I Will Teach You To Be Rich » Taxes http://www.iwillteachyoutoberich.com Personal finance blog for college students, recent graduates and everyone else -- including entrepreneurship -- for getting rich. Featured in the Wall Street Journal and New York Times. Tue, 07 Feb 2012 16:11:54 +0000 en hourly 1 http://wordpress.org/?v= The Debt Ceiling http://www.iwillteachyoutoberich.com/blog/the-debt-ceiling/ http://www.iwillteachyoutoberich.com/blog/the-debt-ceiling/#comments Mon, 25 Jul 2011 17:35:59 +0000 Ramit Sethi http://www.iwillteachyoutoberich.com/?p=7490

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I’m just back from vacation, and my brother reminded me of a line I used to use in one of my talks.

I’d joke how the only way your government bonds would become worthless is if the government defaults…”and the government doesn’t default, it just prints more money.”

Always good for a laugh. Yet the situation in Washington is becoming increasingly crazy as talk of a government default becomes very real.

Here’s my take:

First, I rarely make predictions as experts know very little. So when people hear I write about personal finance, and their first question is “Any stock tips?” I just stare at them.

Now, despite the thousands of things I hate, I’m an optimist. For a situation like the debt ceiling, all parties involved have incentives to resolve the situation. When everyone agrees that something must be done, it almost always gets done.

But there’s something even more important.

When I hear about people freaking out at macro-economic events like this, it’s not a rational, measured response to serious research. It’s fear of “OMG! The sky is falling! I better do something….maybe I should liquidate my stocks!! Or call my broker!! Or….something!!!”

In the unlikely scenario that the debt ceiling isn’t increased and the doomsday ramifications come through, then we will all have larger problems.

Indeed, the very people who make these rash decisions often make similarly rash decisions as soon as the market turns a corner. From a fascinating Wall Street Journal article, Jason Zweig notes that: “…It looks as though many of the retail investors now getting back into stocks are the same people who bailed from the market just before the start of a historic bull run.”

These same people will curse the President, tax rates, Big Banks, and everyone else possible for their own poor choices, never stopping to spend one weekend reading a good personal-finance book.

Better to think long term.

Yes, it’s possible the government could default, or the stock market could tank overnight…but it’s more likely that very little will happen in the short term. So would you rather focus on the 0.05% chance…or the 99% chance?

Note that I said “focus,” not prepare for. As I write about in my book, you always want to diversify your investments so that if the worst happens, you’re prepared.

But the biggest risk is inaction, not some catastrophic macro-event.

Long-term thinking prevents this.

This is why sensible Indian people always buy 4-door cars: because they know that if you keep your car for 10+ years, you will have kids by that time. Optimize for the long term.

It’s why some people stay married for decades.

And it’s why, when you automate your finances, you’ll be preparing for the long-term…automatically.

Keep this in mind when you hear the raging rhetoric of journalists and pundits. Remember that personal finance is very different than macroeconomics. In fact, in almost every situation, your financial situation has very little to do with what Washington politicians decide.

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I love tax time because all these kooky weirdos come out of the woodwork — including personal-finance “experts” who don’t know what they’re talking about.

These are the people who will get on TV, or on their online soapbox, and lecture you about taxes. One of their favorite go-tos is this old chestnut:

“If you’re getting a tax refund, you’re giving the government free money!”

What they mean is that you should not be getting a refund, because if you are, the government has been sitting on your money and earning interest for the entire year.

Let me break this down for you.

The average tax refund is about $3,000.

How much interest are you losing if you get a tax refund? $2.50 per month. Yes, you read that right. Two dollars and fifty cents a month. I have that much money in my shoe right now.

What’s more, if you’d had that money, you almost certainly would have spent it.

On the other hand, if you get a tax refund, Americans are more likely to pay off debt and save it.

This is a perfect example of “experts” missing the forest for the trees.

Yes, Mr/Mrs. Expert, mathematically, you should pay the government as little as possible during the year and earn interest on that money for yourself.

However, there are 3 problems with your advice:
1. Your advice is totally unrealistic as Americans spend whatever they have
2. Americans don’t understand withholding, despite your repeated exhortations to “change your withholding!” Perhaps you don’t realize that those words sound like COMPLETE GIBBERISH (why personal-finance education is overrated)
3. Most people would rather get money back than pay it — numbers be damned

So why do these “experts” continue promulgating the same, tired old advice that never changes behavior?

Because they can rap ad nauseum about what we “should” do with our money…but they fail to understand the psychology of what we ACTUALLY do.

I went on PBS’s Nightly Business Report to share this perspective. Check out the video:

Watch the full episode. See more Nightly Business Report.

Note: During filming, the cameraman was like, “Um…do you want to button one more button up?” I tried it and muttered, “This goddamn button adds 10 years” so I removed it. Then the other cameraman made a crack about how many viewer emails they were going to get about me and my shirt. However, I think their average viewer age is in their 60s, and I am not popular w/cougars.

Ok, back to tax returns. The reason for the title of this post (“Your parents are delusional about tax refunds”)?

Because in many households, there is a mom or dad who has some of the kookiest ideas about taxes, sitting there in an old, dusty recliner, spouting off uninformed nonsense about the government and tax rates. Once you’ve heard something enough times — and “getting a tax refund is BAD!” is one of the more innocent ones — you start to believe it.

So send this article to your parents and 3 friends. See what they say. Leave a comment with their responses.

This is just another example of a counter-intuitive money lesson you’ll find on I Will Teach You To Be Rich.

Remember — personal finance is AT LEAST 50% about psychology.

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How many people in your life lecture you about finances, but don’t have their own finances under control?

Nothing is more infuriating than someone telling me I’m “throwing away money on rent” when they haven’t spend even 2 hours running the numbers.

Or someone who proudly proclaims that they found a higher interest rate on a new bank, which is giving them 2%!!! When you politely say, Wow! How much is that worth? they get very very quiet…because (1) they never thought about it, and (2) you know that an extra 1% is only worth $8/month for a $10,000 balance.

