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Everyone Will Be Able To Save More For Retirement in 2019

Retirement savers can rejoice, as the IRS has announced the 2019 inflation-indexed increases for retirement accounts contribution limits and other key retirement plan figures. Unlike last year, both workplace retirement plans and Individual Retirement Accounts saw an increase in the amount you can contribute toward your retirement.

All figures here will be effective starting January 1, 2019 through December 31, 2019.

Workplace Retirement Plans

$19,000 max employee contribution: 401(k), 403(b), and most 457 plans

$500 increase over 2018

$55,000 for the total contribution between the employee and employer

$6,000 additional catch-up contribution limit for those over 50

$13,000 contribution limit for SIMPLE accounts ($500 increase)

401(k) Plans

The most common workplace plan saw a bump of $500, which will allow workers to contribute up to $19,000 per year and take a tax deduction for it. 401(k) plans also commonly offer a matching component, where the company adds additional money to the employee’s account. When combining the amount the employee and employer contributes, a maximum of $56,000 can be contributed for those under 50, and $62,000 for those over 50.

403(b) and 457 Plans

Non-profits and government agencies offer their own version of the 401(k) called the 403(b). And some organizations also offer a 457 plan. The 457 plan is an unusual plan in that you can contribute the maximum to both the 457 and another workplace retirement account. If you have access to a 403(b) and a 457 plan, you may have the ability to contribute a maximum of $38,000 to your tax-deductible retirement accounts. $19,000 in the 403(b) and $19,000 in the 457 plan.

SIMPLE Retirement Accounts

For those with SIMPLE or SEP plans, contribution limits increased to $13,000; after being unchanged last year. SIMPLE and SEP plans are more common for those who work for small businesses and have these plans as an alternative to the 401(k). These retirement plans are easier for small companies to set-up and manage, but their contribution limits are lower.

IRA Plans (Individual Retirement Accounts)

$6,000 per person

$500 increase

$7,000 for those over 50

$1,000 additional catch-up contribution limit for those over age 50

Traditional IRA plans allow you to take a tax deduction for the contributions you make to your retirement funds, thereby lowering your taxable income and saving on your tax bill. The Roth IRA option doesn’t offer the current tax deduction, but will avoid taxation in retirement. The maximum contribution to an IRA got a bump this year (after being left out of the increases last year) to $6,000 for 2019. 

Unlike workplace plans, you can set up an IRA on your own, without having to rely on your employer.

Traditional IRA Phase-Out Limit

$64,000 to $74,000 Single taxpayers ($1,000 increase)

$103,000 to $123,000 Married taxpayers filing jointly ($2,000 increase

$193,000 to $103,000 Married taxpayers where one spouse has a workplace plan and the other doesn't (A nice $4,000 increase)

$0 to $10,000 Married filing separately (not a typo, the IRS doesn't like married filing separately)

For those below the income ranges, it is possible to ‘double dip’ and take a deduction for your workplace retirement account and take a second deduction for a traditional IRA. For those above the income limits, they may potentially contribute to the Roth IRA, which has it’s own income limits discussed later. 

The ranges above show when you start to lose the deduction, and when your income gets to the top of the range you no longer can deduct from a Traditional IRA if you have a workplace plan.

Roth IRA Phase-Out Limit

$122,000 to $137,000 Single taxpayers and head of household

$193,000 to $203,000 Married taxpayers filing jointly

$0 to $10,000 Married filing separately

Contributing to a ROTH is prohibited for high-income earners, due to the fact the government is deferring it's tax collection. You'll begin losing the ability to contribute to a Roth IRA at the beginning of each income phase-out range listed above, depending on your tax filing status. When you hit the top of the income range, you'll completely lose the ability to contribute to a Roth directly. (Talk with a fee-only and fiduciary financial adviser about indirectly contributing to a Roth)

Saver's Credit

$64,000 income limit for married couples filing jointly ($1,000 increase)

$48,000 income limit for head of household ($750 increase)

$32,000 income limit for singles and married filing individual returns ($500 increase)

The Saver's Credit saw between a $500 to $1,000 increase in income limits before low-income individuals lose the credit. The Saver's Credit offers a refundable tax credit for low-income and moderate income families who actively contribute to retirement savings. If you are under the above income limit for your filing status, saving for retirement offers a double tax refund benefit for your family, along with greater retirement security for yourself.

Low income families would benefit from hiring a financial advisor who can guide them in beginning a retirement plan and claiming the deduction. They should be careful, though, of commissioned sales representatives, calling themselves financial advisors, who prey on low-income families.

