your life and pay your bills with cash. You will thank me for it later.

7. Be Pennywise… and I don’t mean that big-headed clown from It.  Live frugally. Notice that I did not say “cheap”. Being frugal is all about being an informed and vigilant consumer. You take the time to shop for the best deal possible, You take the time to research alternatives and options (rummage sales, goodwill stores, etc.). You make informed decisions. You set limits for how much you will spend and you try your best to stay within those limits. You budget and save for big purchases and you set aside funds for splurging. You understand who you are, what your attitude is about money and try to protect yourself from yourself. It takes practice, but you will be thankful that you did this now vs. later.

8. Understand that all things that glitter, isn’t gold. You will have friends that have a new car, bought those $100+ jeans, partied last weekend in VIP at ‘the club’. They’re living this fabulous lifestyle. However, they have no assets, bank account is just above the minimum (if not constantly incurring overdraft fees), and they’re barely making ends meet. This is not a judgement – just an observation. When you’re young, its natural to want to go out and have fun, but you have to be smart. If you need a car, buy a used one with cash (you will be amazed by what you can get for $5-10k). Budget for that fun and don’t get carried away. Leave charge cards at home and pay with cash. If you plan to do it up big, plan for it a month or two in advance and work it into your budget (Note: that you will have to cut back somewhere, so be prepared to paper bag your lunch for a few weeks). The point is, everything has a cost, so be considerate of what frivolous spending can have on your long-term goals.

9. Luxurious Living costs you big time. Thinking about moving to the “hot urban areas” with the brand new apartment complexes? With one bedrooms costing nearly $2,000/month ($24,000/year), you say “what the heck… you only live once, right?” That may be true, but if you were able to find a studio a few miles away at $1.250/mo ($15,000/year), you can save $9,000 year which could go towards, savings, investments or retirement. That same $9,000 saved in that one year could grow to $235,197 in 40 years towards your retirement (assumed the 30-yr return of the S&P 500 of 8.5%).

10. Speak to a professional. You may not necessarily be ready to work with a financial advisor year-round, but it doesn’t hurt to pay a few hundred dollars to meet with an accountant and a fee-only advisor to discuss tax, budgeting and investment strategies for the ensuing 6-12 months. Also, you can utilize tools like Mint.com , Betterment.com, Learnvest.com, if you feel comfortable and savvy enough to navigate through this with a little help.

Well, I hope that this information is useful to you.  Please provide me with feedback via twitter.  I would love to hear from you.  Thanks and watch those pennies!

Keeping Your Holiday Budget Under Control

Hi Everyone and Happy Holidays!

Looking to keep limits on your holiday spending? Set up a budget!

1. Take the time to create a list of nearest and dearest ones that you would like to give to during the holidays.

2. Segregate that list into categories (i.e., family, professional, acquaintances, friends, service providers, etc.)

3. Set hard caps on certain categories (i.e., business acquaintances are capped at $25 each; service providers capped at $10, etc.). For hard caps, save yourself headaches and time by just getting gift cards.

4. Shopping for family, close friends and a significant other can be a little tricky. That can be relaxed by having the family do something like Secret Santa with pre-set limits (to relax the need for family to buy siblings/cousins/other family and their kids presents) or establish “rules” for gifting among family members (i.e., my siblings and I don’t exchange gifts; instead, we give to each other’s kids’ 529 plans). The point is that families need to discuss gift giving before the holiday arrives in order to avoid awkwardness when it comes time to open presents.

5. Christmas Clubs are in full effect – it may be too late for this year, but consider setting aside $25, $30, or $40 a paycheck so that you have a decent pot of funds available for gifting – not just to family and friends, but also to charities and other causes close to your heart.

6. Put That Credit Card Down! – If you have to charge it (emphasis on the words “have to”), you can’t afford it. It does you no good to put yourself in debt for the sake of appearances. If its going to be a lean Holiday season, so be it. Keep it real with yourself and others and give what your budget will allow. If that means taking advantage of sales after the Holidays, that’s what it means. The people that love you and care about you understand. The people that talk behind your back and judge you….. well, we know that God don’t like ugly, right?

