Category — Taxes

In case you’ve been in a cave, today is the last day to file your tax return. Unfortunately for me this is the first year that I have owed taxes, but it was a planned decision.

Last year my wife and I received a pretty hefty refund, so I decided to increase my withholding to 2. Most of my friends advise claiming zero, which causes the most taxes to be taken out, but pretty much guarantees you will receive a refund at the end of the year. Doing this, however, is like giving the government a free loan through the loan since you don’t earn interest on the money they keep. Knowing that we were going to owe taxes this year, I saved the extra money every paycheck so that it would be available when the bill came due. In the meantime that money was sitting in an account earning interest.

It wasn’t much, but we earned about $20 in interest on the money we had saved. When we finished our taxes I was a little sad to move the money out of our savings account, but I am still happy that we made the decision we did.

There is one catch to doing this, and one I was not aware of until working on our taxes this year. If you underpay your taxes too much, you can get hit with a penalty for underpayment. Funny isn’t it? If you give the government too much during the year they don’t pay you for holding your money. But if you try to keep the money you worked for they hit you with a penalty.

Overall tax time has made me bitter towards the way our government spends money. I don’t mind paying for education and health care (as long as it’s done right). But I hate that our government gives money to poorly run companies and spends money on wars in other countries. But of course that’s a topic for another post.

Just curious about others, did you owe this year or did you get a refund? Leave a comment!

After watching a preview for the movie I.O.U.S.A. and reading the book Fewer I am really beginning to think the problems facing the United States are much more serious than anyone previously thought.

According to the projections in I.O.U.S.A. the government will need to double taxes to cover budget deficits caused by overspending, social security, and medicare/medicaid. On top of that, according to Ben Wattenberg, the author of Fewer, the population of the United States is shrinking due to a birthrate below the replacement rate. With a lower tax base, maybe the tax increase projections made by the I.O.U.S.A. team are actually optimistic.

How does this affect you? The biggest change I see coming is increasing tax rates, which may influence what type of retirement account you choose. Typically a worker will choose an IRA for a tax break now so they can pay taxes later, when they are in a lower income tax bracket. On the other hand, a Roth IRA is popular for someone who wants to pay taxes now so their retirement income is tax-free. I’m thinking right now that a Roth IRA might be the better deal, at least for now while taxes are relatively low, and especially as a supplement to a tax advantages 401(k) if you have one.

As far as asset allocation goes, I think global assets are more important than ever to own, although that’s still a tough call due to the high positive correlation between U.S. and global stock markets. I think domestic stocks are not going to achieve the returns they have returned historically, and domestic bonds are also going to be challenged by a difficult interest rate environment. Commodities like gold and silver may be a good choice for diversification.

Overall I think that diversification is going to be more important now than ever. Your exposure to any one asset class, including domestic stock, foreign stock, domestic or foreign bonds, commodities, or real estate (through REITs) should remain balanced compared to anything else.

Speaking of exposure and balance, when was the last time you checked your portfolio to see how it was doing? Have you analyzed what you did right and what you could improve? If you haven’t done it lately, now is the time to check.

With all of the bailouts happening it really makes me wonder what else that money could be used for. Luckily The Consumerist has done the homework for me so I don’t need to do the research.

But hey, at least we don’t have socialists for politicians, right?

There was an interesting editorial piece in the New York Times regarding John McCain’s healthcare plan and what it entails.

A few of my favorite parts :

the McCain health plan would treat employer-paid health benefits as income that employees would have to pay taxes on

So much for cutting taxes. And later in the article:

The whole idea of the McCain plan is to get families out of employer-paid health coverage and into the health insurance marketplace, where naked competition is supposed to take care of all ills

We’ve seen lately how well the free market works when regulation is weak, and there’s no doubt regulation would be weak in the healthcare sector.

For comparison purposes, here is another opinion piece in the Wall Street Journal comparing Senator Obama’s plan to Senator McCain’s.

Any thoughts on what matters to you in healthcare reform?

Tonight it was announced that the U.S. government will bailout A.I.G. for the bargain price of $85 billion dollars. Add this to the $29 billion for the Bear Stearns bailout and $25 billion (or more) for Fannie Mae and Freddie Mac. Now we’re talking $139 billion dollars that the government is paying out to companies who made poor financial choices and put the United States economy on the line.

Your taxes are not going down

McCain and Obama both like to advocate lower taxes, but the more the government spends the less likely it is that either of them can hold true to their promises. Keep in mind that the government can tax you indirectly through seigniorage, aka the inflation tax. It costs the federal reserve almost nothing to print new money, which the government can then use to pay their debt. But surprise! Printing new money means the money in your pocket is now less valuable than it was before.

So by printing out money and under-reporting inflation the government can take your money right out from under you.

Privatize the profits, socialize the losses

Politicians advocate a free market on the way up, but when things turn sour it is almost guaranteed that they will rush in to help on the way down to prevent stock holders from losing too much money. Of course they are selective in who they bailout. Generally the riskier a company is the more likely it is to be bailed out.

I am a believer in free markets, but if the government is going to step in when things go wrong they need to put regulations in place to limit the tax payer liability when the market goes bust. The saddest part is that money going towards corporate bailouts is money that could go towards helping people who really need the money like those without healthcare.

Times are rough, and we are seeing drastic changes to the financial infrastructure of the U.S. Now is the time to pay off any debt you have, whether it’s credit card, autos, or a mortgage. If you don’t have a liquid emergency fund with a few month’s salary cushion then it’s time to build one up. Only then would I recommend trying to invest money in the stock market, and even then I am not sure I would recommend it.

Keep an eye on what’s going on in the news. There are more failures coming for sure. Washington Mutual is likely to be next, and who knows what’s going to happen in 2009. I still believe that things will get a lot worse before they get better.

Just a quick run through some numbers to get you thinking about another reason you should try to reduce your expenses and save for retirement.

Suppose you had $400 in monthly debt payments, and your tax rate was 20%. You would have to earn $500 a month before taxes to make a $400 debt payment. So once that debt is paid off, you can now contribute $500 a month to a pretax retirement account such as a 401k or IRA and still maintain the same budget you had when you were making the debt payments. So now not only are you not paying interest on your debt, but you can now save an extra $100 a month not paying the tax man. That works out to an additional $1200 a year that you can keep to yourself on top of the $4800 saved from not making debt payments.

Now of course if your tax rate is higher you will save even more money by paying off debt and investing in a tax advantaged account. If your effective tax rate is 30%, you will need to make about $572 to make $400 after tax. [$572 * 0.70 = $400.40]

Pay off that debt and you will have $6864 that you could contribute to a retirement account. With that retirement account growing at 9% a year tax free, you will have over $1 million in about 30 years. Start doing this at 30 and you can be a millionaire by the time you’re 60. And thanks to the miracle of compound interest, you will have $2 million in another 8 years at 9% interest. All because you reduced your expense $400 a month. Pretty cool, huh?

Stay tuned as I start a series on retirement accounts and investment decisions. And as always please fee free to leave a comment with any questions, or email me at rich@freefrommoney.net

On the topic of tax rebates, I’m curious what people are planning on doing with their rebate checks that they get. Of course my wife and I are planning on using ours to pay down our credit card debt, although taking a vacation did cross the mind.

So what does everyone plan on doing with their checks when they get them? Save? Spend? Donate to charity? I know I have a few readers, please chime in!

Five Cent Nickel has found and posted the IRS’s tax rebate schedule. I’m a little disappointed they’re not sending payments out until May, but I guess they have to wait until after April 15th to start.