Scrooge's Nephew Fred Is a Traveler (2007-12-17)

by David John Marotta

Every December I reread "A Christmas Carol" by Charles Dickens. Ebenezer Scrooge's nephew Fred is the character young people most easily relate to. He is young himself, carefree, in love and enjoying life with his friends. He has a "traveler" personality.

In his description of financial personalities in his book "Why Smart People Do Stupid Things with Money," Bert Whitehead describes a "traveler" as someone who would rather spend money on experience than things.

Whitehead maps financial personality on two different scales. The first measures people's tendency toward greed or fear. Fred, like all travelers, is neither particularly greedy nor fearful, whereas his uncle Ebenezer appears greedy in the extreme. The second scale measures an individual's tendency to save or spend. That Scrooge is a saver we have no doubt; Fred, like all travelers, tends to spend freely.

Travelers yearn to see new places and learn new things, and they love celebrations like Christmas. Sometimes they even pride themselves on their antimaterialism.

Uncle Scrooge asks, "What right have you to be merry? What reason have you to be merry? You're poor enough." To which his nephew Fred replies, "What right have you to be dismal? What reason have you to be morose? You're rich enough."

Fred's wife comments that Scrooge is very rich. "What of that, my dear?" Fred replies. "His wealth is of no use to him. He doesn't do any good with it. He doesn't make himself comfortable with it."

Fred got married simply because he fell in love. To Scrooge, his nephew's decision is even more ridiculous than a merry Christmas. The young are such romantic idiots!

Travelers like Fred may not have realized the value of saving and investing to reach their objectives, but they have such delightful goals: to marry for love, to celebrate happiness to its fullest and to live in peace with everyone.

Fred wants nothing from Scrooge and he asks nothing of him other than friendship. So every year at Christmastime he invites his uncle to come to his house and join in the celebration.

In Victorian England, being invited to someone's house was not as simple as merely attending. You were expected to repay the favor in some way. As a result, rich relations were invited more places than they really cared to go.

So Scrooge isn't just being overly cynical when he's suspicious about Fred's invitation. Scrooge even swears at his nephew, but Fred keeps his Christmas spirit to the last and wishes his uncle a merry Christmas. Fred is thoroughly good-natured, laughs freely and sometimes doesn't even care what they are laughing about. He passes the bottle with good humor.

The idea of a rich old uncle leaving a poor nephew a bundle of money is a cliché for a reason. Fred may have the purest of motives for inviting Uncle Scrooge, but the thought of an inheritance from the old man is never far from his thoughts.

Fred's beautiful bride confesses, "I'm sure he is very rich, at least you always tell me so." To which Fred replies, "But he hasn't the satisfaction of thinking that he is ever going to benefit us with it." Fred hopes that his encounter with Scrooge has at least rattled the old man enough so he leaves 50 pounds to his poor clerk Bob Cratchit.

Even if Fred's motives are altruistic, his thoughts often return to Scrooge's money and the potential inheritance that might come his way. And so even if Scrooge is as cold as the winter toward Fred, his cynicism is at least partially justified.

This suspicion between travelers and nontravelers over motives and money is a common one. Young people are more likely to be travelers until they settle down and become what Whitehead calls nesters. The older generation knows that money can get tight later on in life, and the sooner you start saving the better.

For young people, meeting basic needs may seem simple: income often easily covers expenses, and the surplus can be used for savings, investment or added consumption. Many young people mistakenly assume they are doing so well financially that they can simply spend their extra money and consume more. They do not realize that the urgent needs of family life typically follow these years of plenty. Bob Cratchit knows all too well that expenses multiply once children enter a family.

Additionally, saving when you are young gives you more time in the markets and more time for your investments to grow. For example, saving $5,000 a year for seven years and then stopping is worth more than starting in the eighth year and saving for the rest of your life. After seven years of saving, your investments should be earning more than you were contributing each year.

Or looked at another way, for every seven years you delay saving and investing, you cut your retirement lifestyle in half. So in the story, Scrooge is focused on the long term while Fred is living in the moment. But achieving a balance between these two impulses is possible.

Fred is interested in experiences and supposedly doesn't care about money. But if he truly was indifferent about the money, he could save and invest half his income while enjoying life just as much. After all, if money doesn't bring happiness, Fred shouldn't need to spend all he earns. He can become both rich in wealth and rich in experiences.

If Fred saved and invested he could have given to the poor himself, started a business and hired his own clerk or provided for Tiny Tim's medical expenses out of his own largess. For someone who consumes everything he produces, he is overly critical of the spending of those who through frugal living produce more than they consume.

At the Christmas party, Fred and his wife are described as a musical twosome. After dinner they sing a Glee and a Catch. Fred's wife plays the harp admirably, which helps soften Scrooge's heart toward the couple. Travelers often appreciate music, which doesn't have any monetary value.

After a musical interlude, the partygoers play "Forfeits" because "it is good to be children sometimes." Each person in the room gives up some personal belonging for the game. One player is chosen to be the judge and another holds items one at a time over the judge's head so he (or she) can't see them. For each item the judge orders the owner to do some stunt to get their property back.

The commands are usually silly requests intended to get everyone at the party laughing, such as "dance a jig," "tell how to make a pie without talking," "yawn until you make someone else yawn" or "try to stand on your head." The judge must be careful what he demands because at some point in the game his own item will be held over his head!

Next they play the games "Blindman's Buff," "How, When and Where" and then "Yes and No." None of these pleasures cost a cent, which is a lesson Scrooge has forgotten.

Victorian priorities dictated that men attend to business. Hard work was the way to achieve respectability and advance in society, feeding the culture of materialism in the rising middle class. Industriousness and productivity were extolled virtues.

To the extent that travelers are simply avoiding burdensome and stressful responsibilities, they are not yet wise or mature. But if they keep a sense of wonder about life and a spirit of adventure that does not deplete their resources, travelers like Fred can find a satisfying balance in life. Because without some self-restraint, Scrooge's warning could come true: "What's Christmas time to you but a time for paying bills without money; a time for finding yourself a year older, but not an hour richer?"

Many holiday delights need not even show up as a line item in your budget. Watch a Christmas video or read a Christmas story as a family. Play Christmas music or go caroling. Make your own Christmas cards or bake and decorate cookies. Do some errands for an elderly neighbor.

May Fred's wise words from "A Christmas Carol" inspire us to enjoy the nonmaterial joys of this season:

"There are many things from which I might have derived good, by which I have not profited, I dare say, Christmas among the rest. But I am sure I have always thought of Christmas time, when it has come round -- apart from the veneration due to its sacred name and origin, if anything belonging to it can be apart from that -- as a good time: a kind, forgiving, charitable, pleasant time: the only time I know of, in the long calendar of the year, when men and women seem by one consent to open their shut-up hearts freely, and to think of people below them as if they really were fellow-passengers to the grave, and not another race of creatures bound on other journeys. And therefore, uncle, though it has never put a scrap of gold or silver in my pocket, I believe that it has done me good, and will do me good; and I say, God bless it!"

from http://www.emarotta.com/article.php?ID=261

by David John Marotta

When you're building wealth, saving a penny on your taxes is just as important as earning a penny in the markets. You can use both investment losses and investment gains to good tax advantage.

For example, in November some U.S. stocks experienced a significant drop. Disciplined investors use these declines to save on their taxes and rebalance their portfolios.

But most people are loss averse. Selling an investment for a loss feels like failure. So they hold on and wait for it to come back up before they sell. It doesn't matter if another investment might appreciate faster and recover the loss more quickly. Their reluctance to sell is even more pronounced when the investment was purchased recently. In taxable accounts, however, investors must overcome this loss aversion and learn to realize capital losses whenever possible.

The stock market normally appreciates over 10% each year. Any investment you hold for a few years will probably have a satisfying capital gain. The only investments you are likely to be able to sell for a loss and deduct on your taxes are recent purchases. Be quick to sell your capital losses in taxable accounts and reinvest the money at a lower cost basis going forward.

The difference between what you paid for an investment and its current worth is called a "capital gain" or a "capital loss." As long as you continue to hold the investment, the gain or loss is "unrealized." Selling the investment means "realizing" the gain or loss, which you must report on your taxes.

Realized capital gains are commonly taxed at a reduced 15%. Realized losses can offset realized gains, but you are also allowed to deduct up to $3,000 of capital losses against other types of income. If you have net losses in excess of $3,000 in one year, you can carry your losses forward to future years.

