Tag Archive taxes

ByCurtis Watts

What Happens if You Lie on Your Taxes?

A young man sits at his desk on a laptop computer

NOTE: Due to the COVID-19 coronavirus pandemic, the IRS has extended the federal tax filing and payment deadline to July 15, 2020. The recent relief package passed by Congress may have additional tax implications. Please contact a tax adviser for information you may need to complete your taxes this year. Learn more.

According to the IRS, the average tax refund in 2018 was $3,103. When you hear that number and then do your own taxes, you expect your refund to be close to that amount. If it’s not–or worse, you owe money–it can be tempting to fudge the numbers to increase your refund. However, misrepresenting yourself on your return is tax fraud, and it has grave consequences.

Consequences of lying on your taxes can include:

  • Being audited
  • Fines and penalties up to hundreds of thousands of dollars
  • Jail time

Learn more about the penalties below and how to avoid them.

Will I Get Caught if I Lie on My Taxes?

The IRS gets all of the W-2s and 1099s that you receive, so it knows if you don’t report all of your income. Even if the income you’re trying to hide came in the form of cash payments, your financial activity can send up a red flag with the IRS that might trigger an audit.

What Is an IRS audit?

An IRS audit is an extensive review of your taxes and financial records to ensure you reported everything accurately. Though most people have a less than 1% chance of being audited, it’s not worth the risk.

Undergoing an audit is a time-intensive and costly process that involves providing years of documentation and even in-person interviews. If the IRS audits you, you can hire a professional to represent you and your interests.

While the IRS may have only flagged one return for audit, it can review any return from the past six years. If it finds more issues, it can add penalties and fines for every year with problems. If you made tax mistakes for the past several years, you could end up owing thousands for taxes you misrepresented.

Can You Go to Jail for an IRS Audit?

While being audited in itself doesn’t mean you did anything wrong, if you’re found guilty of tax evasion or fraud, that’s a different story. The outcome of an audit is a determining factor in whether or not you will be charged with an offense that carries jail time.

What Is the Penalty for an Incorrect Tax Return?

If the IRS finds errors on your return and audits you, the penalties and fines assessed can be steep.

According to Joshua Zimmelman, president of Westwood Tax and Consulting, lying on your taxes to reduce your tax bill or boost your refund may end up costing you more in the long run.

“If you don’t pay your tax liability by the due date, the IRS will charge you a late payment penalty. Even if you file on time, you may still be charged a late payment penalty if you under-report your income and the IRS find out,” Zimmelman said.

In addition to that penalty, the IRS can also charge you interest on the underpayment. “If you’re found guilty of tax evasion or tax fraud, you might end up having to pay serious fines,” said Zimmelman.

While tax evasion or tax fraud is normally imagined as something that affects high earners and big executives, even those with lower incomes need to be careful. When describing the penalties for tax fraud, the IRS does not differentiate between income amounts or how much you underpaid your taxes. If you falsify any information on a return, it can fine you up to $250,000.

Can the IRS Put a Person in Jail?

In addition to owing thousands of dollars in penalties, fees and interest, you may also face criminal charges that result in jail time. While the IRS itself cannot jail offenders, the courts can.

Criminal investigations and charges start when an IRS auditor detects possible fraud during an audit of your returns. Courts convict approximately 3,000 people every year of tax fraud, signaling how serious the IRS takes lying on your taxes.

How Long Is the Jail Sentence for Lying on a Tax Return?

The length of the sentence for lying on a tax return depends largely upon the specific details of your situation. These details determine the exact charge against you. That determines the penalties you may face.

The odds of the IRS charging you for fraud is relatively small. Even if you are investigated, the chances of you facing a criminal charge are pretty slim. However, with the potential consequences being as severe as they are, lying on a tax return is not worth the risk just to get a little extra money in your refund.

Are There Other Ramifications of Lying on Your Taxes?

In addition to massive fines, penalties and potential jail time, lying on your taxes to reduce your income can have other negative ramifications. For example, it can impact your ability to secure lines of credit.

“If you under-report your income, it might hurt you when you try to buy a house or apply for a personal loan,” said Zimmelman. “You might not get it if it looks like you cannot afford to pay it back, so lying on your taxes may hurt in that respect.”

When mortgage companies and banks review your application, they request copies of your tax returns to check your total income. If you lied about your income to lower your tax liability, your full income won’t be on the return. That means you may be denied for the loan you need, hurting your financial future.

Moreover, failing to file a return at all can completely tank your credit report. So, not only do lenders not have an accurate picture of your income, they see a less than stellar credit report as well.

How Can You Get More on Your Tax Return Legally?

Nobody likes owing money to the IRS at the end of the year or getting a miserly refund. However, tax fraud is a serious crime. Glossing over your income, boosting your deductions or any other form of “fudging numbers” is lying on your tax return, and that’s tax fraud.

That doesn’t mean you’re stuck with owing or receiving less than you desire. There are a number of legal ways to get a bigger tax refund.

Even if none of those avenues are open to you, it’s still better to tell the truth. Saving yourself a little money at filing time can end up costing you thousands of dollars. It may even land you in jail.

Save yourself the headache and report your information accurately and on time. And, make sure you know what you need to do to avoid common mistakes made on taxes.

The post What Happens if You Lie on Your Taxes? appeared first on Credit.com.

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ByCurtis Watts

Are Social Security Disability Benefits Taxable?

A disabled woman talks to her accountant about taxes.Social Security benefits, including disability benefits, can help provide a supplemental source of income to people who are eligible to receive them. If you’re receiving disability benefits from Social Security, you might be wondering whether you’ll owe taxes on the money. For most people, the answer is no. But there are some scenarios where you may have to pay taxes on Social Security disability benefits. It may also behoove you to consult with a trusted financial advisor as you navigate the complicated terrain of taxes on Social Security disability benefits.

What Is Social Security Disability?

The Social Security Disability Insurance program (SSDI) pays benefits to eligible people who have become disabled. To be considered eligible for Social Security disability benefits, you have to be “insured”, which means you worked long enough and recently enough to accumulate benefits based on your Social Security taxes paid.

You also have to meet the Social Security Administration’s definition of disabled. To be considered disabled, it would have to be determined that you can no longer do the kind of work you did before you became disabled and that you won’t be able to do any other type of work because of your disability. Your disability must have lasted at least 12 months or be expected to last 12 months.

Social Security disability benefits are different from Supplemental Security Income (SSI) and Social Security retirement benefits. SSI benefits are paid to people who are aged, blind or disabled and have little to no income. These benefits are designed to help meet basic needs for living expenses. Social Security retirement benefits are paid out based on your past earnings, regardless of disability status.

Supplemental Security Income generally isn’t taxed as it’s a needs-based benefit. The people who receive these benefits typically don’t have enough income to require tax reporting. Social Security retirement benefits, on the other hand, can be taxable if you’re working part-time or full-time while receiving benefits.

Is Social Security Disability Taxable? 

This is an important question to ask if you receive Social Security disability benefits and the short answer is, it depends. For the majority of people, these benefits are not taxable. But your Social Security disability benefits may be taxable if you’re also receiving income from another source or your spouse is receiving income.

The good news is, there are thresholds you have to reach before your Social Security disability benefits become taxable.

When Is Social Security Disability Taxable? 

A senior's tax return

The IRS says that Social Security disability benefits may be taxable if one-half of your benefits, plus all your other income, is greater than a certain amount which is based on your tax filing status. Even if you’re not working at all because of a disability, other income you’d have to report includes unearned income such as tax-exempt interest and dividends.

If you’re married and file a joint return, you also have to include your spouse’s income to determine whether any part of your Social Security disability benefits are taxable. This true even if your spouse isn’t receiving any benefits from Social Security.

The IRS sets the threshold for taxing Social Security disability benefits at the following limits:

  • $25,000 if you’re single, head of household, or qualifying widow(er),
  • $25,000 if you’re married filing separately and lived apart from your spouse for the entire year,
  • $32,000 if you’re married filing jointly,
  • $0 if you’re married filing separately and lived with your spouse at any time during the tax year.

This means that if you’re married and file a joint return, you can report a combined income of up to $32,000 before you’d have to pay taxes on Social Security disability benefits. There are two different tax rates the IRS can apply, based on how much income you report and your filing status.

If you’re single and file an individual return, you’d pay taxes on:

  • Up to 50% of your benefits if your income is between $25,000 and $34,000
  • Up to 85% of your benefits if your income is more than $34,000

If you’re married and file a joint return, you’d pay taxes on:

  • Up to 50% of your benefits if your combined income is between $32,000 and $44,000
  • Up to 85% of your benefits if your combined income is more than $44,000

In other words, the more income you have individually or as a married couple, the more likely you are to have to pay taxes on Social Security disability benefits. In terms of the actual tax rate that’s applied to these benefits, the IRS uses your marginal tax rate. So you wouldn’t be paying a 50% or 85% tax rate; instead, you’d pay your ordinary income tax rate based on whatever tax bracket you land in.