Happy Holidays! Keep those dollars in check!

A Quick Share regarding the Proposed Tax Reform Debate

Hi,

I am sharing this article to provide insight on some of the news that’s out there regarding the question regarding reducing corporate tax rates and its effect on wages.  It is the current administration’s claim that a reduction in the corporate tax rate from 35% to 20% will result in the typical US household receiving a $4,000 annual increase in income.

Take a read of the attached and let me know what you think on Twitter.

How to Raise Wages: Policies That Work and Policies That Don’t

Understanding the Proposed Republican Tax Reform Framework – Part 1

Hello Everyone,

Please do not ask me about the rock that I have been under, but be rest assured that I have been thinking of getting a post published non-stop since my last submission.  I have no excuses, so let’s get on to our discussion of the day – TAXES.

Taxes_1

Yesterday, the “working group” of Republican leadership in the House of Representatives, the Senate and the White House released a framework for a tax proposal.  This framework expands on a previously announced tear sheet that outlined a proposed Republican tax reform plan (May 2017).  Here are the highlights of the potential tax bill (with many details forthcoming):

General Themes/Principles of Tax Reform – President Donald Trump has laid out four general principles of his vision for tax reform.  They include (1) simplifying the tax code, (2) providing everyday Americans a “pay raise” by reducing their tax burden, (3) lowering tax rates for American businesses in order to make the US more competitive for US jobs and operations, and (4) repatriate trillions of dollars in offshore profits in hopes that its presence and circulation in the US economy will expand economic growth through the tax multiplier effect.

This post will focus on the personal tax side of the proposal, but we will summarize the business tax and international tax proposals in our next post.

Proposals to Taxes Affecting Individuals

  • Contraction of Tax Rates: In our current progressive tax scheme, we have seven tax rates/brackets that individuals fall into based on the level of their income: 10%, 15%, 25%, 28%, 33%, 35, 39.6%.  The proposed framework calls for reductions of this brackets to three: 12%, 25%, and 35%.  This is nothing new, previous administrations have (i.e., George W. Bush) have provided tax cuts by “reducing the rates while widening the base”.   There are also suggestions that the brackets will be indexed for inflation so that there will be little need to expand them in the future.
  • Doubling the Standard Deduction: Under the proposed framework, the Standard Deduction will essentially double from its current amount of $6,300/$12,600 to $12,000/$24,000 for Single/Married Taxpayers.  It is assumed that the same doubling will occur for Head of Household filers as well (i.e., $9,250 to $18,000).  In addition, the proposal eliminates personal exemptions (valued at $4,000 per taxpayer and dependents and subject to an income phaseout).
  • Enhanced Child Credit: The framework increases the Child Tax Credit from its current max of $1,000 and increases the income levels that can qualify for it.  In addition, the Chil Tax Credit is proposed to become refundable, which means that you DO NOT have to owe taxes in order to receive it (like the Earned Income Tax Credit and part of the American Opportunity Education Tax Credit).  Lastly, the framework allows for an additional $500 non-refundable tax credit (i.e., you have to have taxes to take advantage of it) for non-child dependents (i.e., elderly parents or other individuals that meet the dependent definition under the Tax Code).
  • Changes to Itemized Deductions:  The framework eliminates itemized deductions for (1) Medical Expenses, including Long-Term Care Insurance, (2) State and Local Taxes, and (3) Job-related Expenses and Miscellaneous Deductions.  Preserved are the itemized deductions for Charitable Contributions and Mortgage Interest.  Just for your information, itemized Deductions are deductions that individuals can take instead of the standard deduction. In general, you only take these deductions if they exceed the standard deduction (i.e., provides a tax benefit).
  • Elimination of Alternative Minimum Tax:  The framework eliminates the Alternative Minimum Tax (a dual tax that is placed upon high-income earning families that have relatively
  • Elimination of Estate Tax: The framework eliminates the Estate Tax (a tax that is levied on estates greater than $5.49 million).