Or people who bragged about their hot tech stock being up 80%…but then don’t mention it 2 years later when they realize it crashed and they are actually not very good at picking individual investments. I’m guessing that on their idiotic penny-stock-picking website, they probably didn’t learn the two most important words for choosing investments: asset allocation.

Introducing the STFUDF Technique

So it’s with great pleasure that I introduce the STFUDF Technique. DF stands for Dumb Friends.

One of my newsletter subscribers, Chris Sundberg, inspired this when he told me how he uses tax refunds strategically.

“I get the lecture from just about everyone I know. However, I purposely have my employer take an additional amount out of my paycheck so that I get a bigger refund each year. I know the government gets to use it interest free for a year, but…. I also get a little “bonus” every year to spend on whatever I want. I’ve automated the rest of my finances so I don’t miss the money a bit. And if the government gets to use it for a year…. we’ll call that patriotism. My paycheck gets split between my “bill paying” checking account and my “spend on whatever the fuck you want” account. That way I don’t have to budget. My bills all get paid automatically out of my bill paying account (including automatic contributions to my Roth IRA), and about $50 per month goes into an Orange Savings.

So…. whenever I get the lecture, I ask the person how much they’ve contributed to their Roth that year and when they can’t answer me honestly I tell them to STFU.“

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3 important rules for the STFUDF principle

  1. First of all, when people give you advice on finances, let’s be honest: They’re probably right. That’s because most people are horrible at finances, so just statistically, you probably are, too. You’re not allowed to use this technique until your finances are reasonably automated and optimized.
  2. HOWEVER — since you read this site and have presumably automated your money using my book, chances are you know more than this person. In this case, it’s permissible to implement the STFUDF Technique.
  3. Do not simply shout out “STFUDF STFUDF STFUDF” repeatedly. That would be uncouth. Instead, use subtle questions like this:
    - “That is really interesting advice. So should I think about this first, or my asset allocation?”
    - “Really? Woah…I never thought of that. What do you think should come first? [Their advice] or maxing out my Roth IRA? (Wait while they make something up, then say this): How come?”
    - “Nice! So how do you do this AND hit your 401(k) employer match AND your Roth IRA AND stay debt-free? I just don’t think I could do it.” This one is particularly clever as you’re employing a self-admission of inadequacy, which will make your friend writhe in pain since it’s impossible to counter.

Use the STFUDF Technique with care. It is powerful.

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tax-form
Photo by blmurch

A few weeks ago, I offered you the opportunity to ask David Bergstein, professional tax analyst and CPA, your tax questions and a chance to get a free account at CCH CompleteTax.

Some of this is pretty technical, but I wanted to get your advanced questions answered, so here are David’s answers.

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“IWTYBR readers posted some excellent questions. One of the main categories appears to be related to homes. So, I’d like to tackle that area. Before I do, let me just caution you that these are general comments not specific tax advice. For tax advice about your specific situation, you should seek the one-on-one guidance of a CPA.

Advanced tax breaks for home owners

Home ownership is both a blessing and a curse. The blessing is you have a place to live and hopefully, over time, you will build equity. As I read the questions, there seems to be a lot of interest in what happens when you sell your home. So I will give Ryan, ZT, Chris, Steve and everyone else information to start with that can be followed up with a visit to a CPA or a site such as www.completetax.com where you can access the free Tax Guide for additional detail and examples that will help you.

Starting with the basics: Generally, a taxpayer may exclude from gross income up to $250,000 (or $500,000 for qualified spouses filing jointly) of gain on the sale or exchange of a principal residence. The taxpayer must have owned and used the home as a principal residence for an aggregate of at least two of the five previous years. The exclusion applies to only one sale or exchange every two years. In the simplest of terms, an exchange is basically a swap of properties.

Ownership and Use Test. The required two years of ownership and use need not be continuous. The test is met if the taxpayer owned and used the property as a principal residence for a total of 730 days (365 x 2) during the five-year period before the sale. The ownership and use test may be met at different times (i.e., ownership of previously rented home), provided that both tests are met during the five-year period before the date of sale. Short temporary absences for vacations or seasonal absences are counted as periods of use, even if the taxpayer rents out the property during those periods.

The home that is sold does not have to be the principal residence at the time of the purchase or sale. For example, taxpayers could move into their vacation home, convert it into their new principal residence and have up to three more years to sell their old principal residence to take advantage of the exclusion. The residence also doesn’t have to be a traditional house. It can be a condominium, houseboat, house trailer or stock held by a tenant-shareholder in a cooperative housing corporation.

Amount of Excludable Gain. The entire gain on the sale of a principal residence may be excluded up to $500,000 for married individuals filing jointly if:

(1) either spouse meets the ownership test,

(2) both spouses meet the use test, and

(3) neither spouse is eligible for exclusion by virtue of a sale or exchange of a residence within the last two years.

If the spouses do not meet all three requirements, the exclusion is determined on an individual basis and equals the sum of the exclusion limitations to which each spouse would have been entitled had they not been married.

With this basic background, let’s look at a few of the questions readers asked.

Ryan wanted to know if he qualified for a prorated exclusion. The exclusion is prorated if a taxpayer does not meet the two-year ownership and use requirements in the case of a sale or exchange due to a change in place of employment, health or unforeseen circumstances. In such cases, the amount of the available exclusion is equal to the amount of the applicable exclusion ($250,000 or $500,000) multiplied by the ratio of:

(1) the shorter of

(a) the aggregate periods during which the ownership and use requirements were met during the five-year period ending on the date of sale; or

(b) the period after the date of the most recent sale or exchange to which the exclusion applied, over.

(2) two years.