It’s also important to note that you could be temporarily pushed into a higher tax bracket if you receive Social Security disability back payments. These back payments can be paid to you in a lump sum to cover periods where you were disabled but were still waiting for your benefits application to be approved. The good news is you can apply some of those benefits to past years’ tax returns retroactively to spread out your tax liability. You’d need to file an amended return to do so.

Is Social Security Disability Taxable at the State Level?

Besides owing federal income taxes on Social Security disability benefits, it’s possible that you could owe state taxes as well. As of 2020, 12 states imposed some form of taxation on Social Security disability benefits, though they each apply the tax differently.

Nebraska and Utah, for example, follow federal government taxation rules. But other states allow for certain exemptions or exclusions and at least one state, West Virginia, plans to phase out Social Security benefits taxation by 2022. If you’re concerned about how much you might have to pay in state taxes on Social Security benefits, it can help to read up on the taxation rules for where you live.

How to Report Taxes on Social Security Disability Benefits

If you received Social Security disability benefits, those are reported in Box 5 of Form SSA-1099, Social Security Benefit Statement. This is mailed out to you each year by the Social Security Administration.

You report the amount listed in Box 5 on that form on line 5a of your Form 1040 or Form 1040-SR, depending on which one you file. The taxable part of your Social Security disability benefits is reported on line 5b of either form.

The Bottom Line

A disabled man in a wheelchairSocial Security disability benefits aren’t automatically taxable, but you may owe taxes on them if you pass the income thresholds. If you’re worried about how receiving disability benefits while reporting other income might affect your tax bill, talking to a tax professional can help. They may be able to come up with strategies or solutions to minimize the amount of taxes you’ll end up owing.

Tips on Taxes

  • Consider talking to a financial advisor as well about how to make the most of your Social Security disability benefits and other income. If you don’t have a financial advisor yet, finding one doesn’t have to be complicated. SmartAsset’s financial advisor matching tool can help. By answering a few simple questions you can get personalized recommendations for professional advisors in your local area in minutes. If you’re ready, get started now.
  • While you don’t have to reach a specific age to apply for Social Security disability benefits or Supplemental Security Income benefits, there is a minimum age for claiming Social Security retirement benefits. A Social Security calculator can help you decide when you should retire.

Photo credit: ©iStock.com/kate_sept2004, ©iStock.com/JannHuizenga, ©iStock.com/AndreyPopov

The post Are Social Security Disability Benefits Taxable? appeared first on SmartAsset Blog.

Source: smartasset.com

ByCurtis Watts

10 COVID-19 Stimulus Benefits for the Self-Employed

Since the outbreak of the coronavirus pandemic in March 2020, life and business certainly have changed. If you’re self-employed full-time or earn business income on the side of a day job, you may be wondering what economic relief applies to you.  

Let's review what relief Congress passed to help self-employed Americans cope with financial challenges. I’ll review ten key stimulus benefits that apply to solopreneurs and small businesses.

If you're experiencing economic hardship due to the coronavirus, using some of these new regulations may be the ticket to managing your personal and business finances better.

10 ways the self-employed can get financial relief

The Coronavirus Aid, Relief, and Economic Security (CARES) Act became law on March 27 as the largest stimulus legislation in American history since the New Deal in the 1930s. Here are ten ways it provides relief for individual solopreneurs and small business owners.

1. Getting lower interest rates

On March 3, the central U.S. bank, also known as the Federal Reserve or Fed, made a surprising emergency interest rate cut of half a percentage point. That’s the largest single rate cut since the financial crisis of 2008. While this move wasn’t part of a coronavirus stimulus package, it was an aggressive cut meant to prepare the economy for problems the pandemic was expected to cause.

An economic recovery could take a few years, which likely means the Fed rate will stay near zero through 2023.

In mid-September, the Fed reiterated its promise to keep interest rates near zero until the economy improves and the unemployment rate declines. They indicated that a recovery could take a few years, which likely means the Fed rate stays near zero through 2023.

While savers never celebrate low interest rates, they're beneficial to borrowers. In general, the financing charge on variable-rate credit cards and lines of credit goes down in lockstep with interest rates. Carrying a balance on your personal and business credit cards may be slightly less expensive, depending on your card issuer and type. For instance, if your card’s annual percentage rate or APR is 20%, your adjusted rate could go down to 19.5%.

If you have a fixed-rate credit card, the APR doesn’t change no matter what happens in the economy or with federal interest rates. Also, note that if you pay off your balance in full each month, a credit card’s APR is irrelevant because you don’t pay interest on purchases.

2. Having more time to file taxes

Earlier this year, the due date for filing and paying 2019 federal taxes was postponed from April 15, 2020, to July 15, 2020. You didn't have to be sick or negatively impacted by COVID-19 to qualify for this federal tax delay. It applied to any person or business entity with taxes due on April 15, 2020.

If you missed the tax filing deadline, be sure to request an extension.

Most businesses make estimated tax payments each quarter. Those payment dates have shifted, too. The 2020 schedule gives you more time as follows:

  • The first quarter was due on July 15, 2020, which changed from April 15, 2020
  • The second quarter was due on July 15, 2020, which changed from April 15, 2020
  • The third quarter was due on September 15, 2020
  • The fourth quarter is due on January 15, 2021

Individuals and businesses can request an automatic extension to delay filing federal taxes. But it doesn’t give you more time to pay what you owe for 2019, only more time to submit your tax form—until October 15, 2020.

If you missed the tax filing deadline, be sure to request an extension. Individuals must file IRS Form 4868, and most incorporated businesses use IRS Form 7004.

However, depending on where you live, you may have to pay state income taxes, which have not been postponed. If you need a state tax filing extension, check with your state’s tax agency to determine what’s possible.

Taxes due on any date other than April 15, 2020—such as sales tax, payroll tax, or estate tax—don’t qualify for relief.

3. Getting more time to contribute to retirement accounts

You typically have until April 15 or the date of a tax extension to make traditional IRA or Roth IRA contributions for the prior year. But since the CARES Act postponed the federal tax filing deadline, you also have until July 15 or October 15, 2020 (if you requested an extension) to make IRA contributions for 2019.

However, this deadline doesn't apply to retirement accounts you may have with an employer, such as a 401(k). Nor does it apply to self-employed accounts, such as a solo 401(k) or SEP-IRA, which correspond to the calendar year.

4. Getting more time to contribute to an HSA

Like with an IRA, you typically have until April 15 or the date of a tax extension to make HSA contributions for the prior year. Under the CARES Act, you now have until July 15 or October 15, 2020, to make HSA contributions for 2019.

To qualify for an HSA, you must be covered by a qualifying high-deductible health plan. In early March, the IRS issued a notice that a high-deductible health plan may cover COVID-19 testing and treatment and telehealth services before meeting your deductible. And just as before the coronavirus, you can pay for medical testing and treatment using funds in your HSA.

5. Delaying tax on retirement withdrawals

While you typically must pay income tax on retirement account withdrawals that weren’t previously taxed, the good news is that for a period, you can delay or avoid tax altogether. The CARES Act gives you two options for withdrawals made in 2020:

  • Repay a hardship distribution within three years to your retirement account. You can replace the funds slowly or all at once, with no change to your annual contribution limit. If you take money out but return it within three years, it’s like you never took a distribution.
  • Pay taxes on a hardship distribution from your retirement account evenly over three years. If you can’t pay back your distribution, you can ease your tax burden by paying one-third of your liability for three years. 

Since withdrawing contributions from a Roth retirement account doesn’t trigger income taxes, it’s a good idea to tap a Roth before a traditional retirement account when you have the option.

6. Skipping early withdrawal penalties

Most retirement accounts impose a 10% early withdrawal penalty if you take make withdrawals before age 59.5. Under the CARES Act, if you have a coronavirus-related hardship, the penalty is waived.

Under the CARES Act, if you have a coronavirus-related hardship, the penalty is waived.

For instance, if you, your spouse, or a child gets diagnosed with COVID-19 or have financial challenges due to being laid off, quarantined, or closing a business, you qualify for this penalty exemption. You can withdraw up to $100,000 of your retirement account balance during 2020 without penalty. However, income taxes would still be due in most cases.

The no-penalty rule applies to workplace retirement plans, such as 401(k)s and 403(b)s. It also applies to IRAs, such as traditional IRAs, Roth IRAs, and SEP-IRAs.

Since you make after-tax contributions to Roth accounts, you can withdraw them at any time (which was also the case before the CARES Act). However, the earnings portion of a Roth is subject to income tax if you withdraw it before age 59.5.

