Thursday, October 30, 2008

Analyzing the Mortgage "Tax Break"

One of the financial sentiments among most people that just grind my gears is the notion that you should keep a mortgage in order to get a tax break. Hear me clearly...I would not suggest that you make any financial decisions with taxes being the sole motive. While I believe in sound tax planning as a part of your financial plan, I do not believe that there are many, if any, financial decisions that you should make based on taxes alone.

If you had the money available to pay off your mortgage, would you? Many financial advisors say that you should not pay off your mortgage because (1) the interest is low, (2) you will lose the tax break and (3) your money will make more in the market, which has historically averaged 10-12%. We can chat about all three, but I want to chat about #2, with an illustration.

Assume the following:
Mortgage: $100,000
Interest rate: 6%
Tax bracket: 25%

Person A choses to keep the mortgage in order to keep the tax break, therefore at 12/31/20XX , Person A...
  • paid Example Bank $6,000 in interest
  • got a tax break of $1,500 (they are in the 25% tax bracket, so $6,000 * 0.25)
  • overall out of $4,500 (6,000 interest paid - 1,500 tax savings)
Conclusion - Person A sent the bank $6,000 so they could get $1,500 back from the government.

Person B chose to pay off the mortgage and give up the tax break, therefore at 12/31/20XX, Person B....
  • paid Example Bank $0 in interest
  • paid $1,500 in taxes because there was no tax break (6,000 income * .25)
  • overall out of $1,500
Conclusion - Person B has $6,000 more in income because they did not pay interest, which means that the $6,000 is taxable. Since they are in the 25% tax bracket, they had to send the IRS $1,500 but they kept $4,500.

When time meets opportunity, I will be Person B! How about you?


Monday, October 27, 2008

Quicken Online - FREE

Those who know me know that I am a stickler for maintaining my monthly cash flow analysis (i.e. budget). Over the past 5 years I have a developed a system (okay spreadsheet) that works wonderfully for me. Because I have a perfected system it takes me all of 90 seconds to do my budget monthly and I am not kidding.

There are many resources available but I use a nice and simple excel spreadsheet. If you would like to see a version of what I use, feel free to contact me and I will send it to you. Let me warn you that there are no pictures, graphs or any other illustrations. I emphasize the word simple.

For those of you who may want something a little more jazzy for the same cost, Quicken is offering their online version for FREE. Quicken is made by Intuit, the same company that makes Turbo Tax and Quickbooks. I am not providing any endorsements here, I am merely sharing information. If you choose to try it you will do so at your own risk just like I will do so at my own risk. If and when I do try it myself, I'll be sure to chat about it with you.


Monday, October 20, 2008

Open Enrollment

For many workers this is open enrollment time. Open enrollment is that once a year opportunity to make adjustments to your health plans, assuming your employer offers them. I want to chat specifically about an option that if available, is most often overlooked - the health savings account (HSA) and qualified high deductible health plans (HDHP).

An HSA combines a high deductible insurance plan with a tax favored savings account. In other words, you can have an HSA only if you have a qualified high deductible insurance plan.
  • Qualification: The IRS defines an HDHP as one that has a minimum deductible of $1,100 for singles and $2,200 for families. If you have an HDHP, you can open an HSA (Health Savings Account).

  • Contributions Tax Free: You can contribute money tax free to your HSA for the use of medical expenses (co-pays, deductibles, prescriptions, dental, vision, certain over the counter drugs...even peroxide and cough drops). For 2009 singles can contribute up to $3,000 and non-singles can contribute up to $5,950 - tax free!

  • Earnings Tax Deferred: Various banks and brokerages offer HSAs (your plan or employer may dictate where you have to open your HSA but they all work pretty much the same). Interest and other earnings accumulated in the account are tax deferred. If you spend the money on qualified medical expenses, the earnings are not taxed...ever.