Now is a good time to review your portfolio for investments you can sell for a loss. Use software to track your investments. Even a simple spreadsheet can compute the current value minus the cost basis of each investment. Consider any significant losses for tax-loss selling.

Ask yourself, "If I did not own that security now, would I buy it at current prices?" If the answer is no, sell. If the answer is yes, sell it anyway. Then wait 31 days and buy it back. That way you "realize" the loss for tax purposes and still hold the security. And you have reduced your tax liability by sharing that loss with Uncle Sam.

Another technique is to double up. First, purchase the same number of shares you currently hold in that security. Wait 31 days. Then sell the original shares for a tax loss. Waiting a month between the sale and the buyback avoids a "wash sale," which would prevent you from taking the tax loss.

Most investments (stocks, bonds, mutual funds) are subject to the same tax rules, but owning individual stocks provides additional tax-loss selling opportunities.

Compare two millionaire investors. The first buys $1 million of a mutual fund that invests in 200 different stocks. No stock represents more than $10,000 of the investment, and the amount invested in each stock is $5,000. Although the mutual fund might have a tame 10% return for the year, one of the underlying stocks in the fund might have doubled and two others lost 50% of their value during the year. But this investor only owns shares in the mutual fund, and he cannot take advantage of any tax-loss selling.

The second millionaire buys all 200 as individual stocks. Her overall portfolio also has a tame 10% annual return, but she has additional choices that help boost her earnings even higher. She can sell the two stocks that have a 50% negative return and take the loss on her taxes. By selling the stocks with losses, she realizes their loss for tax purposes. By not selling her stocks with gains, she avoids realizing those gains and therefore is not required to pay any capital gains taxes.

Selling investments with losses can reduce your taxes, but you can also save on investments that have gone up by using appreciated assets for your charitable gifting.

Many Americans donate to charities in December. No matter what worthy organizations you support, you can contribute up to 15% more if you give appreciated investments instead of cash.

For example, if you sell $1,000 worth of appreciated stock, you most often pay capital gains tax of 15%. If most of the stock's value is appreciation, the tax burden approaches $150, leaving only $850 for charitable giving.

But if you give the stock directly to the charitable organization, you can take the full $1,000 tax deduction, and the organization will not have to pay any taxes when it sells the stock. You could save up to $150 on capital gains taxes, and the gift itself reduces your taxes at your marginal rate. In total, your $1,000 gift could cost you $500 or less if you use appreciated stock!

Here's how to do it:

1. Ask your financial advisor to choose which stocks are best for charitable giving (probably those that have appreciated the most and you do not want to continue holding in your portfolio).

2. Determine the amount of each charitable contribution. To compute how many shares of stock to give to each charity, divide the current price of the stock into the amount you wish to donate. The number of shares will not work out exactly, so you may need to round up or down.

3. Call the designated charities and ask for their "stock liquidation brokerage account." Nearly every organization has one expressly for this purpose. You may like to give anonymously and without fanfare, but you only have to request this account number once.

4. Instruct your brokerage firm to transfer the correct number of shares from your account into the charity's stock liquidation account. You can fax this request directly and then send the original by mail.

5. Save these letters and account numbers for next year's charitable giving.

6. Report the gifts to your tax accountant. Stock gifting is deductible at the fair market value, that is, the amount the stock was worth at the close of the day it was transferred. The stock may change value after you have transferred the stock but before the charitable organization sells it. These changes do not affect your tax deduction, but it may mean the charity reports a different amount than you must declare on your tax return.

Giving appreciated stock is a great way both to reduce your taxes and to give more generously to worthy charities.

from http://www.emarotta.com/article.php?ID=260

by David John Marotta

If you think hiding money under your mattress is a risk-free way of building wealth, think again. Cash, it turns out, has been the riskiest investment since 2002. Many investors try to avoid risk by putting their money in a bank account or investing in CDs. But like any other investment, cash is subject to its own set of risks.

Cash is dangerous because the dollar can be devalued. When our currency decreases in value, we experience inflation and the purchasing power of the dollars we hold is compromised. Having the same amount of dollars doesn't do you any good if your dollars won't buy as much as they used to.

Since the beginning of 2002, the U.S. dollar has lost much of its purchasing power. From 2002-2007, the U.S. Dollar Index has dropped over 36% from 120 to 76.5. During that same period, the dollar has dropped over 39% against the Euro going from $0.88 to a Euro to $1.45. And the dollar has dropped over 64% against gold going from $280 to an ounce of gold to $795.

Money market's real risk is the dropping value of the dollar, not exposure to subprime lending. Cash in money market has lost over 40% of its buying power since 2002. And the US Dollar has dropped 10% just this year alone.

Interestingly enough, the consumer price index (CPI) over this same period has only registered a 15% drop in the dollar's purchasing power. While 15% is still significant, many economists believe that the federal government has been under reporting CPI since they changed the rules for computing it in 1996.

Purposefully under reporting CPI allows the government to cut the impact of cost of living increases in social programs and helps curb runaway government entitlement programs. Started under the Clinton administration and continued under Bush, these changes have rendered the official CPI numbers less meaningful.

Current CPI calculations have changed inflation numbers through tricks such as "substitutionary adjustments", "component removal" and "hedonic deprecators". This creative accounting rivals anything done by Enron. These changes were made specifically during a political debate over cutting back cost of living increases to Social security and other federal benefits. The changes have saved the Government tens of billions of dollars a year at the expense of benefit recipients whose benefits buy them much less now than they did a decade ago.

Any attentive consumer knows that cumulative price inflation since 2002 has been closer to 50% than 15%. This corresponds to the CPI being understated by about 5% a year. One study suggested that the CPI index has been understated by about 7% per year. No matter the exact amount, your bank deposits and money market funds have been the riskiest investments and have lost significant buying power to inflation. The danger of the U.S. dollar continuing to decline is aggravated if you try to be "safe" and over-expose your investments to cash and money market.

Just this year the dollar has continued its decline. Since the beginning of 2007, the U.S. Dollar Index has dropped 9% from 84.2 to 76.5. The dollar has dropped over 10% against the Euro going from $1.30 to a Euro to $1.45. And the dollar has dropped over 21% against gold going from $625 to an ounce of gold to $795.

Over half of your portfolio should be protected against the risk of a falling dollar. You can protect your portfolio against a falling dollar with investments in foreign bonds, foreign stocks, and hard asset stocks. Hard asset stocks are one of the best ways to protect yourself. As an asset class, they have also provided one of the best returns since 2002.

Hard asset investments include companies that own and produce an underlying natural resource. Examples of these natural resource stocks include companies that produce oil, natural gas, precious metals (particularly gold and silver), base metals such as copper and nickel, and other resources such as diamonds, coal, lumber, and even water.

Keep in mind that investing in hard asset stocks is not the same thing as investing directly in commodities. Buying gold bullion or a gold futures contract is an investment directly in raw commodities or their volatility. Commodities, as an asset class, generally maintain their buying power in dollar terms. Stocks, as an asset class, generally appreciate over inflation after dividends are factored in. For that reason, it may be to your benefit to invest in hard assets stocks which have an underlying commodity.

One index that tracks hard assets is the Goldman Sachs Natural Resources Index. This index is comprised of 70% energy and 11% materials. As of the end of October 2007, this index is up 34.00% year-to-date. Its three-year annualized return is 30.69% and its five-year annualized return is 30.43%.

And please don't be fooled into thinking that cash in your mattress is a safe investment.

from http://www.emarotta.com/article.php?ID=259

by David John Marotta

Medicare Medical Savings Account (MSA) Plans are one of the newest Medicare Advantage Plan options. Private companies began offering these accounts in 2007. Like Health Savings Accounts, a Medical Savings Account puts you in control of your own health care dollars.

If you are in good health and want to limit the maximum you would need to pay in a medical emergency, you may want to consider a Medicare Medical Savings Account plan during your retirement years.

When you choose a Medicare MSA plan, you are still participating in one of Medicare's plan options. A Medicare MSA plan is a "Medicare Advantage Plan," also known as Medicare Part C.

A Medicare MSA has two parts: a medical insurance plan and a savings account. The medical insurance portion is a high-deductible health care plan which covers your medical expenses only after you have met a high out-of-pocket deductible. But before you receive coverage, you'll have to pay all of your health costs until you reach your deductible. However, to help you pay the out of pocket costs, the Medicare deposits money into your savings account each year. You can use this money to pay your health care costs before you meet your deductible.

