Tara Unverzagt March 21, 2016 No Comments

How to Save at Tax Time

It’s that time of year to dig through the files and prepare your tax return for 2015. As I prepare tax returns and talk with clients I realize there are some tidbits of the tax code that aren’t obvious that could save you money or problems down the road. I thought I’d share them.

Medical Deductions

When deducting “medical insurance premiums” the IRS includes dental and qualified long term care. It does not include life insurance, disability, and other types of insurance. And do remember to provide premium payments, along with any “out of pocket” expenses for dentist, doctors, labs, prescriptions, to your tax preparer. You may not be able to use them, but you might be surprised. They have to add up to more than 10% of your Adjusted Gross Income (AGI) or 7.5% of AGI if you were born before 1951.

Did you know you can deduct acupuncture treatments as a “medical expense”? You can also deduct much of your travel expenses for medical treatment, even if that includes a plane trip. You cannot deduct nonprescription drugs, supplements, or health clubs. You can deduct the cost of weight loss programs, if it’s in response to a disease, like diabetes or high blood pressure. The cost of the program is deductible, the cost of food or other items is not.

Charitable Contributions

When you donate to a charity, you should make sure it’s really a 501(c)3. This is the tax code the IRS uses to determine that an organization is a non-profit charity. If it’s not a 501(c)3, you cannot deduct a contribution to the organization. You may still choose to donate, it just doesn’t affect your taxes. Any organization that is political in nature (a candidate or a political party would be included here) would not be a 501(c)3. Churches, schools, and other government organizations are automatically 501(c)3s.

Car Registration

Taxes paid for your car registration may or may not be deductible. In some states, like California, your car registration is based on the value of your car, that registration fee is deductible. In some states, like Illinois, the fee is based on the type of vehicle (car, truck, motorcycle, etc.) that is not deductible.

Real Estate Taxes

When you deduct your real estate taxes for itemized deductions, all real estate tax can be deducted. That includes second homes, extra lots that might be associated with your property, and in cities, if you “own” your parking spot, the property taxes on those can be deducted too.

Calculating the Cost Basis of Your Home

When calculating the cost basis for your home, vacation home, or rental (easiest if done as you live in your house and not left to when you sell the house), you can add improvements that increase the value of the house to the basis, but you can NOT include repairs. So fixing a leaky faucet doesn’t get added to your basis while repiping your house does. You also cannot add paint, wallpaper, and carpet to your cost basis EXCEPT if you are doing a major remodel or renovation, in which case you can include all the repairs and remodeling as well as actual improvements to the structure. You can find more information about cost basis in another posted article.

When you sell your house, if you meet certain criteria, you are exempt from paying taxes on $250,000 of gain for one person and $500,000 for a couple. You can take this exemption more than once, as long as you meet the criteria each time. You do not need to buy another home to take advantage of this exemption. If you end up selling at a loss, you do not get to realize the loss unless it is a business property. You can also take the loss on a home if it’s sold by an estate after death, even if it was a personal home, not a business property.

Is Your Child Really a Dependent?

You can take a child as a dependent if they live in your house and you pay most of their living expenses. If they move out of the house, and they have income, even as little as $4,000 of gross income (i.e. what they were paid or investment income), you won’t be able to declare them as a dependent. If you pay for more than half of the support of any relative, whether they live with you or not, you may be able to declare them as a dependent. That includes stepchildren, step-nieces & nephews, half-siblings, children-in-laws, parent-in-laws, aunts, uncles, adopted children. But if they have gross income you may not, even if they have no taxable income.

The tax code is vast and complex. Many people think they can deduct things that they can’t and they also miss deductions that can reduce their taxes. If in doubt, you can look at the publications on irs.gov. Publication 17 is often a great place to start and will refer you to other publications that have more details on particular topics. Or ask your tax preparer.

If there’s a tax topic that you’d like me to explore or a question answered, you can contact me at www.southbayfinancialpartners.com.

 

Tara Unverzagt March 11, 2016 No Comments

Sold Your Home? Now What?