7. Getting larger retirement plan loans

Some workplace retirement plans, such as 401(k)s and 403(b)s, permit loans. Typically, you can borrow 50% of your vested account balance up to $50,000 and repay it with interest over five years.

You can delay the repayment period for a retirement plan loan for up to one year.

For retirement plans that allow loans, the CARES Act doubles the limit to 100% of your vested balance in the plan up to $100,000. It applies to loans you take from your account until late September 2020, for coronavirus-related financial needs.

You can delay the repayment period for a retirement plan loan for up to one year. For example, if you have $20,000 vested in your 401(k), you could take a $20,000 loan on September 30, 2020, and delay the repayment term until September 30, 2021. You’d have payments stretched over five years, ending on September 30, 2026. Any amount not repaid by the deadline would be subject to tax and a 10 percent early withdrawal penalty.

Note that individual retirement accounts—such as traditional IRAs, Roth IRAs, and SEP-IRAs—don’t allow participants to take loans, only hardship distributions.

8. Suspending student loan payments.

Starting on March 13, 2020, most federal student loans went into automatic forbearance until September 30, 2020, due to the CARES Act. On August 8, the suspension of student loan payments was extended through December 31, 2020.

On August 8, the suspension of student loan payments was extended through December 31, 2020.

The suspension covers the following types of loans:

  • Direct Loans that are unsubsidized or subsidized
  • Direct PLUS Loans
  • Direct Consolidation Loans
  • Federal Family Education Loans (FFEL)
  • Federal Perkins Loans

Note that FFEL loans owned by a private lender or Perkins loans held by your education institution don’t qualify for automatic forbearance. However, you may have the option to consolidate them into a Direct Loan, which would be eligible for forbearance. Just make sure that once the suspension ends, your new consolidated interest rate wouldn’t rise significantly.

During forbearance, qualifying loans don’t accrue additional interest. Even if you have federal student loans in default because you haven’t made payments, zero percent interest applies during the suspension period.

Additionally, missed payments during the suspension don’t get reported to the credit bureaus and can’t hurt your credit. Qualifying payments you skip also count toward any federal loan repayment or forgiveness plan you’re enrolled in.

However, if you want to continue making student loan payments during the suspension period, you can. With zero percent interest, the amount you pay gets applied to your principal student loan balance, enabling you to get out of debt faster.

With zero percent interest, the amount you pay gets applied to your principal student loan balance, enabling you to get out of debt faster.

If you’re not sure what type of student loan you have or the pros and cons of consolidation, contact your loan servicer. Even if your student loans are with private lenders or schools, they may offer relief if you request it.

9. Having Paycheck Protection Program (PPP) loans forgiven

The PPP is part of the CARES Act, and it supports small businesses, organizations, and solopreneurs facing economic hardship created by the pandemic. The program began providing relief in early April 2020, and the application window ended in early August 2020.

Participating PPP lenders coordinated with the Small Business Administration (SBA) to offer loans to businesses in operation by February 15, 2020, with fewer than 500 employees. Loan amounts could be up to 2.5 times the average monthly payroll up to $10 million; however, annual salaries were capped at $100,000.

For a solopreneur, the maximum PPP loan was $20,833 if your 2019 net profit was at least $100,000. The calculation is: $100,000 / 12 months x 2.5 = $20,833.

When you spend at least 60% on payroll and 40% on rent, mortgage interest, and utilities, you can have those amounts forgiven from repayment. Payroll includes payments to yourself, but you can’t cover benefit costs, such as retirement contributions, or payments to independent contractors.

In other words, a solopreneur could have received a PPP loan for up to $20,833, paid the entire amount to themselves, and not repaid it by having the load forgiven. Using a PPP loan for qualifying expenses turns it into a grant.

The best part about PPP loan forgiveness is that it won’t qualify as federal taxable income. Some states that charge income tax have indicated that they won’t tax forgiven amounts.

However, if you have employees, the PPP forgiveness calculations and requirements are more complex. For example, you must maintain reasonable salaries and wages. If you decrease them by more than 25% for any employee (including yourself) who made less than $100,000 in 2019, your forgiveness amount will be reduced. 

PPP loan forgiveness also depends on keeping any full-time employees on your payroll. But if you had employees who left your company voluntarily, requested a cut in hours, or got fired for cause during the pandemic, your loan forgiveness amount won’t be reduced for those situations.

The best part about PPP loan forgiveness is that it won’t qualify as federal taxable income. Some states that charge income tax have indicated that they won’t tax forgiven amounts.

However, not all states have issued their rules on taxing PPP forgiveness. So be sure to get guidance if you live in a state with income tax.

You must complete a PPP Loan Forgiveness Application and get approved by your lender to qualify for forgiveness. The paperwork should come from your lender, or you can download it from the SBA website at SBA.gov. Most PPP borrowers have from six months after loan disbursement or until the end of 2020 to spend the funds. 

The forgiveness application explains what documents you must include, and they vary depending on whether you have employees. Once you submit your paperwork, your lender has 60 days to decide how much of your PPP loan can be forgiven.

If some or all of a PPP loan isn't forgiven, you typically must repay it within five years at a 1 percent fixed interest rate. You don't have to start making payments for ten months after loan disbursement, but interest will accrue during a deferral period.

10. Getting SBA loans

In addition to PPP loans, the Small Business Administration (SBA) offers several loans for businesses and solopreneurs facing economic hardship caused by a disaster, including the COVID-19 pandemic.

  • Economic Injury Disaster Loan (EIDL) can be up to $2 million and repaid over 30 years at an interest rate of 3.75 percent. You can use these funds for payroll and other operating expenses.
  • SBA Express Bridge Loans gives borrowers up to $25,000 for help overcoming a temporary loss of revenue. However, you must have an existing relationship with an SBA Express lender. 
  • SBA Debt Relief is a program that helps you make payments on existing SBA loans for up to six months.

Depending on your state, you may qualify for unemployment assistance, which allows self-employed people, who typically are ineligible for unemployment benefits to get them for a period.

This isn’t a complete list of all the economic relief available for small businesses and solopreneurs. There are federal tax initiatives, funds from local and state governments, and help from private organizations that you may find by doing a search online.

How to manage money in uncertain times

When it comes to surviving uncertainty, such as how COVID-19 will affect the economy, those who have emergency savings will feel much less financial stress than those who don’t. That’s why it’s essential to maintain a cash reserve of at least three to six months’ worth of living expenses in an FDIC-insured bank savings account.

If you don’t need to dip into your emergency fund, continue shoring it up when possible. If you don’t have a cash reserve, accumulate savings by cutting non-essential expenses, and even temporarily pausing contributions to retirement accounts. That’s a better option than succumbing to panic and tapping your retirement funds early.

If you don’t need to dip into your emergency fund, continue shoring it up when possible.

If you find yourself in a cash crunch, contact your creditors before dipping into any retirement accounts you have. Many lenders will be willing to work with you to suspend payments or modify existing loan terms temporarily.

RELATED: How to Reduce Money Anxiety—Compassionate Advice from a Finance Pro

My new book, Money-Smart Solopreneur: A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlers, covers many strategies to earn more, manage variable income, and create an automatic money system so you can strengthen your financial future. It’s a great resource if you’re thinking about earning side income or have already started a business.

Many economic factors that affect your personal and business finances aren’t under your control. Instead of worrying, look around, and figure out how you can create more income or cut unnecessary expenses. Working on tasks that you can control gives you more clarity and helps manage stress in uncertain times.

Source: quickanddirtytips.com

ByCurtis Watts

FIRE: How to Find Your Aha Moments and the Key to Achieving FIRE

Although enduring the pandemic has been stressful to say the least, I have learned a multitude of lessons I’ll never forget. One of the biggest is that, like it or not, I’m not cut out to homeschool four kids while trying to work at home. Most of all, though, the pandemic has reinforced my feeling of gratitude for the life I live — and the life my family lives.

For example, when schools began shutting down and the whole country went into lockdown, neither my wife, Mandy, or I had to miss work or struggle to find childcare. When I work on my blog, my podcast, and other ventures in my home office, my wife already stays home with the kids and has done so for several years. 

And when the economy stalled and the stock market dropped like a rock, we never had to wonder how we’d pay our bills or what the future might hold. After all, we have a fully stocked emergency fund, and have plenty of passive income streams that aren’t tied to an employer or the stock market on any given day.

The bottom line: The pandemic has reminded me all I have to be grateful for, including the peace of mind that comes with financial independence.

Teaching My Kids About Financial Independence

Anyway, part of me has always worried that my kids wouldn’t get to learn the same financial lessons I did — at least, not in the same way. Because of the situation we’re in, my kids have never really lived in a modest home, and they have never had to go without. They have never been in a situation where we are trying to stretch the groceries for another week until payday, and in fact, the pandemic has made us rely a lot more on takeout and food delivery than we normally do.