What does this mean?  How would it affect you?

That’s really the long and short of it, right?  How would these changes affect the everyday US family if these proposals became law?  There are a plethora of tax change scenarios that can present itself, but here are the major themes that you can expect to see across the board:

  1. Low-income taxpayers get some (but very little) additional relief – By doubling the standard deduction (but taking away the personal exemption), and enhancing the child tax credit, some low-income families may possibly see lower taxes, but the tax savings will not be significant.  Remember, that many families in this sector don’t pay much by way of taxes at all.  In addition, most if not all of their tax returns result in refunds either because their income is so low relative to deductions, or due to the application of certain tax credits that are both non-refundable (reduces your taxes dollar for dollar) or refundable (you don’t have to owe taxes to get it – its “free money”) like the Earned Income Tax Credit.  So Trump really isn’t doing the working poor any favors tax-wise.
  2. While high-income families that are subject to the Alternative Minimum Tax will find relief, they will be hurt by the loss of exemptions and the loss of state & local income and property tax deductions – High income families (households with incomes higher than $200,000) who live in high income tax states with high property taxes  will be ultimately harmed by the new tax laws due to the loss of itemized deductions for state and local income taxes and property taxes.  One rebuttal is that this same couple is spared the Alternative Minimum Tax, so the taxpayer is made whole.  There are phase-in arguments that you can make against this position, but the overall loss of exemptions and income phaseout of tax credits may ultimately harm taxpayers in this situation.
  3. Seniors who have significant medical and property tax outlays are at risk of being hurt by the proposed tax rules – Many retirees who are homeowners and have no mortgage debt still have property taxes to pay and enjoy the potential tax benefits associated with them (especially in states with relatively higher property taxes like NJ).  In addition, a significant amount of retirees income is paid out to medical-related expenses (i.e., insurance, prescription drugs, etc.) – even if the retirees are on Medicare (a typical couple pays on average ~$1,000/month for Medicare Part B, D & F premiums along with Long-Term Care).  Even with a 7.5% floor, many seniors can clear this hurdle and get some tax benefits for the significant outlays they make toward healthcare costs.  With the proposed tax reforms, retirees would lose both.
  4. Getting Rid of the Estate Tax benefits who? – The spin is that the repeal of the estate tax supposedly provides relief to successful small business owners, owners of farms and real estate… the so-called “first generation job creators”.  That might be slightly true, but for individuals with wealth like this, there are plenty of strategies in place in the tax code that provides ways for them to avoid the estate tax (i.e., trusts, spousal exemption, lifetime gifting, etc.).  I will discuss this topic in more detail during my Part II post.

In Part II, I will briefly discuss the proposed business and international tax changes and their potential impact on businesses and you the taxpayer.  In addition, we will do some fact checking on tax change claims using actual federal tax data.  Thanks so much for taking the time to read my posts.

Your Expanding Waistline and Your Retirement. Not Perfect Together.

Into Fitness Meme

I have a confession.  I am overweight.

Like many Americans, I indulge a little more than I should when it comes to eating and nice cocktails.  I exercise regularly (which is why I look more like a bouncer than Fat Albert), but I know deep down that if I really want to change the way I look and feel, I need to address my diet and fitness with more attention and seriousness.

One of the skills that I credit from my mom is that I am a pretty good cook, so I am not a slave to fast food and casual dining establishments.  Here are a couple of my creations:

  • Asian-Styled Short Ribs

Asian-Styled Short Ribs

  • “Rif-Daddy” Wings

Rif-Daddy Wings

  • Slow-Cooker Turkey Chili

Turkey Chili

  • Kale Salad with a Tomato medley and Thumbelina Carrots

 

Kale Salad

So, preparing meals is not an issue.  Preparing the right ones in the right portions is the challenge.  I have dabbled in going meatless (but not strict vegan or vegetarian), juicing and hitting the gym like a mad man.  My typical results are a 20-pound drop here, a 30-pound drop there, and then I would shoot back up in weight when I stop the new routine.