A client recently contacted me about selling their home to retire in a sunny, warm place. They wanted to know what information they would need to collect about the sale of their home for their taxes. There are many tax benefits to purchasing a home which are well known, like deducting interest payments on a mortgage. And tax reporting occurs when you sell your home. I wish I could say gathering the data to report the sale is simple, but it’s not. The following outlines what you need to track when you buy a home.

When selling your house, you will need to know the dates you purchased and sold your home, the selling price and expenses, and the adjusted cost basis of the home. The first three are easy to determine. The adjusted cost basis is not.

The cost basis of real property (land and anything built on or attached to it) is usually its cost. Your adjusted cost basis is your cost basis plus any increases or decreases as described below. I’ll refer to adjusted cost basis as “basis” from now on.

It is easiest to calculate the basis of your house as you go along. If you wait until you sell your home, you are likely to miss many expenses that could increase the adjusted basis. You might consider keeping a ledger (on paper or in a spreadsheet) that keeps track of your basis, much like you do for your checking account balance.

Some costs/expenses you incur during the buying, selling, and maintaining of your home are added to your basis while other expenses you can deduct during the year the expense is incurred. You can’t do both.

Some credits reduce your taxes this year, but also reduce your basis, so you DO pay tax on those expenses, just not now.

If you add the cost of a capital improvement to your basis and you later remove the capital improvement, you must also reduce your basis. For example, if you add a fence to your property, you would increase your basis. If you later replaced that fence, the cost of the original fence would be subtracted from your basis and the cost of the new fence would be added.

Keep in mind that expenses which add to your basis will result in the sale of your home having a smaller gain (the sell price minus the basis) and thus potentially less taxes owed. Credits that cause you to reduce your basis will result in a bigger gain on the sale of your home and therefore potentially increasing taxes.

If you’d like a summary of what expenses increase and decrease your basis, please contact me.

The information given here is found in the IRS’s Publication 17.

Tara Unverzagt February 21, 2016 No Comments

The Bond Case

I recently had a conversation about buying individual bonds versus a bond mutual fund. I’m always amazed that investment advisors believe that buying individual bonds is a bad idea. The most cited reason for not holding individual bonds is that you get a terrible price compared to the “Big Boys” at a mutual fund. But the difference in price is less than the 1% that the Big Boys are charging you annually to manage your bond fund (and some funds have much higher annual management fees).

Another argument is that the Big Boys get a much better price when selling. I argue that the Big Boys are probably selling far too often. I’m a big believer in buy and hold, especially with bonds. Get a bond ladder in place and hold the bonds until maturity. You don’t have a selling commission and you get full face value for the bond. Why sell and potentially lose money?

Some say that “you never know when you’re going to need the money NOW!” My first response to that is, “If you have a plan in place with a proper Emergency and Set Aside Fund, you won’t need to liquidate your bonds NOW.” And my second response is, “Does that mean you’re not going to invest in stocks? Because being forced to sell at a bad price is far more likely with equities than bonds.”

I’ve also heard it said that you can’t diversify and will have larger holdings in each bond. This argument implies that if a company defaults on a bond you own, you’ll be out a lot of money. I only recommend buying investment grade bonds which are highly unlikely to default. That’s not to say that investment grade bonds never default, investing your money always carries risk, but an investment grade bond defaulting is not as likely as stock prices falling.

Some will argue that your principal in the bond isn’t protected against inflation. Is any investment “protected” against inflation? Inflation exists and we are always trying to beat inflation. The cash you put in any investment is going to devalue at the same rate, you aim to have the return (growth and income) outpace that devaluation. Money used to buy bonds in a bond fund will be affected by inflation the same as money used to buy an individual bond.

Another concern with bond funds is that it’s not always obvious what you are buying. The Big Boys might appear to “beat the market”, but this is achieved by taking on increased risk with lower grade bonds (which have high yields due to high risk) or by using derivatives (futures and options) that can definitely raise yields in good times, but can also go very badly in bad times.

It seems to me that the Big Boys have done a wonderful job marketing and selling to the masses that you can only invest in bonds if you go through them. I argue, individuals can do just as well or better at a given risk level by investing in individual bonds.

