Ten Easy Year-End Tax Tips

Year-End Tax TipsHave you thought about your taxes lately? Probably not, but this month is probably one of the most important months in tax planning because it’s the last time you’ll have an opportunity to effect any meaningful change to your taxes next year. Once December ends, 2008 is essentially frozen and your taxes will be what your taxes will be. So, what sorts of tax moves should you consider making?

Sell your stock losers. Any losses you realize from the stock market, that aren’t offset by gains, can be deducted from your regular income, up to a limit of $3,000 a year. If you’ve been thinking about dumping some losers, now’s the time to do it. If you have more than $3,000 in losses, you can carry those forward indefinitely (until death). More advanced traders may also consider tax loss harvesting as an option as well.

Donate to your favorite charities. Times may be tough but they’re even tougher for charities and philanthropies, who rely on generous contributions to stay in operation. Consider donating money, goods, clothes, your car, anything – to one of your favorite charities so that they can stay operating through these difficult economic times. If you itemize your deductions, you can deduct contributions from your regular income.

Delay bonuses and income. If you can swing it, try to push any additional payments until the new year. If you are paid this year, you have to pay taxes on it in a few months. If you are paid next year, you won’t have to pay taxes on it for an extra year. If your employer withholds taxes on your bonus payments, this is a less valuable strategy. 🙂

Prepay state and local taxes. This one is a little tricky, if you don’t think you’ll be subject to the AMT, consider prepaying your state and local taxes. State and local taxes are federal tax deductions so prepaying them today means you can deduct them today as well.

Accelerate other deductible expenses. If you have a mortgage, consider paying next month’s payment this month. If you pay it this month, you can deduct the interest payment against this year’s income. If you pay for it on January 1st, it’ll have to wait until you file 2009 taxes. This is true of any deductible expenses you may have from student loan debt to medical to your real estate taxes. If you want, you can make the payment with a credit card and then pay off the credit card next month and still have it be deductible for 2008.

Use up your $12,000 gift exclusion. Each year, you are allowed to give $12,000 to someone else tax-free. If you give more than $12,000, then you are subject to what is known as the gift tax. It’s a little backward but it’s a page out of the estate planning book since heirs to an estate are often taxed on that estate. Anyway, if you were planning on giving someone a very generous gift, don’t forget to to do it. Next year the limit rises to $13,000 so you can give $25,000 to someone within a week and avoid the gift tax ($12,000 on December 31st, $13,000 on January 1st). If you are married, you could give someone $50,000 ($25,000 from each spouse).

Beware buying into mutual funds with capital gains distributions. Mutual funds buy and sell stuff all year, then distribute a bit of that at the end of the year. What you won’t want to do is buy into a mutual fund that is set to make a year-end capital gains distribution because you’ll be immediately taxed on that distribution. Imagine a mutual fund that costs $100 a share. You buy it and the next day it makes a $1 per share distribution, lowering the cost per share to $99. You just bought the thing and already are on the hook for $1 per share in taxes. Boo!

Contribute to your retirement. If you aren’t maxed out on your 401(k), or similar, plan, consider doing it because each dollar contributed is entirely deductible. The 2008 contribution limit for your 401(k) is $15,500 ($20,500 if you’re 50 or greater). Another good idea is to contribute towards your IRAs but you have until April 15th to accomplish that.

Get married. Your tax filing status is based on your status as of December 31st, 11:59 PM. If you were married on December 31st, you’re considered married for the year. If that helps your tax situation, you might want to consider it. 🙂

Get everything ready. If you’re due a refund, try to get all your ducks in a row as soon as possible so the government will mail you your refund check ASAP. All you’re really waiting for is the official W-2 from your employer, which they are required to mail out by January 31st, and you should be ready to hit the e-file button.

(Photo: thetruthabout)

 Devil's Advocate 

401(k)’s and IRA’s Are For Suckers

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This is a Devil's Advocate post.

This Devil’s Advocate comes straight at you and assails the one last bastion of hope for a prosperous retirement – 401(k)s and IRAs. While it probably doesn’t feel that way with the volatility in the market, conventional wisdom says that the best way to save for retirement is tax-advantaged accounts like 401(k)’s and IRAs. The power of having that money grow tax free trumps all other options.