My current journey has me incorporating a “lifestyle change”, where I look at everything that I do well (regarding living healthier) and find a way to do things that work in my everyday lifestyle.  This includes (1) keeping eating out to a minimum (it was a remote occurrence when I was kid, so I am trying to get back to that paradigm), (2) increase water intake, (3) more FRESH fruits and vegetables incorporated into my daily diet, (4) keep processed foods to a minimum,  (5) take a break on the bottle and (6) doing more cardiovascular exercise on a daily basis.  The key is to try to find the combination of healthy behaviors that I can make into an overall healthier lifestyle, and do it before a doctor makes me do it.  I’ll keep you posted on my progress, but if you have any ideas or success stories to add/share, please reach out to me and share the information.  I would be eternally grateful.

Now on to the personal finance side to this post.  What does weight and living a healthier lifestyle have to do with finances?  Well, not be a buzzkill, while Americans today have better medical care and technologies, we are living more unhealthier lives (i.e., sedentary lifestyles and poor diets) vs. generations of the past.  With current medical advances, people are living longer in the US, but not necessarily healthier.  The costs associated with such unhealthy lives can be substantial, especially in retirement.  When planning for retirement, one should take care to take stock of their health, their family’s hereditary history and factor this information into their planning to ensure that their assets can handle the potential impact of rising health care costs.

Health and Retirement … What’s the Connection?

Per a white paper produced by Fidelity Investments titled “America’s Lifetime Income Challenge”, many retirees who venture into retirement face the challenge of dealing with “rising health care costs”.  These costs come to light for many, as they become solely responsible for their health care costs (vs. paying a fraction of the costs under an Employer Healthcare insurance plan or paying little to nothing under an Employer-provided Retirement Healthcare benefit).  Therefore, many retirees who retire at Medicare-eligible ages find themselves paying for Medicare Part B (medical insurance), Medicare Part D (for prescriptions), and Medicare Part F (Supplemental Coverage) (or Medicare Part C/Advantage Plans, which A&B coverage and other benefits under a private insurance company) can find themselves facing health care costs in excess of $15,000 – 20,000/ year (medical care costs be as high as a third of a retiree’s household budget) .  Per the report, “over a 30-year retirement, a couple may need $351,960 simply to cover maximum out-of pocket medical expenses not covered by Medicare”.  And that’s for healthy retirees.

See the attached article on the topic here.

Poor health not only causes medical costs to be higher (from a prescription and out-of-pocket medical cost perspective), the chances other catastrophic expenditures such as Long-Term Care Costs become very real as the risk of stroke, diabetes, or dementia become magnified.  Without Long-Term Care insurance, such an occurrence can decimate a family’s retirement nest egg and potentially place them at the mercy of state government programs such as Medicaid.

Helpful Hints

I am not a health professional, but I will do my best to provide some pointers to help you protect your retirement while making your life potentially more healthy in your golden years.  Here it goes.

  • Take a DNA test – With take-home tests that can map out your hereditary makeup, you can now get insight into sicknesses or diseases that you may be susceptible to and prepare accordingly.
  • Change your lifestyle NOW – Start today.  Seriously.  Start walking to local destinations vs. driving.  Crowd out your meals with fresh fruits and vegetables.  Eat a healthy meal before going out for drinks with friends.  Watch your alcohol intake (no more than 14 drinks a week spread out over the week) and keep fatty meats and seafood to a minimum.  Moderation is the name of the game, so make small changes every day until you create the habits needed to change your life.
  • Do a Retirement Financial Plan – Work with a financial advisor or financial planning software to estimate your planned income and expenses in retirement.  You may want to run different scenarios that show spikes in medical care costs and the potential mitigation of such costs with insurances such as Long-Term Care Insurance.  In any event, you should plan out the numbers and have a plan in place to deal with the outcome of such scenarios.

Thanks so much for tuning in.  I really appreciate it.