All information provided is general in nature and not meant to be advice for you in particular. I can’t predict the future, the discussion above is my best guess given the current data that’s available to me. If you’d like to know more about how this topic relates to your situation or are looking for a financial planner, contact me.

Tara Unverzagt February 19, 2016 No Comments

What’s up with 529 plans?

Let’s explore college planning for your children or grandchildren. There are so many great questions about the “best way” to get ready financially for college, but the answers are very complicated. There’s no way to cover this vast topic in one shot, so let’s look at one college saving method: the 529 plan.

If you haven’t heard of 529 plans, they are college saving accounts that are run by states. You can invest in the state where you are a resident or most any other state’s plan. Most people only look at their state, but if you are considering a 529 plan, it’s a good idea to look at what plan fits your needs best. That may be your state’s plan or another state’s plan.

I’ll use Illinois and California as examples of the differences between states. California has one 529 plan which is a savings plan. Illinois has four different plans which include saving plans and pre-paid tuition plans. I’ll just be addressing the Illinois Bright Start program here which is a savings plan similar to the California 529 plan.

What are the advantages of saving for college in a 529 plan?

  • On the state level, there are often tax advantages on contributions.
  1. California does not have a tax advantage for California residents.
  2. Illinois has a deduction of up to $20,000 of Illinois income for a married couple. Illinois businesses can also get a tax break for matching contributions. And there’s a tax break for rolling over another state’s program into Illinois.
  • On the federal level, 529 accounts are somewhat like a Roth IRAs. Contributions are after-tax dollars while the account’s earnings and growth are tax free.
  • The accounts are professionally managed. If you don’t have an investment advisor or you aren’t comfortable managing your own investments, 529 plans can help you with investment decisions.

Are there disadvantages to investing in a 529 account verses other investment accounts?

  • At the state level, some of the advantages mentioned above can come back to haunt you.
  1.  If you rollover your Illinois account to another state, it will be included in your Illinois income.
  2. Since California doesn’t allow deduction on contributions, there is no recapture if you move the funds to another state.
  • Most 529 plans have low fees, but each plan is unique. Illinois has the same plan via advisors and direct with the state. The Advisor version can have almost 1% higher fees than the direct plan. If your account has $100,000, that’s almost $1,000 per year going to fees!
  • Most plans are with a particular investment company (for example, TIAA-CREF or Fidelity) and you will be limited to the investment options they allow. This doesn’t always represent the best choices for you.
  • On the federal and state level, if you don’t take the funds out to pay for qualified expenses, you may pay taxes on the earning and a penalty. I’ll discuss this further later.

What if my child doesn’t go to college or goes to a cheaper college than we expected?

  • Non-qualified distributions (distributions not used for tuition or fees) will be taxable and have a 10% penalty on the earnings if withdrawn.
  • You can use the funds if your child wants to go to graduate school or take vocational/advance skills classes.
  • You can change the beneficiary and use it for someone else’s educational expenses. Haven’t you always wanted to go to culinary school?
  • You can save it for the next generation’s education.
  • There are exceptions that can eliminate the penalty (but you will still pay taxes on the earnings), including: the beneficiary dies or becomes disabled, goes to a US Military Academy, or receives a scholarship.

How does a 529 account affect federal financial aid?

  • A 529 account is counted as an asset of the parent. Federal financial aid considers 5.64% of parents’ assets and 30% of their income “available” to pay for college and 20% of a student’s assets and all their income over $6,260.
  • A grandparent can also start their own 529 account for a grandchild. That account is not included in financial aid reporting.
  • The catch with a grandparent’s account is that the distribution is included in the child’s income the following year.
  • If a grandparent plans to have a 529 account with one year of tuition and fees, your grandchild could save it for their senior year. The funds would never be counted as assets or income for financial aid.

What are the advantages of using a retirement account to pay for college instead of a 529 account?

  • A Roth IRA or Roth 401(k) makes a good college saving tool. You don’t pay taxes or penalty on Roth distributions for principal that has been in the plan at least 5 years.
  • Retirement accounts aren’t counted toward assets for financial aid.
  • If you distributed the taxable earnings from a Roth IRA or Roth 401(k) or from a traditional IRA or 401(k), the funds distributed won’t be penalized (they will be taxed though)

What are the disadvantages of using a retirement account to pay for college instead of a 529 account?