The five-year period may be suspended during any period that the taxpayer is a member of the uniformed services or Foreign Service on official extended duty. A sale will be considered as occurring primarily because of unforeseen circumstances if any of the following events occur during the taxpayer’s period of ownership and use of a residence:

(1) death;

(2) divorce or separation;

(3) becoming eligible for unemployment compensation;

(4) a change in employment that leaves the taxpayer unable to pay the mortgage or reasonable basic living expenses;

(5) multiple births resulting from the same pregnancy;

(6) damage to the residence resulting from a natural or man-made disaster, or act of war or terrorism; or

(7) condemnation, seizure, or other involuntary conversion of the property.

From Ryan’s post, it appears he sold his home to study abroad. That is not one of the IRS-defined reasons for allowing a prorated exclusion. However, if additional circumstances (as outlined above) apply to his situation, he may be able to take a prorated exclusion.

Steve questioned whether he had to pay taxes on the sale of his home in one year even though he then used that money to purchase a new home the following year. Generally speaking, your tax obligation related to the sale of your home has nothing to do with whether or not you purchase a new home with the proceeds. The tax obligation on the home you sold is related to whether or not the profit you realized exceeded the $250,000/$500,000 exclusion. If not, then no capital gains are owed on the proceeds; if gains were more than this, then taxes are owed on that amount.

ZT also had a question on selling a home. Several costs related to closing are deductible. These include the interest and real estate taxes that are allocated to the seller; and for the buyer, the points, interest, real estate taxes and costs for private mortgage insurance. When you sell a house you add the expenses of fixing it up to the basis to reduce you gain. Sales commissions reduce your amount realized and thus your gain also.

Chris wonders if he should be able to take some of the home-related deductions for a home jointly owned with someone else. Generally speaking, you are entitled to deduct interest and taxes on residential property that you own as either your primary or secondary home. If this is the case and the home is jointly owned with one person having taken all the deductions, then both parties would need to file amended returns for the specific tax years if they now decide that the deductions should have been shared. Rules are different if the property is investment property, if it’s rented out, etc. In instances like this, where there are multiple parties and extenuating circumstances, consulting a tax professional is strongly advised.

Darkling, Kode and Elizabeth all have questions related to the first-time homebuyer tax breaks. I wrote about these in my previous column.

Let’s start with Kode’s question about the timing of taking the first-time homebuyer credit. If you purchased a home in 2009 and already filed your 2008 tax return without taking the credit, you can file an amended return to claim the credit on your 2008 tax return. But you do have to have purchased the home before July 1, 2009, to take the credit on your 2008 return. You do use the form F5405. There is confusion because the initial F5405 for 2008 only included the $7,500 credit, which also was to apply to homes purchased in 2009. Earlier this year, however, legislation changed the rules for first-time homebuyers who purchased their home in 2009, increasing the credit to $8,000. This required the IRS to create a new F5405 for 2008. So, another group of people that may want to file an amended return are those that purchased a home in 2009 and are eligible for the $8,000 credit but used the old F5405, taking only the $7,500 credit. The IRS may issue specific instructions here on whether they will automatically do this but there is nothing at this point in time

Darkling bought a home in 2008 and asked whether he could take the more generous $8,000 tax break for 2009 or was stuck with the $7,500 tax credit offered to first-time homebuyer in 2008 that needs to be paid back. Timing is everything. As of this point, the new rules for 2009 are not retroactive. So, if you purchased your first home in October 2008, then the $7,500 credit that must be repaid applies, assuming you meet the other criteria for this credit.

Finally, Elizabeth asked whether there are downsides to taking the first-time homebuyer credit on the 2008 tax return if you bought the home in March 2009. If you take the credit on your 2008 tax return, you will lower your tax bill immediately, and you will still be able to take the home-related deductions in 2009.

These were all great questions. The above should provide you a general starting point at the least. As always it’s a good idea to follow up with a CPA if you have complicated tax issues or use a site like www.completetax.com to help you with preparing your taxes.

About the Author: David Bergstein, CPA, is a tax analyst for CCH CompleteTax.

Winners: As promised, we’ve chosen the 10 best questions we received and are giving them each a free accout with CCH CompleteTax. The 10 winners are:

Uriel, Laura, Chris, Henry, Karen, Andrew, Deb, Candice, Satya, Amanda

Congratulations to our winners! We will be contacting you within 24 hours with your free codes.

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Now that tax season is here, I’ve asked David Bergstein, professional tax analyst and CPA, to offer iwillteachyoutoberich readers customized tax advice. Don’t worry if this advice doesn’t apply to you — if you have a specific question, you can get it answered below, for free, by David..

april-15th

While Ramit focuses on teaching you how to be rich, I can share with you a few pointers on taking advantage of tax breaks that may be available to you, because paying more in taxes than you owe is a sure way not to get ahead.

One of the first things to understand is that not all tax breaks are created equal. For example, there are tax credits and deductions. Credits are a dollar-for-dollar reduction in your tax bill. Deductions, on the other hand, reduce your taxable income. Say you are in the 25-percent tax bracket. A $500 deduction reduces your tax bill by $125, while a $500 credit lowers your tax bill by the full $500. If ever forced to choose, go for the credit.

So what credits and deductions do you need to know about? Well, that depends on your specific circumstances, but following are a few that apply to many individuals, particularly younger taxpayers.

It’s important to note that the tax code is now more than 70,000 pages and includes not only what is taxed, but also the tax breaks. So, to really hone in on the tax breaks best for you, your best bet is to get some help. Tax software, such as CCH CompleteTax, that walks you through the tax prep process can be an incredible time saver because it asks you questions specifically designed to identify tax breaks for which you may be eligible.

That said, here are a few credits and deductions you should be thinking about as you prepare your 2008 tax returns.

Credits of Note
Two special tax credits worth noting for 2008 are the recovery rebate and first-time homebuyer credits.

  • You may be able to claim the recovery rebate credit if you did not receive a full economic stimulus payment last year. For example, say you made too much money in 2007 to get the full stimulus payment, but were laid off in 2008. Your 2008 reduced income may make you eligible for the recovery rebate.