SAM

How do you pick stocks? – Rapid Fire Responses, Part 2

Hello once again!  I am so sorry for the brief hiatus.  Things get so busy from time to time and I am terrible at putting activities into daily slots.  However, I am committed to this endeavor and will have to dedicate time to writing in order to make sure that I am bringing relevant and interesting content to you on a regular basis.  My goal is to get out a minimum of two posts per week.  I hope to get on this regular scheduling starting next week.  Thanks so much for your understanding.

Now on to today’s topic ….. How do you pick stocks?

Memorable Quotes About Stocks

  1. “If you’re emotional about investing, you’re not going to do well. You may have all these feelings about the stock, but the stock has no feelings about you.”  (Warren Buffet in the HBO documentary Becoming Warren Buffett)
  2. “Don’t get emotional about a stock.  It clouds your judgment.” (Michael Douglas as Gordon Gekko in the 1987 film, Wall Street)
  3. “Buy the dips.  Sell the rips.” (Quote is taken from The Wall Street Daily News, 1988)
  4. “I will tell you how to become rich. Close the doors. Be fearful when others are greedy. Be greedy when others are fearful.” – Warren Buffett
  5. “The individual investor should act consistently as an investor and not as a speculator.” – Ben Graham
  6. “Know what you own, and know why you own it.” – Peter Lynch
  7. “Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas.” – Paul Samuelson
  8. “The stock market is filled with individuals who know the price of everything, but the value of nothing.” – Phillip Fisher
  9. “The only way one should buy stocks is if you understand the underlying business. You stay within the circle of competence. You buy businesses you understand.” – Mohnish Pabrai
  10. “How many millionaires do you know who have become wealthy by investing in savings accounts? I rest my case.” – Robert G. Allen

These quotes say a lot more about investing in stocks than most of what this post will, but if you can humor me for a few moments, I will add more color to some of these timeless quotes on the art of stock picking.

Are you an investor, trader or speculator?

So, the first question I will typically ask a client is whether they are an investor, trader or speculator.

Note – Before I dive into this, please be aware that I am “going light” on this topic.  I am not going to get into Top-Down Analysis, Bottom-Up Analysis, Charting, or hard core fundamental analysis (e.g., Discounted Cash Flow Analysis), etc.  At least not yet.  So bear with me as I break it down for common folks without MBAs in Finance (smile).

So, what’s an investor?  To keep things simple, we will define investors as individuals that are interested in buying stable, well-run companies and do not have a defined date for selling the stock (as long as the company continues to run well and its stock price is relatively stable).  So hypothetically, these can be purchases that can be made, and the stock held indefinitely.  This post is mainly for investors.

Traders are individuals that buy in and out of stocks.  They can hold stocks for months, weeks, days, hours, minutes, and even seconds!  Traders look for large swings in the price of a stock to make profits.  Another distinction for traders is that they don’t necessarily buy a stock with the hope that the stock will go up in value.  Short sellers or put option buyers trade with the hope that a stock will decline in value.  “Short” activity on a stock can sometimes act as a leading indicator as to whether a stock will change in value – not necessarily due to fundamental flaws in the stock’s business, but due to market/trading forces (i.e., a stock can go up in value simply because short sellers have to “cover” their shorts by buying shares).  I will get into puts and shorts on another post, but just understand that traders typically take short-term positions on a stock that can be based on a positive (hope that the stock will go up) or a negative (hope that the stock will go down) bias.  This post is not for traders, so if you’re looking to trade stocks, this post isn’t for you.

Speculators are simply people who buy heavily depreciated stocks or short highly priced stocks in hopes of making a profit.  They take positions that can be either short-term or long-term in nature.  Again, this is a post for investors, so I am not going to get into speculation at this time.