To purchase the Medicare MSA coverage, you probably won't have to pay an additional premium. In keeping with the Medicare Advantage Plan system, you'll simply have to pay the Medicare Part B premium. The costs of Part B are dependent upon your yearly income. In 2008, seniors will pay a monthly premium of $96.40 per person if they are married filing joint and reported $164,000 or less in income ($82,000 for single filers). Monthly premiums climb as high as $238.40 if you are in the highest income bracket.

With a Medicare MSA, you can keep all the money you don't spend on health costs. In fact, you may do better than break even each year. The annual amount you are given will not cover the gap until you meet your deductible. But if you spend less than the amount you are given, your account could grow in size. You may be able to accumulate enough money in your account to cover all of your health care costs up to the amount of your deductible. And like a true savings account, anything you don't spend one year carries over to the next. With an MSA, it's your money.

As an example, the Anthem MSA plan in Virginia has an annual deductible of $3,000 and an annual deposit $1,300. In short, you pay all medical costs up to $3,000. But to help you cover those costs, Medicare will deposit $1,300 at the beginning of the year into your medical savings account.

If you don't need all of your savings for medical expenses, you can spend your account on what you do need. Withdrawals for Medicare covered expenses are tax-free and count toward your deductible. Withdrawals for qualified medical expenses that are not Medicare covered (such as dental, vision and prescription drugs) are tax-free but do not count toward your deductible.

Qualified expenses may also include items which may or may not count toward your deductible. The IRS has approved a long list of qualifying expenses. In addition to doctor's visits, hospitalizations, lab tests and the like, the list also includes prescriptions, some over the counter drugs, vision and dental costs.

You can withdraw and use a portion of the money in your Medicare MSA for non-medical reasons (such as groceries and utilities) without penalty. You will still need to pay income tax on non-medical withdrawals, just as you would with a traditional IRA. The limit you can withdrawal without penalties is equal to your account balance on December 31st of the prior year minus 60% of your policy's deductible. Withdrawals above that for non-medical expenses will be taxed as income and slapped with an additional penalty.

A Medicare MSA can also be a good solution if you have very high out-of-pocket costs under your current Medicare program. Unlike the plain vanilla Medicare Part B which could leave you paying 20% of all your medical costs --with no limit, a Medicare MSA account caps your liability. Once you've met your annual deductible, your insurance plan will cover 100% of your Medicare-covered health costs.

Consumer-driven health care plans may help shape consumer behavior and keep health care costs from spiraling out of control. Contrast Medicare MSA plans with other Medicare Advantage Plans. Generally HMOs pay for medical services. Doctors dictate which services are given, and patients are the ones who actually benefit from these services. With Medicare MSA plans, consumers pay, dictate and benefit from services. They are empowered to make their own healthcare decisions.

Those covered by a Medicare MSA plan should be more likely to engage in healthy behaviors and to get annual check-ups. They should also be more likely to inquire about costs and less likely to consume health care they don't need. If this sounds like you, you may be a good candidate for a Medicare MSA.

Medical Savings Accounts offer you the opportunity to take more control of your health care spending. The money you save on your medical expenses is really yours and can be used to pay whatever bills you might have in retirement, even if those bills are not Medicare covered expenses.

Enrollment in a Medicare MSA is limited to one percent of Medicare recipients on a first come first serve basis. If you are interested, I suggest you sign up early. Open enrolment for Medicare MSA plans begin November 15th and ends December 31st every year.

from http://www.emarotta.com/article.php?ID=258

by David John Marotta and Beth Anderson Nedelisky

Many seniors look forward to saving on medical insurance costs by enrolling in Medicare at age sixty-five. However, navigating the Medicare system is not for the faint of heart. Medicare is an alphabet soup of plan choices. Currently Medicare is organized as parts A through D.

Medicare Part A provides hospital insurance to seniors. For the majority of seniors who have paid into the plan, enrolling in Part A comes at no cost. Part A covers hospital stays, home health care services, and hospice care. However, if you just need a check up, you'll need to resort to Part B or Part C to help with those costs.

Part B helps to cover doctor's services, some outpatient care, and routine preventative services. However, unlike Part A, you'll have to pay a monthly premium to buy the coverage. The costs of Part B are dependent upon your yearly income. In 2008, seniors will pay $96.40 per month if they were married filing joint and reported $164,000 or less in income. Monthly premiums climb as high as $238.40 if you report lots of income in retirement.

However, unlike Part A, Part B may require you to first pay the $135 deductible before Medicare will pick up the tab. For other services, Medicare will cover 80 percent of your medical costs, requiring you to pay the other 20 percent. Still in other cases, you'll wind up paying both the $135 deductible plus 20 percent of the remaining costs.

Don't try and save a few bucks by skipping Part B coverage. If you fail to enroll in Part B at age 65, you'll be slapped with a 10% penalty for each year you delayed enrollment.

Your Part B insurance will provide you with some free services such as a flu shot, diabetes and cancer screenings, and 'Welcome to Medicare' physical exam. If you take advantage of these services you may avoid more costly and more dangerous conditions.

Most seniors sign up for the Original Medicare plan, a combination of Parts A (hospital insurance) and B (medical insurance). However, if Uncle Sam's doesn't provide you with sufficient coverage, you may be better served by a private insurance company offering a Medicare-approved insurance plan.

Part C, also known as Medicare Advantage Plan, includes coverage for parts A and B through private insurance companies. The plans are usually offered in the form of a Health Maintenance Organization (HMO) or a Preferred Provider Organization (PPO). Your premiums, co-payments, coinsurance and deductibles will vary based on your specific plan benefits. And, although offered by private companies, Medicare Advantage Plans are approved by Medicare.

Choosing a Part C plan may mean you already receive prescription drug benefits. If your prescription drug coverage is deemed "creditable" by Medicare, you won't have to pay an additional premium for the Medicare prescription drug plan, also known as Part D.

Part D, the Medicare Prescription Drug Plan, is the newest of all the Medicare programs. However, Medicare does not provide the insurance directly. Instead, each state has contracted with insurance providers to offer the drug coverage. If you are a senior, you must decide if you should sign up, and then which plan you should purchase.

Most states offer at least 40 different drug plans. Premiums average $28 per month, depending on the level of coverage and the types of drugs covered by the plan. If you are enrolling in the Original Medicare or don't already have "creditable coverage", you'll need enroll in Part D, or face a penalty. If you fail to enroll at age 65 but decide to enroll at a later date, you'll pay a 1% penalty for each month you delayed enrollment.

The costs of Part D vary, and if you don't think you will need the coverage you should find the lowest cost Part D to avoid the penalties. That way, if you need the coverage later, you won't be stuck with premiums inflated by penalties. You can always change providers at a later time, if you decide different coverage suits your situation better.

If your income and assets are low enough, you may be able to save money on your Medicare costs. This assistance is done through your State Medical Assistance and is often called Medicaid. Call even if you aren't sure if you qualify. The Virginia Medicaid office can be reached at 804-786-7933. Call 1-800-MEDICARE to get the telephone number for other states.

The initial enrollment period begins three months before your sixty-fifth birthday and ends three months after your birthday. Be sure you enroll to avoid unnecessary penalties.

You can get more information by visiting Medicare on the web at <a href="http://www.medicare.gov" target=_blank>www.medicare.gov</a> or by calling 1-800-MEDICARE.

from http://www.emarotta.com/article.php?ID=257

by David John Marotta

Health Savings Accounts (HSAs) can provide inexpensive medical coverage if you maintain a healthy lifestyle. With your healthy lifestyle you may not spend anywhere near your high deductible insurance and consequently save on your medical costs. Even if you do not need to, we recommend funding your account with the maximum allowed. If your HSA builds up it may help you cover any extra medical expenses during retirement.

An HSA is a tax free savings account. As long as funds are spent on qualified medical expenses, all contributions, capital gains, and withdrawals remain untaxed. And like any other bank account, HSAs come complete with debit cards and checks.

But to qualify for one of these tax-free savings accounts, you must have a high deductible health plan (HDHP). Now, you may be thinking your insurance plan has a high enough deductible already. However, to qualify as a high deductible health plan, your insurance deductibles must be a minimum of $1,100 for individuals and $2,200 for families in 2007.

The good news is, once you meet your out-of-pocket deductible, most HSA-eligible high-deductible plans cover 100 percent of most medical expenses like emergency room visits, hospitalization, lab tests and prescriptions. Still, these deductibles are nothing to joke about. Paying a couple grand out of pocket before your insurance chips in may seem like financial suicide.