Regardless, I recently took some time on one of our homeschool days to map out what it takes to run and pay for a household for my kids. 

Writing It All Out

On a giant whiteboard in my office, I created a list of most of our household bills — our mortgage payment, transportation expenses, phones, gas, insurance, utilities, and all of the taxes we pay. In another column, I wrote out a rough example of the amount of income it would actually take to cover those bills. 

From there, I talked with the kids about our household wants, or stuff they prefer to have. My kids went ahead and added shoes to the list, an Xbox and some dolls. 

At one point, the kids started asking questions about where the money for our bills actually comes from. I explained that, while I continue working on my podcast and blog and other business ventures, the majority of our income is mostly passive — as in, I am not actually working for it and I am no longer getting paid by an employer.

And in that moment, I began explaining to them my thoughts on financial independence — what it means to me, and how we actually got to that point. 

While my kids were sick of dad teaching and barely listening by then, they did have some thoughts on financial independence. I explained to them that, if they could save a ton of their income in their early working years, they could invest in passive income streams they could rely on for decades after that. 

We also talked about how secure it can feel to have enough money stashed away to get by, and to not have to rely on the whims of an employer or a J-O-B to stay alive. 

How I Realized We Were Financially Independent

All of this got me thinking about when I knew we were financially independent, and the “aha moments” I had along the way. After all, our journey to financial security didn’t happen overnight, even though sometimes it does feel that way.

But before I share how I knew we didn’t need to worry about money, I want to explain what I think financial freedom really is, based on a note I wrote on my whiteboard for our kids. 

What Financial Independence Is (and What It Isn’t)

For me, financial independence is not about making the most money you absolutely can, and it’s not about how much is in your bank account, the car you drive, or the size of your home. 

Instead, financial independence is about choice. 

Based on the way I interpret the FIRE movement, financial independence is about being able to choose where you work and what you work on, having the ability to spend your free time how you want, and living life on your own terms. It’s about not having to go to a job you hate, and to still have the money you need to pay bills and live comfortably, regardless.

Further, financial independence means being able to have the freedom of choice without any worry, without any stress, and without any anxiety — at least when it comes to paying bills.  

My Aha Moments

So, what are the “aha moments” that helped me realize we had been blessed with all we need — that we are financially independent?

In reality, it has been a lot of small things over the last decade or so — things like being able to rent two hotel rooms or a large Airbnb each time we travel, and not having to worry whether we can afford it. After all, I have four kids, and my wife and I don’t want to sleep in a hotel room stuffed six-people deep. 

Another big moment we had was the first time my wife and I maxed out our old Roth IRA accounts while also fully funding our 401(k)s, which happened early in our marriage. 

Then there was the year we started building our first “dream house,” which we lived in before the one we live in now. Our “starter home” was around 1,900 square feet and we lived there for quite a while. But we started building our 5,000 square foot dream house right before the birth of our second son — we even put in a pool shortly after that. 

This was when we were in our early 30’s, and building at that time just seemed like a dream come true. We even started building our new home before we sold our old one, which was only possible because we had our financial ducks in a row.

Other key “aha” moments along our journey to financial independence included:

  • The many times I turned down lucrative job offers and opportunities so I could continue pursuing my own dreams
  • When I realized I could take two weeks off to drive my family to the Grand Canyon in an RV — and I did it!
  • When I’ve made more money in a month than my parents used to earn in a whole year (since my parents topped out at around $40,000 to $50,000 per year during their working years)
  • Realizing I had the cash savings to purchase my childhood dream car (a yellow Lamborghini!), if I really wanted to
  • The time I sold a minority stake in one of my businesses and was handed the largest check I have ever received to date
  • The first time I paid $400 for a pair of Jordan shoes with no regrets or stress, which actually happened just a few years ago!

Funny enough, I sent my wife Mandy a text, for research purposes, asking when she first felt financially independent. Her answer was totally different than mine. 

Mandy says that she felt like she no longer needed to worry about money when we reached one year of expenses in our emergency savings account.

I have to agree with her, because that milestone did give me a lot of peace of mind. After all, having 12 months of expenses in an emergency fund means a lot could go wrong with our finances and we would still have the time and space to figure it all out.

3 Key FIRE Principles and How You Know You’re On Track

If you’re pursuing financial independence but progress feels slow, know that your path to financial freedom will have a lot of bumps along the way. If you’re like me, you might also find that you’re inching toward financial freedom in spurts, and that it doesn’t all hit you at once. 

The key for those seeking FIRE is being on the lookout for those “aha moments” that tell you you’re on the right path. No matter what anyone says, you won’t become financially independent overnight. Instead, you’ll probably hit several different stages over the months and years it takes to get there.

Not only that, but you should strive to adopt the right mindset for FIRE. For the most part, this means being willing to think differently about how the world works and how it should work, and being open to going your own way.

What are the key principles of FIRE — or the key mindset changes that can get you there? Based on my personal experience, here’s what I think they are.

Key Principle #1: Gratitude for What You Have

In my opinion, being grateful for what you have (and what God has provided) is one of the most important steps anyone can take. Even if things aren’t really going your way, and if life seems bleak and miserable at times, there is always something we can be grateful for. 

With that said, I recommend being grateful and hungry — as in, don’t be so grateful that you become complacent and stop pushing for more in your life. 

Continue to entertain the idea that there is always something else you can learn, more experiences you can have, and more wisdom to obtain by trying new things. And if you try something and fail, look for the lessons you can find in that failure and be grateful you had the chance to learn them. 

Key Principle #2: Flexing Your Bold Intentions

Another key principle of achieving financial independence is being willing to share your goals with the world — loudly and without hesitation.

In your own life, you might’ve noticed that people who are pursuing FIRE can’t stop talking about it. This is because FIRE enthusiasts usually have one important thing in common: they’re brave enough to put their bold intentions on display no matter what anyone thinks.

Let’s say you have the bold intention of achieving financial independence and retiring at 35. Why not take that goal and post it to your Facebook page? Start sharing it with your family, and don’t forget to tell your friends. 

Chances are good that you’re probably going to get a lot more criticism than support from your peers, but who really cares? 

Most people who pursue FIRE actually don’t care at all what other people think. That’s part of the reason they’re able to live differently, save a large percentage of their income, and stop trying to keep up with the Joneses in the first place.

Key Principle #3: Full Release of the Past

Finally, you have to make sure your future is bigger than your past — as in, don’t let your past mistakes define who you are today and who you can become.

I know from experience that it’s far too easy to focus on all of the mistakes you’ve made and opportunities you’ve missed out on. Trust me, I’ve made more than my share of bone-headed mistakes that could’ve easily derailed me, yet here I am. 

The key for anyone pursuing FIRE is having some humility for the situation while never letting your past mistakes hold you back. You have to be willing to put yourself out there again and again, knowing you might fail. The thing is, every failure has a lesson, and sometimes those lessons lead you to something great right around the corner. 

Maybe you skipped saving for retirement early in your career, and you feel behind from where you should be. Although you definitely missed out by not getting started early, you can only control the steps you take to reach your goal right now.

Perhaps you made a poor investment and lost money at one point, which is something most investors have done at least a few times. Instead of dwelling on that mistake, you have to learn to cut your losses, find the lesson in the mess, and move on. 

Why? Because the alternative isn’t moving forward, and that won’t get where you want to be.

The bottom line: Let go of the past and take stock of where you’re at now. From there, figure out a plan to reach your goals, and don’t stop until you get there.

The post FIRE: How to Find Your Aha Moments and the Key to Achieving FIRE appeared first on Good Financial Cents®.

Source: goodfinancialcents.com

ByCurtis Watts

How I Invest

One of the most common questions I receive from readers like you—especially since Grow (Acorns + CNBC) published my story last week—asks me how I invest.

All this theoretical investing information is fine, Jesse. But can you please just tell me what you do with your money.

That’s what I’ll do today. Here’s a complete breakdown of how I invest, how the numbers line up, and why I make the choices I make.

Disclaimer

Of course, please take my advice with a grain of salt. Why?

My strategy is based upon my financial situation. It is not intended to be prescriptive of your financial situation.

I’ve hesitated writing this before because it feels one step removed from “How I Vote” and “How I Pray.” It’s personal. I don’t want to lead you down a path that’s wrong for you. And I don’t want to “show off” my own choices.

I’m an engineer and a writer, not a Wall Street professional. And even if I was a Wall Street pro, I hope my prior articles on stock picking and luck vs. skill in the stock market have convinced you that they aren’t as skilled as you might think.

All I can promise you today is transparency. I’ll be clear with you. I’ll answer any follow-up questions you have. And then you can decide for yourself what to do with that information.

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Are we clear? Let’s get to the good stuff.

How I Invest, and In What Accounts…?