Other Key Limit Increases

Although the above are the most common retirement changes affecting Americans, a few other items impact for high-income employees. These limits are summarized below, but aren't discussed in detail. They are important for financial advisers, tax preparers, and Human Resources professionals.

$280,000 annual compensation limit (up $5,000)

$180,000 for the definition of key employee in top-heavy plans (up $5,000)

$125,000 for the definition of highly compensated employee (up $5,000)

How Not To Let The Recent Market Drops Ruin Your Financial Plan

The end of last week saw a stock market drop which has many spooked. Pundits, financial pop -media, and others who make their living off of scaring investors have been using words like ‘market crash’, ‘historic drop’, and ‘recession’. In fact, I’ve personally seen a number of social media posts from friends discussing how they have gone 100% to cash after the recent market turmoil.

Here are the 5 things you can do to keep the market downturn from ruining your financial plan.

1. Not A Damn Thing

The number one thing you can do to avoid ruining your financial plan is to ignore all of this turmoil and keep on track with your existing plan. Market downturns happen, and an investor is going to experience up to a dozen market downturns over their entire investing life. If you are not nearing or in retirement, don’t react to a market downturn which will honestly have zero impact on your overall investing plan.

And if you are in retirement, don’t react to a market downturn, the chance of which should have already been factored into your financial plan.

No matter how grave the situation may seem, don’t fall into the temptation of reacting to short-term market movement by changing a well-thought-out financial plan. Instead, stick with the plan and ride out these seemingly important but ultimately inconsequential market drops.

Even the 2008 credit crisis would have had no impact on an investor who stayed the course. In 2009 the SPY S&P 500 stock index lost 1/2 it’s value from it’s high in 2006; dropping from around $174 to around $70. Those that did nothing were rewarded over the next decade with a 300% gain from the low in 2009.

Doing Nothing Beats Market Timing

Those who are dialing back their investments in the stock market, or who are fully moving to cash, are practicing a method of investing called Market Timing. The idea is simple, you sell investments right before a market crash. The problem is, one would have to be incredibly arrogant or gullible to believe they (or anyone else) have accurate knowledge of the future.

When looking at the math of market timing, the math overwhelmingly favors those who ignore the news and do nothing with their investments. William Sharpe, a Nobel prize winning economist and a distinguished Professor of Economics at Stanford, conducted research on comparing the mathematics of market timing verses simply staying in the S&P 500 and doing nothing.

Sharpe found a market timing strategy had to be right 74% of the time in order to simply match the returns of an investor who did nothing. Meaning, unless you think you will accurately predict when the market will drop (in order to sell investments) and also accurately predict when the market will rise (in order to buy investments), then you will earn more money by doing nothing.

Those who actually do try to predict the direction of the market are wrong more often than they are right. Essential Advisor Research studied experts in technical analysis and market timing (those talking heads you see interviewed on the news). What they found was the experts were correct only 47% of the time.

2. Consider the Source

Be very careful of where you get your information from and whose advice you take. The media does very little to vet sources for long-term accuracy, and often the more outlandish and bold the expert’s predictions are, the more the media flocks to them. Simply because outlandish and bold predictions help attract an audience. These experts are simply the P.T. Barnums of the modern era.

Two of the experts often sought after and quoted by pop-media are Murrey Gunn and Peter Schiff. In fact, many of the posts from friends cited articles featuring these two men as the ‘economics experts’ who are predicting a market downturn. Both Gunn and Schiff are well-known known chicken littles who profit off of scaring people into buying Gunn's and Shiff's investment strategies to 'protect against market crashes.' In reality, their investment strategies actually do little more than make Murrey and Peter rich.  On October 12, 2016 Gunn asserted “With the US stock market selling off aggressively on 11 October, we now issue a RED ALERT.” In the 2 years after that "RED ALERT" the S&P 500 went up 28% (14% return per year). Following Schiff would be just as bad, as he continually pushes the collapse of the economic system in order to make profit selling gold investments to the investing public. Schiff's amazing predictions include a 2012 prediction that Gold was going to rise to $5,000 by 2014. At the time gold was sitting around $1,700 an ounce. In reality, the price of gold crashed by 24% shortly after the prediction, and is currently down 30% since the prediction, sitting at $1,230 per ounce.

Don’t Believe Anyone’s Crystal Ball

Anyone who tells you they know what will happen in the market should be roundly ignored. And that includes me if I ever make such a stupid assertion. I'm not saying a market correction can't happen, but managing the risk of market corrections should be based on strategies rooted in academic research that create a consistent multi-decade plan. Not rooted in guesses of what will happen to the market over the next year or two.

