I’m not one who makes resolutions, probably because I wasn’t in the 8% very often!   But clearly many people are making them, and many relate to personal finance.

Harmful Financial New Year’s Resolutions

While setting financial goals is a good thing, are all resolutions equally good? Could some well-intended resolutions end up being detrimental to your financial health? Let’s take a look at seven potentially dangerous financial New Year’s resolutions, and better alternatives.

1. I will make a ____% return on my investments this year.

This sounds innocent enough and, on the surface, a reasonable goal.  The problem is that we don’t control the market! Whether it goes up or down, we have nothing to do with it. When the market doesn’t cooperate with your stated goal, many investors will begin to search for higher returning investments. Unfortunately, higher return also means higher risk.  Perhaps so much risk that you won’t stay invested if a market downturn continues. Chasing returns is a loser’s game.  Don’t play it. Understand your personal risk tolerance and invest accordingly.

A better idea: Instead of trying to meet an arbitrary return goal, try to match the returns in the market this year by being well diversified and minimizing fees and taxes.

2. I will invest in _______ since Person XX (my neighbor, co-worker, brother-in-law) has been so successful with it.

It is human nature to see someone else’s success and want a little of it for ourselves. But that doesn’t make it a good idea!

For example, I often see people who have been successful with rental property. As a CPA, I can run the numbers and see the obvious tax benefits of building a portfolio of rental properties.   But my personality is not well aligned with what is needed for investment property success. I have had some commercial rental property experience in the past, and while it was financially successful, it was a big headache and a source of worry. For me, investing in REITs makes a lot more sense.

A better idea: Create resolutions based on your strengths and specific goals, not what has worked for someone else.

3. I will max out my 401k in company stock.

No matter how well your employer’s stock may be performing, I believe investing in your company stock is a mistake. You have enough tied up with one company when they are your employer, you don’t need to have your investments tied up with them, too.

Diversification across all company sizes (large, mid-size and small companies), countries, and asset classes (stocks, bonds, REITs, etc.) will reduce your risk.

A better idea: “I will max out my 401k in a well diversified, low cost portfolio.”

4. I will “save more” or “spend less” or “invest more”.

Resolutions like these sound good, but are far too general in nature to be effective. If you save an extra $5 in one month, are you done for the year? If you cut your latte habit to four a week instead of five, have you cut your spending enough to meet your goal?

A better idea: Try more specific goals: “I will increase my 401k withholding 1% every quarter this year.” Or one I really like, “I will increase my 401k contributions by 50% of any pay increases this year.”

5. I will prepare a monthly budget in January that I’ll follow every month.

If you’ve spent any time on this site, you’ll know I am a big advocate of preparing a budget or spending plan. So what’s not to like about this resolution?

To be effective, budgets need to be prepared monthly. Yes, some items will be the same each month (like rent, or your monthly car insurance premium). But many things change throughout the year. No single month’s budget fits every month. Trying to make one “master budget” to use all year will lead to frustration (and probably stopping budgeting altogether) as the spending doesn’t fit.

A better idea: Commit to preparing a spending plan every month, before the month begins. Make it specific to the needs of that month.

6. I will prepare a budget every month to bring our household spending under control.

Notice the “I” and “our” in this resolution. Effective budgeting should be a joint effort. Both spouses should participate and contribute to the budget preparation process. Using the budget as a hammer to try and force your spouse to change their behavior will almost certainly fail……and will cause a lot of heartache in the process!

A better idea: Strengthen your relationship by working together on your finances. Something like, “We will work together to prepare our monthly spending plan before the month begins,” will be much more effective. And you’ll be drawn closer to each other as you work together to meet goals important to each partner.

7. I will purchase a new car (or another high ticket item) this year since interest rates are so low.

New cars are awesome. That new car smell. All the gadgets work (and you have a warranty if they don’t). No stains. No french fries under the seat.

You’ll get no argument from me that new cars are fun to drive, but they are not as fun to pay for. The average new car loan is now $644 per month, with a term of 67 months^[2]. Ouch. Even if the interest rate is zero, you’ve already committed a sizable portion of your budget – for the next 5 ½ years – on a vehicle going down in value every month. Where could you invest that money instead…..and what would it be worth in 67 months? Probably a lot more than a 5 year old car.

This same principle holds for other items for which you’d borrow money. Forget the interest rate…..just stop borrowing money! Remember, the borrower is slave to the lender (Proverbs 22:7).  Financial freedom is a lot more enjoyable.

A better idea: Instead of borrowing money for a purchase, commit to saving the cash needed to pay for it in full. Better a paid-for used car/truck/boat/camper than a new one that comes with a payment book!

Setting measurable and well defined goals to meet your objectives is always a good idea, whether it’s January 1^st or not.  Just make sure that the financial New Year’s resolutions you make are ones that will further your progress towards your personal goals and not lead you in the wrong direction!

