Financial lessons for anyone, from college financial aid

Posted on February 15, 2012February 15, 2012 by Danielle

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I’m really in the trenches this year. After being a know-it-all for some time about the college financial aid process, I’ve finally had to do it close to home. While the process itself included all the forms I expected, I did learn a few tricks which are relevant to your money management even if you don’t have a college-age child.

It doesn’t get any better if you avoid it. If something has a deadline (for example, choosing your 401K investment mix, assembling records for taxes, or choosing the right options for your flex-spending account) your ability to think this through and get adequate information decreases as the deadline gets closer.
With any important financial move, follow up. It’s hard to believe, but two of the schools my daughter applied to lost significant parts of her application, which had to be re-sent.
The more complicated the transaction, the more follow up needed. Financial systems are set up to have lots of checks and fail-safes. Why? Because, guess what, they fail. If you are making a transfer of accounts, for example, you or your financial advisor needs to be watching it like a dieter looking at pizza.
Don’t ignore your accounts for long periods. I once had a major brokerage transfer someone else’s $250,000 account into one I was managing. The actual owner never noticed, and you can bet his broker never told him.
Get names or follow-up is hopeless. Dear daughter has been trying to send some supplementary materials (recent awards, extra recommendations) and, at one school, has been given five different names on who is actually reviewing her admissions. Turns out two students with her name are applying this year to the same school. Belongs in Ripley’s Believe It or Not. I wouldn’t believe it but it’s happened before—two people with the exact same name had a checking account at the same local bank and one of them became, temporarily, $10,000 richer. This was only discovered after the rightful owner’s checks began bouncing all over town. Straightening out these snafus required quite a bit of contact with one person who could keep the details straight and be accountable for fixing the problems.
Things you dread turn out to be easy, and things that are hard you never see coming. Everybody worries about filling out the FAFSA, but this year’s version takes about 10 minutes if you have your tax return. On the other hand, the CSS/Profile (for private schools), took hours, lots of extra explanations and several calls to the organization about what I still believe are errors in this year’s form.
Good records are important. Having to reconstruct or unearth financial records in a time of stress makes everything worse. Really, it’s worth spending an hour on the weekend entering spending and investments in Quicken or Mint.com, filing those papers or creating a decent file system on your computer, and reading an article or two on something financial. You’ll be so grateful when you fill out those college apps, try to do taxes, or retire; you’ll have a better idea of whether you can retire and how much money you really need; you’ll have some check on runaway spending; and your heirs will thank you. Put in that spade work. It’s all good.
You can go broke saving. It’s important to analyze whether an action really puts you ahead. Sometimes people get so focused on getting financial aid that they make poor investments (often, annuities) that reduce their assets for aid, but are also high cost and hard to get out of. People justify bigger houses for the mortgage interest tax deduction, not realizing that they are spending much more to save just a little. Is it worth your time? Is it worth the cost?
Most authorities are already hip to your little tricks. College financial aid officers and the IRS generally clue in to the most “creative” strategies pretty quickly. In the case of the IRS, just how much money and time do you want to spend in an audit? (see #8 above!)
On the other hand, you are entitled to what’s due. There’s no reason not to apply for financial aid if you’re on the borderline. In the larger scheme of things, spending a day filling out forms could have a pretty big payday. If you really do work out of your home, you’re entitled to home office deductions just the same as any business deducts its expenses.

In college applications as in life, the more complex the system gets, the more “controls” are introduced, the more money at stake, the more that can go wrong. Good luck, and keep on top of it!

What’s a reasonable emergency fund?

Posted on February 8, 2012February 8, 2012 by Danielle

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Sure we all know we should have some rainy-day savings, but for too many of us that’s spelled C-R-E-D-I-T C-A-R-D. Unfortunately, it’s very easy to lurch from crisis to crisis, racking up ever larger charges until the credit card bill itself becomes the emergency. Every time I see an article on how much the fund should be, it’s usually a breathtaking amount. But really, how much is enough?

The standard CFP® exam question’s correct answer is usually some variant of three months if you’re married with a working spouse, have a trust fund, or a second job; and six months if you’re single, or married with a stay at home spouse. However, I would add to that six months’ recommendation a few other considerations: if you work in an industry or place where it would require major effort or relocation to get another job; if you have any health problems; if you’re over about 45; if you have no retirement savings; or if the economy remains in the toilet for much longer. In fact, some people are starting to recommend that you look at the current unemployment rate and save the equivalent number of months—9% unemployment, 9 months’ worth of savings.

Now that your heart has skipped a beat, let me tell you that you can safely reduce that amount somewhat by a few subtractions. Let’s say your gross is $100,000. That puts you in the 28% tax bracket if you’re single. With no other deductions your tax bite is going to be around $22K. I’m sure you have other deductions, but let’s just use this as an illustration. If you don’t have any income you’re not going to be paying any taxes, so take that off your gross. So, single person, we’re down to $77,878. Now, let’s say you were putting 5% in your 401K. No job, no 401K contribution–$72,878. I’m not going to tell you to reduce your grocery estimate, because if you’re unemployed for six months you’re going to need significant chocolate. However, being terrified, you probably will decide to eat out less and maybe not replace your entire wardrobe this year—let’s take another $1,500 off the total: $71,378: your six months’ emergency fund needs to be $35,689, not the $50,000 you thought I was saying at first gulp.