Identifying Stocks for Investors

Here are some thoughts/ideas and pointers for identifying stocks that might appeal to you as an investor:

  • Buy What You Know – This past November, my daughter (who was 8 at the time) picked five stocks for a school project.  She picked the following stocks – (1) Disney because she loves watching the Disney Channel (DIS), (2) Amazon (AMZN) because we order everything from the site, (3) Panera (PNRA; going private) because she loves going there for lunch and snacks, (4) BlackRock (BLK) because I used to work there (smile) and (5) Novartis (NVS) because they make Triamedic cough medicine which she takes at home, and she postulated that with winter coming up “people were bound to get sick and need medicine.”  This is the performance of the stocks between November 2016 and April 2017:

SLM Stock Performance

You read it right, she made more than 15% in three months.  That’s over $1,500 made on a $10,000 investment made in 90 days.  Compare that to the less than 1% that you can get from a checking account, or 1.85% for an 18-month CD.   Look at companies behind the goods and services you buy every day.  Go online and do some research.  Are these companies profitable?  Do their profits and/or performance have a track record of going up consistently?  Are they among the top 5 participants in their respective industries?  Is the stock price steady growing?  Does the stock pay nice dividends?   If there are enough “yes” answers to these questions, you may have a stock that you can invest in.

  •  Understand the businesses behind the stocks you buy – I can’t impress on you to get a strong understanding of the businesses that you invest in.  Fortunately, you don’t have to be a wall street analyst to do research on the internet.  In fact, most of these companies provide you the information that you need by looking at their own financial statements (found on the company’s own website or www.sec.gov ).  User-friendly websites like Google Finance, Yahoo Finance, CNBC, Bloomberg, etc. all have tons of data and summarized information at your fingertips.  For every company, you want to know the company’s (1) Strengths (industry leader, solid historical stock performance), (2) Weaknesses (weak customer service, sub par product, technological obsolescence, etc.), (3) Opportunities (potential merger, new product development), (4) Threats (rising competitors, technological threats, unfavourable governmental legislation, etc.).  Buy investments in ignorance at your own peril.
  • Don’t confuse speculation for analysis – I can’t tell you how many clients, friends, family, and acquaintances approach me with investment ideas based on speculation vs. actual knowledge of a company’s market or actual opportunities.  “I believe that the company is going to do this” or “If this technology catches on, the stock could fly”, are things I often hear.  It sounds great, but when I ask for evidence – numbers, research and how projected growth translates into a higher stock price – I get “Ums” and/or “Wells”.  How about when such ideas fail or never come to fruition?  Do these prospectors (because they are certainly not investors) have an exit plan?  If so, at what price do you sell?  What will be the trigger to sell?  As you see, it isn’t hard to undress a speculator masquerading as an investor.  If you want to speculate, go to the casino.  The stock market is not a place to be placing half-cocked bets.  There’s nothing wrong with taking insignificant chances on a name or two once in a while, but understand that you should be making such bets with money that you’re comfortable losing.  If not, don’t do it.

Conclusion (for now)

There is no foolproof way for picking winning stocks, so understand that it is likely that when investing in individual stocks you will pick winners and losers.  If you have the stomach to get through it and learn from the experience, I do encourage you to embrace this wealth building activity.  Lastly, you should consider building the foundation of your portfolio with broad-based market exposure via a low-priced stock market index fund or ETF.  Then you can look to invest in single name stocks to help enhance growth opportunities.

I hope that you found this post informative and helpful.  As always, I am available if you have questions to discuss.  In the meantime, good luck!

Client Questions and Rapid Fire Responses – Part 1

Rapid Fire Image

Hi there.  Welcome back.  A few days ago, I asked some of my Facebook friends if they had any questions/suggestions for my blog.  I got a few questions and some ideas for topics that I will address in upcoming posts.  Here is one of the questions that I answered and hope will provide some useful information to you all.

Question #1 – What’s Better?  Saving vs. Paying Off Debt

Answer – This is the one question that I get all of the time, and I have a slightly different view on things vs. many of the popular personal finance experts out there.  Suze Orman and Dave Ramsey both shout that DEBT IS EVIL and it must be paid off at all costs.  I don’t disagree, but I guess I ‘m more in tune with what people go through every day and take more of a “weaning off” approach vs. the “quit cold turkey approach” that most financial experts proselytize.

