Business, Personal Finance, Retirement, Taxes 
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My Six Biggest Tax Deductions for 2006: 401k/Retirement Contributions

This is the second of my big six income tax deductions for 2006 and this one is a little bit of a freebie because you don’t really need to do anything in order to claim it because your employer will automatically deduct 401K contributions from your income, which will ultimately be reported in your W-2. So, with a 401K, you simply do nothing and you get this deduction. How about people who contribute to a Traditional IRA? And for those who have businesses, or are independent contractors, and are contributing to a SEP-IRA as an employer (I’ll be doing this for the second year in a row)? That’s when things get a little trickier.

Traditional IRAs

If you have taxable income (and you won’t turn 70.5 this year), you’re eligible for a Traditional IRA. For 2006, you’re allowed to contribute $4,000 towards the Traditional IRA (this maximum limit is also shared with a Roth IRA, so you can only contribute a total of $4k any type of IRA) if you are under 50 and up to $5,000 if you’re over 50, it’s called a catch-up provision. You must open an IRA with an approved institution.

How much of the contribution you can deduct depends on your modified adjusted gross income. If you are a single filer, you get a 100% deduction if your MAGI is under $50,000; a partial if your income is between $50,000 and $60,000; and no deduction if your MAGI is over $60,000. If your MAGI is over $60,000, then it is far better you to contribute towards a Roth IRA since you get no deduction in the first place.

SEP-IRAs

If you have self-employment income, the Simplified Employee Pension Plan (SEP-IRA) is a great way to defer some of your income and any business, sole proprietorships included, that earns any income can start something like this. You can contribute up to 25% of compensation to a maximum of $44,000 (2006 limits) and deduct this from your Schedule C income.

For more on SEP-IRAs, I wrote a whole series of articles when I was investigating it for my side business (this site), hopefully you will find them helpful:

  • Primer on Self-Employment Taxes, or Why SEP-IRAs? – A brief introduction to self-employment taxes and my logic in opening a SEP-IRA in the first place.
  • Introduction to SEP-IRAs – More on SEP-IRAs and how the employer deduction works.
  • Vanguard Deposit Recoding Sample Letter – I accidentally made a contribution as an employee (bad, because the SEP-IRA contribution limits are shared with Roth and Traditional, and I maxed out my Roth contribution already) so I had to send Vanguard a letter to reclassifying the contribution as an employer contribution for 2006.

 Free, Personal Finance 
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Airline Credit Card Free Mileage Promotions

Two years ago, I was a few credits shy of a free flight on Southwest and I was planning a trip to the west coast which usually runs around $300+. So, I did what ever resourceful consumer does, I signed up for a Southwest airlines branded credit card just so I could get the free credits and then canceled the next year. If you’re only a few credits (on airlines like Southwest and Airtran) or a few thousand miles (on traditional airlines) short of a free flight, you should consider signing up for that airline’s credit card in order to get enough free frequent flyer miles for that free domestic ticket. the best part about these credit cards are the fact that while they usually have an annual fee, they will waive it for the first year and likely waive it in subsequent years if you ask them to (i.e. have them waive it or you’ll cancel it).

Below I’ve compiled all of the airline credit cards I’m aware of, how many miles you need for a domestic (contiguous 48 states) and their current mileage promotions:

  • Southwest Airlines Rewards Card – $20 off your first purchase, 4 Rapid Rewards credits after your first purchase, 16 Rapid Rewards credits for a domestic ticket on Southwest Airlines.
  • WorldPerks Visa Signature Card – 10,000 WorldPerks (Northwest Airlines) miles after your first purchase, 25,000 miles for a domestic ticket on Northwest Airlines.
  • WorldPerks® Visa® Platinum Card – 10,000 WorldPerks (Northwest Airlines) miles after your first purchase, 25,000 miles for a domestic ticket.
  • JetBlue Card from American Express – 25 TrueBlue points with first purchase, 100 TrueBlue points for a domestic ticket.
  • Airtran A+ Visa Signature – 6 credits with your first purchase, 16 credits for a domestic ticket.

 Personal Finance 
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Net Worth Comparison by Age and Income

When I read that Jane Dough got her moniker back and is now blogging over at WomenWallStreetClub, I wanted to pop on over to see what a professional personal finance blogger looked like and saw a post about a net worth comparator tool from CNN Money based on income and age that piqued my interest.


(Click to continue reading…)


 Personal Finance, Taxes, The Home 
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My Six Biggest Tax Deductions for 2006: Mortgage Interest

The mortgage interest deduction is usually the largest deduction for most taxpaying individuals and if you are legally liable for a “secured debt” on a “qualified home,” then you better be itemizing your return and taking this deduction. Publication 936 explains all the rules and gory details involved with the mortgage interest rate deduction and it’s important if you have some special scenario, but for most people with simple scenarios, Pub 936 is overkill and I’ll explain what I know of it below.

Acquisition versus Equity Debt

Basically, there are two types of debt – acquisition debt and equity debt. Acquisition debt is the debt you assumed when you purchased the house whereas equity debt is like a line of credit or a loan you acquired to make improvements onto the house. If you have mortgage debt, you can claim the full interest deduction if the loan is under $1.1M for married couples, $500,000 for single filers. If you have home equity debt, you can claim the full interest deduction if the loan is under $100,000 for married couples, $50,000 for single filers.

Qualified Home

So, what counts as a qualified home? If it has sleeping, cooking, and toilet facilities then it is considered a home – so this would include things like a condominium, a mobile home, a trailer and boats if they have those facilities, in addition to your primary and secondary residences. For second homes, you can deduct interest from only one of them and you have to use it at least 14 days during the year. If you rent it out, you must use it more than 10% of the time that it’s rented out in order to claim the interest deduction, otherwise the interest must be listed on Schedule E instead of Schedule A.