In this section, I’ll detail how much I save for investing. Then the next two sections will describe why I use the investing accounts I use (e.g. 401(k), Roth IRA) and which investment choices I make (e.g. stocks, bonds).

Stock Market Forecasters See Modest Gains at Best This Fall | Barron's

How much I save, and in what accounts:

  • 401(k)—The U.S. government has placed a limit of $19,500 on employee-deferred contributions in 2020 (for my age group). I aim to hit the full $19,500 limit.
  • 401(k) matching—My employer will match 100% of my 401(k) contributions until they’ve contributed 6% of my total salary. For the sake of round numbers, that equates to about $6,000.
  • Roth IRA—The U.S. government has placed a limit of $6,000 on Roth IRA contributions (for my earnings range) in 2020. I am aiming to hit the full $6,000 limit.
  • Health Savings Account—The U.S. government gives tremendous tax benefits for saving in Health Savings Accounts. And if you don’t use that money for medical reasons, you can use it like an investment account later in life. I aim to hit the full $3,500 limit in 2020.
  • Taxable brokerage account—After I achieved my emergency fund goal (about 6 months’ of living expenses saved in a high-yield savings account), I started putting some extra money towards my taxable brokerage account. My goal is to set aside about $500 per month in that brokerage account.

That’s $41,000 of investing per year. But a lot of that money is actually “free.” I’ll explain that below.

Why Those Accounts?

The 401(k) Account

First, let’s talk about why and how I invest using a 401(k) account. There are three huge reasons.

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First, I pay less tax—and so can you. Based on federal tax brackets and state tax brackets, my marginal tax rate is about 30%. For each additional dollar I earn, about 30 cents go directly to various government bodies. But by contributing to my 401(k), I get to save those dollars before taxes are removed. So I save about 30% of $19,500 = $5,850 off my tax bill.

Editor’s Note: The original version of this article incorrectly stated that 401(k) contributions are taken out prior to OASDI (a.k.a. social security) taxes. That claim was incorrect. 401(k) contributions occur only after OASDI taxes are assessed.

Many thanks to regular reader Nick for catching that error.

Second, the 401(k) contributions are removed before I ever see them. I’m never tempted to spend that money because I never see it in my bank account. This simple psychological trick makes saving easy to adhere to.

Third, I get 401(k) matching. This is free money from my employer. As I mentioned above, this equates to about $6,000 of free money for me.

Roth Individual Retirement Account (IRA)

Why do I also use a Roth IRA?

Unlike a 401(k), a Roth IRA is funded using post-tax dollars. I’ve already paid my 30% plus OASDI taxes, and then I put money into my Roth. But the Roth money grows tax-free.

Let’s fast-forward 30 years to when I want to access those Roth IRA savings and profits. I won’t pay any income tax (~30%) on any dividends. I won’t pay capital gains tax (~15%) if I sell the investments at a profit.

Tax GIFs | Tenor

I’m hoping my 30-year investment might grow by 8x (that’s based on historical market returns). That would grow this year’s $6000 contribution up to $48000—or about $42000 in profit. And what’s ~15% of $42000? About $6,300 in future tax savings.

Health Savings Account (H.S.A.)

The H.S.A. account has tax-breaks on the front (36.7%, for me) and on the back (15%, for me). I’m netting about $1300 up-front via an H.S.A, and $4,200 in the future (similar logic to the Roth IRA).

Taxable Brokerage Account

And finally, there’s the brokerage account, or taxable account. This is a “normal” investing account (mine is with Fidelity). There are no tax incentives, no matching funds from my employer. I pay normal taxes up front, and I’ll pay taxes on all the profits way out in the future. But I’d rather have money grow and be taxed than not grow at all.

Summary of How I Invest—Money Invested = Money Saved

In summary, I use 401(k) plus employer matching, Roth IRA, and H.S.A. accounts to save:

  • About $7,100 in tax dollars today
  • About $6,000 of free money today
  • And about $10,500 in future tax dollars, using reasonable investment growth assumptions

Don’t forget, I still get to access the investing principal of $41,000 and whatever returns those investments produce! That’s on top of the roughly $25,000 of savings mentioned above.

I choose to invest a lot today because I know it saves me money both today and tomorrow. That’s a high-level thought-process behind how I invest.

How I Invest: Which Investment Choices Do I Make?

We’ve now discussed 401(k) accounts, Roth IRAs, H.S.A. accounts, and taxable brokerage accounts. These accounts differ in their tax rules and withdrawal rules.

But within any of these accounts, one usually has different choices of investment assets. Typical assets include:

  • Stocks, like shares of Apple or General Electric.
  • Bonds, which are where someone else borrows your money and you earn interest on their debt. Common bonds give you access to Federal debt, state or municipality debt, or corporate debt.
  • Real estate, typically via real estate investment trusts (REITs)
  • Commodities, like gold, beef, oil or orange juice
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Here are the asset choices that I have access to in my various accounts:

  • 401(k)—my employer works with Fidelity to provide me with about 20 different mutual funds and index funds to invest in.
  • Roth IRA—this account is something that I set up. I can invest in just about anything I want to. Individual stocks, index funds, pork belly futures etc.
  • H.S.A.—this is through my employer, too. As such, I have limited options. But thankfully I have low-cost index fund options.
  • Taxable brokerage account—I set this account up. As such, I can invest in just about any asset I want to.

My Choice—Diversity2

How I invest and my personal choices involve two layers of diversification. A diverse investing portfolio aims to decrease risk while maintaining long-term investing profits.

The first level of diversification is that I utilize index funds. Regular readers will be intimately familiar with my feelings for index funds (here 28 unique articles where I’ve mentioned them).

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By nature, an index fund reduces the investor’s exposure to “too many eggs in one basket.” For example, my S&P 500 index fund invests in all S&P 500 companies, whether they have been performing well or not. One stellar or terrible company won’t have a drastic impact on my portfolio.

But, investing only in an S&P 500 index fund still carries risk. Namely, it’s the risk that that S&P 500 is full of “large” companies’ stocks—and history has proven that “large” companies tend to rise and fall together. They’re correlated to one another. That’s not diverse!

Lazy Portfolio

To battle this anti-diversity, how I invest is to choose a few different index funds. Specifically, my investments are split between:

  • Large U.S. stock index fund—about 40% of my portfolio
  • Mid and small U.S. stock index fund—about 20% of my portfolio
  • Bond index fund—about 20%
  • International stocks fund—about 20%

This is my “lazy portfolio.” I spread my money around four different asset class index funds, and let the economy take care of the rest.

Each year will likely see some asset classes doing great. Others doing poorly. Overall, the goal is to create a steady net increase.

Updating My Favorite Performance Chart For 2019
An asset class “quilt” chart from 2010-2019, showing how various asset classes perform each year.

Twice a year, I “re-balance” my portfolio. I adjust my assets’ percentages back to 40/20/20/20. This negates the potential for one “egg” in my basket growing too large. Re-balancing also acts as a natural mechanism to “sell high” and “buy low,” since I sell some of my “hottest” asset classes in order to purchase some of the “coldest” asset classes.

Any Other Investments?

In June 2019, I wrote a quick piece with some thoughts on cryptocurrency. As I stated then, I hold about $1000 worth of cryptocurrency, as a holdover from some—ahem—experimentation in 2016. I don’t include this in my long-term investing plans.

I am paying off a mortgage on my house. But I don’t consider my house to be an investment. I didn’t buy it to make money and won’t sell it in order to retire.

On the side, I own about $2000 worth of collectible cards. I am not planning my retirement around this. I do not include it in my portfolio. In my opinion, it’s like owning a classic car, old coins, or stamps. It’s fun. I like it. And if I can sell them in the future for profit, that’s just gravy on top.

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Enter full nerd mode!

Summary of How I Invest

Let’s summarize some of the numbers from above.

Each year, I aim to save and invest about $41,000. But of that $41K, about $15K is completely free—that’s due to tax benefits and employer matching. And using reasonable investment growth, I think these investments can save me $15,000 per year in future tax dollars.

Plus, I eventually get access to the $41K itself and any investment profits that accrue.

I take that money and invest in index funds, via the following allocations:

  • 40% into a large-cap U.S. stock index fund
  • 20% into a medium- and small-cap U.S. stock index fund
  • 20% into an international stock index fund
  • And 20% into a bond index fund

The goal is to achieve long-term growth while spreading my eggs across a few different baskets.

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And that’s it! That’s how I invest. If you have any questions, please leave a comment below or drop me an email.

If you enjoyed this article and want to read more, I’d suggest checking out my Archive or Subscribing to get future articles emailed to your inbox.

This article—just like every other—is supported by readers like you.