3. Get Some Perspective

Last week’s market drop may seem like a huge deal, as SPY dropped from $288 to $274 in the matter of a couple days. The reality, however, is the last few days have not been crazy, or a plunge, or a crash. It's been a 5% drop.

While the market could fall further, don’t think the recent drop guarantees anything in the future. To put the drop into perspective, the stock market drops by 10% on average once every year (357 days). And drops by 5% much more often than that.

What this means is a 5% drop is not only normal, it’s incredibly mild considering the market usually drops by more than twice that amount once a year. In fact, the average market drop within a year is quite larger. According to Standard & Poor’s research, the average annual drop in the market (from peak to trough of a single year) is 14.2%.

Putting last week into the perspective of what is 'normal’ based on history, a 5% drop is quite meaningless.

4. Don’t Be So Short-Sighted

Finally, stop managing your money as though your plan is to die soon. Ultimately, market timing is an exercise which assumes you don’t have time to outlast whatever financial storm might come. Your investing success is determined not by what happens in the next few years, but by what happens in the next few decades. Even retirees have multiple decades of retirement to plan for.

The following two graphs will tell you everything you need to know about why the last week doesn’t matter to your final investing success.

How The Last Month Looked

When looking at the stock market returns over the past month, the drop of last week looks downright scary. The problem, of course, is the chart offers no perspective of history.

Instead of showing the history of the market, charts like this show a brief snippet in time. Often, showing a chart with such a short time frame is done to intentionally spin the truth into something else.

For you personally, looking at a chart like this will give you a misleading view of what is happening. A view which then might lead you to make mistakes with your investments.

How That Same Month Looks Within 15 Years

If we pull our timeline out to look at the last 15 years, however, the recent drop doesn’t look so bad. In fact, many will be hard pressed to actually see the little drop at the end of the stock market chart. But it is there.

Interestingly, this time perspective even includes the massive crash of 2008/2009. But from this perspective, that crash looks more like a blip than a catastrophe. Of course, if you decided to sell your investments in the stock market even before the market crash happened, you have lost out on a lot post-crash returns. Sadly, there are many who are still waiting for the right time to invest after the market crash of 2009.

5. Don’t Confuse a Bull Market with Brains

One of the worst things you can do as an investor is to assume the success of your investing strategy is due to your own intelligence. Over the past decade, the stock market has increased massively with very little volatility. This consistent growth has led many active investors to think it is their amazing analysis of buying and selling at the right time which caused the increases in their portfolio. In reality, however, they likely lowered their potential return due to minor mistiming and increased fees.

A researched-based investing strategy doesn’t involve timing your way into or out of the market. It involves setting a long-term asset allocation model that invests in broad asset classes with low correlations to each other. Not in guessing what the stock market (or any other asset class) might do tomorrow.

SEC 'Fiduciary Rule' Has A Long Way to Go

Spoiler: It isn't a 'fiduciary rule'

Now that the DOL Fiduciary rule has been defeated in court by the combined efforts of the broker/dealer and insurance industries, attention is focused on the SEC as they attempt to offer new rules related to how broker/dealers, Registered Investment Advisors, and their respective representatives interact with the investing public. Sadly, the SEC rule is anything but a fiduciary standard.

While the rule requires broker/dealer representatives to work in the best interest of their clients, it fails to subject them to a fiduciary standard, which offers significantly greater legal protection to the client. Instead, broker/dealers and their representatives will continue to be subject to the suitability standard.

Suitability Defined

The difference between a fiduciary standard and a suitability standard is vast. The fiduciary standard provides both a requirement for the advisor to act solely in the interests of the client and an opportunity for legal recourse should an advisor violate the standard and harm the client. The suitability standard, however, only requires the advisor to give advice which is suitable, even if the advice is not in the best interest of the client.

Suitability means an advisor can recommend an investment predominantly based upon how much the advisor is paid, so long as the investment is not bat-shit crazy. The suitability standard allows for investment advice which may clearly not be in the best interest of the client, but is still legal because there exists enough redeeming qualities to meet the extremely low bar of 'suitability.' 

Suitability is also how insurance agents (who are under the same standard) can sell a high cost annuity contract to a 21-year old college student, with an additional cost of a long-term-care rider in case the 21-year old developed exceptionally early-onset alzheimer's disease.   