  • If you bought your first home in 2008, after April 9th, you may be eligible for a first-time homebuyer credit of up to $7,500, which must be repaid after 36 months in the home. The economic stimulus package enhances this credit for 2009, increasing the credit amount to $8,000 for taxpayers buying their first home in 2009 and removing the payback requirement, so long as you stay in the home for at least 36 months. Also, a bit confusing, but if you buy your first home in 2009 before July 9, 2009, and before you file your tax return, you can take the first-time homebuyer credit on your 2008 tax return. For both years, the credit begins to phase out for taxpayers with adjusted gross income above $75,000 ($150,000 for joint filers).

Other credits important to know about, particularly for younger taxpayers, include credits for post-secondary education expenses. These include the Hope Credit offering up to a $1,800 credit and the Lifetime Learning Credit offering up to a $2,000 for 2008. Both have specific restrictions, including income eligibility, and, if you take one, you can’t take the other. Looking forward to 2009, the economic stimulus package renames the Hope Credit the American Opportunity Tax Credit and temporarily increases the credit to $2,500.

Deductions You Want to Consider
Even though credits save you more than deductions, you still want to take deductions when you can.

Two common deductions that have special twists for 2008 are the standard deduction and the standard mileage deduction.

  • The 2008 standard deduction ($10,900 for joint filers and $5,450 for single filers) adds a temporary property tax deduction, which allows taxpayers who do not itemize deductions a limited deduction for state and local real property taxes. Taking this deduction can increase a single filer’s standard deduction by $500 ($1,000 for joint filers).

  • The standard mileage rate also has a twist for 2008 thanks to a mid-year rate change. For the first part of the year, the deduction was 50.5 cents per mile for business and 19 cents for medical and moving travel; and for the last half of 2008, the deduction was 58.5 cents for business and 27 cents for medical and moving travel.

Also worth noting, if you moved to take a new job, the cost of your moving may be deductible. If you were one of the unlucky ones and lost your job, the cost of your job search may be deductible.

In addition to the education credits mentioned above, there also are post-secondary education deductions. These include a higher education tuition deduction for up to $4,000 in qualifying expenses and a student loan interest deduction of up to $2,500 base on interest paid on the loan.

Finally, exemptions are another area of tax breaks to know about. There is a personal exemption of up to $3,500 available to most taxpayers. If you’re lucky enough to work for an employer that offers Qualified Transportation Fringe Benefits, you also don’t have to pay income taxes on these benefits. Additionally, if you are in the military, any pay you received while serving in a combat zone in 2008 is exempt from income tax.

Taking Action & Getting Help
As I mentioned, the above are just a handful of the many tax breaks that may apply to your circumstances. If you want to learn more about any of these, you can read up on them in the CCH CompleteTax Tax Guide 2009. If you just want to have CCH CompleteTax help figure it out for you, you can go to www.CompleteTax.com.

About the Author: David Bergstein, CPA, is a tax analyst for CCH CompleteTax.

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Tax giveaway: Do you have tax questions? I’ve arranged to have David answer your specific tax questions — plus, the best 5 questions will get free accounts at CCH CompleteTax. Each is good for tax prep for one 2008 federal and one 2008 state tax return valued at $29.90 to $49.90. Leave your questions below.

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After watching the debate tonight, I figured I’d translate what both candidates were saying. Sorry I’m not as politically correct as them, but I hope this is informative.

Things will get a lot harder before they get better.
All the predictions about the recovery taking until “at least the end of the year” are horseshit. In truth, nobody knows, but it would be political suicide to admit that a recovery — whatever that means — will take a few more years. The truth is, nobody knows how long it will take. But if there’s one thing Americans love, it’s a leader pretending to know everything. And if there’s another, it’s that Americans love a quick fix…only to later complain about it not being done right.

Your questions about how “quickly” we can get out of this crisis are misguided.
Sometimes a forest needs to be cleaned out with fire before it can grow again. Again, an unpopular position. Since the government has virtually unlimited resources, it can certainly alleviate the pocketbook pain we’re feeling…but it will come back to bite us in the ass later.

Not all homeowners deserve to stay in their houses.
Renting is a perfectly reasonable alternative, but the idea of Americans “losing their houses” is politically untenable. Why? Because America perpetuates a mistaken culture of homeownership. Owning your own home is the kind of BS sacred cow that got us into this mess: Our parents tell us to buy a house. Our friends are impressed if we own a house in our twenties. The government literally encourages us to own a house by offering tax deductions. Homeownership is the American Dream!

The truth is, if you’re making the largest purchase of your life, you need more than a slogan — you need to take the responsibility to do some research. (And note that you can’t advocate for increased homeownership and also argue for Americans to keep their houses. By not reducing the prices, younger people cannot buy houses at these inflated prices.)

Yes, there was an exceptional amount of predatory lending.
For every blogger who argues loudly about personal responsibility, an angel dies and an Ogilvy executive lights a marshmallow in hell and eats a delicious snack. Wall Street and realtors are also to blame for this. But so are average Americans. It’s difficult to have a nuanced discussion about real estate on the campaign trail, so we resort to cartoonishly simplistic caricatures of things like Wall Street’s corruption. True — but also take a look in the mirror.

Homeowners are delusional about how much their houses are actually worth (see this, too).
As a wise commenter said, “I love the fact that it’s “acceptable/normal” for a home to increase its value by 100% during a five-year time frame, but it’s “unreasonable/impossible” for a home to decrease it’s value by 30-40% during a similar time frame.”

Taxes: Pandering to ordinary Americans instead of telling them to stop spending on stupid stuff
The reason Obama and McCain spent so much time talking about taxes is that most Americans are historically horrible at managing their spending. Since they make a fixed amount of money (revenue) and can control only one thing (costs), both politicans use tax breaks to pander to voters. Most people have never seriously thought about how to make more money. Fine. But what’s even more outrageous is Obama and McCain’s complete lack of honesty about what people really need to do to weather the economic crisis. Did you hear either one plainly say, “You’re going to need to buckle down and save more?” Of course not. You might as well walk into a Dave Ramsey seminar and argue that credit cards are a useful tool. It’s a suicidal suggestion. But it’s true.