  • It's Yours: There is no use it or lose it provision like the HSA's cousin, the flexible spending account (FSA). The money is yours and does not have to be used by a certain time. The money continues to accumulate until you use it.

  • No Forms To Submit: Depending on the financial institution where you establish the HSA, you can use checks and/or a debit card for transactions.

  • Low Premiums: Because you are taking on more potential medical costs by having a high deductible, premiums are generally much lower than other plans.

  • Portable: The HSA goes with you wherever you go. It's yours!

  • Unused Funds: If you do not use the money in your HSA, you can use the funds in retirement (after age 65) just like you would your 401K or IRA. The distributions will be taxed as regular income, just like 401K distributions in retirement.

Can you tell that I am a big fan of HDHPs? Even though I think they are the best thing since sliced bread, they are not for everyone. The two most common alerts are:

  • If you cannot fund the HSA there is no need to get a HDHP because chances are you won't be able to cover your deductible should you have to.

  • If you are a person prone to sickness and usually need medical care beyond the annual preventative care, an HDHP may not be an option for you either.

Remember to pay attention to everything that impacts your finances. Be vigilant and purposeful about your money. When you begin to do smart things with money, money will begin to do smart things for you.

***if you are currently uninsured, an HDHP may be an affordable option for you.

We'll chat soon...


Sunday, October 12, 2008

Debt - The Definition

Merriam-Webster defines debt as something owed or a state of owing. I'm not sure about you but that definition does not really put a stinch on debt that would make me want to stay away from it. Not that it is inviting, the definition just does not ring the alarm.

If someone asked me to pen the new definition of debt I would simply say that debt is a silent thief. As strong as that may sound, here are a few things that debt steals:

  • Future Income and Time: Debt presumes unfairly on our future income. When we use credit to make purchases without the intent or ability to pay it off in full each month, we are essentially presuming that we will have the income to service that debt at a later time. We are also leveraging our future time. Let's say you make $10 an hour and you charge an item that costs $500. To keep the example simple, let's assume 0% interest (ha! I hope you are laughing too). By making the purchase on credit you have agreed to give the creditor 50 hours of your work time (50 hours * $10). Regardless of how much you make the principle works the same. Chances are if you make more money and use credit, you will charge more and leverage the same 50 hours;-).

  • Reality: Debt creates an illusion of wealth by allowing us to obtain things we would not have otherwise been able to attain. For purposes of this post, I am excluding reasonable mortgages although I am completely on board with having a home paid off (we'll chat about that later). Many people use debt to increase their lifestyle. Rather than living below or at their means, they spend over 100% of their income each month. We have all heard the expression "keeping up with the Jonese." By the way, has anyone every met them?

  • Creativity: Debt robs us of our creative ability by presenting a quick fix. I remember hearing something to the effect that we use less than 20% of our brain. I am not sure if this is true but I am certain of one thing, always running to credit cards, lines of credit and personal loans will surely rob you of the ability to creatively think of a smarter way to achieve the goal at hand.

  • Hopes, Dreams and Choices: Debt can rob us of our true purpose and calling. We can become so enslaved by debt that we stay in a job we really do not enjoy just because it pays enough to service our creditors. Are you doing what you love? If not, what is preventing you from pursuing your passion? If your answer is debt, the good news is that this could be a temporary situation. You can implement basic financial principles to pay off your debt and begin pursuing your dream.

I know there is supposed to be good debt and bad debt but for all intents and purposes, it is all debt to me....yes, some is better than others....gosh how I struggle with that concept. Basically I do not ever want to be comfortable with financing my life so I choose to see it all as debt, plain and simple. Currently I have no consumer debt, no car debt and no education debt but I do have mortgage debt. When I created my debt snowball I included mortgage in there as well and now it is the lone ranger on the list. My goal is to pay off the mortgage within the next 5 years or so. Yes it is a lofty goal but it's my goal and i'm sticking with it until that time comes. Can you imagine what your life would be like if you had no payments? One paid for house can change the course of your financial life forever, think about it....