Take Action

If you think this is a step in the wrong direction, you can read the proposed Best Interest Regulation on the SEC website and leave a comment for the SEC. The comment period ends August 7th. You can comment at https://www.sec.gov/rules/proposed.shtml. Look for Regulation Best Interest posted April 18, 2018. Below is the comment letter I submitted to the SEC regarding the proposed regulation.

My Comment to The SEC:

While I applaud the SEC's attempt to increase the obligations of registered representatives of broker/dealers to deliver advice in the best interest of their clients, the end result of the proposed rule will cause more confusion amongst retail investors, and will likely result in continued harm to the public.

First, the regulation does not subject broker/dealers to a fiduciary standard, even while using the same language in describing the obligation of a registered representative to work in the best interest of the client. This 'borrowing' of the fiduciary language without subjecting a true fiduciary relationship can only lead to confusion in the consumers' mind regarding whether the relationship is under a fiduciary standard. As a result, a great number of unsuspecting investors will believe they have a fiduciary relationship with their broker representative, when none exists.

Further, hybrid broker/dealer-registered investment advisors will continue to be able to proffer advice under a two-hat model, whereby the representative can choose whether to be subjected to a fiduciary or suitability standard, and the client is intentionally left in the dark about whether the advice is subject to fiduciary relationship or not.

Continuing the existing two-hat model can ONLY lead to clients believing advice is subject to the fiduciary standard when, in fact, a portion of the advice is not. Worse, representatives have an obvious incentive to put on their "suitability" hat when their advice is questionable as to whether it is in the best interest of the client. As a result, investors will likely be following riskier advice with greatly reduced legal recourse; which is exactly when the investor needs the added protection of a fiduciary standard.

The SEC should use this opportunity to create a regulation far more in line with the obvious congressional intent of the Investment Advisors Act, whereby advice can only be offered under a fiduciary relationship, except when it is truly incidental to the sale of a product. And when advice is offered incidental to the sales relationship, the regulation should require the registered representative to disclose the advice is being made as part of a sales transaction and is not subject to the fiduciary standard. The regulation should further clearly define what constitutes as advice incidental to a sale so that registered representatives are not left to their own discretion in deciding if they wear the suitability hat or the fiduciary hat with their unsuspecting client.

Your Taxes Are Done! Time to Start on Your Taxes

A collective sigh of relieve was heard today as millions of tax filers sent in their taxes. Most also mistakenly think tax season is over. But savvy people know the best time to start on next year’s taxes is the beginning of this year. If you are one of those who understands the benefits of filing your taxes early, continue that positive habit by starting your taxes early as well.

The following will help you understand your planning options as well as give you a concise list of things which may qualify for a tax deduction. Keeping records and documents of any expenses related to potential deductions will help your tax preparer to maximize your actual deductions.

A History or A Plan

When a CPA prepares your tax return, they have little ability to actually impact your taxes. The reason is your tax return is a historical document about what happened last year. Since you can’t change history, any true tax planning strategies are lost. Next year, however, hasn’t happened yet. As a result, you have complete control over the tax planning environment and can make truly substantive planning decisions.

If your tax preparer never explained this to you, don’t be upset with them. Accountants (including CPAs) are historians by their nature. Their job is to identify how they can make what happened in the past year fit into the extremely complex tax law in the most beneficial way possible for you. Financial planners and tax planners, on the other hand, focus on the future and strategizing how you can use the different elements of your financial plan to make your finances more tax-efficient. They are two very important but very different skill sets.

Plan to Substantiate Your Deductions/Credits

The most powerful tools you have in your tax plan are your tax deductions and tax credits. In order to take deductions and credits, however, the IRS requires you to substantiate them. Substantiation means keeping a document trail which can be used in tax court to prove you are entitled to the deduction or the credit.

Although the law is vague about what constitutes ‘substantiation,’ the IRS and the tax court use a fair amount of common sense when determining if a tax payer has substantiated their claim. If the deduction is well-documented by paperwork which was not generated by the tax payer, it is usually considered substantiated.

If the documents are vague, unofficial, or generated by the tax payer themselves, then they will hold less value as a means of substantiation. And, of course, if the documents have nothing to do with the deduction/credit you are claiming, then they are irrelevant.

Deductions vs. Credits

Although the terms tax deductions and tax credits are sometimes used interchangeably, there is a world of difference between these two. Most are familiar with the concept that both reduce your tax burden and can increase your tax refund if you have overpaid your taxes. Deductions and credits, however, take on completely different characteristics on your tax return.