The post 7 Dangerous Financial New Year’s Resolutions appeared first on FinMasters.

But what about the annual life insurance premiums? How about the semi-annual car insurance payments? Even events like Christmas can be a budgeting challenge. Do you budget your Christmas spending just in November and December (which can be tough if your budget is tight), or do you somehow spread the budgeting out all year? And how can you easily keep track of it all?

Enter the sinking fund.

What Is a Sinking Fund?

It’s historically a term used in accounting to describe setting aside money for debt retirement or a large capital expenditure (think of a new roof or expensive piece of equipment that will need to be bought in the future). The company will simply set aside an amount (often fixed) each month for a set period of time, after which the funds needed to purchase the equipment or new roof will be readily available.

For a simple example, if the company needs a new $24,000 truck next year, they will set aside $2,000 per month for 12 months. Often sinking funds are used for very large, multi-year projects. Imagine a large commercial building needing a $1,000,000 roof replacement every 25 years. It’s a lot easier to set aside $3,333 per month for 25 years than to come up with $1,000,000 when the replacement is needed!
Let’s do a little Q&A regarding sinking funds for our personal use!

Using a Sinking Fund for Personal Finances

Using a sinking fund is great not only for large-ticket items (like a car replacement) but also for irregular expenses throughout the year. We all face those large periodic expenses. Perhaps in the past, we’ve stressed about how we’ll come up with the amount due by the deadline.

The use of a sinking fund has eliminated the significant fluctuations in our monthly spending. It’s much easier to set aside $100 every month than trying to come up with $1,200 at one time. Most of us don’t have that much leeway in our monthly spending to cover a bill that large.

What Expenses Should Be Included in Your Sinking Fund?

Personally, we use this principle for many of our irregular expenses:

• Annual automobile, homeowners and umbrella premiums
• Personal Property Taxes
• Real Estate Taxes
• Christmas and other gifts
• Vacation
• Gym membership (paid annually for better pricing)
• School expenses, summer camps

Some expenses are lower if paid annually, so a sinking fund can actually save you money!

For example, auto and home insurance are often less if paid in full at the beginning of the policy. Our gym offers three free months if we pay for a year in advance. Relatively small savings like these really add up over the course of the year, so don’t miss out on them!

You’ll need to determine your own list. Scour your monthly spending plan for any items that will occur sometime during the year, but not on a monthly basis. If you pay your car insurance monthly, leave it in your budget. If you pay it annually as we do, include it in the sinking fund.

Of course, be reasonable. For small bills (for example, an annual $20 magazine renewal), simply fund them with your regular cash flow during the month of renewal. Sinking funds should only be used for those expenses that can’t be easily funded in one month’s budget.

How Much to Add to the Sinking Fund Each Month

Simply estimate the annual budgeted amount for each of the items you have selected to include in your sinking fund. Then total the individual estimates and divide by 12 to convert the annual total to a monthly amount. This freshly calculated monthly amount then appears on the spending plan (i.e., budget) each month.
An example might look something like this:

Sinking fund contribution calculation

For this example, $400 would be added to your sinking fund each month and it would appear as a line item on your monthly budget, just like food and utilities.

Be sure to review these amounts each year as they will surely change. Some may be removed and others added.

This may sound complicated, but it really isn’t! Let me illustrate with a case study:

Sinking Fund Case Study

Suppose your monthly income was $3,500 and your sinking fund contribution for the month was $400 (as calculated per the guidelines described earlier). Assuming (for simplicity sake) you’re opening your bank account with your first month’s paycheck.

Further, assume over the next three months, you’ll have to pay your life insurance annual premium of $255, and your annual gym membership of $360, in addition to your regular monthly expenses.

When you calculate your $400 sinking fund contribution amount, you include these two expenses.

Your check register might look something like this:

Each month your paycheck is deposited on the first. Immediately $400 is transferred to your sinking fund. On 1/15/16 and 3/22/16, you paid the two bills being funded by the sinking fund.

Notice that those disbursements come from the sinking fund and not your checking account. Why? Because you’ve already set aside the money in the sinking fund! You no longer have to worry about how you’ll come up with the $360 for the gym membership when it renews! You’ve planned ahead and have money resting comfortably awaiting the time when it’s needed.

Where to Keep the Sinking Fund Balance Until It’s Needed

Some will choose to set up a dedicated savings account to transfer this amount to each month. Many banks will set up a free savings account and link it to your checking account, with easy online access. Ask your bank what options they offer.

Others, like ourselves, leave the money in our checking account, but we segregate it from the other spending money within the account. Allow me to explain: Notice in the case study above how the “Account Total” column to the far right didn’t change when the sinking fund was funded. Since the money is still physically in the same account, it wouldn’t change. When we complete our bank reconciliation each month, we’ll use the “Account Total” column instead of the “Checking Account” balance.

As with all financial issues, you’ll have to decide what works best for your situation.