HSA-eligible high-deductible premiums are only a fraction of the cost of a traditional medical insurance plan. As an HSA owner you'll likely do better than break even each year. With the savings on your insurance premiums, you should be able to accumulate a sizeable nest egg in your HSA.

Unlike your traditional health care plan, your HSA funds are not subject to a "use it or lose it" policy. Anything you don't spend one year carries over to the next year. After all, it's your money. While you're on a roll, why not check out the invest options offered by your HSA bank?

Some people put only enough into their HSA each year to fund their medical expenses. This is shortsighted. We would recommend making the maximum HSA contribution each year, after covering your other financial needs.

In 2007, you can contribute $2,850 for individuals or $5,650 for families. If you are 55 or older you can make an extra $800 catch up contribution. In 2008, you can contribute $2,900 for individuals or $5,800 for families. If you are 55 or older you can make an extra $900 catch up contribution.

Once you enroll in Medicare (typically at age 65) you can't make new contributions to your HSA. But any money left in your HSA will continue to accumulate tax free. It is a good idea to over fund your HAS while you are young so that during your retirement you will have some extra tax-sheltered dollars to use for medical expenses. After enrolling in Medicare, you can't contribute to an HSA.

Any HSA withdrawals that are not for qualified medical expenses are counted as taxable income and subject to a 10% tax penalty. The tax penalty does not apply, however, if you are 65 or older, or are permanently disabled. However, the withdrawals are still taxable at ordinary income rates.

In other words, any excess contributions you make to your HSA can be withdrawn after age 65 without penalty. Just like a traditional IRA, when the funds are used for non-qualifying medical expenses you will have to pay tax on the withdrawals, which is no different than other retirement savings option.

The law is currently silent on what happens to your HSA when you reach 70 1/2. We expect that the IRS will treat your HSA like an IRA and therefore require minimum distributions, but this has not been settled.

When you die, your surviving spouse inherits your HSA and it is treated as their HSA if they are named as the beneficiary. Otherwise, your HSA ceases to be an HSA and is included in the federal gross income of your estate or the named beneficiary.

There are three strategies that you can use to grow your HSA large enough to cover your retirement years. First, make the maximum allowable deposit to your HSA each year. Second, if your medical plan includes the option, invest your HSA in mutual funds instead of keeping your account entirely in an FDIC-insured savings account. And third, delay reimbursing yourself from your HSA account as long as possible to profit from its tax sheltered compounding interest.

You can reimburse yourself for qualified medical expenses at any time, but you also have the option of leaving the money in your HSA so that it continues to grow tax free. You can save all your receipts in a shoe box for decades and then decide to withdrawal your reimbursements at any future date when you need the money. This allows the growth on these funds to continue to compound tax-free.

Once you turn 65 and enroll in Medicare you can no longer fund your HSA. Medicare will pay for the majority of your health expenses during retirement. There are some expenses, however, that Medicare will not cover that your HSA can. In retirement, your HSA can cover proactive health screenings, unconventional treatments for terminal illnesses and nursing home expenses. Your HSA can even cover long term care expenses if you decide to self insure, or pay your long-term care insurance if you decide not to. None of these expenses will be paid by Medicare.

Another option during retirement is to enroll in a Medicate Medical Savings Account. This account is similar to an HSA, but funded in retirement by Medicare contributions. If you select a Medicare MSA during retirement, you can use the funds in your HSA until you build sufficient value in your Medicare MSA.

Maximizing your contributions to an HSA may secure your health care spending for life. Even if you end up not needing it, you can pay income tax and withdraw it without penalty after age 65 just like a traditional IRA.

from http://www.emarotta.com/article.php?ID=256

Roth Conversions Can Help Build Wealth (2007-11-05)

by David John Marotta and Beth Anderson Nedelisky

If you don't have retirement savings in Roth IRAs, it's time you considered the benefit of these tax-savings accounts. The long-term tax savings opportunities are driving more Americans to rollover various retirement funds into Roth accounts. These so called "Roth conversions" can be performed on traditional IRAs. And, beginning in 2008, it will be easier to roll money from an employer plan into a Roth IRA.

But first, you may be wondering what's so great about Roth IRAs. Roth IRA contributions are always made with after-tax dollars. That's right; you won't get a tax deduction for contributing. However, the principle grows tax-free and the account holder may make tax-free withdrawals at 59 1/2. Furthermore, there are no required minimum distributions for a Roth, which makes them ideal for funding the latter years of retirement.

Conversely, a traditional IRA allows before-tax contributions to grow tax-deferred, but not tax-free. So, although you can usually deduct your contribution to a traditional IRA, you pay ordinary income tax on the withdrawals. Furthermore, the IRS will require you to take minimum distributions, whether you need the money or not.

However, Roth IRAs may not provide tax savings for everyone. Remember, contributions to Roths are made with after-tax dollars whereas traditional IRAs are made with pre-tax dollars.

Roth IRAs provide tax savings for individuals who expect to be in a higher tax bracket later in life. The tax benefits of a Roth are created by the tax disparity between your tax bracket when you put your money in versus your tax bracket in retirement. The lower your tax rate, and the longer you have until retirement, the more likely a Roth conversion will play in your favor.

Imagine John, age 60, owns two traditional IRA accounts. Each is funded with $5,000. Let's assume he keeps the $5,000 in one IRA. But with the other, he uses some of the funds to pay the taxes due and then converts it to a Roth. Assuming John remains in the same tax bracket and the accounts deliver the same return on investment, each account will generate the same spending money in retirement, after taxes are paid on the traditional IRA. If John drops into a lower tax bracket after his retirement, the traditional IRA would have been the better bet. But if John's taxes rise, the Roth IRA proves to be the better option.

Guessing your future tax rates is nearly impossible. Traditionally, it was thought your tax rate in retirement would be less than when you were working, but this is increasingly not the case. Tax rates are not adjusted for inflation, so many retired couples continue to creep into higher tax brackets. Also, tax rates are at a historic low and likely to rise if the political winds change.

If you expect to see your tax bracket increase significantly - from say, 15% to 25% - you will likely benefit from a Roth conversion. This is true for younger workers and also for new retirees. In the early retirement years, many couples dip into a lower tax bracket just after retirement but before Social Security checks start arriving.

Before you rush off to begin your Roth conversions, be sure you have enough money to cover the tax bill. During a conversion, you'll withdraw funds from your traditional IRA, report the funds as income, and roll them over to a Roth IRA account. The tax implications from the conversion will vary based on whether you took a deduction on the principal. If you deducted your IRA contributions, you'll have to pay taxes on both the principal and the earnings. If you didn't, you'll just pay taxes on the earnings. I say 'just,' but either way, this could be a big bill.

The good news is you can withdraw funds from your traditional IRA and convert them to a Roth without incurring the 10% early withdrawal penalty.

You'll also have to pass an income test. Until 2010, income limits do apply. Only joint and single filers with a modified adjusted gross income of $100,000 or less can qualify. After 2010, the income restrictions on converting funds from a traditional IRA to a Roth IRA will disappear completely.

Traditional IRAs, SEP IRAs and SARSEP IRAs are subject to the same conversion rules. Until 2010, you'll have to pass the income test to qualify.

SIMPLE IRAs can also be converted to Roth IRAs, if you participated in the plan for more than two years. SIMPLE IRA account holders are not subject to this rule if they are over 59 1/2. The income test of $100,000 or less (no requirement after beginning in 2010) still applies.

Keep in mind there are more ways than one way to get funds into a Roth IRA. Although conversions from a traditional IRA to a Roth are common, funds in employer sponsored plans  like 401k, 403b and 457 plans - can also be rolled over to a Roth.

In 2007, rollovers from an employer plan cannot go straight to a Roth IRA. Instead, you'll first have to rollover funds into a traditional IRA. Once in the IRA you can immediately do a Roth conversion. But thanks to the Pension Protection Act of 2006, it will soon be easier to convert your retirement savings to a Roth IRA. Beginning in 2008, funds from your employer sponsored plan can be directly rolled over into a Roth IRA.

However, don't confuse Roth conversions with the other Roth plans sponsored by your employer. Currently, you cannot convert a traditional 401k or 403b to its employer-sponsored Roth counterpart such as a Roth 401k, Roth 403b.

Remember, no matter when you do your conversion, it must be done before Dec. 31st of the tax year. Later, if you find you weren't eligible for the Roth conversion, you can undo the damage with a Roth recharacterization before your file your taxes.

