TedCo Software Financial Matters Blog

It’s True: It’s What You Keep That Matters

As an investor you take on risk in the hope of receiving sufficient reward to justify that risk. That is just basic investing; where there is no risk there is no reward. Another basic reality of investing is that governments love to tax any profit you happen to make. It may not seem fair that you take the risk and they get some of the reward (ok, it more than seems unfair) but, “that’s the cost of living in a civilized society” (or so say those that take your profits).

The reality of investment-related taxes means that tax planning is an important part of your investment planning. Careful planning can help you reduce that cost. This planning won’t help you avoid taxes you rightfully owe, but with a little care you might be able to shrink the tax bite a bit.

Tip #1 – Keep Good Records
Whenever cash moves into or out of an investment you get some sort of receipt (often a trade confirmation). Keep all of these irritating bits of paperwork. With them you can establish your cost basis (how much you paid for the investment). Whether you use a computer or a journal you can keep track of your taxable gains and losses throughout the year. Track your tax liability as the year progresses and you might avoid an unpleasant surprise come tax time.

Tip #2 – Take Advantage of Tax Breaks
Investment accounts that allow you to defer taxes or even take income deductions can be a good way to manage investment-related taxes. 401ks and deductible IRAs are a nice way to push those taxes off for many years. When buying mutual funds outside of a tax-deferred account, pay attention to portfolio turnover (the lower the better). Another approach is to focus on index-based investment. They often have little turnover so produce little gains in the course of the year. Annuities can provide some tax deferral as well, but they do have a drawback. Though you do not pay taxes on gains until you draw the money out those gains are all taxed as regular income, even if the increase is mostly capital gains (which would normally be taxed at a lower rate).

Tip #3 – Use Those Losses
Have you taken losses in the last couple of years? Keep track of them. Capital Losses (usually from losses on stocks and stock mutual funds, but there are many other sources) can reduce your taxable income up to $3,000 a year. Whatever you do not use in a given year will carry forward into the next. Here is the trick: these losses offset Capital Gains dollar for dollar until they are used up. For example: I recently spoke with a woman who was heavily invested in stock mutual funds before the crash. Near the bottom of the market she finally gave up and sold her investments, switching to more conservative income producing investments. She has $180,000 in carry-forward losses. Unfortunately, she can only use $3,000 a year to reduce her income. At that rate it will take her 60 years to use up those losses. However, if she invests in something that produces Capital Gains those losses can offset her Capital Gain income dollar for dollar. That makes a lot more sense (assuming that sort of investment makes sense for her situation).

Keep your eye on the investing ball, including the tax implications of your decisions. To find out how these ideas fit into your investing plans consult your tax professional.

Jim Heitman, CFP®, is a writer, speaker, Certified Financial Planning practitioner in Southern California, and the founder of Compass Financial Planning – a fee-only planning and money management firm. Phone (909) 373-5204 Facsimile (909) 912-8290 www.myfinancialcompass.net

As the economy worsened, not only did retirement funds drop in value with the market, but also many people have been tempted to tap savings as a way to cut debt or otherwise shore up their finances after a job loss. Still more have found that employers have dropped matching contributions to shore up their own finances.

Worry about retirement seems to be widespread. A January survey by the National Institute on Retirement Security noted that 83 percent of Americans are concerned about their ability to retire.

Yet the worst thing you can do is tap or give up on your retirement funds. No one can know with any certainty when the investment markets will rebound, but even if you can contribute something, you stand to gain once markets start to rebound. Even more important, you risk penalties and the lost potential for earnings if you turn your back.

Before you make a move, seek out some advice. It’s a good idea to check in with an expert such as a Certified Financial Planner™ professional to see where your retirement funds stand in light of all your finances before you do anything.

In the meantime, here are things you can do to put your retirement funds in better shape.