How to Handle the First Year’s Sinking Fund

By now you might be asking: “How do we handle the first year’s sinking fund if bills come due before the money is available?”

This sounds like a complicated question, but it’s pretty straightforward.

Let me ask it this way: Using the earlier example of a $400 per month sinking fund, how would you handle a $600 bill that is due in January if you only had $400 set aside at the time?

Suppose the actual payment schedule for the sinking fund items in our example were as follows:

You will note the $400 being added each month and the bills being paid throughout the year. Both total $4,800 as expected. However, in both April and October the sinking fund is negative! The total of the year-to-date bills due exceeds the amount contributed through that period of time.

Of course, we can’t have a negative sinking fund!

There are several possible solutions to this problem:

1. Make a one-time initial contribution to the sinking fund to cover the shortfall. In this example, it would require a $450 contribution in January. Doing so would keep April and October from going negative.
2. Bump up each of the contributions from January 1 to the first negative month by enough to cover the shortfall. In this example, adding $12.50 to each of the first four month’s contributions would eliminate the shortfall.
3. Cover the shortfall from that month’s operating budget. For example, on your April budget, include $50 for Personal Properties Taxes and only remove the available money from the sinking fund.

The final option would be my personal preference, but again, you’ll need to make your own decision.

This is generally only an issue for the first year that you use a sinking fund. In later years, you should start the year with a “carry over” balance from the previous year to boost the balance high enough to cover large items early in the year. Continuing our example, here is Year 1 and Year 2 of the sinking fund balances (assuming you use option #3 above):

Notice in April of Year 1 that I only withdrew the available amount of $985.00. The other $50 needed for the Personal Property Taxes will have to be added to the April budget. By handling it this way, you’ll note the Year 1 December ending balance in the sinking fund is $50.00.

In April of Year 2, the full amount of the Personal Property Taxes is available in the sinking fund when they are due. Problem solved!

Conclusion

Sinking funds are a great way to smooth out your spending and avoid some of the stress that can arise due to irregular due dates for some expenses. While your amounts will surely be different from those in our case study, you should be able to easily determine the amount you should use.

Keep in mind that this is not an exact science. Surely your amounts won’t come out as evenly as I’ve shown here (I know ours don’t!). But with practice and determination, you too can develop a sinking fund strategy that works for your exact situation!

The post Using a Sinking Fund to Smooth Out Your Cash Flow appeared first on FinMasters.

Yes, yes, I know we enter the home buying process with our budgets set and emotions in check. No real estate agent or mortgage lender will get us to move from our firm price limit!

Yeah, right.

3 Reasons We Overspend When Buying a House

So why is the home buying process fraught with overspending?

1. It’s Emotional

First, home buying is a very personal and emotion-filled process. Where do we want to raise our kids? Are the schools of good quality? Is the neighborhood safe? Is it convenient to work and church and other activities?

These are all reasonable questions, but also very personal in nature.  It’s no longer just a monetary transaction. It involves your loved ones. We want the best for them.  That’s an admirable thought, but it can lead us to make emotional – instead of reasoned – decisions.

2. We Justify Our Way Into It

Also, we justify it with statements like:

“We’ll be here a long time. We should get what we want.”

Ever hear of a job change, job loss, or illness changing your plans? Maybe you have another child and the house gets small quickly. Maybe the neighborhood changes… and not for the better.

Everyone hates moving and we vow to not do it again for a long, long time.  Then suddenly, for any number of reasons, a realtor is putting a for sale sign on your front lawn. Maybe the “long term” wasn’t so long after all.

“Real estate always goes up. What a great investment.”

Really? Remember 2007? Enough said….

“They’re not making any more real estate! I better buy now.”

True, God’s not making more real estate. But there are a lot of new houses for sale every day. In 2020, there were over 19,400 homes sold each day. You don’t need real estate to be created. There is plenty around to be purchased and the listings are changing every day.

“But the bank said I could spend $xxx,xxx!”

Do you let the grocery store tell you how much you’ll spend this week on food? Of course not. Then don’t let a builder, realtor, or a lender do it! It’s your money… you decide.

In truth, we want what we want.  There’s nothing wrong with that… until what we want isn’t in our best interest. Trying to justify it with fancy-sounding ideas and opinions doesn’t change the facts. A pig is still a pig no matter how much lipstick you slap on her.

3. Mortgage Math is Not Your Friend

Finally, often mortgage math works against us. Rates are so low and terms so long that a change in price doesn’t seem to have much impact on the payment. But what is the long-term impact?

Let’s say you increase your loan amount by $25,000 to pay for the new sunroom or upgraded kitchen. At 4% on a 30-year loan, the monthly payment goes up “only” $119.35. Pretty affordable, right? That doesn’t sound like too much of a financial impact.

Don’t stop your calculations now! Run the numbers all the way out. Thirty years of an extra $119.35 per month is a total of almost $43,000! Quite a bit more than the $25,000 you spent!