A deduction reduces your income in the eyes of the IRS; i.e. it deducts money from your gross income. As a result, the benefit you receive is equal to your highest marginal tax bracket times the deduction.

An Example: Say you make $60,000 per year and are in the 20% tax bracket. You would owe $12,000 in taxes ($60k x 20%). If, however, you gave $5,000 to charity, resulting in a tax deduction, your income would be reduced in the eyes of the IRS to only $55,000 ($60k - $5k). The new tax bill is $11,000 ($55k x 20%) instead of the original $12,000. The $5,000 deduction gave you $1,000 in tax savings.

Tax credits on the other hand are when the IRS pretends you paid taxes you actually didn’t pay; i.e. it credits your paid in taxes amount. As a result, the benefit you receive is equal to the actual dollar value of the tax credit.

An Example: You gain make the same $60,000 and are in the 20% bracket. This time, however, your get a tax credit worth $5,000. You still owe $12,000 in taxes ($60k x 20%), but now the IRS pretends you already paid $5,000 in taxes due to the credit. The credit would lower your tax bill to just $7,000 ($12k - $5k). The $5,000 credit gave you $5,000 in tax savings.

As a general rule, tax credits are more valuable than deductions, but there aren’t that many of them.

Start Collecting Possible Deductions and Credits

Since you are not a tax professionals, you may not know what constitutes a tax deduction or a tax credit for your return. Instead of spending hours trying to figure this out, start collecting, organizing, and filing any and all documents related to possible tax deductions and credits. When tax time comes, your tax professional will be able to determine which deductions and credits you qualify for. Only now they will have all the documentation they need to give you the maximum benefit.

Without an organized filing system of all your possible deductions, you will leave money on the table and pay more for the tax preparation. To get the greatest benefit, use a filing cabinet and create folders for each of the following categories. Begin saving receipts, confirmation letters, and other documents for any expense related to any of the categories in their respective folders. Each of the below areas can potentially earn you a tax deduction or tax credit.

Career Expense

Since your income tax is taxed on your...well...income, many expenses which are required for your job may be tax deductible. The new tax code has eliminated many of these deductions for regular employees, but a tax preparer may still be able to use them as self-employment expenses if you have a side-gig. While you may not have a side-gig now, you may end up working freelance at some point in the future. Having good documents of career-related expenses can help a tax preparer maximize your deductions next year.

This includes union or professional dues, work-related expenses, professional development, and even job search expenses. Receipts and documents for any expenses you incur related to your career should be organized and filed in case you qualify for these deductions.

Education Expenses

Similarly, education expenses may still be usable if they assist you with earning self-employment income through a side-gig. If you are currently working in your profession,  you may be able to deduct student fees, tuition, and even books. You may also be able to deduct certain expenses if you are pursuing a new profession. Additionally, you may qualify for an education-related tax credit, which are even more valuable. Keeping all education-related receipts and documents will help you to substantiate both the deductions and credits you are eligible for.

Housing Expense

The new tax law made some changes to the home mortgage interest deduction, but the changes will not impact the first mortgage interest for the majority of taxpayers. Most people are familiar with the home mortgage interest deduction for income taxes. There are many additional deductions you can take, however, related to your housing. Most charges or fees related to your mortgage are also potentially deductible including late payment fees, prepayment penalties, points, and mortgage insurance premiums.

Home improvements can also be tax deductible. There are numerous deductions and even credits for energy saving home improvements. And costs of most major home improvement project can be deducted from any capital gains when you sell the home in the future. Keep copies of all your home improvement receipts as well as before and after pictures to prove the improvements made to the home.

Child-Related Expenses

Again, almost everyone is familiar with the dependent exemption you are entitled to when you have a child, which acts like a deduction. This exemption has been eliminated in the new tax code, but it has been replaced with a greatly expanded child-tax credit.

There are also, however, tax credits available for both adoption expenses and child-care expenses. If you qualify, these tax credits can significantly lower your tax burden. Maintaining good records of childcare and adoption expenses will help your tax advisor to get the most out of any tax credits you qualify for.

Charitable Giving and Expenses

Again, it is well understand that charitable contributions and activities are tax deductible, but many don’t know the details about how the charitable deductions work. Charitable giving should be well documented including keeping all receipts, thank you letters, and cancelled checks. When you donate property, you should keep not only the documentation from the charity but also pictures of all items donated so you can prove what was donated. There are also some other strange rules for donating property to charity, which you should be aware of.