Shut up about your money worries unless you’ve taken the time to read a book about how money really works
You need to read a couple of good books about money. Not read the screaming headlines of CNN.com. But a real book that explains how money works. If you don’t, do you really have the right to complain about how scared and nervous and worried you are about your money? (Note: If you want to get my favorite book recommendations, sign up for my free newsletter by Friday, 10/10/08. In fact, I’m giving away free personal-finance books in the upcoming weeks.)

Americans don’t know how to be frugal — yet
Things will get more expensive. Taxes will eventually go up. They have to. Costs of ordinary goods will go up. They always do. If you’re expecting it to get easier, you’re wrong. The key is to make more money and cut your costs. Sadly, Americans are poorly versed in being frugal. You think it makes sense to buy a new car every few years? You think it’s normal to eat out 5 times per week (lunch and dinner)? You feel good about yourself for ordering water when you go to a restaurant, but you blew $50,000 because you didn’t take the time to understand your mortgage? You’re not frugal. But a few more years of an economy like this and things just might change.

Sensible investors don’t change strategies very much — even in a market like today’s
With the market cratering hundreds of points every day — then climbing a similar amount the very next day — billions have been pulled out of the market. Yet long-term investors have the discipline to stay steady. Panicked spouses and overconfident investors think they know better by trying to time the market, but they’re wrong. In fact, here’s an excerpt from my upcoming book:

Recently, a group called Dimensional Funds studied the performance of the S&P 500 from January 1970 to December 2006, during which time the annualized return of the market was 11.1%. They also noted something amazing: Of those 36 years from 1970 to 1986, if you missed the 25 days when the stock market performed the best, your return would have dropped from 11.1% to 7.6%, a crippling difference.

Now, if only we could know the best investing days ahead of time.

Of course, we can’t. That’s why I continue to dollar-cost-average money into the market, slowly. Will it go down in the short-term? Almost certainly. But as my funds get cheaper and cheaper, I’ll pick up more and more shares. And eventually — over a 10, 20, or even 50-year time horizon, I’ll make a significant amount.

But encouraging people to continue investing during times like this wouldn’t be received well. More often than not, politicians need to seem to be doing something — ANYTHING!! — in order to keep you happy. Frankly, with a balanced portfolio, there’s really not much to change. But that’s not sexy enough to tell most people. (Plus, they have no idea what a balanced portfolio is.)

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Sorry if I was too harsh. I’m usually not political, but I’m tired of the bullshit around our money. Every single one of us knows co-workers, family, or friends who are worried about their money. It’s time to get honest about what’s going on. (Want to read more? Check out my popular articles, personal-finance links, and my forum.)

More to come in future posts.

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I’m trying something new: If you liked this, please digg this article.

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If you’re running late filing your taxes, don’t worry.

Get an automatic 6-month extension by filing a simple IRS form.

And if you still haven’t picked up a copy of the 2008 Tax Makeover Guide, check it out here:

2008-tax-makeover-cover-small.jpg

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My college roommate JRK sends me some interesting thoughts about the upcoming government tax rebates from an MIT report. As usual, it’s not just about rationality, but about the form in which the money is delivered (debit card vs. check):

  • [The 2001 tax rebates] “show that taxpayers spent about two-thirds of their rebates within six months of receiving checks.”

  • “The 2008 rebate program is aimed at low-income households, because these households are the least likely to save the rebates.”
  • “…rebates that are received as electronic deposits may seem less like spendable cash, and more like potential savings, than checks that taxpayers receive in the mail”
  • “I suspect that giving people a prepaid debit card will do more to rejuvenate the economy than mailing out checks, but direct deposits wouldn’t be nearly as effective,” Ariely said in a recent commentary for the Marketplace radio program. “I also suspect that if we added a line on the debit card that reads ‘spend the government’s money’ this would work even better.”
  • “If consumers save rather than spend the money, there will be no stimulus”

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When it comes to be tax time, people love to start throwing around phrases that enrage me and make me wish to become a cartoon hero that points at someone and ejects a roll of duct tape towards their mouths to silence them. In my dreams, I would be a cross between Spiderman and a librarian.

Anyway, how often have you heard this phrase?

“If you get a tax refund, it means you’ve given the government too much money.”

This oft-repeated phrase assumes rationality: ‘If you get a refund, it means you sent extra money to the government! Why would you let them make interest off your hard-earned money? You should only send the minimum amount!’ Then these people are usually out of breath because of their own self-proclaimed brilliance.

Technically, they’re right. I live in a world of reality, however, which means that “technically” isn’t always correct. Here’s why I’d rather get a tax refund than owe the government money:

First of all, if you end up owing the government money at tax time, most people don’t have extra cash lying around. We know this because they are horrible at managing their money and have record debt rates. Sorry, it has to be said.

Second, how much interest are we really talking about? Let’s say you get a government rebate of $600. At my high-interest ING account, that’s $1.50/month in interest. Oooh, the government is making bank off my money! Get a life.

And, in fact, people’s opinions reflect this:

…when asked if they’d prefer to owe taxes, get a refund or break even, none said “owe,” according to the USA TODAY/Gallup Poll. Fifty percent hope they break even, and 45% hope they get a bigger refund this year than last.

In real life, $600 that you owe to the government would affect your life far more than getting $600 back, meaning it’s better to get money back than to owe it. So if you end up getting a tax refund, don’t feel bad. And don’t just follow what the pundits say. We live in the real world, and there’s a difference between the best decision and the financially smart one.

* * *

Edit:
Q: “What about people taking their tax return and spending it on junk?”
A: Actually, researchers know that people will tend to save lump sums in times of economic hardship. That’s why the Obama administration, which knows about the psychology of consumer behavior, issued a tax refund to happen a few $/month — that way, people just spend it.