For more information about tax planning, you are invited to attend the November NAPFA Consumer Education Foundation presentation. John G. Bowen, CPA, CFP®, AIF®, of Bowen Financial Services, LLC, will be speaking on the topic of year-end tax planning.

The seminar will be held on Saturday, November 10th from 12:00pm to 1:30pm at the Northside Library in the Albemarle Square shopping center. For more information call (434) 244-0000, or send an email to Charlottesville at NAPFAfoundation.org. To learn more about the NAPFA Foundation visit <a href="http://www.napfafoundation.org/NAPFAfoundation_Charlottesville.htm" target=_blank>http://www.napfafoundation.org/NAPFAfoundation_Charlottesville.htm</a>.

All presentations are free and open to the public. You are encouraged to attend and to bring your financial questions.

from http://www.emarotta.com/article.php?ID=255

by David John Marotta and Beth Anderson Nedelisky

Income-shifting is one of several tax planning tools families have used to lower their tax bill. Historically, parents could save a bundle by transferring highly appreciated investments to their children who are in lower tax brackets. However, this year, Congress has made income-shifting a dream of the past, trapping more kids in the dreaded "kiddie tax." Beginning January 1, 2008, children under 24 will owe taxes on unearned income at their parents' higher tax rates.

The "kiddie tax," or so it has been affectionately named, is a tax on children's unearned investment income or capital gains. Instead of taxing income and capital gains based on the child's tax bracket, the kiddie tax requires unearned income to be taxed at the parents' income and capital gains rates.

Before the expansion of the kiddie tax, parents turned to Uniform Transfer to Minors Accounts (UTMAs) or Uniform Gift to Minors Accounts (UGMAs) to move appreciated investments out of their estate. Once in the child's name, the assets were taxable at the child's - typically much lower - tax rates.

Shifting appreciated assets to a child could save a family 10% in capital gains taxes. Since most children earn little income, they usually fall into the lowest marginal tax brackets of 10% or 15%. Capital gains in these lowest two brackets are taxed at just 5%, compared to the typical 15% rate paid by many parents.

Savings could be even greater on short-term gains and investment income which are taxable at ordinary income tax rates. A child in the 10% bracket would pay 10% tax, instead of rates as high as 35% if mom and dad own the asset. 

A once-in-a-lifetime kiddie tax loophole made intergenerational transfers even more appealing. In 2008, 2009, and 2010, capital gains rates are set to drop from 5% to 0% for individuals in 10% and 15% tax brackets. In other words, before the recent changes to the kiddie tax law, children 18 and over in the lowest two tax brackets could expect to pay no capital gains taxes in the next three years.

The new kiddie tax rule closes this loophole forever. If you were waiting for the days of 0% capital gains tax, you can kiss that dream good-bye.

Through 2005, the kiddie tax was limited to kids under 14. Last year, Congress cast the tax net wider, requiring children under age 18 to pay the kiddie tax. And this year, with the passage of the Small Business and Work Opportunity Tax Act of 2007, children under 19, or full-time students up to 24, will be subject to the kiddie tax. The good news is the new kiddie tax law doesn't take effect until January 1, 2008. If your child is between the ages of 18 to 23 this year you can still realize gains at your child's lower rate, if you act now.

After January 1st, children under 19, or full-time students under 24 will be stuck paying income and capital gains at their parents' tax rates. The kiddie tax applies as follows: No tax on the first $850 of earnings. Income between $851 and $1,700 is taxed at your child's tax rate. Any unearned income over $1,700 is taxable at the parents' marginal tax rate. However, children who provide for more than half of their own support will not be subject to the new law.

The expanded kiddie tax law now makes UGMA and UTMA a poor choice for college savings. Instead, 529 college savings accounts provide tax-free growth on contributions, allowing families to reduce their exposure to income and capital gains taxes. Qualified expenses such as college tuition, books, room and board can be withdrawn tax-free. And unlike UGMA and UTMA accounts, the college savings accounts are owned by the parent.

For more information about year-end tax planning, you are invited to attend the November NAPFA Consumer Education Foundation presentation. John G. Bowen, CPA, CFP®, AIF®, of Bowen Financial Services, LLC, will be speaking on the topic of year-end tax planning.

The seminar will be held on Saturday, November 10th from 12:00pm to 1:30pm at the Northside Library in the Albemarle Square shopping center. For more information call (434) 244-0000, or send an email to Charlottesville at NAPFAfoundation.org.
To learn more about the NAPFA Foundation visit <a href="http://www.napfafoundation.org/NAPFAfoundation_Charlottesville.htm" target=_blank>http://www.napfafoundation.org/NAPFAfoundation_Charlottesville.htm</a>.

All presentations are free and open to the public. You are encouraged to attend and to bring your financial questions.

from http://www.emarotta.com/article.php?ID=254

IRAs Offer Big Tax Savings for Charitable Gifts (2007-10-22)

by David John Marotta and Beth Anderson Nedelisky

For a few more days this year, the tax law will allow you to give to charity directly from your IRA and count that gift toward your required minimum distribution. Giving to charity from your IRA will also provide you with additional tax savings.  But, to qualify, you must make your donations before 2008.

Unlike the typical deduction you may be taking to offset your charitable giving, the Pension Protection Act of 2006 offers you tax savings opportunities which a charitable contribution deduction will not.

The Pension Protection Act provisions allow you to make so called "qualified charitable distributions" from your IRA and to exclude the gift from your gross income. Furthermore, such gifts can be used to fulfill required minimum distributions. But you must give before 2008, when the provision sunsets.

If you are an IRA account owner over 70½, you are required to take withdrawals, known as "required minimum distributions" (RMDs), from your IRA account. You must take your RMD each year, regardless of whether you need the money or not. What's more, IRA withdrawals must be reported as income and are taxed at ordinary income rates. After all, Uncle Sam won't let your money go tax-free forever.

The Pension Protection Act offers a unique tax benefit with these so called, "qualified charitable distributions." Here's how: Gifts you make to charity from your IRA bypass your taxes altogether. Since your gift is not counted as income, it does not increase your adjusted gross income (AGI).

Your adjusted gross income determines your tax bracket and your eligibility for a number of other tax benefits. By reducing this number, you may avoid the phase-out rules which may limit your itemized deductions or personal exemption amounts. You may even be able to drop to a lower income tax bracket.

If your IRA contains both before-tax and after-tax dollars, you can save even more by giving. Qualified charitable distributions made from an IRA containing both before-tax and after-tax dollars are taken from the portion of untaxed dollars. This is a radical departure from the typical IRA model which requires you to withdraw the pre-tax and after-tax dollars proportionately. Under the Act, you'll be able to give away the dollars which carry the highest tax liability. At the end of the day, you'll have a higher percentage of after-tax dollars left in your IRA.

To be considered a "qualified charitable distribution," your donations must meet a few criteria. First, only IRA account holders age 70½ or older are eligible to participate.

Next, your donation must be made directly from your IRA to the charity. Contact your IRA trustee for more instructions on how to initiate the transfer. Any distribution made payable to you won't qualify.

Finally, be sure the receiving organization is a qualified public charity or private foundation which can receive donations. Contributions to donor advised funds aren't considered qualified charitable distributions. And, as with any gift to charity, don't forget to obtain a receipt acknowledging your gift.

Qualified charitable distributions will help to fulfill your annual required minimum distributions. But, your donation can be greater than your required minimum distribution amount. You can exclude up to $100,000 in qualified charitable gifts each year. A gift amount over $100,000 must be recognized as income and deducted according to the standard charitable deduction rules.

Above all, keep in mind that you cannot double-dip and take a deduction for your IRA qualified charitable contribution. No deduction is permitted for charitable distributions which are not recognized as income.

Finally, be sure you act soon. Only contributions made to charity before January 1, 2008 can be characterized as qualified charitable distributions.

Qualified charitable distributions are just one tax planning tool which may save you money. We advise our clients to meet with their tax professional in November or December to review their tax plan before year's end. Tax planning is complex and time consuming. So, make an appointment with your tax professional before the real tax season hits.

For more information about year-end tax planning, you are invited to attend the November NAPFA Consumer Education Foundation presentation. John G. Bowen, CPA, CFP®, AIF®, of Bowen Financial Services, LLC, will be speaking on year-end tax planning.