Don’t stop funding your 401(k) under any circumstances: In March, the Spectrem Group, a Chicago-based consulting firm, reported that 34 percent of U.S. employers have reduced or eliminated matching contributions to their defined contribution retirement plans – which include 401(k)s and 403(b)s – since January 2008. The Pension Rights Center reports that besides the Big Three automakers, dozens of major companies have cut back their match, including Motorola, Starbucks, and JPMorgan Chase & Co. It’s a significant impact. US News & World Report recently reported that for a worker who earns $50,000 annually and receives a full employer match of 50 cents to the dollar on six percent of his or her pay, the match cut means $16,000 less for retirement. An employer dropping its contribution is bad news, but you should make every effort to keep up with your contribution because if you don’t, you’ll miss valuable tax deductions and the chance to build your funds more effectively for the long term.

Stay invested: Because no one precisely knows when the market is headed up or down it’s best to stay invested at a time when everyone is waiting for a rebound. Keep in mind that the market’s top performing days typically come at the start of a recovery, so leave your money in your 401(k) and IRAs.

Keep in mind that withdrawing or borrowing your funds can be costly: If you have an emergency situation, be careful. Workplace 401(k) plans do allow for hardship withdrawals, but you might have an option to take a loan, which would save you the taxes and the 10 percent penalty that accompany hardship withdrawals for account holders under the age of 59. The majority of 401(k) plans allow you to borrow up to 50 percent if your vested account balance or $50,000, whichever is less.

Adjust your spending so you can save more: If you have an existing Roth or traditional IRA or other means of saving for retirement, do whatever you can to get more money into these accounts. It may not come close to meeting the shortfall from losing an employer’s contribution or the chance to add to a 401(k) after you’ve lost your job, but it’s critical to keep some savings going.

Jim Heitman, CFP®, is a writer, speaker, Certified Financial Planning practitioner in Southern California, and the founder of Compass Financial Planning – a fee-only planning and money management firm.

Have you wondered what effect the 2005 changes to the US bankruptcy laws have had?

The answer is available in a June 2008 report made available by the AARP Public Policy Institute titled, “Generations of Struggle“, by Deborah Thorne, Elizabeth Warren and Teresa Sullivan. The conclusions may surprise you because the report indicates changes at both ends of the age continuum. And even with the changes

In short, younger Americans are filing at a lower rate but bankruptcy filings have significantly increased for those age 55 or older.

The full, 16 page, report is available from the AARP web site.

You Know The Banking System Is Unsound When….
Credit card rates can go up … well, just because
Debit cards for your 401k

Not a lot of good news or positive views in these three, but certainly important considerations. I’d read them in the order provided. First Mish’s take on the banking system, then the eye-opening results of a survey of credit card companies that raise rates “just because”, and finally the worst idea of all … a firm that offers debit cards for 401k accounts … absolutely dumb.

This one’s not a pretty picture, but it’s very interesting reading.

“The Housing Crash and the Retirement Prospects of Late Baby Boomers” by Dean Baker and David Rosnick was released in just last month by the Center for Economic and Policy Research.

It’s a study of the retirement prospects of people between the ages of 45 and 54 under three alternative scenarios. The first is that real house prices fall no lower than the March 2008 level, the second scenario assumes the 2009 average will will 10% lower and the third assumes a 20% fall for the 2009 average.

You can read the full report online, but the stand out for me is that so many people may have planned to use their house as a source of funds for retirement. Interestingly, renters seem to come out ahead in this paper. The authors project renters in the same group in 2004 will have more wealth in 2009 than homeowners in all three of the scenarios!

The takeaway: buying one’s home is not about investing. Home buying is probably done best when one is actually buying a house in which to make a home.

More than half of U.S. employees have less than $25,000 in savings and investments (this includes retirement savings but excludes homes). About 40% of people age 55 and older have less than $100,000 in retirement savings!

The U.S. Senate unanimously approved a bill which designates October 21 through 27 as National Save for Retirement Week in an effort to encourage employees to save more for retirement.

How’s your retirement savings? If you’d like a good idea of what your financial future holds, download a free trial version of Future Value of Savings Calculator.

Take some time during National Save for Retirement Week to pay attention to your retirement savings.