Good Bad and Ugly

First, we need to ask whether we’re talking “good debt” vs. “bad debt”.  Good Debt (if there is such a thing) are debts that are associated with acquisitions/investments that have a chance to increase in value.  That would include a house because they typically increase in value over time to the point where the value of the property exceeds that of the debt.  Another example would be student loans because you’re investing in your surest bet – yourself.  With more education and expertise, it is hoped that your earning power and ability to obtain higher levels employment (and hence, greater wages) will allow you to pay off the debt more quickly over time.  Lastly, many of these debts have tax incentives associated with them (the mortgage interest deduction and student loan interest deduction).  Hence, the US government is supporting you in your efforts to take on and pay off this debt.

Bad Debt is generally any debt that is personal in nature, like credit cards, personal lines of credit, auto loans, and retail credit accounts.  What makes these debts “bad” are that the debts are being generated for buying “stuff”.  With the exception of a car (which can be a necessity for work, transporting family, etc.), many purchases on retail and/or everyday items are “expenses” that are used up or rapidly lose value after purchase.  However, the debt associated with such purchases are steep, ranging from 8,99% to 29.99%!  And this debt compounds daily, which if left unchecked can lock an unsuspecting consumer into a vicious cycle of making payments on debt that doesn’t seem to go away.

Now that we have our debts straight, we can now contemplate whether it makes sense to save while dealing with debt or to apply that money to pay off the debt quicker instead.  The answer is “it depends” (the typical accountant answer – sorry).  It depends on the type of debt we’re dealing with and the where a person is with their savings.   All of these facts help with the decision making, but I am going to present a basic framework that I use with many of my clients.  It’s called waterfall budgeting and it works like this:

  1. Pay yourself first – 10-15% of your paycheck
  2. Address Necessities first – Food, Shelter, Transporation to/from Work
  3. Pay Minimum Amounts Due on “Bad Debt”
  4. Savings toward Retirement (enough to fully secure company match)
  5. Pay Minimum Amounts Due on “Good Debt”
  6. Savings towards Retirement (if you qualify, max out our Roth or Traditional IRA, or contribute to your work plan up to amount needed to meet your retirement goals)
  7. Pay towards non-monthly expenses – Quarterly, Semi-Annual Bills, etc.
  8. Fund “Fun and Splurge” bucket – 3-5% of paycheck
  9. Pay remaining to “Bad Debt”

Now you might say “Why are you paying both”?  My mother taught me to never “cut off your nose in spite of your face”, meaning not to do something against an enemy that will wind up ultimately hurting yourself as well.  If we apply this logic to the situation at hand and take all of our money in an effort to pay off debt, what happens when a financial emergency occurs and there are no savings there?  You reach back for that credit card and the vicious cycle repeats itself.  If you build up savings while contemporaneously paying down debt, you have a better chance of withstanding the bumps in the road along the way.  And how good would it feel to have your debt paid and your savings at appropriate levels (6-12 months of expenses)?  As happy as I am to wrap up this post (smile)!

Thanks for tuning in.  I apologize for the overly worded post.  I am trying to keep these to 500 words or less.  Thanks again!

Open A Flexible Spending Account and Get Extra Cash!

Flex Account Image

Do you participate in your employer’s flexible spending plan?  If not, you may be leaving hundreds to over $1,000 in tax savings on the table.

I thought about flexible spending accounts (FSA) today when I dropped my daughter off at camp.  She goes to a moderately priced summer day camp that charges around $400 a week, and that’s cheap for Central NJ.  Ok, so let’s do the math.  $400 for camp plus $50 for lunch times 10 weeks equals $4,500!  I thought to myself that these prices are obscene, and thank goodness that I funded an FSA with the pre-tax funds to pay for it!