We’re almost done… just one more calculation to go.

Instead of the upgrade, suppose you invested the $119.35 per month for the same thirty years. Assuming a modest 8% long-term return, your $119.35 monthly payments would grow to nearly $178,000 over 30 years.

I hope you like the granite countertops!

4 Tips to Avoid Overspending on Your Home

So what’s the cure? How do we inoculate ourselves against emotional overspending on our home?

1. Set Your Limit Through a Formula, Not Some Arbitrary Number

It’s important to go into the buying process already certain of your budget. But we know how hard it is to stick to it when you start seeing actual houses.

To help us keep to the budget, it’s important to have a formula to define the limits.  When we set a limit arbitrarily, it doesn’t have the same sense of certainty that a formula provides.

I recommend my coaching clients limit the monthly payment (including insurance and tax escrows) to 25% of their take home pay.

Further, this should be on a 15-year, fixed rate mortgage. Skip the 30 year (and now 40 year) options. The interest rates are higher, and do you really want to make 360 (or 480!) payments on anything?

Skip the adjustable rate mortgages, too. If rates happen to drop in the future, you can always refinance. Refinancing is much quicker and cheaper than just a few years ago. If rates rise, you’ll be glad you have the fixed rate.

Set your spending limit with thought-out reasons and you’re more likely to stick with it.

2. See Your Housing in the Context of Your Life Goals, Not Just a Place to Live Now

As with every big financial decision, it’s important to consider first how it fits into your overall life goals.  For example, if your goal is early retirement in ten years, then an expensive home (with its high mortgage and maintenance costs) may prevent it from happening.

Maybe you’d like an eventual career change to a dream job in another city. Does buying the house you’re considering get you closer to your goal or push it farther away?

When we see things in a broader context, it helps to keep today’s emotions in check.  We understand that no matter how pretty the house or the view, it won’t help us move closer to our bigger goals.

Sometimes an emotional cold shower is just what we need to make sound financial decisions.

3. Consider the Opportunity Costs

As we saw in the example above, it’s not just the increased interest cost and higher monthly payment you’ll get with blowing the budget, it’s also what you could have done with the money instead!

Instead of just seeing the bigger house, consider the possibility of a bigger investment account balance or retiring a few years earlier, too. Suddenly, you may have a change of heart about the house you’re about to buy!

4. Start Looking at Property Well Below Your Budget, Not at the Top Limit

Too often we tend to start looking at homes at the top of our budget. Then we see another option costing just a little bit more and our attention is turned to it instead.  Next thing you know the budget is shot.

Instead, look first at properties 10% to 20% below your top budget amount. Then if you see some properties costing just a bit more, you can consider them without going over the amount you want to spend.

You may end up with a nicer home than you originally considered but still stay within (or under!) budget.

Buying a home doesn’t have to cause a financial meltdown. Nor does it have to cost you your long term dreams. If we enter the house buying process with a defined plan, and view our wants with a long term perspective, we can successfully purchase the right house.

So enjoy the process of looking at homes and getting excited about purchasing one.  Just don’t let the excitement lead you into a financial trap!

The post How to Prevent House Buying From Blowing Your Budget appeared first on FinMasters.

One such service available to those who are seeking mortgage or financial support in the purchase of property or investment is the finance broker. This article will give you some insight into who they are and what they can do to help you out.

Who a Finance Broker Is

These individuals are the middlemen who usually arrange any financial loans for those looking for one. Because the process of applying for, waiting for, and struggling for, a loan can be quite discouraging, finance brokers offer their help with everything from all of the above and more and are authorities in helping you get financial aid for your future home (or car).

Finance brokers deal with everything from concept to completion, including the lenders, and go through all the paperwork so you don’t need to. They know all the legal jargon and can make it much easier for you in acquiring a loan of most amounts.

Sometimes these finance brokers are called mortgage brokers and they are primarily knowledgeable in helping to sort out most loan types for property or investments only.

If one of these individuals is arranging a loan for you, which is covered by the credit law, they must have a license to practice and operate their business.

Finance Broker Fees

This is something everyone needs to know when deciding whom to work with. There are typically three types of investment brokers.

1. First are finance brokers who do not charge you a fee but rather the lender will pay them for introducing you to them and sometimes they also receive a “trailing commission” for the length of your loan.
2. Then there are the brokers who only charge a fee to you and do not get any compensation from the lender. They are not as common as one may think due to obvious reasons. They don’t get many advantages out of this.
3. And lastly, the third kind of finance broker is one who charges you a fee based on their commission and also gets a trailing commission from the lender, this is the bigger advantage for all parties.

As a rule of thumb, if you don’t find a finance broker that does not charge you, the fee will be about 2% maximum of the loan amount being arranged. For example, if the loan amount is $200,000 they would charge you somewhere between $3000-$4000.