Taking the Deduction

Bottom line, your lender will send you a Form 1098: Mortgage Interest Statement and that’s all you need to prove to the IRS that you’ve paid interest so save it.

Standard Deduction or Itemize Deductions & Claim Mortgage Interest?

Well, the standard deduction for 2006 for a single filer was $5,150 so a single filer would need to pay more than $5,150 in mortgage interest (assuming no other itemized deductions) in order for itemizing to be “worth it.” For married filing jointly, that magic number is $10,300. For most folks, itemizing will be worth it, at least in the beginning of the mortgage.


 Investing, Personal Finance, Retirement 
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Saving The Bare Minimum: Emergency Funds and 401Ks

I was reading a recent answer by Walter Updegrave to a reader question about how much a new college graduate should save in order to “get a healthy start” on their financial life. The answer was a bit of a cop-out as he basically says “it depends on your situation,” but I think there exists a bare minimum of what you should be saving from month to month and it should be a standard for everyone who has gainful employment. The absolute bare minimum consists of two things: 401(k), if your employer offers a match, and an emergency fund of at least three months of your expenses.

401K

I had a friend back at my old job that didn’t contribute to his 401K, even though we were given a 3% match on a 6% contribution, because he had student loan debt and wanted to pay that off first. He also didn’t truly appreciate how he would be getting a 3% match by his employer and so it wasn’t until a year or two into the job that he actually started starting contributing (if you ask him though, he’ll say he’s been contributing since the beginning). If your company is offering you free money in order for you to save towards your own retirement, you have to take it… it’s silly not to. Also, the match usually is capped at something in the low single digits, so you’re only talking about giving up a small amount of your earnings (especially after taxes).

Emergency Fund

This is usually a source of discussion and argument: how many months worth of expenses should be in your emergency fund? Whether you believe it’s three, six, or twelve months, it’s critically important for you to fund this account as soon as possible because this will help you smooth out the unexpected financial burdens when they appear. The reason you have an emergency fund is so that when your car does break down or you are unexpectedly fired from your job, you have a few months saved up so you can weather the storm. For those months you don’t need to tap into your retirement accounts or start selling your assets, you can deal with the situation knowing you have a little bit of breathing room. How much breathing room you will need depends on your own comfort level, some people can operate knowing they only have three months in their safety net – others require a full year. Either way, funding this as quickly as possible is crucial.

After these two, I feel what you’re able to do depends on your situation, as Updegrave says, but I feel that everyone should include both the 401K and the emergency fund in their financial plans. After that, depending on how much you’re able to put away, you can start considering Roth IRAs and larger contributions to your 401K.

Source: CNN Money


 Personal Finance 
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Weekend Personal Finance Reads

Flexo warns that you shouldn’t be chasing trends when it comes to investing.

Nickel maxed out his Roth IRAs (his and his wife’s), if you haven’t done so already you don’t need to worry, you have until April 15th to max out for 2006.

JLP talks about how fixed rate mortgages are back, which isn’t terribly surprising. A lot of folks are now realizing how ARMs work and how interest rates were rising so they refinanced for the predictability, so it’s expected that this would be happening.

FMF has a listing of all the types of insurance you probably need.

If you honestly thought about melting pre-1982 pennies, I think you’re a fool. But now it’s also illegal to melt coins reports MBH.


 Debt, Personal Finance 
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Remembering Payoff Statements

If you’ve only ever had debt in the form of credit cards, you’ve probably never seen a payoff statement before. Unlike the nice grace periods of credit cards, there is no grace period when you’re talking about debt such as an auto loan, a mortgage, a student loan, or a home equity loan. Every minute that passes, that loan is accruing interest. That means when you check your account and it says that you owe $1,000; the moment you mail that check out, you actually owe a little more than $1,000.

Instead, what you should be looking for and getting is something called a payoff statement. It’s a document that will indicate how much you need to pay to completely pay off the entirety of the loan and that amount should be good until the end of the current billing cycle. When you send the check, it’ll actually be how much you would’ve owed at the end of the current billing cycle and the lender should credit you the different in interest once they receive the payment.

Sometimes you won’t need to request a payoff statement, your account will simply state that you need to send a check for $X.XX in order to pay off the debt. If your account does show that value, you should be all set once you send out the payment. If your account does not, you will have to call your lender and specifically request a payoff statement. If you do not, you’ll find that you’ll owe some additional interest because you missed it the first time around and that interest will accrue its own interest. It’s not the end of the world if you forget to request a payoff statement, essentially you’ll be dealing with a minor paperwork headache and paying out a little more interest unnecessarily.

So, remember to request that payoff statement!


 Personal Finance 
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Remember Inflation in Investing Projections

Do you ever hear people proclaim that if you invested $100 in the stock market today and it appreciated 11% for the next 30 years, you’d have almost $2,300 at the end? It seems as though people can remember inflation when making short term decisions (such as whether or not to invest in a particular bond or certificate of deposit), but it seems to disappear from the discussion whenever long term decisions are made.

That was the premise of my friend’s article on salary increases, how people tend to forget about inflation when projecting salaries over many years and I think that applies even more so to investing. See, when you invest $100 today and it appreciates 11% to $2,300 in thirty years, you have to keep in mind that $2,300 in 2036 won’t represent the same amount of purchasing power as it does in 2006 – that’s because of inflation. At 4% inflation, your $100 investment is worth around $761 in purchasing power because it really appreciates at 7%, not the full 11%.

I believe that most people (unless you’re a politician, because those guys still don’t have every tax number tied into inflation yet) understand the concept of inflation, the hidden tax, and I hope this just serves as a subtle reminder about its pervasiveness and that you should remember it when you’re doing long term projections (especially if you’re doing long term projections).


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