The seminar will be held on Saturday, November 10th from 12:00pm to 1:30pm at the Northside Library in the Albemarle Square shopping center. For more information call (434) 244-0000, or send an email to Charlottesville at napfafoundation.org. To learn more about the NAPFA Foundation visit <a href="http://www.napfafoundation.org/NAPFAfoundation_Charlottesville.htm" target=_blank>http://www.napfafoundation.org/NAPFAfoundation_Charlottesville.htm</a>.

All presentations are free and open to the public. You are encouraged to attend and to bring your financial questions.

from http://www.emarotta.com/article.php?ID=253

Employee Retirement Options - Part 2 (2007-10-15)

by David John Marotta

Most employees have all their retirement eggs in one basket --their employer's retirement plan. The plans usually offer less than two dozen fund choices to cover all your hopes of maintaining your lifestyle, independence, and dignity in your later years. As discussed in the previous article, the more baskets (and eggs) you have, the better. If most of your retirement assets are with your employer, here's how to make the most of what you've got.

First, there are some mistakes to avoid. Probably the most common mistake made by employees is to allocate an equal amount of money to each of the fund choices. Studies have shown that given ten choices, employees tend to put 10% in each choice. Given five choices they put 20% in each choice. If four of the choices represent one type of asset and the fifth is unique the asset allocation is split 80/20. If the funds happen to be the other way round then the asset allocation is 20/80.

The equal proportions methodology builds very poor portfolios. You can't afford to make these types of mistakes with your future livelihood. The only thing worse than the equal proportions strategy is allocating all of your money to just one fund. You need an investment philosophy that integrates all of your asset holdings. Only then can you evaluate which of your company's fund options are right and determine what percentage to allocate to each.

Many employer sponsored retirement plans are just mediocre. Neither the fund company nor plan provider has much incentive to fill your selections with stellar choices. Plan sponsors have a fiduciary responsibility, but few take that responsibility seriously. Procedures may or may not be in place even to meet minimum guidelines. Still, you should be able to find a few funds worth selecting in order to gain your employer's match.

Your own company or plan provider usually isn't the best place to turn for advice. After all, they are the ones that picked the options in the first place. You should get the outside opinion of a professional financial planner on where to invest.

Another common mistake is to invest in whatever funds have done the best over the past 1, 3, or 5-year period. None of these measures is long enough to produce a balanced asset allocation. Every financial disclaimer states that "past performance is no indication of future returns," and yet, past performance remains the primary selection criteria for many investors. Too many employees pick the asset category that has done the best over the past three years. However, these higher-than-average returns often represent a peak. Going forward, they are the fund choices most likely to under-perform for the next three years.

While three year average returns is a poor way to select a fund, thirty year average returns is a good way to select an asset category for including in your asset allocation. If small cap value is a good asset category to include for the long term, see if your plan includes any small value funds. Then judge them against other outside funds within their asset class and not against other funds within your plan.

You should be looking for funds which are the best funds within their asset class regardless of how well the asset class has done over the short term of just the last few years. Funds that are the best in their category can often be found through index funds that have very low expense ratios.

Remember also that you are looking for a team of funds and not just a few hot shots. Your retirement portfolio consists of more than just your employer's plan. Even if your employer's plan only has a couple of good choices, you can use your other investments to create a balanced asset allocation. While the choices in your employer's plan may be limited, investments in your IRA or taxable account will have an unlimited number of choices from which to craft a balanced allocation.

It is important to start with an over all asset allocation plan and then see what asset classes your employer's plan offers that would integrate well with your investment philosophy. Since your employer's plan usually has the most limited number of choices, pick the best it has to offer that fits with in your over all plan.

The NAPFA Consumer Education Foundation is holding a free seminar on how to build a well diversified retirement portfolio using your employer's retirement plan choices. I will be presenting how to build retirement portfolios using the choices available at the University of Virginia. The talk will be held on Saturday, October 20th from noon to 2pm at the Northside Library. For more information call (434) 244-0000, or send an email to <script language="JavaScript">eval(unescape('%64%6F%63%75%6D%65%6E%74%2E%77%72%69%74%65%28%27%3C%61%20%68%72%65%66%3D%22%6D%61%69%6C%74%6F%3A%63%68%61%72%6C%6F%74%74%65%73%76%69%6C%6C%65%40%6E%61%70%66%61%66%6F%75%6E%64%61%74%69%6F%6E%2E%6F%72%67%22%3E%63%68%61%72%6C%6F%74%74%65%73%76%69%6C%6C%65%40%6E%61%70%66%61%66%6F%75%6E%64%61%74%69%6F%6E%2E%6F%72%67%3C%2F%61%3E%27%29'))</script>. To learn more about the NAPFA Foundation visit <a href="http://www.napfafoundation.org/NAPFAfoundation_Charlottesville.htm" target=_blank>http://www.napfafoundation.org/NAPFAfoundation_Charlottesville.htm</a>.

from http://www.emarotta.com/article.php?ID=252

Employee Retirement Options - Part 1 (2007-10-08)

by David John Marotta

Putting all of your retirement eggs in one basket is easy to carry, but risky. Most workers are putting all their retirement assets in the basket of their employer's retirement plan. They are depending on one employer and two dozen eggs (funds) to hatch and maintain their lifestyle, independence and dignity in their later years. Don't trip.

Just one generation ago employers provided their employees with defined benefit plans for retirement. The employee could plan on a benefit that the employer had contractually promised. The employer was responsible to insure that a defined amount would be payable to each employee when they retired. Such security today is obsolete.

The new model moves the outcome responsibility from the employer to the employee through what are called defined contribution plans. The employer is helping with the input (the contribution), but no longer guaranteeing the output (the benefit).

An employee's retirement income is now contingent on four variables: how much the employee puts in, how much the employer matches, the performance of the underlying funds and of course, time.

In a typical defined contribution plan the employer will match dollar for dollar the first 3% of your salary, and fifty cents per dollar on the next 2% of your salary. That means if you contribute 5% of your salary, your employer will give you an additional 4% of your salary in retirement contributions.

Getting the maximum amount possible of this free money should be your first priority in saving for retirement. Even if your 401k or 403b defined contribution choices are not stellar, you still get an automatic 80% return on your money the very day you contribute. Strangely, many employees neglect to pick up this free money. The 80% automatic return is an offer you should not refuse.

After saving enough to get the full match from your employer, don't necessarily continue to use your employer's plan as your only retirement basket. After getting the full match, we recommend funding your Roth IRA, your spouse's Roth IRA and your taxable account. Only after adequately funding these individual account choices should you consider putting more money into your employer's plan than is necessary to get the full match.

Retirement plans through work are laden with fees and expenses that are not on individual investment accounts. The difference in fees is often 1% or more. The longer you leave your money in a defined contribution plan, the more the excessive fees will erode its value. There are plans so laden with fees that they are not even worth the match. Where the fee differential is 2%, after 30 years the fees will have eaten up the entire 80% match.

In other words, if you had the same amount of money in a traditional IRA account earning 2% more because of lower fees after 30 years you would have 81% more money in your account. For this reason alone, make sure that you don't leave money in an employer's retirement plan any longer than you have to. After terminating employment with one employer you should always roll that money into an individual IRA Rollover account where you can invest with lower fees and better choices.

It is a mistake to move money from a pervious employer's plan into your current employer's plan. This mistake, however, can often be undone. Money that has its source from another employer is usually allowed to be rolled out of an employer's plan and into an IRA Rollover account. If you are in this situation you should see if you can rescue some of your investments from the higher fees and limited choices of your current employer's plan.

There's another important tax reason not to put all of your retirement assets in your employer's plan. If you take a deduction while you are in a low tax bracket and in retirement when you are taking withdrawals you are in a higher tax bracket then your contributions work against you. You would have done better to have put your extra non-match retirement savings into a Roth or taxable account. Your tax rates are likely to be higher during your retirement. Currently, top marginal tax rates are only 35%. Before the Bush tax cuts the top marginal rate was 39.6%. Before the Regan tax cuts the top marginal rate was 70%. Before the Kennedy tax cuts the top marginal rate was 90%. Tax rates are at historic lows.

When you take the money out of an employer's plan or a traditional IRA account you will have to pay taxes at whatever tax rate is currently in effect. And after age 70 ½ you will have to start taking required minimum distributions in order for the government to ensure that they will get their tax. Historically speaking, the odds are your withdrawals during your retirement will be charged at a higher income tax rate than the deduction you received when you put the money in.

It may be better for you to pay your current tax rate and get your money into a Roth IRA where it won't be taxed again or a taxable investment account where the growth is only taxed at capital gains rates.