Getting value for your money should be your top priority when dealing with these services. Feel free to check what other facilities are available to you. Their main concern should be you, and you alone and they should act on your behalf at all times and so the best advice anyone can give you is to not assume this, or that they will always get the best deal for you.

Some can be motivated only by the commission they will receive from the lender, in which case good or bad deal, they won’t be bothered. This is why you should shop around and see which one fits your needs the best and works most ethically.

Should You Use a Finance Broker

This decision will be entirely up to you, and you could either hire the help of one or none. The alternative is for you to deal with the lenders directly yourself.

There are institutions that can be of good value and who will find a loan that suits your needs and beats the competitive rates of the market, but then there will be others that won’t save you much, and having to do everything yourself may be the cost-effective solution.

Keep in mind, that if you have been having trouble getting a loan from any place you should seek the advice of professionals who may be able to see why that is and find a solution.

The post What Does a Finance Broker Do? appeared first on FinMasters.

Many would classify preparing a monthly budget, as a thankless, unenjoyable task.  If you’re not a budgeter, it may be hard to see the benefits of creating one every month. However, for those of us who prepare one faithfully, we can’t imagine starting the month without a spending plan in place.

Benefits of Budgeting

1. It helps natural spenders to save, and natural savers to spend

Each of us is wired differently. If you found a forgotten $100 bill in your coat pocket, some would want to spend the found money on a surprise treat, while others would see it as an opportunity to add it to the emergency fund. Neither is inherently right or wrong, just different.

A monthly budget allows the natural saver to more easily spend because they know that saving is also occurring. Likewise, the natural spender more easily saves knowing that they will also be able to enjoy the lattes they crave.

2. It creates accountability for married couples

The budgeting process should be a joint effort, not something prepared by one spouse and imposed on the other. Many married couples that I’ve counseled have commented on how the budgeting process actually strengthened their marriage as they learned more about how their mate thought about money and worked together to meet both of their needs.

3. It helps you meet your short and long-term goals

A monthly budget helps to make sure that an appropriate amount of funds are set aside for your goals each month. Waiting until the end of the month, hoping that something is left over, is no way to meet these goals in a timely manner.

Whether saving for next year’s vacation or for retirement several decades from now, a budget will help ensure something is set aside each month for your financial goals.

4. A budget will expose your bad spending habits

Most of us have spending weak spots of some type. Whether it’s eating out a little too often, or downloading a few too many songs, a spending plan will shine a light on those areas and give us the opportunity to change them.

5. It increases your financial peace of mind

Wouldn’t your vacation be more enjoyable and less stressful if you didn’t have to worry about how you were going to pay for it when you get home? Or, how much more comfortable would you feel knowing that you had a fully-funded emergency fund when (not if) an unexpected bill arrives?

Don’t increase tomorrow’s uncertainty by not planning for it today.

6. It helps you avoid debt

One of the most common causes of unplanned debt is a lack of budgeting. The unexpected medical bill may be paid with a credit card if there is no emergency fund already funded.  A car replacement may need to come with a payment book because some money wasn’t set aside each month over the last few years in anticipation of the need. Or, you and your child may be strapped with student loan payments for decades because money wasn’t set aside for college as they were growing up.

Creating a monthly budget doesn’t have to be a time-consuming and complicated process. My wife and I still prepare one each month with paper and pencil in only a few minutes. 

There is a learning curve, so show you and your spouse some grace as you begin the process of budgeting. Most of us are bad at budgeting when we first begin but commit to it for at least 90 to 120 days. If you stick with it, the long-term benefits are worth every minute spent.

Free Monthly Budget Spreadsheet Template

• This simple monthly budget template makes budgeting fun and exciting.
• Easy-to-follow instructions so you can get started budgeting in no time.
• Access your budget online from anywhere. See all features

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The post 6 Great Reasons to Budget Your Money appeared first on FinMasters.

Perhaps the most impactful change was the near doubling of the standard deduction. This change led to a significant reduction in the number of taxpayers who continued to itemize. The Tax Foundation estimates that only 13.7% of taxpayers will itemize in 2019, compared to 31.1% in the previous year.

The unintended consequence of this dramatic reduction in itemization was the loss of the tax benefit of charitable deductions for those no longer itemizing. If your itemized deductions, which typically include mortgage interest, state and local taxes, and charitable contributions for most taxpayers, don’t exceed the new higher standard deduction, there were no tax savings for having made the contributions.

To be sure, charitable contributions should always be made based on one’s desire to support an important organization, not for a tax deduction. After all, giving $1 to save 30¢ in taxes never made financial sense, but it was nice to reduce your tax bill based on giving you were already doing. So, do these former itemizers have any opportunities to enjoy tax savings from their philanthropic contributions? Actually, yes, they do!

3 Tax-Savvy Charitable Giving Strategies

Here are three tax-smart ways to donate, whether you still itemize or not. Of course, each taxpayer’s situation is different and some may not apply to your specific tax situation. Always consult a tax professional before implementing any of these strategies.