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Should I Rollover My 401(k)?

Reader Jeff is switching jobs and wondering, given the market’s drop the last few months, if he should roll over his 401(k) to a Rollover IRA. His concern is that he’d be “selling low and buying high” in that situation and didn’t know what he should be doing.

I’m not a retirement nor an investing expert but I can say that your biggest concern shouldn’t be the performance of the market, it’s the volatility. With the various indicies gaining and losing large single-digit percentage points on a daily basis, it’s the volatility that is the big concern. A rollover takes time. Depending on how quickly or slowly you, your 401(k) administrator or your Rollover IRA administrator is, you could be left waiting for many days on the sideline as your 401(k) assets as liquidated, transfered to you, then transfered to the Rollover IRA. In that time, the market could go down big, go up big, or go sideways pretty erratically. My point is that the volatility is unpredictable, so on that basis alone, without any other compelling reason, I’d stand pat for now.

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 Personal Finance 

Roundup: Nixing 401(k) Tax Deduction, Free Tools & More!

Jeremy at GenXFinance wrote about one of the most horrible proposals I’ve heard in a very long while, House Democrats are contemplating abolishing 401(k) tax deductions. Yep, House Democrats are actually thinking about removing one of the last incentives people have to save money. Oh, and to make matters more exciting, workers would instead get a $600 subsidy, be required to contribute 5%, and, get this, it would be administered by the Social Security administration.

My buddy Fred at One Project Closer has been giving away tools on his site. This month, he’s giving away a ceiling fan from Home Depot (it’s really a $175 gift card from Home Depot) and all it takes to enter is a comment. You can get more entries by subscribing to his Feedburner email distribution or writing about it, like I’ve done here. If you’re a home improvement junkie, just a few posts will get you hooked (just ask my friend Dave, who clicked over once from BFP and has been hooked every since!). If I won the gift card I think I’d get myself some tiling supplies for one of our bedrooms or a fancy power tool. One second though, I’d definitely get a power tool.

I don’t normally toot my own horn in these roundups but I recently had reason to revisit a post I wrote last August (2007), about how you should be comparing salaries. It was written back before the bulk of the financial turmoil and when some of the financial talk was on salaries of college graduates. I still think, over a year later, it’s a healthy way to approach the idea of looking at salaries and I still feel the same way about it. I’m curious to hear what you all have to say on the subject though.

Seems like the bottled water known as Sam’s Choice of Wal-Mart and Acadia of Giant Food didn’t quite meet the standards of California. They tested more than those two brands and in that larger group, they found “Coliform bacteria, caffeine, the pain reliever acetaminophen, fertilizer, solvents, plastic-making chemicals and the radioactive element strontium.” Those two brands had quality so poor that the study had to release their names. Not all bottled water is created equal!

This is the best “F U I Quit” letter ever, written by a hedge fund manager who raked in huge profits betting that subprime would blow up.

Finally, there are six reasons why the current economic turmoil can be good for you. I totally agree, stop freaking out and look for some sales! Stimulate my economy! 🙂


McCain & Obama Propose IRA & 401(k) Rule Changes

With the recent cratering of the stock market, both Presidential nominees have proposed changes to IRA and 401(k)s that would allow for both early withdrawals, up to certain limits, and suspension of the required minimum distribution rules. Jeremy at GenXFinance hated the idea but I think offering the option, especially since we are headed towards certain stagflation (inflation for the trailing 12 months before August 2008 was a staggering 5.9% and unemployment was rising). People are going to be strapped. Offering the option of the lesser of two evils is better than forcing people to take drastic measures.

Here are the proposals:

McCain: “Temporarily suspend mandatory annual withdrawals. Current rules require investors to start selling stocks at age 70½. Allow savers who are younger than 59½ to withdraw up to $50,000 at the lowest tax rate of 10 percent in 2008 and 2009.”

