Money Mommy

Stuff your mom should have taught you, but didn't…

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Can I afford that?

The American Dream: Own your own home. Buy a car. Take a dream vacation. But can you afford it?

It’s very easy to figure out. Do you play to buy a house, a vacation home, a car, a new roof on credit? Decide how much your monthly payment will be. Let’s say you want to buy a car and you are willing to pay $500 per month. Okay. Let’s take that $500 for a test drive. Before you buy that car, start putting $500 away each month in a separate account. Do this for 6 months. Do NOT touch this money. Remember, if you had actually bought the car, that money would be gone anyway. Take stock at the end of these 6 months. Were you able to put that money away each month? Are you willing to continue paying $500 until your car is paid off? If the answer to both questions is yes, then you can afford the car payments. Don’t forget to include gas and maintenance in your new budget.

Want to buy a house? Same steps. Figure out how much your monthly mortgage payment could be. For illustrative purposes, we’ll assume $1,000. Start putting that money aside each month. If you are currently paying rent in the amount of $500, you can add that amount to your available monthly mortgage calculations. Because this is such a long-time investment, I would encourage a full year of putting this amount aside. At the end of the year, it will be time to take stock. Are you able to meet a mortgage of $1,500 per month. Don’t forget insurance and property taxes should be included in your mortgage calculations along with principal and interest payments. Also, your housing budget also cover utilities and maintenance of your new house.

If, after this exercise, you feel that your purchase is affordable then it’s time to purchase. What to do with the money you have saved? It can be used for a down payment. It can be kept as your 6 month emergency fund. It can be a combination of both. When Marie bought her first home, she had saved up $10,000 more than needed for the closing costs. After much consideration, she opted to keep it for an emergency fund rather than immediately paying down the mortgage. Two months after moving in, she was laid off. It took another three months to find a new job. Meanwhile, she was able to make her mortgage payments using her savings. She did not enjoy seeing her savings diminish, but her lender received her monthly payments, her credit remained good, and there was no worry about late payments.

How about new shoes or a great vacation? Again, put that money aside to see if its in your budget. If, after 6 months of savings, you haven’t saved up enough to cover this consumer want, you can’t afford it!

Roth IRA’s – One Size Fits All

OK.  Maybe not all.  But most.  Whether you are just starting out or well into your career the Roth IRA will provide you with an exciting way to save on taxes and ultimately hold onto more of your money.  I recommend it as the vehicle to save for that all important emergency fund, first home, college fund, and, of course, retirement.  And, let’s face it, unless you plan on kicking the bucket in a few short weeks, who doesn’t need an emergency fund or retirement fund?
The Roth IRA has one awesome characteristic.  All monies contributed to your Roth IRA are after tax dollars.  That means you pay your tax before you invest it.  All earnings from your IRA remain untaxed in your IRA until you withdraw these funds.  This includes interest, dividends, capital gains etc.  When you withdraw money from your Roth IRA after your 59 1/2 birthday (and your IRA has been open at least 5 years), all these funds will come to you totally tax free.  If you withdraw money earlier, then  any increase in your Roth IRA is subject to taxes and penalties.
But what about your initial contributions? Because the tax has already been paid on the contribution to your IRA, that amount can be taken out without tax or penalty.  Stash your  funds in a ROTH IRA and that money will remain available to you whenever you may need it.  Any earnings should be left if for the long run, but the original contribution may be taken out in an emergency with no adverse effect (other than decreasing your retirement savings).  If you need to tap these funds, simply withdraw the original contributions and leave the earnings for your retirement.  You will not have any penalty or additional tax to pay.
At the end of the year, you will receive a 1099R stating the amount of money that you have withdrawn from your account.  This must be listed on your 1040 federal tax form.  But you also get to list the original amount of your contribution.  This is known as your basis in your IRA and is simply the total money that you had invested and left in your Roth IRA.  If necessary you can withdraw funds more than once from your IRA.  Simply reduce your basis by the amount you have withdrawn in the past.  As long as you have basis, a pre-retirement withdrawal will not be included in your taxable income.
IRAs and retirement funds are not to be tapped lightly.  They are meant to provide security in your twilight years. The discipline of putting money aside for fifty years is daunting…you may be hesitant to commit funds for such a long time.  The Roth IRA encourages this savings by leaving a back door open to tap these funds.  Through the Roth IRA you will have taken your first step towards financial independence.