Source: bestinterest.blog

ByCurtis Watts

5 Legal Documents You Need During a Pandemic

As Americans grapple with how to stay physically and financially healthy during the COVID-19 pandemic, it’s critical to make sure you and your family have the right emergency documents. It’s much easier to prepare for a potential disaster than to recover from one that blind-sides you. After a tragedy occurs, it may be too late to make critical decisions.

Let's talk about the different emergency documents and why you may need to create or update existing paperwork. If you get COVID-19 or have another unexpected illness or accident, these documents will help you manage your finances and make essential decisions with more clarity and less stress.   

5 emergency and legal documents to have during a pandemic

Instead of being caught off guard during a difficult time, consider if you should have these five legal documents.

1. Last will and testament

The purpose of a will is to communicate your final wishes after you die. Too many people don’t have one of these incredibly important documents because they mistakenly believe it’s something just for old rich people.

The fact is, every adult should have a will. If you die without one, the courts decide what happens to your possessions, not your family.

The fact is, every adult should have a will. If you die without one, the courts decide what happens to your possessions, not your family.

And once you have a will, don’t forget to update it periodically to make sure it addresses all your wishes, assets, and beneficiaries. Critical life events—such as getting married, divorced, having a child, or losing a spouse or partner—should trigger you to update your will.

If you’re starting from scratch, make an inventory of your assets—like bank accounts, investments, real estate, vehicles, expensive belongings, and sentimental possessions—and decide what you want to happen to them. You can list beneficiaries for specific items, like who gets a piece of heirloom jewelry or an artwork collection. You can also create distribution percentages, such as 50 percent of the value of your assets go to your partner and 50 percent to your only child.

In addition to dealing with your possessions, a will allows you to name a guardian for your minor children.

In addition to dealing with your possessions, a will allows you to name a guardian for your minor children. And don’t forget to leave instructions for what you want to happen to your pets, digital assets, intellectual property, and business assets. You can create a plan for your funeral, such as where you want to be buried and whether you want your organs donated.

Someone must carry out your final wishes and legal details. You can name a designated family member, friend, or attorney to be your “executor” and handle all the arrangements. Depending on the size of your estate, this can be a challenging and time-consuming task. So, make sure they’re capable and willing to do the job.

The bottom line is that having a will makes death easier for the loved ones of the deceased. It can help keep peace in your family by settling disagreements, minimizing bureaucracy, and even saving your heirs from unnecessary expenses. You don’t need a lawyer to create a will, but if you have a high net worth or many different types of assets, it’s a good idea to hire one.

2. Living will

In addition to a last will, you also need a living will. This document specifies what you’d want to happen regarding your end-of-life care. It would help if you were unresponsive for an extended period or in the final stages of a terminal condition.

Having a living will makes your wishes clear when you’re facing death. It’s an essential guide for family and doctors who might need to know if you’d want to extend your life by artificial means or to die without any interventions.

3. Health care proxy

When it comes to your health care, another critical document is a health care proxy. You might also hear this called a health care power of attorney or a health care surrogate. In it, you designate someone to make medical decisions for you when you can’t.

Imagine that you’re in an accident or come down with a severe illness and become mentally incapacitated. Having a health care proxy allows the person(s) you choose as your representative to make medical decisions for you or admit you into a health care facility.

Having a health care proxy allows the person(s) you choose as your representative to make medical decisions for you or admit you into a health care facility.

You might want to name two proxies in case one isn’t available when you need them. Consider who you’d trust with your care and discuss the responsibilities and your wishes with them.

Some hospitals won’t allow medical professionals to disclose any information about you—even to your health care proxy—unless you have a HIPAA (Health Insurance Portability and Accountability) medical privacy release. Your family needs to speak to your doctor about your medical situation without creating a legal problem for the doctor, so consider having this legal document as well.

4. Power of attorney

Even if you don’t need a designated proxy to make medical decisions for you, you likely need someone you trust to help with other types of decisions, such as managing your finances or legal affairs. Creating a power of attorney (POA) allows another person to stand in for you as an agent if you’re incapable of making routine transactions, such as paying bills or signing contracts.

You can use it power of attorney any time you’re not capable of doing something like selling real estate, making insurance claims, filing taxes, or making financial decisions.

There are different kinds of POAs, but the most common is a durable power of attorney. You can use it any time you’re not capable of doing something like selling real estate, making insurance claims, filing taxes, or making financial decisions. You can also create one or more limited powers of attorney, which name people to act on your behalf for specific transactions during a limited period.

Having a POA is how the financial end of your life can run smoothly if you become incapacitated. It’s also a tool for giving someone the authority to manage nearly any aspect of your life if you’re unavailable or don’t have time to handle it yourself.

5.  Childcare authorization

If you’re the parent of a young child, you should have a childcare authorization. This document can address a variety of situations, such as whether your child’s school or daycare can release them to another individual.

You can use this authorization to allow someone else, such as a partner or nanny, to temporarily make decisions for your child in your unexpected absence.

Do you need emergency documents if you’re married?

Don’t make the mistake of thinking that you don’t need emergency or legal documents because you’re married. While a spouse may be able to make some crucial decisions for you, you could both die or become incapacitated at the same time.

Let’s say your spouse is in a coma in the hospital due to a disease or accident. If you had a financial hardship and needed to sell assets, such as jointly owned investments or real estate, it could be difficult. Each of you would have to authorize the transaction.

Married couples and domestic partners should give each other power of attorney to avoid having financial restrictions during a crisis. And each of you should have wills and healthcare proxies.

Therefore, married couples and domestic partners should give each other power of attorney to avoid having financial restrictions during a crisis. And each of you should have wills and healthcare proxies.

Also, consider what would happen to your minor children if you and your spouse were in an accident together. It’s critical to name a guardian in your will, so the court doesn’t appoint one for you that you may not like.

Where should you keep emergency documents?

Keep your original signed legal documents safe, such as at your attorney’s office, in a fireproof safe, or a bank safe deposit box. Also, maintain copies of everything at home in case you need them at night or on the weekend. You should scan and upload them to a cloud-based storage service, such as Dropbox or Evernote.

Do yourself and your family a favor by getting all your emergency documents created as soon as possible. If you already have them, put an annual reminder on your calendar to make any necessary updates. You’ll feel at ease knowing you’re as prepared as possible for the unexpected. Your emergency documents make sure that you and your children’s future is protected no matter what happens.

Source: quickanddirtytips.com

ByCurtis Watts

401k Early Withdrawal: What to Know Before You Cash Out

When it comes to making a 401k early withdrawal, there are a number of reasons why it might be tempting. With millions still unemployed due to the pandemic, unexpected expenses are taking a particularly hard toll. One reason why early withdrawal isn’t uncommon in the U.S. might be because it’s easy to assume you’ll have time to rebuild your 401k nest egg.

However, is the benefit of withdrawing your retirement savings early truly worth the cost? For many people, their 401k is their primary method of investing in their financial future. Before making a decision about early withdrawal, it’s important to consider the penalties and fees that could impact you. Read on to learn exactly what happens when you decide to dip into your 401k so you won’t be surprised by the repercussions.

How Much Are You Penalized for a 401k Early Withdrawal?

On the surface, withdrawing funds from your 401k might not seem like a bad option under extenuating circumstances, but you could face penalties. Young adults are especially prone to early withdrawals because they figure they have plenty of time to replace lost funds.

 

401k early withdrawal penalties

 

If you’re not experiencing a significant hardship, 401k early withdrawal probably isn’t the right choice for you. Ultimately, you could lose a substantial portion of your retirement savings if you choose to withdraw your 401k early to use the money to make other risky financial moves. Below, let’s delve further into the penalties that usually apply when you withdraw early.

1) Your Taxes Are Withheld

When you prematurely withdraw from your retirement account, your first consideration should be that you’ll have to pay normal income taxes on that money first. This means you’re losing at least roughly 30 percent of your savings to federal and state taxes before additional penalties.

Even if you only have $10,000 you want to withdraw, consider that you’re automatically giving $3,000 of your cash to the government. In the best case scenario, you might receive some money back in the form of a tax refund if your withholding exceeds your actual tax liability.

2) You Are Penalized by the IRS

If you withdraw money from your 401k before you’re 59 ½ , the IRS penalizes you with an extra 10 percent on those funds when you file your tax return. If we use the example above, an additional $1,000 would be taken by the government from your $10,000 — leaving you with just $6,000. If you’re 55 or older, you could try to get this penalty lifted by the IRS through the Rule of 55, which is designed for people retiring early.

Also, there are exceptions under the CARES Act, which is designed to help people affected by the pandemic. There are provisions under the act that state individuals under the age of 59 ½ can take up to $100,000 in Coronavirus-related early distributions from their retirement plans without facing the 10 percent early withdrawal penalty under certain conditions.