Obama: “Temporarily suspend mandatory annual withdrawals from Individual Retirement Accounts and 401(k)s. Current rules require investors to start selling stocks at age 70½. Exempt withdrawals made up to the required minimum amount from taxation. Allow savers to withdraw 15 percent, up to a maximum of $10,000, without paying a penalty as the law currently requires for withdrawals before age 59½. These withdrawals are subject to normal taxes.”

(You can read all of their economic & tax proposals at the New York Times)

I think the suspension of required minimum distributions is crucial and I’m glad the candidates both agree on that. It’ll be the biggest help to those nearing retirement because they won’t be forced to liquidate those stocks that have lost value.

As for the second piece, of the two, I prefer Obama’s proposal because it offers 15%/$10,000 (rather than $50,000) and it is subject to normal taxes as opposed to 10%. McCain’s proposal of dropping the tax rate on withdrawals to 10% is too attractive. All of my 401(k) contributions were done in the 25% tax bracket, I’d have a huge incentive to withdraw my money because I’d immediately see gains because I would only pay 10%, not 25%. (should either proposal ever become law, I wouldn’t withdraw money unless I absolutely needed it though)

Don’t get me wrong, I still think withdrawing funds from your retirement account is a huge mistake. But people will be in trouble and they will either turn towards credit cards and dangerous loans, or they will withdraw the money anyway and simply be left with less of it. It’s truly the lesser of two evils.


My 401(k) Is Losing Money, What To Do?

401K DyingMy 401(k) is hemorrhaging but I’m not freaking out. I’m not freaking out because I’m 28 and years away from retirement. However, several readers have emailed me recently asking me what they should do about their 401(k)’s and IRAs after recent events. Unfortunately, I told them to call up a financial adviser because I don’t really have a suitable answer. But this afternoon I spent some time thinking about it and wanted to give a more reasonable response. I tried to put myself in their shoes and say what I would do.

If you’re like me, about forty years away from retirement, the answer is that you should do nothing differently. Make your regular contributions, check your asset allocations, and do something else with your time. A lot can happen in forty years so you shouldn’t do anything rash like liquidate all of your assets. We had a recession in the 80’s, a mere twenty years ago, and since then we’ve seen the longest bull market period in a very long time. Trying to time the market is a fool’s errand and, honestly, your time is better spent enjoying life rather than fretting about your balance sheet.

If you’re slightly closer to retirement, say ten years away, now’s a good time to adjust where your new contributions are going and go towards a more conservative allocation. I wouldn’t liquidate your equity positions but any new money should go towards conservative investments that will lower the amount of volatility you’re exposed to. Check out the1-year chart of the CBOE Volatility Index, an index that tracks the 30-day volatility of the S&P 500 index using a variety of investment vehicles. Note the fact that since August, that index has been going insane. The enemy of a retirement in the near future is volatility. While I wouldn’t sell everything off, I would adjust my contributions to lower the volatility by going with safer investments.

If you’re a year or so away from retirement or in-retirement, hopefully your exposure to equities is limited. Either way, chances are your investment portfolio went down along with everything else. For retirees, I don’t know what the right answer is except that you might want to consider getting some supplemental income to buy more time until the market has an opportunity to somewhat correct itself. I would liquidate enough funds, from equity positions, to make it through the next three to five years and keep the rest as is. But remember, I’m 28, so I would take that advice with a very large grain of salt.

Do you have any better advice?

(Photo: silvaazniv)


The Smartest 401(k) Book You’ll Ever Read by Daniel Solin

The Smartest 401(k) Book You'll Ever Read by Daniel SolinThe main point of Daniel Solin’s The Smartest 401(k) Book You’ll Ever Read is that your 401(k), or 403(b) or 457(b), and it’s employer match may not be a no-brainer investment because it could be filled with funds that fat on fees and poor on investment selections. His answer? It’s to model the Thrift Savings Plan, the retirement plan available to government employees that consists entirely of low-cost index funds (the expense ratio is around 0.03%), and use low cost index funds for your retirement options. Look inside your mutual fund options to find the ones that most closely model index funds and go with them.