Taxes Paid

The federal income tax system actually allows you to deduct taxes and expenses related to paying taxes, up to $10,000 for state and local taxes. Many state and municipal taxes qualify as tax deductions. You can also deduct the fees you paid last year to prepare and file your tax returns. Any document you get from your state, county, or city related to taxes or fees should be filed and kept for your tax professional to determine if you can deduct them.

Business Owners

If you own a business, almost all expenses related to the running/growing of your business are tax deductible against the income of your business. Save, organize, and add up all expenses related to your business and provide them to your tax advisor. In order for the expenses to qualify, they must be ordinary, reasonable, and necessary for running the business.

Self-employed & Home Offices

Similar to a business owner, the self-employed and those with a home office can deduct most of the associated expenses. Any costs you incur related to your self-employment and/or your home office should be documented and kept.

Medical Expenses

Once you hit a certain threshold of your income, almost every expense you pay for medical purposes becomes tax deductible.  Throughout the year, save all paperwork related to expenses for medical care and provide them to your tax advisor. There are more qualifying expenses than you might think, including things like clarinet lessons for teeth alignment. Generally speaking, if it is prescribed by a doctor or related to health insurance costs, it is potentially tax deductible.

Low Income Families

Two tax credits are available for low and moderate income individuals: the Earned Income Credit and the Savers Tax Credit. Although millions of households qualify for these credits, a small portion of those that qualify actually claim the credit on their taxes.  As a result, low income families lose out on thousands of dollars in financial support.

The rules for both are available on your tax forms and on the IRS website. If you don’t understand them, talk to a tax professional.  The $50 it costs to get your taxes professionally prepared could result in hundreds or even thousands of dollars in your pocket come tax time.

Other Deductions

The expenses listed above are not an exhaustive list of every deduction you could be eligible for, but they are the most common. Additionally, your income or other circumstances may disqualify you to receive the tax benefit of a deduction. The purpose of this article is to provide you with a foundation to know what receipts and documents you should keep in order to maximize your deductions when filing.

Seeking Professional Help

If you are itemizing your deductions, you should always consult a professional tax advisor before claiming a deduction and filing your tax return. When seeking help, avoid dropping a large box of receipts on their desk. Your tax professional will have no problem entering all of those numbers into a spreadsheet for you because they’ll charge you $100 an hour to do it.

Instead, organize the documents and enter the information into a spreadsheet organized by type of deductions. Then add up the deductions and provide the total for each category along with the spreadsheet and original documents. This will save your tax advisor hours of time and save you hundreds of dollars in tax preparation fees.

These Steps Can Put You Back In Control After The Equifax Security Breach

The most recent Equifax data breach has made more people than ever aware of the growing problem with identity theft. If you were part of the 143 million whose data was released by Equifax, your personal security is unfortunately wide open to criminals. If you weren't part of the theft, you should still consider taking steps to protect your identity from future breaches.

Getting your credit report is just the first step in protecting your identity. To fully protect your identity, you'll need to go beyond the three big credit bureaus to protect yourself against banking fraud, tax fraud, Social Security fraud, and other criminal activities. The following are the concrete steps (along with direct links to the fraud webpages) you can take to protect your identity.

1 - Get Your Credit Report

If you haven't done it yet, get your credit report from the credit reporting agencies through the online form at annualcreditreport.com. The three major agencies -- Transunion, Equifax, and Experian -- all provide the legally mandated free report through this website.

You are entitled to one free credit report per year from the reporting agencies, and if you spread out the reports, you can actually check your credit for free three times a year. (The Purposeful Finance Challenge has scheduled challenges to remind you which report to check and when throughout the year.)

Other services, like Credit Karma offer you the ability to check your credit more often. The upside of these services are obvious, you get to check your credit regularly, and can even take a peak at your credit score.

The downside of using these services are you have given your information to one more company which could be hacked. The three major credit 

2 - Place a Fraud Alert & Consider a Credit Freeze

Through the same website you can place a fraud alert on your credit report. This will make it significantly harder for criminals to use your credit, as it will subject future applications for credit to additional scrutiny. 

If you want to go to the extreme option, you can place a credit freeze on your credit. This makes it impossible for a criminal to use your credit, unless you give out the Personal Identification Number they give you. Keep this PIN safe, as you will need it to be able to take out loans or do anything else with your credit in the future.

Realize, however, that this is an extreme option and freezing your credit has significant downsides. Make sure you understand the reasons why not to freeze your credit before making this decision.

