JoeTaxpayer

From Innumeracy.com:
Innumeracy: A term meant to convey a person’s inability to make sense of the numbers that run their lives. Innumeracy was coined by cognitive scientist Douglas R Hofstadter in one of his Metamagical Thema columns for Scientific American in the early nineteen eighties. Later that decade mathematician John Allen Paulos published the book Innumeracy. In it he includes the notion of chance as well to that of numbers.

From “Money Merge Advantage“, an MMA agent’s blog:
“In FACT… The software alone could still beat the 2nd scenario (putting the $300 discretionary to the mortgage each month)… WITHOUT using that discretionary income AT ALL. Yes, SERIOUSLY!”

If you have no idea what Money Merge Accounts are, or what I am talking about, please see my Money Merge Links page for references and then read on. In the blog I reference, the example starts with $250K, 30 yr, 6.5% mortgage. Then we are told a bi-weekly will provide some $75,800 worth of interest savings. No problem there, a bi-weekly is like paying 8% higher than the required monthly payment, usually in the form of a 13th payment snuck in once a year. The examples then offer that $300 more each month will cut the mortgage down to 19 yrs 8 months, which I still follow. But then the blog writer claims that with no extra money, beyond the $300, MMA will cut the mortgage to 14 yrs 4 months! This is beyond the wildest claims I’ve seen so far, and completely beyond reason.

Lastly, came the quote above, suggesting that with no extra funds available, the HELOC shuffle alone can produce savings greater than a $300 monthly principal payment would achieve. This raises new and troubling questions. The couple in the example have a net income of $3800/mo. If their HELOC were 0%, and they borrowed this $3800 at the beginning of each month, and paid it back at month’s end, it would gain them just under $21 per month, nowhere near $300. And no HELOC offers a 0% interest rate. At best, the HELOC is a percent or two under the fixed rate mortgage. This is simple math, folks, and no “sophisticated algorithms” are going to change the fact that 1+1=2 or that the best one might squeeze out of their HELOC shuffle efforts is $20-$30 per month, certainly not $300.

Joe

written by JOE \\ tags: HELOC, income, innumeracy, interest, jferheart, mma, money merge account, Mortgage, saving, sophisticated algorithms, UFF

I recently read a post “Why I love Roth IRAs” in which the author ignores much of the math going in and coming out. Now, I love Roths myself, but only when used to take most advantage of the tax rates involved. Let me explain. From my feature article earlier this year titled “Can you save too much, pre-tax?” we see that a couple with $447,500 in their 401(k) or Traditional, Pre-Tax IRA, can take withdrawals and remain in the 0% bracket. This is due to the combination of standard deductions and exemptions. The next $401,250 will support withdrawals at the 10% rate.
If you have a defined benefit pension (a traditional pension) the numbers certainly will shift, and you need to take this income into account. Pensions are getting more scarce and those who frequently changed jobs are likely to have never vested into any one plan.
So, now I’ll ask, what percent of retirees are likely to have saved this sum, a total $848,750 from the numbers above? I cite an article from AARP titled 2004-05 Boomers which offers a forecast. One chart in this report offers that for those born in 1956-65, their mean (this means average, important distinction from median, middle) wealth is forecast to be $839K. But reading on, we find that after subtracting non-retirement wealth and present value of Social Security benefits, we are looking at a retirement account balance of just $140K. It turns out the 4th quintile (this is the second 20% from the top) is forecast to have $906K, this scales to about $151K in retirement accounts. Even the top quintile (top 20%) will average $2028K total wealth, with maybe $350K-$400K in retirement accounts. So it’s only the upper portion of that group (in addition to those with fat traditional pensions) that need to consider the Roth while working. For the rest of us, we will likely be in the 10% or if fortunate, the 15% bracket upon retiring.
I’ll close with this thought - each family has their own set of numbers. This is why if you write in to a web site or magazine and ask “Is Roth good for me?”, it’s impossible to answer without knowing many details. We know more the closer you are to retirement, but only have a series of clues the further away you are. Another blog “The Finance Buff” offers a view similar to mine. I remain surprised at how many wave the Roth flag without some level of analysis. For those who have access to a Roth 401(k) and Roth IRA, it would be a shame to load those up and find that they missed out on the tax savings that pretax savings could have provided.

Joe

written by JOE \\ tags: 401(k), Finance, income, IRA, Retirement, retirement account, roth ira, saving, Savings, Social Security, tax, tax rates, traditional pension, wealth

In a simulcast of publishing both here, and my main web page, where I publish a monthly article, I am happy to offer my List of Lists;

Ever since 1977’s “Book of Lists“, our fascination with lists and sets of rules has grown. David Letterman’s Top Ten List has been going on for decades with no end in sight. These are Rules of Money that I’ve saved over the past few years, enough to post my favorite “List of Lists”. If I missed one of your favorites, please leave a comment and I will add it.