Very similar to what people would do if they increased their deductions and got a little more $ each month.

* * *

You can learn about the applied psychology of money in my book.

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[From Ramit: Yesterday, Todd wrote about what to do before you file your taxes.

Today, this article is specifically for college students. I know, I know. You feel guilty because your parents are paying thousands every semester while you're busy napping all day and trying to spit game at the girl next door. And failing.

Your parents may be able to save on taxes if they follow some of the instructions below. Take a look and send them this article.]

* * *
Guest post by Todd Doerr

Are you in college or about to attend college? Are you in your junior or senior year? Consider sending this to your parents. This article has a lot of with ideas that may help save your parents thousands of dollars each year and may even put some extra money in your pocket.

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I can sense it now. You must be feeling some pride (or bewilderment) that your college student is thinking about how to help you financially and how to make your life a little easier. Who would have thought that your student would start to get a financial clue?

I’ve coached many families who already have college students or will soon have at least one child in college. There are ways to successfully navigate the waters of paying for college. In this article, I will share a game plan with you, the parents, to make your life easier and to help your student get off to a strong start in the real world. I will also provide you with some tax-savings ideas that may speed up your progress even faster.

Let’s first look into the financial future of your college student once they graduate.

Post-Graduation Snowball

As you are probably aware, the typical college graduate has both credit card and student loan debt. Recent graduates have an average of over $19,000 of student loans and over $3000 of credit card debt. The typical graduate degree student leaves with $24,000 to over $100,000 of student loans.

So, your college graduate begins the new season in their life and the snowball builds….

Then, your graduate buys the new car (take it from someone who bought the new car one month after walking the stage – it happens a lot). Another $300 per month in payments out the door.

Then, your graduate rents the nice apartment as they are sick and tired of dorm life or the college apartment. Oh yea, that nice apartment makes the college furniture look nasty. New furniture on the MasterCard – PRICELESS.

Then, your graduate starts making payments on the student loans (sure, the interest rate might be fairly low, but the payment still stinks). Potentially hundreds more of outflow each month.

Then, all of their friends start to get married and everyone starts dropping serious cash on wedding gifts, parties, travel, dresses, and tuxes. The numbers here really add up when you multiply by the number of friends.

Maybe it’s none of these events – maybe they spend $300 per month eating out. Maybe it’s buying cool gadgets. I’ve coached many clients in their 20′s. Their stories are different, but the result is generally the same. The debt adds up quickly and the minimum monthly debt payments grow substantially.

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About this time the two big “M-words” might sneak up – Marriage and Mortgages. You get the picture.

The good news is that the snowball does not have to claim your graduate. They can thrive financially if they live off a budget, get out of consumer debt, and avoid going into additional student loan debt.

The best financial coaching advice that I can share with you, the parents:
Help your child graduate with as little or no debt as possible.

Why? Because when they are free of consumer debt and student loans, they can really begin to thrive financially and to build a hopeful future for themselves.

Let’s say your graduate didn’t have that “normal” student loan payment, the “normal” MasterCard payment, those 2 payments could can easily add up to several hundred dollars per month. Instead, he or she invested $300 per month from age 25 to age 65 in a retirement account earning 8% per year. At age 65, they could have approximately $1 Million in retirement savings. Obviously the cost of living will go up, so it won’t feel as big. But it gets them off to a great start towards retirement savings.

Winning with College Expenses
Here is the overall game plan I share with my clients. It does take some work, but it is truly worth it to follow as many of the strategies as possible.

  • Save-Save-Save. If you have time before one of your children heads off to school, save aggressively with an Education Savings Account (ESA) or a 529 College Account, or even just a high-yield savings account. My favorite resource for these 529 and ESA plans is www.SavingForCollege.com. If you are just a couple of years away, I would avoid investing in 529′s or ESA’s as the value could go down if invested in stock mutual funds. I would stick with a high-yield savings account in that case.
  • Proactive Scholarship Hunting. Get proactive and diligent about applying for scholarships and grants, even if your student is midway through college. Don’t give up!
  • It’s possible to find thousand of dollars in scholarships and grants. I recommend Ramit’s postings on these topics. He really knows how to win in this area.
  • Hire a scholarship coach. I send some of my clients to a productive scholarship coach. She consistently helps her clients find $10,000 to over $40,000 of scholarship and grant money.
  • Cash Flow College. As a family, do everything you can to pay for college with cash and to avoid borrowing and credit cards. Here are some ideas to get you started:
  • Part-time jobs for your student, or even yourself. Part-time jobs are a great way for students to develop life and time management skills. They are not forever, and can provide a significant boost for college expenses.
  • Drive used cars. This can really boost your monthly savings. It’s not just a lower payment (or no payment at all if you a big bargain) – older vehicles also depreciate more slowly than newer vehicles.
  • Maximize as many tax strategies as possible for parents. I will cover this in detail later. This step alone can put money in your pocket each year.
  • Become a bargain hunter on everything. Buy used textbooks, used computers, used furniture, etc.
  • Hold off on expensive vacations. This could save $1000’s over 4 years in college.
  • Sell things. Have a massive yard sale. Sell the motorcycle. Sell the piano that no one plays anymore.
  • As a last resort, Student Loans. I’m not going to slam you for taking a student loan, but let’s work REALLY hard on all of the other steps before we start taking these on. The benefits can be substantial.
  • Avoid borrowing or withdrawing from your 401k or IRA’s for college expenses. Even though you can withdraw or borrow money penalty free in specific scenarios from some retirement accounts, you are putting your financial future and retirement at risk.
  • Avoid borrowing on your home to pay for college. Borrowing against your home puts your home at risk, especially in today’s crazy real estate market where people end up upside down on their mortgages.

    • Review Tax Savings Ideas
    Make sure you research every possible income tax savings opportunity – this could save lots of dollars every year of college. By making tax-smart moves, you can free up more money to pay cash for college.

    Here is a list to review that may help to boost your plan. Some are best handled by your personal tax accountant.