  • The limit for a Roth IRA or Roth 401(k) contribution is $5,500 ($6,500 if you’re over 50) in 2016 and phased out for higher incomes.
  • Each 529 plan has its own limits, but many will let you contribute $300,000 or more at one time.
  • Grandparents should remember you will have to pay gift tax for contributions over $14,000 ($28,000 for married couples) to each beneficiary or up to $70,000 each using a special 5 year exemption, but requires a Form 709, Estate & Gift Tax form, to be filed for each grandparent.
  • Distributions will count as income towards financial aid the next year.

Whether you should use a 529, a Roth IRA/401(k) or other saving plan depends on your needs and expectations. You also need to think about everyone’s tax situation, likelihood of wanting financial aid or need based scholarships, and flexibility. There’s not one right answer for everyone.

admin January 26, 2016 No Comments

Financial Planning Girl Scout Style

People don’t normally think about Girl Scouts and financial planning together. Common thoughts are more along the lines of cute little girls in green, camping, and of course cookies. But a lot goes on to make those camping trips happen. And cookie sales are really an owner-run small business. Like any family or business, a troop has chores to do, conflicts to overcome, projects to plan (that might require buying insurance in case anything goes wrong,) and a budget to balance.

As a Girl Scout leader for twelve years, I most enjoyed watching the girls learn financial planning, Girl Scout Style. I knew they’d apply these financial skills in their personal lives in the future. Here are the key lessons learned by Girl Scouts.

  1. The girls learned that it’s ok to dream about fun adventures. We started each year determining what the troop wanted to do.
    1. Financial planning starts with a desire to buy or experience something.
    2. Write down your goals and dreams, short term and long term.
  • What are your daily/weekly/monthly expenses? Girl Scouts pay for snacks, meeting supplies, field trips, badges. Families have food, shelter, clothes, medical expenses, and transportation. These are actually just short term goals.
  • What are your required long term expenses? In Girl Scouts, there are handbooks & badge books to buy at each level, replacing/repairing tents for camping, and ceremonies. In a family you have cars and appliances to replace, a roof to replace/repair, college education, retirement. These areas need to fit in the budget too.
  • Most people, whether Girl Scouts or not, want to help their community or a charity by donating money, time, or talent.
  • After making sure the basics are covered, it’s nice to have a reward to look forward to. Both Girl Scouts and families dream about going trips, making big purchases, and having money for extras/luxuries. It easier to get through the day to day expenses if there’s a fun dream to look forward to.
  1. Look at what your income sources are. Are you able to make more money? Do you want to?
    1. Girl Scouts income sources include dues, fall product sales (nuts, magazines, and/or calendars), cookies sales, money earning projects (babysitting nights, carwashes, etc). Family income sources include jobs, investments, pensions, and inheritance.
    2. The girls and their chaperones can work harder at the Girl Scout fundraisers or do more money earning projects to increase their income. Families can choose to work longer hours to get more income, invest in more education to get a better job, or save money to buy investmentsthat provide more money in the future.
  2. The fun part of money is obviously spending it. Really, the main reason we work, Girl Scouts or family members, is to make money to spend.
    1. When choosing how to spend money, have a plan based on your goals. All stakeholders need to be involved, including Girl Scouts, Leaders, and parents in a . Involve all members in the family, including kids, in family financial decisions.
    2. It’s easier to make choices and sacrifices if everyone is involved. You may have to cut back on eating out to buy the clothes you want. You may want to cut back on the short term goals to get to your long term goals faster.
    3. Set realistic goals based on realistic income – you can’t spend more than you make in the long run.
    4. Don’t waste money because you don’t have goals. It’s easy to mindlessly buy things. With a goal, you can ask “do I want this or do I want more money in the Dream fund?”
    5. Understand the value of money when you make purchases. With your goals in mind, you can determine if a purchase is appropriate. Is the item you want to buy worth more than progress towards your Dream?
  3. Monitor, Celebrate, Reflect, and Plan your next Dream
    1. Monitor your progress and adjust income and/or expenses to stay on track.
    2. Periodically revisit the dream goal to ensure it’s still what you really want. Is it worth the sacrifices you may have to make?
    3. After you realize your dream goal, celebrate successfully reaching your goal.
    4. Reflect on what went right, wrong, how you could do better next time.
    5. Once a goal has been completed (short or long term goal), it’s time tolook forward to what’s next.