If you are just starting out in your career you are probably in the lowest tax bracket you will ever be in. Therefore it is more important to carry your retirement savings in more than one basket. Fund your employer's plan with no more than is necessary to get the match and then fund your Roth IRA and build your taxable savings.

The NAPFA Consumer Education Foundation is holding a free seminar on how to build a well diversified retirement portfolio using your employer's retirement plan choices. I will be the speaker this month presenting how to build retirement portfolios using the choices available at the University of Virginia. The talk will be held on Saturday, October 20th from noon to 1:30pm at the Northside Library. For more information call (434) 244-0000, or send an email to Charlottesville@NAPFAFoundation.org. To learn more about the NAPFA Foundation visit <a href="http://www.napfafoundation.org/NAPFAfoundation_Charlottesville.htm" target=_blank>http://www.napfafoundation.org/NAPFAfoundation_Charlottesville.htm</a>.

from http://www.emarotta.com/article.php?ID=251

by David John Marotta

Not all deductions are created equal. Some deductions are more valuable than others. What matters is whether or not the deduction is "above the line" or "below the line". The line in this case is your adjusted gross income (AGI).

Above the line deductions are subtracted from your gross income in order to compute your AGI. Therefore, above the line deductions reduce your AGI which also reduces your taxable income. Reducing your AGI can lower many subsequent calculations which will lower other taxes you may have to pay. As a result, above the line deductions are more advantageous than those taken below the line. They are like Dorothy's ruby slippers, once you have them on the Wicked Witch of Taxland can't touch you.

Below the line deductions are more uncertain. Like many items in the tax code the correct answer to "Will they reduce my taxes?" is: "It depends." They are like Dorothy's first encounter with the Wizard. He promises to grant her requests if she would only bring him the witch's broomstick and she never thinks to challenge the man behind the curtain.

AGI minus your personal exemptions and deductions equals your taxable income. You can claim a personal exemption for you, your spouse, and your dependents. In 2007, you can reduce your AGI by $3,400 for each exemption you claim. These exemptions are subject to phase outs above $234,600 for joint filers ($156,400 for singles).

Below the line deductions are subtracted from your AGI to compute your taxable income. You can either itemize your deductions or you can take a standard deduction, whichever is greater. In order to gain from itemizing, your itemized deductions must exceed your standard deduction. Nearly two out of three taxpayers do not gain and choose to take the standard deduction instead.

Your standard deduction is a fixed dollar amount based on your filing status plus some specific adjustments. For 2007, your standard deductions is $5,350 if you are single, $7,850 if you are the head of household, or $10,700 if you are married filing jointly. You can take an additional standard deduction of up to $1,050 if you are age 65 or older.

Home ownership is the most common way to boost your deductions above the standard deduction. The IRS allows home owners to deduct their interest payments each year. If your home mortgage is at 6% and your payments are mostly interest, then most of your mortgage is tax deductible. If your marginal tax rate is near one third, the government is paying 2% of your interest, and you are only paying 4% of your interest. For most middle class families that results in a huge tax savings.

The benefits of a mortgage are greater when the majority of your payment is interest, not principle. There is no tax deduction for payment of principle. Therefore, you want as many years of interest payments as possible. As a result, 30-year mortgages have much greater tax savings than 15-year mortgages.

When it comes to maximizing your deductions, home owners can also deduct real estate taxes and points paid down on the loan. The cost of the points can be deducted over the price of the loan. So, If you paid $3,600 in points for a 30 year mortgage you can write off $10 a month, or $120 each year. If 10 years into the loan you refinance again, all the remaining points that haven't yet been deducted are deductible in the year you refinance anew. In our example that would be $2,400.

If home ownership alone doesn't make itemizing worthwhile, your state and local taxes (including personal property taxes) along with any charitable deductions may push you over the top. Alternately, if you have high medical expenses which exceed 7.5% of your AGI, you can deduct them as well.

Once you have ensured that your itemized deductions are over your standard deduction there are several smaller deductions that can increase your tax savings.

Miscellaneous itemized expenses can be deducted only when their total exceeds 2% of your AGI. For most people, their deductions are too low or their AGI is too high. But, if your income drops for a year, or you retire, you may qualify.

Deducting miscellaneous expenses is difficult unless you keep good records throughout the year. Qualifying expenses may include work related expenses, legal or accounting fees related to tax preparation, investment advisory fees, estate planning and investment expenses including your safety deposit box, professional dues, and newspaper subscriptions.

Overall, keeping good records is vital to determining whether you can itemize your deductions come tax time. Itemizing your deductions may provide you with some additional tax savings. With an overflowing bucket of deductions and exemptions, your tax burden will soon be melting.

from http://www.emarotta.com/article.php?ID=250

Dorothy in Taxland - Tax on Marriage (2007-09-17)

by David John Marotta

Few Americans look forward to the idea of filing taxes. At best we feel like Dorothy being dropped into the Land of Oz. At worst, we feel like the Wicked Witch of the East having the house dropped on us.

As Glinda advises us, "It's always best to start at the beginning," and at the beginning of the tax return is determining your filing status. You would think that this is an easy and straight forward question. But since this is the beginning of dangerous journey on the yellow brick road, it is worth understanding the inequities that this section of the code causes.

Two different people with the exact same income and the exact same deductions can end up with very different amounts of tax owed, simply because of their filing status. Married couples -rich and poor alike- often bear the brunt of the inequities created by our current tax system

Every tax system does a certain amount of harm. The more progressive the tax system, the more devastating the unintended consequences. No marriage-neutral tax system can exist given a progressive taxation system.

Most people wrongly assume that the marriage tax penalty was eliminated by some of the tax changes that were enacted and gradually implemented over the past several years. The marriage tax penalty was eliminated in the 10% and 15% brackets by increasing the number of married couples who get special tax breaks.

Let's look at some examples.

Michael and James work in the same business. Each makes the same salary and takes the same deductions. The only difference is that Michael's wife stays home, while James's wife works at the firm.

In this case, the tax code gives Michael and his wife a tax break. Michael gets the benefit of claiming two personal exemptions (one for himself and one for his wife). The tax code favors these provider/dependent marriages like Michael's. They are better off filing jointly since Michael's wife - who is not earning any income - can't put her personal exemption to good use. But by filing jointly, Michael and his wife can use both personal exemptions, thus lowering the taxes on Michael's earnings.

However, James and his wife find themselves paying significantly more tax simply because they are married filing jointly.

If James and his wife are both low-income their filing status will dramatically change their tax status. A low income couple who marries and combines their income can forfeit other programs designed to help the truly needed. The most important of these programs is the Earned Income Tax Credit (EITC).

For 2007, a couple's income must be under $39,783 in order to qualify for EITC, while filing single or head of household must be under $37,783. Imagine a couple where each makes about $20,000 a year and you can see their dilemma.

EITC isn't small change either. In fact it is a much better way of targeting poor working families than raises to the minimum wage. For 2007, the maximum EITC credit is $4,716 which can make a huge difference in a struggling family.

The marriage penalty remains even if James and his wife are well-off. They are taxed as though they represent one very high income taxpayer and must pay more than they would if they were unmarried and just living together.

Most likely, neither Michael nor James will let the tax code determine if they should get married. But you can bet that Michael's wife and James's wife will let the tax code determine how much they are willing to work.

Because James and his wife are taxed at a combined rate, there is very little incentive for James's wife to continue working. Another way to think of it is a tax on families with two earners. In other words, it is a tax on married women whose husband's work, especially on women with high incomes.

James and his wife, by combining their incomes, have pushed each other into the top marginal tax bracket. That means for every dollar that James's wife earns, she is probably taxed at over 50%, including federal, state, and local taxes.

Now compare James's situation with Michael's. If Michael's wife can save a dollar by bargain shopping and preparing homemade meals, they are a dollar richer. James and his wife would have to earn at least two times as much to fare as well. Because of their combined income pushing them into the highest tax brackets, the government will take over half of everything they earn.

They will also have additional expenses as a result of working, and few, if any, of these expenses will reduce their income. Their business clothes, gas, and child care expenses may all have to get paid with after tax dollars making these expenses two times more costly than the income they may generate.

If all of this public policy debate makes your head swim, you are not alone. The bottom line is: The flatter the tax system, the less it matters whether couples combine their incomes or not. If every dollar of income were taxed the same and there were no deductions or credits, it would not matter if James and his wife combined their incomes. The same flat percentage of a combined amount is still the same flat percentage.