    • Maximize your Hope and Lifetime Credits. These are great credits if you qualify – see IRS Publication 970 for details. The Hope Credit may only be claimed for 2 tax years per child and can only apply to the first 2 years of post-secondary education.
    • Deduct Student Loan Interest. If you are already making student loan payments, you may qualify to deduct a certain amount of interest paid on student loans. See Publication 970 for limitations.
    • Continue to Keep Your Student as a “Dependent”. This assumes that you continue to provide at least one-half of their support. Refer to Exemptions in the Form 1040 Instructions.
    • Hire your student. If you are self-employed or own your own business, hire your child to perform bona-fide work at a reasonable salary. Keep records of time worked, duties, etc. You can deduct their wages as a business expense. This is a more complex strategy that probably would best be handled by your personal tax accountant.
    • Buy-off campus housing. This is for wealthy parents only. I recommend that you do not consider this option unless your primary residence is paid for (no mortgage), you have a substantial emergency fund, you have no consumer debt, and have accumulated a large retirement account (Yes, I know this advice is very conservative). You can “hire” your child to be the property manager. You can also potentially deduct the housing property taxes on your Schedule A. This strategy requires a clear game plan – take your time and don’t rush in. Once again, this one is best handled by your personal tax accountant.
    • Make sure your student has health insurance coverage. This is not a tax strategy, but important enough to mention as a “protect yourself from a financial blow-up” strategy. One serious trip to the hospital could set you back from $5,000 to $20,000 or more without health insurance on your student.

    Tomorrow’s article will outline a financial game plan for the newly engaged and the newly married.

    Todd Doerr is a personal finance coach. He helps his clients to rapidly get out of debt and to build serious wealth. He tells his clients, “It’s not always easy or pretty, but it always works.” You may reach him at todd_doerr@yahoo.com or at www.taxmakeover.com.

    [Update]
    1. See the two other articles Todd wrote:

    2. Then check out his eBook, The 2008 Tax Makeover Guide


    2008-tax-makeover-cover-medium.jpg

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    [Update: Roth IRA amounts corrected below.]

    [From Ramit: Since tax season is here, I wanted to write something about the tax issues we face. But since I'm not an expert, I've typically turned to guest posters to help. Last year, David Bergstein answered your tax questions.

    This year, I've invited Todd Doerr to guest-post for the next three days. Over the next 3 days, he'll write about taxes for three situations: people in their twenties, college students (I know you're lazy so you can just point your parents to the article to do all the work), and recently married couples. And on Friday, after the three posts, I'll announce something pretty cool.

    I like this post below because Todd points out that if you're already saving, why not take a small extra step to dramatically increase your returns?]

    * * *
    Guest post by Todd Doerr

    Stop. Turn off your ipod. Turn off your phone.

    This one post will help you win with money – guaranteed – if you take ACTION. If you are in your 20’s or 30’s, this is going to rock your world.

    I coach many individuals and families in my financial coaching practice – they pay me to help them quickly get out of debt and build wealth. Hopefully you are already saving some each month towards retirement. Why not spend an hour to setup a simple, automatic wealth building plan that will double your return?

    I’m amazed that only 31% of Generation Y workers (born 1978 or later) are saving for retirement in their 401k, according to Hewitt Associates. You can be light years ahead of your friends if you follow the coaching advice that follows. It will only take an hour of your time – your friends will be amazed!

    Let’s dive in – stay with me!

    Let me go ahead and spell out the entire purpose of this post:

    The Roth IRA is one of your most important wealth building tools. Maybe even the most important. If you consistently invest in your Roth IRA during your working years, you will build substantial wealth.

    OK. Maybe it was a little heavy, but I want to get your focused attention for a few minutes. Let’s cover the basics first.

    The Nuts and Bolts of the Roth IRA

    Here are some of the common questions that I get about the Roth IRA:

    Q: Why should I care about a Roth IRA?

    A: The short answer: You don’t want to work the rest of your life. Using a Roth IRA consistently, in addition to your 401k, will make you very rich and will change your life. I would argue that if you save aggressively in a Roth IRA, you will open up new options and freedoms in life that you cannot fathom today.

    Q: What is a Roth IRA?

    A: A Roth IRA is simply a retirement savings account offering amazing “back-end” tax breaks when you take money out at retirement age (59½ years and older). The Roth is a “bucket” – you fill that bucket with good conservative mutual funds (I don’t recommend individual stocks).

    Q: How hard is it to setup?

    A: 1 Hour – I’m dead serious. I’ll cover the specifics later in this article.

    Q: What are some specific benefits?

    A: You can withdraw funds without taxes or penalties once you’ve reached age 59½ and held the funds in the Roth for five tax years after the year you make your first contribution. Here’s an example. Let’s say that you worked your buns off for 30 years and had $1 Million dollars in your Roth. When you retire at age 59½ years (or older), you can take out the $1 Million TAX-FREE. It also grows TAX-FREE each year during your career. Don’t think you can save $1 Million? Keep reading on.

    Q: What are the limits on a Roth IRA?

    A: You can contribute $5000 annually to a Roth ($10,000 for married couples), whether you participate in an employer plan (like 401k) or not, if your AGI (line 37 on Form 1040) is less than $116,000 (joint filers, $169,000).

    Q: Anything else I should know about it?

    A: You can withdraw your contributions penalty-free should you need them for an emergency. You can contribute at any age as long as you have earned income. There are some

    A Sweet Retirement

    OK. Onto the cool stuff. Go ahead – take a peek. Wow.

    The tables below show what you could have in your Roth IRA if you invested monthly or annually during your career. These numbers assume you invested in a diversified, conservative set of mutual funds that could average 11% annually (stock market has averaged over 11% for over many decades).

    You must really like that $400 car payment! Or, maybe the gym membership isn’t looking so fiscally fit anymore. And for sure, the minimum payment to Visa could be put to better use! Maybe the $200 per month for eating out is not so appetizing.