On Flexible Spending – Medical Expenses

The concept of Flexible Spending Accounts (FSA’s) is so simple that people think there must be a catch.  There really isn’t. You budget what your expected annual out-of-pocket medical expenses will be.  Then, you request that amount of money be allocated to your FSA account.  Your salary will be reduced by that amount, so no income taxes will be due on that money.  Although your employer is deducting that amount over the full year, the entire amount will be available to you on January 1 (if that is the start of your plan year.) It is true that you will forfeit whatever you don’t spend, but this is not as much money as you might think.  Let’s examine these points more closer.

(In 2016, the most you can contribute to an FSA is $2,550.00 or approximately $49 per week.  For my examples, I will budget $520 towards medical expenses or $10 per week.)

Budgeting for medical expenses. Let’s assume you visit the dentist twice a year for cleanings ($200), are anticipating four “well baby” visits ($140), and plan on buying new glasses ($180).  Opening a medical FSA for $520 will give you immediate access to those funds on January 1, even though you have budgeted $10.00 per week. You could choose to purchase your new glasses immediately or wait. This will give you some additional flexibility. Because, even though you have regular cleanings, you might also have an expensive cavity. In that case you could choose to put off buying glasses until next year and use the funds available in your FSA account for the unexpected dental bill. Glasses could still be purchased towards the end of the year if funds remain in your FSA account; or they could be put off another year.  You are in control.

Immediate access to budgeted funds.  If you anticipate a major medical expense, FSA accounts will allow you to accumulate the necessary funds immediately and painlessly.  A good friend informed me she needed new dentures.  She anticipated that she would need to wait six months before she saved the $520 needed for a down payment. Luckily her employer  offered FSA plans, and they were still in the open enrollment period. My friend immediately signed up for the FSA plan.  The full amount was made available to her on January 1, and she was able to schedule a dentist appointment for January 10. Her employer reduced her wages by only $10 per week.

Deducting medical expenses from your taxes. Yes, medical expenses are deductible on Schedule A of your tax form.  But for most individuals, these deductions will not affect your taxes.  You can read why on my new blog.  So, the only way to get a federal tax break for most individuals is by using Pretax Dollars from an FSA or HSA account. (But we are focusing on FSA accounts in this blog.)

Tax Savings! I just mentioned saving on your federal taxes. Most Americans are in the 10% or 15% tax bracket. This means of the $520 that we placed in our FSA example, most Americans would save $52 or $78.  Not bad.  But there are more tax savings.  Since the $520 was not included in their wages, there will not be any social security or medicare taxes; additional tax savings of $39. Nor will there be any state or local tax owed on the $520. State tax brackets range from 3% to 13%, so let’s use the middle,  8%, for illustration purposes.  In this case the state tax saved would be $41.  So, we have $520 available in our FSA.  However, we have reduced our overall taxes by at least $132.

Use It or Lose It.  This is true.  If you don’t use the full $520 during the plan year, you will lose the remaining dollars in your account.  I have had people who were wary of opening an FSA because they didn’t want to lose any of their money.  If they choose not to use the $520, they will pay the taxes of $132. This means that only a portion of that $520 actually ends up in their pocket.  In fact, in order to break even in their FSA account they would only need to spend the difference of $388 ($520 – $132.)  The rest would have gone to pay taxes. But since the entire amount was placed in the FSA account, they actually have a free bonus of $132 to use.  Remember, FSA accounts can be used for  dental work, glasses,  diabetes testing supplies, hearing aids and batteries, contact lenses and a myriad of other items as well as medical copays and prescription drugs. So if you find yourself with additional funds at the end of the year, consider purchasing some of these items.

But I’m Healthy and Have Great Insurance.  I have met a few people who are indeed blessed with great health and have equally great insurance with little to no copays, and therefor no medical expenses.  If you are in that enviable position, an FSA might not be for you.  Just know that it is there should the need every arise.  Meanwhile I’m putting in my $520 and saving at least 25% in taxes.

Thoughts on Debt and Credit

Debt. Definitely a four-letter word.  And one to be avoided at all costs.  But no, not really.  Debt is simply another tool in your financial tool box.