FSA Working Image  Dependent Care FSA

So, what is a Flexible Spending Account, or FSA?  An FSA is an employer-sponsored benefit that is offered to employees.  The employee is offered the opportunity to fund an account on a pre-tax basis to cover out-of-pocket costs up to $5,000.  There are two types of FSAs – one for out-of-pocket medical care costs (a “medical care FSA”) and another for dependent care costs (a “dependent care FSA”).  For most employees, you have the ability to contribute up to $5,000 in both (there are employment benefit rules that may limit the amount that an employee can contribute to the dependent care FSA; however, you can always contribute the maximum to a health care FSA).  This maximum applies on a per household basis.  So, the maximum that can be contributed is $10,000 per household ($5,000 for dependent care FSAs and $5,000 for medical care FSAs).

FSA At Work

Benefits of FSAs

  • You save on taxes – Depending on your tax bracket, you stand to save a significant amount of taxes on out-of-pocket medical care expenses and/or dependent care expenditures.  In addition, not only do you save on income taxes, you also save on federal payroll taxes (1.45 % Medicare and 6.2% Social Security taxes).  For example, consider a family that earns $150,000 annually, has a 3-year-old in day care (annual cost of $13,000) and $2,500 in out of pocket medical care expenses (health insurance co-pays, eye-exams, and new glasses, etc.), and is in the 28% tax bracket.  With a family contribution of $7,500 ($5,000 maximum for dependent care and $2,500 for medical care costs), the family will save $2,673.75 in taxes.  That’s cash in your pocket and not in Uncle Sam’s!  That’s you and your wife’s life insurance premiums (assuming 30-yr term policies with good health ratings).  That’s a vacation.  That’s money to pay down consumer debt.  That’s money to put towards savings, or to make an annual lump prepayment on a car note or student loans (if applicable).  The point is, this is money that wasn’t there before.
  • You’re using the funds on things you would pay for anyway – This should be a no-brainer, but for families with (a) dependents that are not old enough for kindergarten, (b) dependents under the age of 13 that need before- or aftercare, or attend day summer camp (sorry – sleepover camp doesn’t qualify), or (c) elderly dependents that attend daily elderly care, this tax benefit can come in handy.
  • Technology makes it easy to access FSA funds.  Many administrators provide debit cards to make it easy to pay for qualified services.  Some even pay the service provider directly on your behalf.  Online portals also make it easy to submit receipts for prompt repayment.

Downsides to FSAs

Use It or Lose It Image

  • Use it or Lose It – You have to be careful in projecting the future medical and dependent care expenses that you plan to spend in the upcoming year.  Budget too little and you may lose the excess of your account balance.  Here’s a quick example.  The Jones family budgeted $2,000 in medical costs for the year but only spent $1,300 by December 31st of the current year.  That leaves an excess of $700 in the account.  In the past, the entire $700 would be forfeit.  However, new regulations do allow you to rollover a maximum of $500 from the current year to the next or allow you up to March of the ensuing year to incur qualified expenses (and up to April to request reimbursement).  Many plans differ in how they administer overages in an FSA account, so make sure that you do your research and budget carefully before designating an amount for the FSA plan.

Qualified Expenses

So what qualifies as a qualified healthcare and dependent care expenditure?  Here are a few examples:

Medical Care Costs

  • Out-of Pocket Co-Pays, Deductibles Co-Insurance Associated with Health Insurance
  • Out-of-Pocket Deductibles associated with Dental or Eye Insurance
  • Medical Transportation Costs (documented)
  • Prescribed Medications (Over the Counter, even if prescribed do not qualify)
  • Medical Supplies (with prescription)
  • Urgent Care Center Expenditures
  • Long-Term Care Insurance Premiums
  • Eye Exams and Eyeglasses (prescription)

Dependent Care Costs

  • Daycare (pre-kindergarten)
  • Summer Camp (dependent under 13; Sleepover Camp does not qualify)
  • Before- or After Care for dependents under 13
  • Babysitter Costs (dependents under 13 and babysitter is not a dependent)
  • Elderly Dependent Day Care (must be needed for both spouses to work)

 

Thanks for reading.  Feel free to contact me with any questions!