Remember: to safely navigate your life without emergencies, plan instead of react. As Benjamin Franklin said, “If you fail to plan, you plan to fail.” Guarantee success with a plan in place and track your progress.

Whether you’re a Girl Scout troop, a family, or an individual, setting goals, making a plan, and monitoring progress will help you get what you want out of life. Goals sometimes change and plans shift, but you’re still further ahead than wandering around in the dark. The more focused you are on your goals, the easier it will be to reach them.

admin January 17, 2016 No Comments

The Crazy Stock Market

What’s the story with the stock market these days? Many people are concerned about the Chinese stock market. Note that the Chinese stock market is much like going to Las Vegas in the US. It has little to do with the Chinese or world economy overall. I typically ignore what’s happening in Vegas as I do with the Chinese stock market.

I have a friend who is in the business of buying commercial real estate. We often discuss current economic and investment events. He once said, “The way to make money is in real estate.” I said, “The way to make money is to buy low and sell high in anything.” He admitted he couldn’t argue with that.

My point was that whatever investment vehicle you use the basics are the same. But knowing where the bottom and the top are can be difficult to determine, especially if you don’t understand what you are investing in. My friend understands commercial real estate and I understand stocks and bonds. There’s a lot of derivatives that no one understands, even financial advisors who are recommending them. People often get caught in the herd mentally and follow the crowd even if they don’t understand what they are following.

What is more interesting to me than the Chinese stock market is the US market. I don’t mind when the stock market plunges because it’s far easier to find investments that are closer to their bottom range. The last few years finding undervalued securities has been like looking for needles in the hay stack. The needles are there, you just have to work to find them. Now, the hay stack is much smaller and the needles are easier to find.

We came into 2016 with many expecting a volatile year (including me) because of world events, an economy that isn’t following the normal rules (low unemployment and low inflation doesn’t happen often), and the political elections. This can be great news for market timers, but it’s also good news for people like me who look for prices at bargain rates. I won’t be churning stocks this year, but I will look to invest as opportunities become available and selling to take profits on the upswings of the market.

As I indicated in my last post, interest rates will continue to struggle in 2016 even though everyone would love bonds to “get back to normal”. Unfortunately the price gains on bonds that have gone with low rates during the past six years won’t happen again. So bonds are likely to have real capital appreciation near 0% for most of 2016. They will continue to be reliable income producers and will continue to reduce the ups and downs of your overall portfolio though.

The stock market will have erratic fluctuations as every little global turmoil will make the day traders twitch, giving opportunities to buy stocks at good prices, if selected carefully, or sell when prices pop up again.

The economy will probably continue its slow growth until everyone (businesses, investors, and individuals) decides it’s safe to stop squirreling money in cash. How and when we get out of this mess will probably be when the big corporations feel it’s safe to invest in their future again. While the “big boys” think it’s safest to invest in cash during uncertain times, uncertain times will continue until the “big boys” put on “big boy pants” and take the brave step outside into the drizzle.

Until then, look for opportunities during a crazy 2016.

All information provided is general in nature and not meant to be advice for you in particular. I can’t predict the future, the discussion above is my best guess given the current data that’s available to me. If you’d like to know more about how this topic relates to your situation or are looking for a financial planner, contact me at tara@southbayfinancialpartners.com.

admin January 11, 2016 No Comments

Have you been paying attention?

Interest rates have gotten REALLY Interesting

Interest rates continue to be a mystery. The Federal Reserve Board (The Fed) is trying hard to raise interest rates on government securities. They are meeting headwinds for two reasons.