When you go into debt, you have borrowed money with the intention of paying it back.  (Otherwise, it is simply stealing.)  Credit is a form of debt where you get the benefit of something now, and promise to pay for it in the future.    Credit includes mortgages, car loans, education loans, business loans and certainly credit cards.

The credit industry is very active and certainly very lucrative.  Count how many credit card offers you receive in the mail; notice how often you are asked if you want a store credit card; listen to the television and radio commercials.  In exchange for paying later, you agree to pay interest every month.  The interest can easily be 18% to 30%, or as low as 0%.  Meanwhile, a whole industry has sprung up to convince you that creditors are evil and that you should not have to repay your loans.

Let me just say it: Ridiculous!  If you are old enough and mature enough to get credit; you should be mature enough to handle it.  I’ve got some suggestions for repaying your credit card debts here, but let’s take a look at some of the different types first.

If you are considering  going in to debt, FIRST consider how long you will benefit from your purchase.

Mortgages allow you to buy a house before you can save the money to buy one (or even build your own.)  Typically, mortgages last anywhere from ten to thirty years.   It seems reasonable to go into debt for a lifelong home.  Be sure to calculate the mortgage, utilities and taxes in your budget before you choose your home.  Failure to pay your mortgage would be very serious to your financial health.

Education loans are another common form of debt.  Here you are pledging future earnings for knowledge and training for a future career.  But, be very wary of taking on student debt.  You may be condemning yourself to a lifetime of debt.  I know a young couple who are starting their married life with education debt exceeding a third of a million dollars.  Ouch. Teaching is a very noble profession, but teachers are notoriously low paid.  Take the steps you can to minimize your student debt now – community college; instate and commuter schools; work study programs; apply for scholarships and grants.  Education is so important; choose carefully and wisely.

Car loans have some very low interest rates to entice a buyer.  In our car dependent society, most people see a car as a necessary luxury.  We need them to get to work, grocery shop, school, the list is endless. If you do decide to purchase a car, remember that you are in control.  You choose the make and the model, and ultimately the cost of your vehicle.  I know young people who bought a car so they could go to work.  Now they go to work to pay for their car.  It is an endless cycle.  Choose a vehicle that will fit in your budget, and aim to pay the car loan off within four years. Once you do pay off this loan, continue to place the same amount in a separate account each month.  This will provide you with funds to pay for necessary car repairs or purchase a replacement vehicle in the future.

I saved store and credit cards for last.  This form of debt creeps up very slowly and bites you before you see it coming.  Going through the drive-thru every day for breakfast or out for lunch may only cost you $10.00 a day, but at the end of the month you will have spent over $300 and have nothing to show for it.  Pay a minimal $25 (which the credit card company is quite happy with, since you now owe interest on the remaining $275), and continue the same pattern and you will owe nearly $600 on your credit card. By the fourth month your credit card bill is over $1,000 and you still have nothing to show for your debt.  Add in a few store credit cards for clothing and other “feel-good” purchases, and you are on your way to being seriously in debt.  Remember, you are in control!!  By using your credit card, you have agreed to pay your bill with interest.  The first month you can not pay off your credit card is when you stop using your credit card. If you are not still benefiting from your credit card purchases that you are still paying for months later, then you should not use the credit card to pay for them.  This is the time to use cash for your splurges.  If you don’t have enough cash – you don’t buy it.  Be in control of your own debt.

Like a chain saw, credit is an incredibly powerful too.  It must be handled carefully, or it could destroy your financial house.

 

 

Hello

Hello Everyone,

Welcome to my blog.  There is so much misinformation out there about savings,  credit, budgets, taxes, annuities, retirement, mortgages … finances in general.  STUFF we think we all know about.

But we don’t.

I’m here to help.  I’m going to nag you about the things that you should be doing; I’ll tell you the things that you should already know.  Things your mother would have taught you – if she had known and you had listened.

You can take charge of your financial life.  Small steps can lead to security.  Knowledge is power.

I’ll tell you about the homeowner who didn’t realize that property taxes came due every year and how to budget for them; the young man who wanted to budget but had no idea how to get started; the father who lost over 60% of his investment because he couldn’t stomach the market upheavals.

Remember, there are no stupid questions; only questions that you don’t know the answers to.  And questions you don’t know to ask.