I think The Smartest 401(k) Book You’ll Ever Read by Daniel Solin does a very good job of opening your eyes to the fee-ladened landscape of retirement investing. He takes specific aim at 401(k) because those “captive audience” type programs are more deceitful than you can imagine. Many companies use plan administrators that offer 401(k) plans for free because they know they can make a killing on the back end with expensive fund choices. If they really had the employee’s interests in mind, then they’d simply offer cheap index funds. In fact, some companies actually pay kickbacks to company HR departments to use them. The plan administrators pay companies for the opportunity to offer their fee fattened funds! It’s pretty ridiculous.

Unfortunately, this means that if you mainly invest in low cost index funds, you won’t get much value out of the first few sections of the book (it could spur you to rollover your 401(k) when the time comes!). The book continues to talk about other retirement investments such as IRAs, both Traditional and Roth, and annuities.

One characteristic I like about the book is that the chapters are short. Many are under three or four pages long, which is exactly how long it should take to explain many of the fundamentals about investing. For example, Chapter 14 is called Simple Investing Is Smart Investing is about three pages long and explains why a simple allocation of basic mutual and index funds will be sufficient for most. Chapter 22 is called “Why Fifteen Is Your Magic Number” and uses three pages to explain why you need to save 15% of your income if you want to expect to have a successful retirement. That, coupled with a applicable quote (usually from some important successful investor such as John Bogle), makes this book an easy read. There aren’t large chapters to digest, there aren’t huge concepts to wrap your head around, this book makes everything nice and simple.


7 Deadly Sins of Personal Finance: Raiding Retirement

7 Deadly Sins of Personal FinanceThis is the second deadly sin of personal finance (the first deadly sin was failing to have an emergency fund) and one that some of our friends have been thinking about “committing.” We’re all in our late twenties and buying our first homes. Despite what the experts say, home prices are still very high in the Baltimore and Washington D.C. areas, barely within affordable reach for many people our age. So, our friends are looking for places they can tap to help with a down-payment.

Inevitably, they learn about how they can borrow (or worse, withdraw and be penalized) from their 401(k) to help with the purchase of their first home. This leads right into the second deadly sin of personal finance:

Don’t Raid Your Retirement Funds

Remember when you were a kid and your parents planned a vacation? Part of the fun of the entire vacation was the anticipation of going on a trip. The excitement the night before as you couldn’t sleep, the energy you had packing for the journey, and the planning of events beforehand. In talking to colleagues, retirement is very much like that. You plan new hobbies to try, new events to attend, and new places to see. When you raid your retirement fund, you put all that in jeopardy. You have to slide back the day you hope to retire. It’s devastating and demoralizing.

Sometimes you can’t help it. A lot of people who hoped to retire last fall are continuing to work because their retirement investments fell. I’ve chatted with at least one person who thinks they’ll have to work a few more years just to get back because they were over-exposed to equities. In his case, he was too aggressive and he came up craps on the roll of the dice. With so many other potential problems, why make things harder for yourself by stealing early from the cookie jar.

You need that money if you ever want to stop working. As Gary Bonner, a contributor of BFP, once wrote in Making a Living? Or, Making a Life?: “no one has ever laid on their death bed saying ‘I wish I had spent more time at the office.'” We want to stop working as much as we want to have a new television, or a new pair of shoes, or a bigger house. However, every single time you take money from your retirement fund, you’re extending the time you have to spend at the office.

$1 today is ~$22 in forty years. At a conservative 8% annual appreciation, every dollar you take out now is worth $21.72 in forty years. Twenty-two bucks may not seem like a lot but you have to think of it as a multiple of twenty-two. $100 is $2,200. $1,000 is $22,000. Is the sacrifice worth it? In most instances, no. There is no clear cut answer in the rent. vs. buy question. With so many different situations and scenarios, you can’t clearly say that one is vastly superior to the other. But I can say, without a shadow of a doubt, you will need your retirement funds in retirement and every dollar you take today will steal $21.72 from you in forty years. That’s just math.

Like everything else, it’s not black and white. If you have a major medical emergency and it’s exhausted your insurance and your emergency fund, you won’t have any choice. You will have to raid your retirement fund. My opinion is that it better come to that and I will have to be in very desperate shape before the retirement fund comes into play.

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