• 25 Rules to Grow Rich By
• 9 money rules to live by
• 16 favorite money rules of thumb
• 5 money rules to live by
• Jim Cramer’s 25 Rules of Investing
• Charlie Munger’s 10 Rules for Investment Success
• The 10 Most-Hated Money Saving Tips
• Eight Secrets of Financial Happiness
• 10 Reasons You are Not Rich
• 20 timeless money rules
• Dilbert’s “Unified Theory of Everything Financial”
• 50 Tips to Help Establish Your Emergency Fund
• Ten Things You Need to Know About Money
• Seven Reasons to Welcome a Recession
• 15 ways to improve your credit score
• 50 Ways To Raise Your FICO Credit Score

Take your time, enjoy the list, and send me your thoughts.
Joe

written by JOE \\ tags: 20 timeless money rules, book of lists, charlie munger, Credit, david letterman, emergency fund, fico, fico credit score, Investing, investment, investment success, jim cramer, money, recession, rich, saving, TIPS, top ten list

Consumer Reports recently offered an article titled “Your Debt; 8 Benchmarks For Borrowing“, which, for the most part, I liked and will consider adding to a List of Rules I’m assembling. Among the warning signs;

• 28% - Monthly Mortgage (including property tax and insurance) should not exceed this number. Really? That’s exactly what I suggested in my post Mortgage 101, so I’m in full agreement there.
• 80% - The first mortgage should not exceed this level. A lower debt to equity ratio is better. Interesting, I made the same comment in Mortgage 101, but that was more to benefit the bank, not the borrower. I’ll maintain that if the payments are still within the guidelines, there’s nothing magic about 80%.
• 6 - month’s worth of income as emergency money. I wrote about this as well, a couple weeks back in my controversial Emergency Funds post. This may be a worthy goal, and right for many, but not at the top of my list. I have been aggressive in retirement savings, well above average, managed the mortgage with serial refinancing to capture a low rate and an amortization that will end the mortgage well before retirement, and funded college in full for a child who is only 10, yet I’ve ignored this rule.

The CR article goes on with guidelines that are still worth reading if not following right to the letter.

Joe

written by JOE \\ tags: amortization, debt, emergency fund, Finance, income, Investing, Retirement, saving

The June Kiplinger’s magazine ran an article, “Raiding your 401(k).*” It advises against borrowing from one’s 401(k) and cites a T. Rowe Price study suggesting that someone borrowing $10,000 for 5 years (at age 35) will be short $145,000 at retirement even after paying back the loan. At 10%, $10,000 would grow to $131,100 in 27 years, that’s just math. Maybe they think this guy will retire at 63, not 62. But he did not take a withdrawal, he took a loan. My 401(k) charges 6.5% for a loan, credited back to the account. This means a 3.5% hit to the return on that borrowed $10,000. The account will come up short about $900 for having had the loan outstanding. Still using the 10% return, the retiree may find he is short nearly $13,000 at age 62, certainly not $145,000. Someone at T Rowe hit the wrong key, and none of my friends at Kiplinger’s catch this?

Think about this, though, the story cannot just end there. I can make the case that what matters is where that $10,000 loan went. Did the person buy a plasma TV and sound system? Or did he pay off all his credit card debt (at 24%) and start fresh? I can add to this - perhaps he was paying $288/mo and would have done so for 5 years to pay off the cards, but now is able to pay only $196 to the 401(k) loan, and use the extra $92 as an addition monthly deposit to his account. He is in the 25% bracket, and deposits a full $123 (which is the gross amount that nets him the $92) to his 401(k) and it’s matched by his employer, dollar for dollar, so at the end of year 1 he has nearly $3000 more in his account which more than makes up for the $350 hit he has from the loan itself. By staying on this path, he’s actually ahead by over $150,000 at retirement time.

As with any example, your mileage may vary. There is just one point I’d like you to take from this post. In finance, there are few absolutes. For every person who uses their 401(k) loan wisely, there may be five who blow the money and run up their credit cards again. But just as I take issue with Dave Ramsey’s statement that ‘responsible use of a credit card does not exist’, I feel that there are wise ways to use loans, 401(k) or otherwise. While I admit that a short article appearing in a magazine cannot cover every possibility, the one missing (and most important question was ignored - what does the borrower do with the money?

Joe

*The article is not yet available on line. As soon as I am aware it’s accessible, I will link to it.