1. Donate Appreciated Securities

Suppose a taxpayer has investments in a taxable brokerage account that they’ve held for over one year and which have gone up in value since they were purchased.  This is rather common with the long bull run in the stock market.

Instead of using cash to make a contribution, donate the appreciated securities to the charity. Then, if you still like the investment, use the cash you would have donated to repurchase a like number of shares.

You will not receive a tax deduction, as we’re assuming you’re in the group of people who will no longer itemize (if you did itemize, you would be able to deduct the higher market value of the security, not the lower cost you paid). However, you will create a “stepped-up basis” in your shares, reducing your tax bill when you eventually sell the shares. Perhaps an example would make this clearer.

2. Donor-Advised Fund

As a charitably-inclined taxpayer, I can contribute several years of donations in one tax year by using a DAF to hold the funds until I’m ready for them to be distributed. I would receive a tax deduction for the full amount added to the DAF, allowing me to itemize for that particular tax year.

Then, in subsequent years when the DAF is distributing funds to my local church or other charities, I would take the standard deduction.

This strategy results in higher deductions over the course of several years. My wife and I use this strategy ourselves. We will contribute to our DAF and itemize in Year 1, followed by utilizing the standard deduction in Year 2. During Year 2, the funds in the DAF are used to contribute our tithe to our church and for other annual giving.

The DAF can be combined with the earlier strategy to donate appreciated securities, thus providing multiple tax-saving benefits.

3. Qualified Charitable Distributions

This option is only available to taxpayers over 70 ½ years old with pre-tax IRA or 401k-type accounts.

Once a retiree has reached the age of 70 ½ years old (now extended to 72 years old by the recently passed SECURE Act), they are required to take Required Minimum Distributions (RMD) from a pre-tax retirement account and, of course, pay tax on the withdrawal. This is required even if they don’t need the money to meet their financial obligations. 

Congress instituted the RMD as a way to ensure they would begin to receive tax dollars on pre-tax accounts. The addition of RMD income to a taxpayer’s return would not only increase their income tax liability but may also impact how much of their Social Security is taxed and potentially increase their future Medicare premiums! Failure to take the RMD results in a whopping 50% penalty for the IRS, so ignoring this mandate is not a good idea

For charitably-inclined taxpayers, the QCD may be a great option. With a QCD, the IRA or 401k custodian sends the withdrawal directly to a qualified charity that satisfies the RMD requirement but the taxpayer does not claim the distribution as income. By keeping the withdrawal off their tax return, the income tax owed is less, and Social Security taxation and Medicare premiums are not negatively impacted.

A Word of Caution

As with every area of tax law, there are exceptions and limitations to these strategies, so be sure to consult a tax professional familiar with your situation. Still, for many taxpayers, one or more of these tax-smart ways to donate may offer significant benefits, even for the multitude who now take the standard deduction.

The post 3 Tax-Smart Ways to Donate appeared first on FinMasters.

Tax Tips That May Help Reduce Your Tax Bill

Consider these tax tips as you tackle another round of tax return preparation.

1. Pull Your Records Together Now to Avoid a Late Filing Season Rush

Collecting your records now will make your life easier later this filing season.

Do you have all of your W-2s? How about your 1099-INT (for interest income), 1099-DIV (for dividend income), and 1099-B (for investments you sold this year) statements from your brokerage company? Did you pay college expenses? If so, you may be due a 1099-T from the college or university and possibly a 1099-Q from a 529 plan. State tax refunds from previous years will usually generate a 1099-G.

Making sure you have all of these forms on hand will prevent you from hurriedly tracking them down in April, which is stressful enough without this additional hassle.  You will also have time to fix any errors. I had to have two corrections made this year, so review your forms closely.

2. Compile Your Potential Itemized Deductions

The Tax Cuts and Jobs Act passed in 2017 roughly doubled the standard deduction leading to a significant reduction in the number of taxpayers continuing to itemize their expenses. However, it may be worth the time to review your potential itemized deductions before simply assuming you’ll use the standard deduction.

Common itemized deductions include state and local taxes (limited to $10,000 per year), mortgage interest and charitable contributions.

Additionally, medical expenses above 7.5% of your adjusted gross income may also be deductible if you itemize.  While an unusually large medical bill is certainly a bad thing, it may be enough to make itemizing possible for last year, especially if the medical issue came with a reduction in your income. This reduced income means the 7.5% floor is lower, making more of your expense deductible.

3. Contribute to Your IRA or Self-Employed Retirement Account

While some retirement plans, like 401(k)’s, require contributions to be made by December 31st each year, contributions to IRAs are allowed up to April 15th of the following year.