Practically speaking, many couples would be better off having either mom or dad stay at home. Having one family member who is working at reducing expenses and improving lifestyle can be the least expensive way to increase family wealth. Saving money by doing more things for yourself is worth two times the income earned by the spouse who winds up in the top brackets. And besides, "There's no place like home."

from http://www.emarotta.com/article.php?ID=249

Dorothy in Taxland: Above the Line Deductions (2007-09-10)

by David John Marotta

Those with wealth look ahead and adjust their affairs according to the tax code. But, most Americans look backward and only hope that Uncle Sam will return some of what they have already paid. Living in the moment and only looking backward is a recipe for paying the most tax at the worst time.

If you are like most Americans, you filed your tax return in mid-April and did not look at any of it during the last four months. The tax preparation which seemed so valuable at the time has faded like Dorothy's memories of Oz when she wakes up back in Kansas.

Many people who use tax computation software don't even understand the changing structure of our country's tax code. You fill in the blanks, press compute, pay the tax, and then forget about the torture until next year.

Into this dark forest of the tax code we throw college students and recent graduates. It is almost a rite of passage, better likened to a fraternity hazing than a step into adulthood. We smile a little when the trees grab the apples out of their hands.

The obfuscation of the tax code helps hide the details. Its Byzantine rules and regulations are carefully crafted to cover up just how much we pay each year. In other words, tax laws are stupid by design. While you are busy trying to translate word problems written in 'Taxglish' you don't realize they are asking all the wrong questions. Like Dorothy in the field of poppies, you can't seem to stay awake long enough to realize the danger.

Still, as long as you are so close to the Emerald City, it would be nice to have Glenda send a rain to help you get inside the city's gates. Similarly, a basic understanding of the specific contours of the stupidity of the tax code can help you avoid meaningless extra payments to the government and keep more of your income.

A professional tax expert can help you get the right deductions, but likely won't motivate you to keep the right records unless you understand the benefit for yourself.

There are three basic ways to reduce your tax burden: above the line deductions, below the line deductions, and credits. Each of these deductions is used in one of the three general formulas on the 1040 tax form. The first formula is: Gross income minus above the line deductions equals your adjusted gross income (AGI).

All deductions are not created equal. Some deductions are more valuable than others. What matters is whether or not the deduction is "above the line" or "below the line". The line in this case is your adjusted grow income (AGI).

Above the line deductions are subtracted from your gross income in order to compute your AGI. Therefore, above the line deductions reduce your AGI which also reduces your taxable income. A lot of calculations and limits are computed from your AGI. So, reducing your AGI can lower many subsequent calculations to lower other taxes you may have to pay. As a result, above the line deductions are more advantageous than those taken "below the line."

Above the line deductions will always lower your taxes. Above the line deductions are rare unless you are self-employed because they are mostly business related expenses. If you are self employed, you should have a lot of above the line deductions you are taking advantage of.

Above the line deductions include everything on Schedule C or F business deductions. If you are not a small business owner, you should consider performing some or all of your work under the umbrella of your own small business. If you run a successful business you will be paid twice what you are currently being paid and find yourself on the yellow brick road of accumulating real wealth. Even if you don't get any more pay, you may find more of your expenses are tax deductible and therefore you will pay less tax.

If you are not a small business owner there are still above the line deductions you can take such as: stock losses up to $3,000, IRA contributions, student loan interest, moving expenses, alimony and several other items.

Payments to your Health Savings Account (HSA) can also be deducted above the line. In 2007 the limit is $5,650 in tax free contributions. One out of every ten patients consumes 69 percent of health care costs. The other nine would benefit from an HSA.

With the savings on your insurance premiums, you should be able to accumulate a sizeable nest egg. And, unlike your traditional health care plan, your HSA funds are not subject to a "use it or lose it" policy. Anything you don't spend one year carries over to the next year. After all, it's your money.

In addition to doctor's visits, hospitalizations, lab tests and the like, an HSA can also pay for prescriptions and some over the counter drugs like aspirin with pre tax dollars. HSA accounts can even pay for vision and dental expenses such as contact solution and teeth cleanings.

Another above the line deduction is specifically designed for teachers. If you are a qualified educator you can deduct $250 for books, supplies and computer equipment you purchase. This deduction has been extended through 2007 as well.

These deductions are like Dorothy's ruby slippers, they are adjustments to your income and once adjusted nothing else in the tax code can touch them. Fund your retirement account, start a health savings account and go into business for yourself to take advantage of these incentives in the tax code.

from http://www.emarotta.com/article.php?ID=248

by David John Marotta

Last week we listed the ways university student are enticed into using credit cards. This week we will examine the economical impact of those initially small and convenient monthly payments.

If your credit card minimum payment was $10 and you repaid it every month for 15 1/2 years with an accruing interest of 15.9%, a $1,000 purchase would end up costing $2,250. Every time you use your credit card to pay for something you risk it being marked up two and a half times the normal sales price. Over time, that $10 T-shirt cost you $22.50!

Whenever you use your credit card, imagine that two and a half times the price of what you are buying will be deducted from your account over the next decade.

Students assume that they can run up a credit card bill because it will be easy to pay it off after they graduate when they get a high paying job. But the larger your debt the longer it takes to pay off that debt using minimum payments. The average student graduates with about $7,000 in credit card debt. They assume that $7,000 will be easily wiped away with their first high paying job.

Being burdened with $7,000 in credit card debt after graduation costs nearly $20,000 and can stretch nearly forty years to erase with minimum payments. Just when you should be saving and investing that $20,000, growing rich or buying your own home you are stuck with unfinished and unneeded college debt.

Whenever you casually reach for your credit card during college, visualize the choice between having the down payment on owning your own home or making that purchase.

Studies have linked accumulating credit card debt to psychological stress that increases the likelihood of dropping out of school and suicide. Students find themselves ill-equipped to handle the anxiety of mounting collection agencies alongside their course of studies.

Studies have also shown that a college degree is worth over a million dollars in increased lifetime earnings. Don't sacrifice the million dollar benefits of an education on the frivolous purchases of a credit card.

Every time you reach for a credit card image that credit card hanging on your wall instead of your diploma. It could cost you a million dollars to frame it.

The years after college and before children are the best time in your life to save. But you lose time and squander your resources if you enter the marketplace with credit card debt.

Your high school and college years are the prime years for funding your Roth IRA. If you use a credit card but don't fully fund your Roth IRA each year you have a credit card problem. Unlike a traditional IRA, you contribute to a Roth IRA after taxes, it grows tax free, and then in retirement you can make tax free withdrawals. Because the money is contributed after taxes, it is best to fund an IRA while you are a poor college student working summers and part time and still in a low tax bracket.

Contributing $2,000 a year to your Roth IRA during high school and college is better than starting to contribute during your first year after college and continuing for the remainder of your life.

Every seven years you wait to fund your Roth IRA you cut in half the standard of living you will have in your retirement. With normal market returns, after seven years of $2,000 a year contributions your Roth IRA will be appreciating at a rate of more than $2,000 a year, without any additional contributions. At normal market rates of return, that $14,000 contribution during high school and college will ultimately grow to more than $2 million dollars by age 67 and more than $4 million dollars by age 73.

Whenever you look at prices in a store or restaurant, imagine taking the decimal out in front of the cents. That is how much tax free income you are losing in retirement by not contributing to your Roth IRA. And by age 85 you could add another zero. The $8.50 lunch costs you $850 at age 63 and $8,500 by age 85.

If you don't think you have any problems with your use of credit cards, but you haven't been saving and fully funding your Roth IRA, you have a problem with your use of credit cards.

Every time you go to use your credit card ask yourself if you've fully funded your Roth IRA for the year. If you haven't, put the credit card right back in your wallet.

All debt is not equal. Credit card debt is bad debt. Student loans are good debt. Good debt is anything that last longer than it does to pay the loan back. Good debt is investing in things that will pay you more money than the debt costs. An education is good debt because it will increase your income, satisfaction in life, and longevity.

Credit card debt is bad debt. Bad debt is anything that you can wear, eat or drink. Always pay cash for these items. If you do, what you wear, eat and drink will be healthier and less expensive. The next time you pull out your credit card for any of these items imagine wearing, eating or drinking $20 dollar bills.

Use these visualization techniques to stem your excessive use of credit. Alternately, just leave your credit card locked in your dorm room. Life's too short to let it get sucked dry by credit cards.

from http://www.emarotta.com/article.php?ID=247