    Here are some specific and exciting ways to boost your savings plan.

    • $100 – $200 – $300 – $400 per month of savings: Go through your budget and find the “luxury” items – you will be amazed when you cut a little here and there. These things add up. My favorites include: driving a used car and dropping the fat car payment, drop the premium cable channels, cut back on the cell phone plan or drop your land line at home, selling the cat (just kidding!), bring your lunch to work except 1 day per week, drop the gym membership, take basic vitamins instead of $100 per month, only buy clothes that are mega-bargains, cancel subscriptions that you don’t really have time to read – the list goes on. You won’t miss these and will truly enjoy knowing you have a plan to win with your money. Get yourself motivated and start making changes now!
    • $200+ per month of savings: Work a part-time job to speed up your progress. Ask your employer for overtime opportunities. Provide a tutoring service. Deliver pizzas (you can make $750/mo doing that). Mow yards or provide handyman services. Start a pet sitting business. Get creative. Get your real estate license. Write software on the side. Don’t analyze this too much – just go for it. If you don’t like your first part-time job – just find another one. This is not a FOREVER job.

    Anyone in America with a decent income can win! The key is to start TODAY and not hesitate. Set your goal and don’t stop until you reach it – $100 – $200 – $300 – $400!

    Annual amount – Assuming 11% return

    Yearly Contribution

    30 years of saving

    40 years of saving

    $1000

    $220,913

    $645,826

    $2000

    $441,826

    $1,291,653

    $3000

    $662,739

    $1,937,480

    $4000

    $883,652

    $2,583,307

    $5000

    $1,104,565

    $3,229,134

    Monthly Investing Results – Assuming 11% return

    Monthly Contribution

    30 years of saving

    40 years of saving

    $100

    $283,022

    $867,895

    $200

    $566,045

    $1,735,791

    $300

    $849,068

    $2,603,687

    $400

    $1,132,090

    $3,471,582

    My

    Simple Way

    To Get Started in less than 1 hour

    STEP ONE: Don’t file your taxes yet. The good news: You can still make a “2007” contribution if you open a Roth IRA before you file your income tax return.

    STEP TWO: Open an account TODAY. The sooner you start, the sooner you start the magic of compound interest.

    • Find $5000 $4000 (the new 2008 limit is $5000) for your “2007” contribution. If you don’t have $5000$4000 right now, just put in whatever you free money that you have. $500 – $1000 – it doesn’t matter. You must get started!
    • Autopilot for 2008. Setup an auto-draft from your checking account each month and have the money invested automatically. It’s too easy to get distracted during the year to write a check each month – set it up once and let it run. Your target amount should be $416 per month ($5000 divided by 12 months). If you have to start small, that’s OK. As you can see, even $100/mo is HUGE at retirement. And don’t forget the next time you get a raise, bump up your monthly investment by even more.
    • Open an account at a low-expense, customer friendly mutual fund company. Simply tell them “I would like to open up a new Roth IRA and make a contribution for 2007. I would also like to setup an automatic investment plan each month for 2008 and beyond.” I highly recommend T. Rowe Price and Vanguard as a great place to open a Roth IRA.
      • T Rowe Price. You can start with as little as $50 per month on most mutual funds. Contact them at www.troweprice.com or 1-800-638-5660.
      • Vanguard – They have higher minimums amounts to start, but offers lower annual expenses than most companies. Contact them at www.vanguard.com or 1-877-662-7447.
    • Choose a conservative “growth and income” mutual fund or balanced fund to get started. These should be funds you plan to hold for a lifetime. You can diversify later into different flavors and styles of mutual funds. For right now, these will work fine.
    • Leave it alone! If you look at the long history of the stock market, 97% of any 5 year timeframe had a positive return. Don’t try to get fancy, time the market, buy individual stocks – stick with the basics. You want your foundation to be strong – don’t tinker with it. Invest and leave it alone.

    Retirement Savings Goals

    In case you are wondering how much you should save each year for retirement, your overall savings goal should be about 15% of your gross income (most of my clients are in the 10% – 20%), in the following order:

    • Fund your employer 401k plan up to your maximum employer’s match.
    • Max out your Roth next up to $5000 (or start with a Roth if no company match).
    • Finish out the 15% by investing more in your 401k.

    Friends, Laziness, and Boosting Returns

    OK. You now have a vision for building significant wealth.

    But what about your friends? Many of your friends probably don’t get it. Why? Because they haven’t seen that significant wealth is possible for the “average” person with an “average salary”. Share this article with them. I’ve found that it helps to have like-minded friends shooting for a hopeful future.

    If you are feeling lazy – you better wake up! I have made it abundantly clear that 1 hour of your time will rock your world. You don’t have to do heavy analysis each month – set up this plan on autopilot and let it run. If you are so lazy that you can’t spend 1 hour on this, then, whew, life is not going to be easy in your later years.

    If you are already saving some, you can turbo charge your results by using low-cost mutual funds that I recommend in this article. Using mutual funds that cost 1% less per year than the average mutual fund could boost your total nest egg by nearly 25% over a 30 year time span. Instead of $1,000,000, you could end up with another $250,000 for a total of $1,250,000.

    Final Thoughts – Keep it Simple and Automatic

    It’s amazing, but you can actually thrive and build wealth with a simple, “boring” diversified portfolio in your retirement accounts. The Roth IRA should be a serious part of most wealth building plans. Open your account today.

    Be sure to join us tomorrow. I will be sharing some specific ways to find $1000 Dollars for college expenses.

    Blessings,

    Todd

    Todd Doerr is personal finance coach. He helps his clients to rapidly get out of debt and to build serious wealth. He tells his clients, “It’s not always easy or pretty, but it always works.” You may reach him at todd_doerr@yahoo.com or at www.taxmakeover.com.

    [Update]
    1. See the two other articles Todd wrote:

    2. Then check out his eBook, The 2008 Tax Makeover Guide


    2008-tax-makeover-cover-medium.jpg