If you need an additional tax deduction and otherwise qualify, consider making a deductible IRA contribution. Should you find yourself in a lower tax bracket, a Roth IRA contribution may be a better idea. You won’t receive a tax deduction for the contribution, but the growth will be tax-free. Don’t underestimate the power of compounded growth. The Roth IRA can grow substantially over time!

Additionally, both IRA types may qualify for a “savers tax credit,” so even a Roth IRA contribution may reduce your current tax bill. If your 2021 adjusted gross income is under $41,500 as a married filer, you may be entitled to this credit.

For example, Simplified Employee Pension (SEP) plans allow contributions up to the due date of the return reporting self-employment income. The options can get tricky here, so if you have self-employment income, check with a qualified tax professional who is aware of your situation.

4. Health Savings Account Contributions Are Still an Option

Like IRA contributions, health saving accounts (HSA) contributions can be made up to April 15th of the following year.

HSA accounts offer a tax deduction for contributions, tax-free growth, and tax-free withdrawals if used for qualified medical expenses. This “triple tax savings” is unique to HSAs and offers eligible taxpayers significant benefits.

You must qualify to make an HSA contribution by being covered by a high-deductible health insurance plan, so verify with your benefits coordinator or health insurance provider to see if you’re eligible.

5. Don’t Forget About Catch-Up Contributions

Once a taxpayer reaches 50 years old (55 years old for HSA accounts), they may be eligible to contribute additional “catch-up” contributions for some account types, such as 401k, 403b, 457, HSA and IRA accounts.  It’s not too late for 2021 “catch-up” contributions to IRAs and HSAs, so make them if you are eligible and have the funds available.

6. Use Any Remaining Flexible Spending Account Funds

Flexible spending accounts (FSA) allow for contributions that are free from income and Social Security taxes and must be used for child care or medical expenses.  Sounds great and it is a nice benefit, especially if you don’t qualify for an HSA for pretax reimbursement of medical expenses.

However, unlike HSA’s, unused FSA balances are forfeited if not used during that tax year. Fortunately, many plans allow for medical expenses up to March 15th of the following year to be reimbursed with these unused FSA funds.

Should you have an unused balance, consider a trip to the eye doctor for new glasses or to the dentist for a checkup before the funds are lost for good.

7. Adjust Your Withholding for Next Year, if Needed

Here’s a tax tip for next year. If you discover that your 2022 resulted in a large refund or amount due, it may be smart to adjust your 2023 withholding to correct the problem.

If you are due a large refund, decrease your withholding. You can use that money better than the IRS!  If you owe a significant amount, consider increasing your withholding to avoid a nasty April surprise next year.

The post 7 Tax Tips for a Better Filing Season appeared first on FinMasters.

Landis (2018) states that this strategy can only be used within the first twelve months of receiving benefits and a claimant may only use the strategy once in their lifetime (p. 239). 

Additionally, all received benefits must be repaid, without interest, to the Social Security Administration (SSA), not only for the claimant but also for all dependents receiving benefits through the claimant’s work record (Landis, 2018, p. 239).

When to Consider the Social Security Undo

There are numerous situations that an advisor may experience that could lead to a recommendation to a “Social Security Undo”. Landis (2018) proposes that the most obvious would be to correct a filing mistake (p. 240).

Examples may include filing too early (with a corresponding lower payment) or filing for the wrong type of benefit (such as a worker benefit instead of a spousal benefit, if eligible) (Landis, 2018, p. 240). 

Additionally, changes that occur after filing may lead to a recommendation of the “Social Security Undo”.

For example, a claimant filing before their Full Retirement Age (FRA) has more earned income than they anticipated, causing their Social Security benefits to be reduced due to the earnings test (Landis, 2018, p. 206). It may be prudent to repay the Social Security benefits received and withdraw their application, leading to a higher benefit payment when they refile in the future.

Or, an unexpected windfall received shortly after claiming benefits may reduce the need for Social Security income for a period of time. Thus, repaying the benefits that were received allows the future Social Security benefit to grow until claimed at a later date.

Understand the Risks

As with many Social Security options, there are potential risks surrounding the “undo” option.

Landis (2018) explains that plausible hazards include the SSA eliminating the provision from future use, dying before executing the “undo” (and thus locking your survivors into the lower payments), or not having the funds available to repay the SSA when required (pp. 240-241). 

In spite of these potential drawbacks, the application withdrawal and refiling strategy may offer a client the opportunity to reverse an unfavorable Social Security filing decision, benefiting not only them but potentially their spouse and dependents as well.

The post The Social Security Undo: A Possible Filing Do-Over appeared first on FinMasters.

Early Filing Impact on Survivors

One such critical issue to consider is the impact of a worker’s filing decision on any widow (or widower) benefits to which their spouse may be entitled. Lemons (2012) posits that generally speaking, a surviving widow(er) is entitled to the same monthly benefit amount received by their spouse at their time of death (p. 59). 