Go to All Four Credit Bureaus

Fraud alerts and credit freezes only work if you have placed them on all four of the credit bureaus. Start with the fraud webpages for the big  three credit bureaus at Equifax, Experian, and TransUnion. Many people are surprised to hear there is a fourth credit bureaus beyond the big three.

Innovis is another credit bureau which collects data on consumers and provides it to creditors. Although not as prominent as the big three, placing a fraud alert or a credit freeze is necessary to fully protect your identity.

The Cost of Protecting Your Credit

Placing fraud alerts on all four bureaus will be free, unless you have purchased this service as part of another product. You don't have to buy a product to place the fraud alert, and any individual can do it on the bureaus' websites.

Credit freezes, however, cost money depending on the state you live in. State law determines the cost of credit freezes, and prices range from free to $10 per change. Per change means you must pay the fee to freeze your credit, and again pay the fee to thaw your credit when you want to use it. You'll also have to pay the fee to re-freeze your credit once you are done applying for credit. 

3 - Place a Security Alert with ChexSystems

Another surprise to most consumers is that there is a credit-like system for checking and savings accounts. The rise of check fraud and other banking fraud has led to the creation of a system for identifying people who have abused checking accounts or other bank accounts in the past.

If a criminal opens a checking account in your name, it may not seem like a big deal. But if the criminal bounces checks, commits banking fraud, or runs up a huge overdraft bill, you would be responsible until you cleared your name. Activity like this would also make it near impossible for you to open a new legitimate checking account in the future.

You can place a security alert or a freeze on your information at the ChexSystems website, as well as getting a copy of your ChexSystems report. Placing a security alert with the company will make it harder for criminals to open checking accounts or other bank accounts in your name.

4 - File Your Taxes Early

One thing many don't consider with identity theft is the risk of a criminal filing your taxes for you. With the information from the Equifax security breach, a criminal has almost everything they need to file a tax return in your name.

If the criminal inputs false information and claims a big tax refund (or an even bigger one with the Earned Income Tax Credit), the IRS will go after you for the money you shouldn't have gotten. It will take significant effort and time to clear your name.

Filing your tax return early will put the IRS on notice that the second criminal tax return is fraudulent. When the criminal files the return, the IRS computer system will see a return is already on file for your social security number and will reject or red-flag the return.

5 - Update Your Security

As soon as you hear about a security breach, you should immediately update your information on all important accounts you have. This includes your e-mail account, bank accounts, investment and retirement accounts, loans, insurances, and others.

Change PINs and Passwords

Start by changing your Personal Identification Numbers and passwords on the websites. As a general practice, passwords should be updated periodically or you could use a password management service.

Update E-mail Addresses

Make sure your e-mail address is updated with all of the account providers. Most financial institutions and other companies will send an e-mail to you if any changes occur on your account. This e-mail could be the best defense you have to find fraudulent activity before it occurs. If your e-mail address isn't updated (of if the criminal has your e-mail password) you may never get the e-mail.

Enable Two-Factor Authentication

One of the best security measures you can opt for is enabling two-factor authentication on all of your accounts. Two-factor authentication requires someone to have both a password and also some physical item to access your accounts. Many companies allow you to register your personal computer or phone as the physical item needed to access the account. Others go further and use a small USB token which must be plugged into the computer.

With two-factor authentication, the criminal needs both your password and your physical computer, phone, or USB token to do anything with your accounts.

6 - Check If Social Security Fraud is Occurring

Social Security fraud is an ongoing problem, where people use your Social Security Number (SSN) to work. Although this may seem like no big deal, it may impact your Social Security benefits in the future. Social Security fraud also subjects you to owing more taxes as the IRS will consider you to have earned the money.

You can create an account with the Social Security Administration to be able to view your work history as reported to the government. If you find errors, you can correct them with your local Social Security Office.

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President Trump’s Individual Income Tax Plan

Before we go too far down the rabbit hole of what would happen if Trump’s one-page tax plan becomes law, it’s important to remember that the plan isn’t law. There is no sign currently that Trump’s plan will become law. And the great deal of historical legislative evidence suggests that if tax reform is passed, Congress will make sure it will be very different from what the President proposed. To paraphrase the military: “No Presidential plan survives contact with Congress.”

What You Should Do

Nothing. Absolutely nothing. Considering the tax reform is nothing more than the intentions of the President, there is nothing you should do, and absolutely nothing you can do based on his tax plan. You should, however, practice good tax planning strategies based on the code we have now.

Assuming the President is able to pass some form of tax reform, whatever it might look like – and assuming you will experience lower taxes next year – you should familiarize yourself with the currently available tax planning strategies such as the timing of deductions, managing your withholdings, and maximizing your tax deductions.