UPDATE - I made an error here. (I prefer to leave the error in tact, above, but add this footnote.) In fact, the article did state “assume contributions stop for the life of the loan, as usually occurs”. This would make the math work, although I still take issue with these assumptions. I plan to revisit this subject in a future post.

written by JOE \\ tags: 401(k), 401(k) loan, credit card, Finance, Inumeracy, kiplinger's magazine, Retirement, saving

There’s a recurring question regarding whether one should rollover a 401(k) from a previous employer to an IRA account (or to the new employer’s 401(k)) or leave it in the original account. One new variable that comes into play is the ability to convert one’s IRA to a Roth IRA, regardless of income, in 2010. How are the two related? When one converts from a regular IRA to a Roth, taxes (at your marginal rate) are due on a prorated basis on the pretax money within the IRA. For example, if you have a $100,000 balance, $20,000 of which is post tax deposits, 80% of any money converted is subject to tax. Now, this presents an interesting opportunity. Most 401(k) accounts will permit IRA money to be rolled back into the 401(k) regardless of the source. So in this example, you might consider rolling the $80,000 in pre tax money into the 401(k) before doing the conversion on the $20,000 post tax money. This two step will avoid any and all tax on that conversion. If you have a 401(k) account, you might consider leaving it for now, and converting it to an IRA only after that Roth conversion is made in 2010.

Joe

written by JOE \\ tags: Finance, Investing, IRA, Retirement, roth ira, saving

For this, you must do a bit of homework to see if this advice can apply to you. Go to Fairmark and look at the tax rate schedule that applies to your filing status. You must also have a good idea what your taxable income will be, at least as the year draws to a close. If you fall near the top of your marginal rate, say $32,550 for a single, $65,100 joint, keep reading.

During the year, of course you should deposit enough to your 401(k) to capture your company match. But beyond that, make use of a pretax IRA if you are able to save more. At year end, if you are going to be just below the top of your tax bracket, make use of the Roth conversion to take some existing IRA money and convert to your Roth account.

For example, as I mention above, the 25% bracket begins for a couple, filing jointly, at $65,100. Remember, this is after exemptions, ($3500*number of family members) and any other deductions including itemized or the standard deduction of $10,900. So you see that one can gross as much as $100,000 or more and still be near the 15%/25% line.

Over the years, by straddling the top of the 15% bracket, but not paying 25%, you will save a lot of money on your taxes, and as you near retirement, the Roth accounts can be used if you retire before 59-1/2 to take withdrawals. Look at the Fairmark site to understand if this wil help you, and send a comment if you have any questions. Enjoy the weekend. Next week, we will talk about how to take advantage of Schedule A vs the Standard Deduction.

JOE

written by JOE \\ tags: Finance, Investing, Retirement, roth ira, saving

Did you know that money deposited to a Roth Ira, while not deductible, may be withdrawn with no penalty? Here’s what this means for you: If you are struggling between the need for an emergency account and saving for retirement, consider opening a Roth IRA, and within the account just buy a CD. As you are able to save more than the Roth limits ($4000 this year or $5000 if you are 50 or older this year) you will have built up an emergency account outside the Roth and can begin to invest the Roth more aggressively. No, you can’t have you cake and eat it, too, but your Roth can perform double duty helping you jump start your retirement savings while acting as an emergency fund. A no-lose proposition.
JOE

written by JOE \\ tags: Finance, Investing, Retirement, roth ira, saving

As the end of the year draws near, I try to think of the Year End moves and financial planning that one may wish to consider. The consideration of a Roth and how it might benefit you continue to enter my thoughts.

If this year you fall into a lower tax bracket than usual, this may be a good time to convert some money from a regular IRA to a Roth, just enough to ‘top off’ the current bracket you are in.

If your income is too high to be allowed to save in a Roth IRA, you may consider saving in a non-deductible IRA as the law allowing conversion will change: from RothIRA.com “Starting in 2010, the existing $100,000 income test for converting a traditional IRA to a Roth IRA will no longer apply. Conversions that occur in 2010 will be able to have half of the taxable converted amount taxed in 2011 and the other half taxed in 2012.” This offers a remarkable opportunity to save post tax (you will only owe tax on the growth from now until 2010*.) and enjoy tax free growth and withdrawals when you retire. If left as post-tax deposits in the IRA, it woul be subject to full, ordinary income rates at withdrawal.

*For any readers who have IRA deposits which are pretax, the conversion rules require you to prorate your entire IRA balance to calculate what is taxable at conversion. e.g. If you made $10K in pretax deposits, and $20 in non deductible deposits, and the account is now worth $50K, 80% of Roth conversion would be taxable (10/50 = 20% is not taxed). If your only pretax savings is in 401(k) accounts, this will not impact you. Always glad to read feedback on my postings, don’t be shy.

JOE

written by JOE \\ tags: Finance, Investing, Retirement, roth ira, saving

On my feature web site, I wrote an article on a couple different Strategies for Roth Conversion. I recently saw a link to an article from the Journal of Retirement Planning titled, “To Convert or Not to Convert, That is the Question.” (note - this is a link directly to a PDF file, it will offer to download directly to your computer. The carefully timed use of a Roth conversion can save you quite a bit of money, it’s worth reading up on this, and understanding the impact a Roth can have on your portfolio.

JOE

written by JOE \\ tags: Finance, Investing, roth ira, saving