First, the economic mandates that The Fed is tasked to use as guidance, inflation and unemployment, aren’t helping them raise rates. The Fed is struggling to get to the targeted 2% inflation rate. A large part of the problem is that oil prices are at historic lows. But there are other areas where prices are also not hitting the 2% mark (consumer goods, food). Unfortunately, there’s a good chance inflation will be like a clog in a pipe, water will resist getting through until suddenly the clog works it way out with a gush.

Unemployment, while in its target range doesn’t feel like it. This is partly due to many people who would like to be in the market have given up and aren’t counted. And people who would like full time work are struggling with part time jobs. There has been improvements but the progress is very slow.

The other reason for headwinds against interest rates increases is the world continues to pour money into US bonds. The US seems to be one of the few stable countries in the world and the world’s perennial favorite “safe haven” is the 10 year US Treasury Bond. Even if the Fed raises rates, with demand for US bonds going up, the price goes up pushing the rate down since bond rates go down when prices go up.

While The Fed raised rates in December and have said they plan to continue raising rates, they will struggle to actually make that a reality.

I explored interest rates and the effect on the bond market in two previous posts:Interesting Thoughts about Interest Rates and The Bond Case .

 

All information provided is general in nature and not meant to be advice for you in particular. If you’d like to know more about how this topic relates to your situation, contact me at tara@southbayfinancialpartners.com.

admin December 18, 2015 No Comments

Saving Your Bubble Gum Money

“It’s just not worth $60 to go to [a famous amusement park].” It’s a proud moment when a Financial Planner Mom hears this from her child.

I started teaching my kids financial skills where most financial planners will tell you to start, with an allowance. I started when they were about three. They received three-quarters that would be split between three jars. One was for spending (we called that “bubble gum money”), one for long term savings (in a two-year old’s world that means a week or longer), and one for charity. I let them split their quarters among the three jars however they like.

In the beginning the quarters were basically randomly deposited. I knew over time they would start to understand how different decisions would impact future options. I didn’t guide them because really, how big are mistakes a three year old can make verses how big the life lessons to be learned are?

Bubble gum money could be spent whenever and wherever. In the beginning, my youngest did spend most of her money on bubble gum.

The “long term savings” could only be “saved up” for bigger purchases. My requirement was that nothing was spent the same week the item was discovered. If they wanted that Lego™ set and had the money to buy it, they had to wait until the next week. They learned that impulse purchases were sometimes not the best financial decisions. Many angry moments led to a change of heart. In the moment, it was the only thing that would make them truly happy, but upon reflection they realized the happiness would be fleeting. On the other hand, there were times when the following week they still wanted to use their money for that Lego™ set and we’d go buy it.

Eventually, they started saving their bubble gum money. They realized bubble gum now was not nearly as rewarding as something big later. Shortly after, I started adding to their allowance. I gave them the birthday party budget. They could have a party or could use it to take a friend to Disneyland. Or they could save it to use for something else if celebrating their birthday was a low priority.

If the choice is a birthday party or no birthday party, who wouldn’t take the birthday party. But if the choice is a birthday party or saving for an iphone or xbox gaming system, there’s some serious thinking to be done. I also gave them the clothes, movie, and dance budget to use as they like. Empower your kids to make those financial decisions. They learn best through experience.

Kids who are older can still learn how to make financial decisions. With older kids still at home, sit down and negotiate an allowance. While it might take time and effort to figure out how much and what it covers, make sure you stick to giving them only the allowance. They may be sad or mad they can’t afford something, but help them realize they can save up by reducing their spending in areas that are less important to them. They can also look into getting a job to have more money available to them. If something is really important, they will figure out a way to save for it.

Adult children may need help learning to live within their salary. You are doing them a disservice by buying them a house they can’t afford or loaning them money for a nice, new car. Making loan payments is no easier than saving a little each month for their next car. Help them open a money market account to keep that money until they need their next car. It is hard to say “no” to your children, but know that they will be happier in the long run if they are financially secure.

The foundation of making financial decisions is understanding that you have a finite amount of money. If you choose to spend money today, you won’t have it available for tomorrow. As adults, our “long term” spending isn’t a week, but years or decades. Is that new car more important than your child’s education? Can you afford to do both? How about retirement? Are you going to put your children through college and then expect them to put you through retirement because you don’t have enough money left over?