3) You Lose Thousands in Potential Growth

Even if you’re not deterred by tax penalties, think twice before you sabotage your long-term retirement savings goals. When you withdraw money early, you’ll miss out on potential future savings growth because you won’t gain the perks of compound interest. Compounding is the snowball effect resulting from your savings generating more earnings — not only on your principal investment but also on your accrued interest.

Also, if you make a 401k early withdrawal while the market is down, you’re doing yourself a disservice because you’ll be leaving thousands on the table. It’s unlikely you’ll fully recover the lost years of compound interest you would have benefited from. You might need to get creative with a passive income stream to help support you later in life.

 

tips to minimize 401k withdrawal penalties

 

When Does a 401k Early Withdrawal Make Sense?

In certain cases, it actually might be strategic to move forward with 401k early withdrawal. For example, it could be smart to cash out some of your 401k to pay off a loan with a high-interest rate, like 18–20 percent. You might be better off using alternative methods to pay off debt such as acquiring a 401k loan rather than actually withdrawing the money.

Always weigh the cost of interest against tax penalties before making your decision. Some 401k plans do allow for penalty-free early withdrawals due to a layoff, major medical expenses, home-related costs, college tuition, and more. Regardless of your strategy to withdraw with the least penalties, your retirement savings are still taking a significant hit.

401k Early Withdrawal, Hardship, or Loan: What’s the Difference?

Knowing the differences between a 401k early withdrawal, a hardship withdrawal, and a 401k loan is crucial. Due to the many obstacles to make a 401k early withdrawal, you may find you want to keep it untouched. If you’re convinced you still need to use your 401k for financial assistance, consult with a trusted financial advisor to figure out the best option.

When Does This Apply?

Taxes and
Penalties

Early Withdrawal

Your funds are withdrawn to pay off large debts or finance large projects. Your 401k fund is typically subject to taxes and penalties.

Hardship Withdrawal

You’re only eligible for this type of withdrawal under circumstances such as a pandemic or natural disasters. Withdrawals can’t exceed the amount of the need and the funds are still subject to taxes and penalties.

401k Loan

The loan must be paid back to the borrower’s retirement account under the plan. The money isn’t taxed if the loan meets the rules and the repayment schedule is followed.

Additional Considerations

If you’ve left a job and don’t know what to do with your Roth IRA, a 401k transfer is a good option. Most likely, you will save money and have a wider range of investment options when you transfer your funds. 401k fees can be high, and rolling over your funds to a Roth IRA account could be wise in the long run. Also, be aware that the process is more complicated for indirect rollovers. 

In Summary:

  • If you’re one of the millions of Americans who rely on workplace retirement savings, early 401k withdrawal may jeopardize your future financial stability.
  • There are very few instances when cashing out a portion of your 401k is a smart move.
  • In most cases, any kind of early 401k withdrawal is detrimental to your retirement plans.
  • Stick to your budget and bulk up your emergency fund to stay one step ahead.

In short, 401k early withdrawals are usually counterproductive. Prevent compromising your hard-earned savings by using a free budgeting tool that will set you up for success. After all, being prepared and informed are two of the most important parts of maintaining financial health.

Source: SEC

The post 401k Early Withdrawal: What to Know Before You Cash Out appeared first on MintLife Blog.

Source: mint.intuit.com

ByCurtis Watts

What Is A Contingent Beneficiary?

A contingent beneficiary is a person, estate or trust that receives the assets of a person who dies if the primary beneficiary, for any reason, cannot receive the assets.

It is commonly recommended by attorneys when their clients are making a will to have at least one contingent beneficiary.

It is possible to have several contingent beneficiaries and they can be listed in a specified order.

After a person dies, his or her assets will usually go through probate. The probate process can be avoided and the assets more efficiently passed to the heirs if primary and contingent beneficiaries are named.

While the contingent beneficiary is one of the most important factors of the life insurance policy process, it’s typically one of the most confused and misunderstood. Any mistakes or misunderstandings can lead to a lot of problems down the road that can cause major headaches for your loved ones.

Why It’s Important To Name Contingent Beneficiary

There are a few key reasons why it’s important to name a contingent beneficiary.

Beneficiaries take precedence over wills

If a beneficiary is assigned to a bank account, that beneficiary has the rights to that account after the owner’s death even if the will states the assets in that account should go to someone else.

Contingent beneficiaries can also be assigned to retirement plans, annuities, and life insurance policies

There will be one primary beneficiary on the policy. This is usually a spouse or partner. They receive the proceeds from the policy upon the death of the policyholder. If a contingent beneficiary is named such as a child or other family member or friend of the deceased and the primary beneficiary cannot receive the proceeds, it will pass to the person next in line.

Electing a contingent beneficiary in wills as well as in insurance policies is a simple way of making sure the surviving loved ones are cared for if the primary beneficiary is incapable of doing so.

Provides a way to donate to a special cause or charity

It is also a way to donate to a special cause or charity after the death of the policyholder. The disposition of assets is not complicated by unforeseen events such as the death of the prime beneficiary.

For example, if a will gives all the deceased’s assets to the spouse as the prime beneficiary, but the spouse is incapable of managing the assets, they can be given to the contingent beneficiary, who may be an adult child, on the condition that the child cares for the spouse during their lifetime. After the spouse dies, the assets can go to the child.

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Circumstance Where A Second Beneficiary Makes Sense

There may be circumstances or stipulations that must be met before a contingent beneficiary may inherit the assets. The contingent beneficiary may need to finish college, reach a certain age or kick a drug habit, and only then they will receive the assets.

A policyholder and their primary beneficiary may die at the same time. This could happen in a car accident or natural disaster. If a contingent beneficiary has been named, the transfer of assets will be easier.

The next in line is usually someone who is financially dependent on the policyholder, but if there is no one dependent, the contingent beneficiary can be anyone else or a charity or cause. It is not advised to make the estate the contingent beneficiary of an inexpensive life insurance policy because the proceeds would be subject to the deceased’s creditors. Life insurance proceeds paid to a person are not usually subject to creditors.

If the primary beneficiary is the spouse, the contingent beneficiary may be a minor child. Consideration needs to be given as to who will manage the assets until the child reaches 18 or 21 years.

It is recommended to assign two guardians for the children including one guardian to manage the money and one guardian to look after the well-being of the child.

In policies from some of the best term life insurance companies, a person can assign a primary beneficiary, a contingent beneficiary, and a tertiary beneficiary. This is another kind of contingent beneficiary and only receives assets or proceeds from the estate or insurance company if all the primary and contingent beneficiaries are unqualified to receive the benefits or are deceased.

When a contingent beneficiary wants to claim assets, they need to provide a certified death certificate for the prime beneficiary and any other contingent beneficiaries that precede them on the list of succession as well as valid personal identification.

Each insurance company might require different documentation depending on their standards. When you name a secondary beneficiary, you need to ask what the requirements are going to be.

Consequences For Not Naming Beneficiaries

There are a few consequences for not naming beneficiaries.

Insurance proceeds could be subject to huge estate taxes

Insurance proceeds could be subject to huge estate taxes if the policyholder names the spouse as sole beneficiary and there is no contingent beneficiary. If the insured outlives his or her spouse, by a few days if they are both in a car accident, the proceeds will pass to the estate incurring huge unnecessary taxes.

If you don’t name a beneficiary, your other family members or loved ones can lose thousands and thousands of dollars because of the taxes that are going to be placed on the payout from the policy.

Your loved ones may struggle to get the money you left them

The other problem is that your loved ones could struggle to actually get their hands on the money itself. Without naming a contingency, the company is going to have to determine who the money should go to, depending on your family situation, this could cause a lot of problems and delays.

ALWAYS Name a Contingent Beneficiary 

contingent beneficiary is a safety feature and a control device. It is the most practical way to control the future distribution of wealth. It’s a simple thing today, but not something that should be decided on lightly. You should spend a lot of time determining who your beneficiary should be.

It’s also something that you should continue to maintain. There are dozens of different life changes that could impact who you would want to name as your beneficiary, which means that once you’ve named the primary beneficiary, it could change years down the road. Don’t forget to look back at your policy and ensure that the beneficiary is still the valid recipient and the best choice for the policy payout.

Life insurance is the most important investment that you’ll ever make for your family and loved ones. You may ask yourself at what age should I get life insurance policy, of course, we recommend the younger the better because the more you age the more risk you are to having health problems, which will increase your premium rates. Purchasing life insurance at age 20 versus purchasing life insurance over the age of 50. Tomorrow is not the day to start your life insurance application.  Begin the process today!

Contingent Beneficiary Review

Time for the pop quiz! Hopefully, you know exactly what a contingent beneficiary is at this point. Not only should you know what it is, but hopefully you understand why YOU should name one.

If you want to learn more about life insurance or naming a contingent beneficiary, we researched and wrote about the process of getting life insurance. We are ready to answer those questions and ensure that you’ve got the best life insurance to fit your needs.