For example, filing early for a worker benefit (prior to full retirement age (FRA)) would result in a reduced monthly benefit. Upon the worker’s death, the widow(er)’s benefit could not exceed the greater of the reduced worker benefit or 82.5 percent of the deceased worker’s primary insurance amount (PIA) (Lemons, 2012, p. 59). 

Conversely, if the worker delayed the start of their worker benefits beyond their FRA, their higher monthly benefit (due to delayed retirement credits) would pass to their widow(er) upon the worker’s death (Lemons, 2012, p. 59). As a result of these guidelines, many researchers suggest that the higher-earning spouse would customarily delay their worker benefits beyond their FRA in order to maximize the potential benefits for the surviving spouse (Lemons, 2012, p. 59).

Consider Survivor Consequences Before Filing for Social Security Early

Experiencing the death of a spouse is difficult, not only emotionally, but also financially. While a married couple may both receive Social Security benefits, the eventual surviving spouse will receive only one monthly benefit, typically the higher of their worker benefit or the survivor benefit. Thus, the widow(er) will always receive a reduction in their monthly income due to the loss of the second Social Security benefit. The widow(er)’s monthly expenses may decrease marginally due to the loss of their spouse. However, they may not be lowered by as much as their income is reduced. 

This loss of net monthly cash flow is further compounded by a potential increase in their income tax liability due to having to pay taxes at the higher “single” tax rates, instead of the “married filing jointly” tax rates. As such, it is critically important that the potential survivor benefit is considered before filing early to receive their worker benefit. 

Failure to do so may result in the widow(er) suffering a material degrading of their standard of living due to their income reduction and the potential increase in their income tax liability.

The post How Does Filing for Social Security Early Affect Survivor Benefits appeared first on FinMasters.

Estate Planning Mistakes to Avoid

1. Failing to plan. Certainly, estate planning isn’t a fun process, but everyone should complete a plan for their situation.  “If you don’t direct to whom and how your assets will be distributed at your death, your state statute will control” (Calio, 2017, p. 26).  The state plan may not match your preferences.
2. Failing to inventory your assets. Your heirs and the fiduciaries of the estate will appreciate having a complete list of your assets, including online usernames and passwords.  This will also prevent assets from being overlooked.
3. Failing to update beneficiaries. Circumstances in life change over time, which can significantly alter to whom the client would like their assets.  Marriage, divorce, new children, or the death of an heir would suggest a review of beneficiaries should be made.
4. Failing to name proper fiduciaries. “Acting as a fiduciary is oftentimes consuming and complex” (Calio, 2017, p. 27).  It’s important to periodically review “the individuals and institutions [that are] appointed [to] fiduciary roles” (Calio, 2017, p. 27).
5. Failing to correctly title assets. Proper titling can avoid probate for certain assets as well as minimize estate taxes (Calio, 2017, p. 27).
6. Failing to consider incapacity. Estate plans should “set forth who will make decisions for you if you are incapable of making them yourself” (Calio, 2017, p. 27).
7. Failing to structure gifts and inheritances appropriately. The needs and special circumstances of your heirs should always be considered.  Proper trusts, for example, can then be established to match the specific needs of the heirs.
8. Failing to properly handle an irrevocable life insurance trust. Some larger estates may benefit from creating “an irrevocable life insurance trust to hold [a life] insurance policy, thereby sheltering the proceeds from estate taxes at…death” (Calio, 2017, p. 28).  However, this treatment is only available if it is “funded and administrated correctly” (Calio, 2017, p. 28).
9. Failing to consider gifting strategies. “The most obvious way to reduce a client’s gross estate is to have the client give away assets during her lifetime in such a way that the gifted assets will not be included in the client’s gross estate” (Mannaioni, 2018, location 966).  Creating a gifting plan can significantly reduce the taxes owed for larger estates.
10. Failing to update the plan. Life changes happen regularly, so “estate plans should be reviewed periodically” (Calio, 2017, p. 28) to make sure they reflect those changes.

Why Do These Mistakes Occur

There are many reasons these estate planning mistakes appear so often. 

First, estate planning is often thought to only be a concern for the “uber-rich” (Calio, 2017, p. 26), which is a false assumption. Every adult needs at least a basic estate plan. “Others find it morbid to think about and plan for their death” (Calio, 2017, p. 26).

Additionally, ignorance of potential probate and estate tax expenses may lead to plans not being developed and implemented.

Finally, “it is tempting to prepare an estate plan and put it on a shelf and forget about it” (Calio, 2017, p. 28).  Considering an estate “complete” or “finished” may lead to problems as circumstances inevitably change.

Remedy for estate planning mistakes

The remedy for these estate planning mistakes is to set specific times of the year to review the estate plan.

While not a fun process, it is important to make sure your circumstances haven’t changed and that you are following through on your responsibility to be a good steward of the resources entrusted to you. Be sure to utilize a qualified estate planning attorney to assist you in this process.

The post 10 Common Estate Planning Mistakes appeared first on FinMasters.