A general example never works for the specific. The emergency fund goal goes up or down depending on how you live your life now. If you’re already contributing the max to a 401K or other retirement plan, if you regularly fund a Roth, dump all your quarters into a mad money jar, in short, if you’re a big saver, replacing your necessities is a smaller number. If you would need to pay child support, buy your own health insurance, or your car is about to crap out, you need to adjust upward. If you’re self-employed, it’s six months at least plus GO GET DISABILITY INSURANCE.

I generally recommend you have an emergency fund of at least three months’ expenses BEFORE you start paying more than the minimum on any credit card debt repayment program. It’s better to pay the minimum balances and fund an emergency fund rather than have no or inadequate emergency funds and send a big payoff to the card. Why? Because without an emergency stash you’ll never get out of debt—something will inevitable come up, and back it goes onto the card. Pay cash and you’ve still got the same credit card debt; no cash and the debt just revolves–no matter how much you send, new stuff keeps getting added.

Where to put this cash? You need immediate access to it, so it needs to be in a checking account, a bank savings account, or a money market fund that you can write checks on. When you do manage to build it up to six months, you might consider putting 3 months’ worth in a 3 month CD at the highest rate you can scavenge locally or through an internet bank. Just in case you might need all the money at once, make sure the CD seller would only ding you on interest, not penalties or principal loss.

Saving six months’ worth of expenses isn’t an instant achievement—if you’re just starting out, it can take you three years or more at a 10% savings rate. I’d propose that any found money also go into this account: here’s where your tax refund (which you shouldn’t be getting), your bonus check, the computer rebates you actually remembered to collect, or the $200 you got for writing an article or making a presentation should go. I’d even suggest that it’s worth some kind of second job or seasonal or short term gig to build that fund. You can blow that stuff later when you have the fund funded. Right now, it’s the best thing you can do for your future security.

What we can learn from Mitt Romney’s taxes

Posted on February 1, 2012February 1, 2012 by Danielle

No wonder he didn’t want to release his taxes. Yes, it’s true, Mitt Romney is different from you and me—he’s way, way richer. Than most everyone on the planet. I’m no fan of his and he deserves every bit of the outrage people are expressing. It’s not that he’s done anything illegal, it’s the smarminess of it all. But maybe there’s just a tiny, envious part in all of us that whispers, “I wish I could do it, too.” I don’t think that will carry him into office (at least, I hope not), but there are a few useful lessons to be learned from scrutinizing his strategies.

Starting or being a partner in a successful business is the way to wealth. Okay, having a really successful parent doesn’t hurt, either, but if you don’t already have one, you probably can’t get one. Your own business offers some significant tax opportunities, both in deductions and in ways you can pay out money to yourself.
Park your accounts where you’ll pay the least taxes. For most of us, this probably isn’t the Cayman Islands. But any of us can do some smart asset allocation, choosing to plunk the appropriate investments in either taxable or tax-deferred/nontaxable accounts, e.g., generally bonds in non-tax, capital gainers in taxable (at least for now) Of course, it’s a little more complicated than that. Maybe you should see a financial planner.
Keep updated and scrutinize those returns—you can bet he has a phalanx of estate planners and tax attorneys who are on top of this. Things do change, and small changes in tax law can cost plenty. More than one set of eyes on a problem can come up with more solutions.
Have an estate plan in place. Romney’s kids aren’t going to be wards of the state. I guarantee he’s got a complex and thoroughly thought-out estate plan. If you don’t have a will and all the appropriate powers of attorney, pick up the phone NOW and call your attorney. If you don’t know one, pick up the phone NOW and call me, I’ll give you some names.
Buy and hold. Do you think Mitt checks his portfolio every day? He’s looking for long-term capital gains, which cost less in both taxes and trading costs.
Don’t miss the itemized deductions. One of the most common mistakes I see is people who have a little side business and don’t take deductions for their costs. When I ask, I’m usually told, oh, I don’t want to depreciate my house. You don’t have to! It’s a different item! So deduct those 5,000 ink cartridges you buy, and the amount of phone service attributable to your business, etc., etc.
Give to charity. I probably wouldn’t select the same charity he did, but at least he gave something. Actually, quite a lot. Do it. It’s only right.
Don’t forget the State you live in. Each state has its own quirks and you, or your accountant and financial planner should review your individual picture to make sure you’re taking it all in (and complying with local law).

That should get you started. The Wall Street Journal had a pretty good article on this same topic (although they perpetuated the same misinformation about home offices.) Here’s a link—if you can’t get the full text, email me and I’ll send it to you through my subscription.