The post What Is A Contingent Beneficiary? appeared first on Good Financial Cents®.

Source: goodfinancialcents.com

ByCurtis Watts

Should I Refinance My Mortgage? When to Refinance

The Federal Reserve recently lowered interest rates in an effort to stimulate the economy during the coronavirus pandemic. As a result, more and more people are becoming interested in refinancing their mortgage. Depending on the situation, refinancing your mortgage can prove to be a savvy financial decision that can save you massive amounts of money in the long-term. But is it right for you? 

If you’re curious about refinancing your mortgage, this article should answer many of your questions, including: 

  1. How Does Refinancing Work?
  2. When Should I Refinance My Mortgage? 
  3. What is the Downside of Refinancing My Home? 
  4. How Do I Calculate if I Should Refinance My Mortgage? 
  5. What are My Refinancing Options? 

How Does Refinancing Work? 

“Refinancing your mortgage allows you to pay off your existing mortgage and take out a new mortgage on new terms,” according to usa.gov. So when you refinance your mortgage, you’re essentially trading in your old mortgage for a new one. The new loan that you take out pays off the remainder of the original mortgage and takes its place. That means the terms of the old mortgage no longer apply, and you’re instead bound by the terms of the new one. 

There are many reasons why homeowners choose to refinance their mortgage. They may want to secure a loan with a lower interest rate, switch from an adjustable rate mortgage (ARM) to a fixed-rate, shorten or lengthen their repayment term, change mortgage companies, or come up with some cash in order to pay off debts or deal with miscellaneous expenses. As you can see, there are a vast number of reasons why someone might be interested in refinancing. 

There are also a couple of different ways to go about refinancing. A standard rate-and-term refinance is the most common way to do it. With this method, you simply adjust the interest rate you’re paying and the terms of your mortgage so that they become more beneficial to you. 

However, you could also do a cash out refinance, where you pull equity out of your home and receive it in the form of a cash payment, or take out a new loan that’s greater than the remaining debt on the original mortgage. Even though you’ll get an influx of cash in the short-term, a cash out refinance can be a risky option because it increases your debt and it’ll likely cost you in interest payments in the long-term.


When Should I Refinance My Mortgage?

Maybe you’ve been wondering, “Should I refinance my mortgage?” If you can save money, pay off your mortgage faster, and build equity in your home by doing so, then the answer is yes. Whether you can achieve this is dependent on a variety of things. Take a look at these refinance tips in order to get a better idea of when you should refinance your mortgage. 

Capitalize on Low Interest Rates 

When mortgage rates go down, a lot of people consider refinancing their mortgage in order to take advantage of that new lower rate. And this makes perfect sense—by paying a lower interest rate on your mortgage, you could end up saving thousands of dollars over time. But when it comes to refinancing your mortgage, there are a number of other factors you should consider as well. 

Regarding interest rates, you should take a look at how steeply they drop before making any refinancing decisions. It might be a good idea to refinance your mortgage if you can lower your interest rate by at least 2 percent. It ultimately depends on the amount of your mortgage, but anything less than that amount likely won’t be worth it in the long run. 

Switch to Fixed-Rate Mortgage

It’s also very common for people to refinance in order to get out of an adjustable rate mortgage and instead convert to a fixed-rate. An adjustable rate mortgage usually starts off with a lower interest rate than a fixed-rate, but that rate eventually changes and it can end up costing you. That’s because the interest rate on an adjustable rate mortgage changes over time based on an index of interest rates. It can alter based on the mortgage market, the LIBOR market index, and the federal funds rate. 

By converting to a fixed-rate mortgage—where the interest rate is set when you initially take out the loan—before the low rates on your adjustable rate mortgage increase, you can minimize the amount you have to pay in interest. If you’re able to lock in a low fixed interest rate, you’ll be less susceptible to market volatility and more capable of devising a long-term payment strategy.   

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When debating the question of “Should I refinance my mortgage or not?”, you should also keep in mind what lenders will look at when determining the terms of your loan. In order to come up with an interest rate and approve you for a refinancing loan, lenders will take the following factors into consideration: 

  • Payment history on your original mortgage: Before issuing a refinancing loan, lenders will review the payment history on your initial mortgage to make sure that you made payments on time. 
  • Credit score: With good credit, you’ll have more flexibility and options when refinancing. A high credit score will allow you to take out loans with more favorable terms at a lower interest rate. 
  • Income: Lenders will want to see that you generate a steady, reliable income that can comfortably cover the monthly mortgage payments.  
  • Equity: Home equity is the loan-to-value ratio of a borrower. You can calculate it by dividing the amount owed on the current mortgage loan by the home’s current value. Before you consider refinancing, you should ideally have at least 20% equity in your home. If your equity is under 20% but your credit is good, you still may be able to secure a loan, but you’ll likely be charged a higher interest rate or have to pay for mortgage insurance, which is not ideal.

What is the Downside of Refinancing My Home? 

Refinancing a mortgage isn’t for everyone. If you don’t take the time to do your research, calculate savings, and weigh the benefits versus the potential risks, you could end up spending more money on refinancing than you would have had you stuck with the original loan. 

When refinancing, you run the risk of placing yourself in a precarious financial position. This is especially true when it comes to a cash out refinance, as this can put you on the hook for even more money and bury you in interest payments. 

Don’t refinance your home and pull out equity just to get quick cash, make luxury purchases, and buy things you don’t need—doing this is an easy way to dig yourself into a deep financial hole. In reality, you should only refinance your mortgage if you know that you can save money doing it. 

How Do I Calculate if I Should Refinance My Mortgage? 

Before you refinance your mortgage, it’s crucial to crunch the numbers and determine whether it’s worth it in the long-run. To do this, you’ll first have to consider how much refinancing actually costs. 

Consider Closing Costs

So how much does it cost to refinance? One of the most significant expenses to take into account when refinancing is the closing costs. All refinancing loans come with closing costs, which depend on the lender and the amount of your loan, but average around three to six percent of the principal amount of the loan. So, for example, if you took out a loan of $200,000, you would end up paying another $8,000 if closing costs were set at 4%. 

These closing costs are most often paid upfront, but in some cases lenders will permit you to make the closing costs part of the principal amount, thus incorporating them into the new loan. While closing costs generally don’t cover property taxes, homeowner’s insurance, and mortgage insurance, they do tend to include the following: 

  • Refinance application fee
  • Credit fees 
  • Home appraisal and inspection fees 
  • Points fee
  • Escrow and title fees 
  • Lender fee

Determine Your Break-Even Point

To make an informed decision as to whether refinancing your mortgage is a sound financial decision, you should calculate how long it will take for the refinancing to pay for itself. In other words, you’ll want to determine your break-even point. To calculate your break-even point, divide the total closing costs by the amount you’ll save on a monthly basis as a result of your refinance loan. 

The basic equation for figuring out your break-even point is as follows: [Closing Costs] / [Monthly Savings] = [# of Months to Break Even] 

Taking this into consideration, you can see how the length of time you plan on staying in a home can make a big difference as to whether or not refinancing your mortgage is the right option for you. If you’re thinking of moving away and selling your house in a few years, then refinancing your mortgage is probably not the right move. You likely won’t save enough in those few years to cover the additional costs of refinancing. 

However, if you plan on remaining at the house you’re in for a long stretch of time, then refinancing could potentially save you a lot of money. To make an informed decision, you have to do the math yourself—or, to make the calculations even simpler, use Mint’s online loan repayment calculator. 

What are My Refinancing Options? 

As stated above, you have options when it comes to refinancing loans. You could refinance your mortgage in order to secure a lower interest fee and a change in the terms of your loan; or you might opt for a cash out refinance that lets you turn your home’s equity into extra income that you can use to pay for home improvement, tuition costs, high-interest debt payments, and more. 

In order to actually start refinancing your home, you’ll have to find a lender and fill out a loan application. Shop around at large and small banks alike to see who will offer you the lowest interest rates and the best terms. How long does a refinance take? The timeline depends on a few things, including the lender you borrow from and your own financial situation. But, in general, it takes an average of 45 days to refinance a mortgage. 

You might also consider forgoing the traditional banks and dealing with an online non-banking company instead. Alternative lenders often offer greater flexibility in terms of who qualifies for a loan and they can, in some cases, expedite the refinancing process. For example, Freddie Mac is a government-sponsored mortgage loan company that, in addition to offering no cash out and cash out refinancing, has a third option available for borrowers whose loan-to-value ratio is too high to qualify for the traditional refinancing routes. Learn more by visiting freddiemac.com. 

When tackling any big financial decision, it’s important that you’re informed and organized. Learn the facts, do the calculations, and research your options before beginning the refinancing process to make sure it’s the right choice for you. 

The post Should I Refinance My Mortgage? When to Refinance appeared first on MintLife Blog.

Source: mint.intuit.com