Even better, use this opportunity to talk with a tax advisor or financial planner about how you can better manage your taxes in the future. If tax reform does come, once you know the details, you can use these same planning strategies to take the best advantage for yourself.

What if?

But for the fun of it, let’s say Trumps plan is implemented exactly as proposed. The following is what I like and what I don’t like, and what elements of the plan may mean for you. Why “may mean for you”? Because taxes are extremely complex, and how things impact you will depend on a host of factors which are unique and specific to your personal situation. Do not take anything on the internet as tax advice. This article is intended as general educational for understanding the possible impacts of the proposed tax reform.

The Devil in the Details

The truth is, even if the plan is implemented as written, there isn’t a lot of detail in the plan. The true impact of any tax plan is in the details. On the plus side, the President’s plan is presented in a simple format which anyone can understand. Too often, legislative proposals are made in a complicated manner so as to be incomprehensible to the average person.

At the same time, the simplicity of the plan means we can understand the broad direction the President wants to go in, but we can’t actually do anything with it due to the lack of details. The good news, by the time Congress is done with it, whatever is made law will likely be hundreds of pages of confusing detail.

Overview of the Plan

Trump is proposing to massively overhaul the personal income tax code down to four tax brackets. He keeps the progressive tax structure we currently have, where the more money you make the higher percentage tax you pay. The highest tax bracket drops from over $400,000 to around $150,000 per person. At the same time, the top tax rate drops from 39.6% all the way down to 25%.

The plan is said to be ‘revenue neutral,’ which means whatever tax deductions are given have to be made up by raising taxes elsewhere. In order to accomplish this, the President says he will take away deductions from the wealthy (single filers making $150,000+ and married filers making $300,000+) except for the charitable deduction and the mortgage deduction. In order for the plan to be truly revenue neutral, though, all deductions will have to be taken away from the wealthy. A significant number of deductions will also need to be removed from those in the proposed 20% tax bracket, which make up the middle class.

What I Like:

The simplification will make it easier for people to do their taxes, and eliminates all tax deductions for very high-income individuals. The proposal also takes away the marriage penalty where moderate- and high-income earners actually pay more taxes when they get married.

Eliminating Income Taxes For Low and Middle Income

The plan will also likely mean lower-income and middle class earners will pay no taxes, as the bottom tax bracket is now 0%. With the standard deduction and personal exemptions, a family of four earning $100,000 or less would likely pay no taxes. This is because the higher proposed standard deduction and personal exemptions will lower their Adjusted Gross Income to the $50,000 range identified in the proposed 0% tax bracket.

Doing Away with AMT

The elimination of the Alternative Minimum Tax (AMT) is also a welcome change. Originally, the AMT was targeted at a couple hundred ultra-high income earners who legally avoided paying taxes. But since it was never indexed to inflation, nearly 50 years later the AMT now catches millions of mainly middle-class Americans. Eliminating deductions for the wealthy is a much better system, as the tax brackets are indexed for inflation.

What I Don’t Like:

Using the IRS statistics for 2014, we can calculate the current average tax rates for people in every income bracket based on the taxes they actually pay. The President’s plan greatly decreases taxes for everyone making less than $100,000, but those making between $100,000 and $500,000 per year would see their taxes increase. Families between $100k and $200k would see an increase in taxes from 17% to 20% under the President’s plan. And those earning between $200k and $500k would see taxes go from 22% to 25%.

Those making above $500k would also see their taxes cut, even with the removal of all deductions. Currently, after all their deductions, those making more than $500,000 per year pay between 28% and 33% of their income in taxes. Dropping to 25% will be a significant tax benefit for this group.

Although I like some elements of the plan, if the plan is tax neutral, as the President says, it is because it represents a major tax break for lower income and ultra-wealthy on the backs of the moderately wealthy and wealthy. Adding in another 30% tax bracket for the highest wage earners and adjusting the President’s top two brackets would be a much more palatable plan in my opinion.

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Congress Killed Auto-IRAs Run By States and Cities

In March, Republicans in Congress rolled back a "last minute" Obama administration rule which allowed city governments to create “low cost” employer-sponsored retirement accounts for small businesses. On May 3rd, the Senate passed legislation rolling back a similar rule allowing State governments to do the same.

The two rules allowed local governments to avoid ERISA regulations and create and administer “Auto-IRA” programs, which automatically force employees to take a percentage of their income and ‘invest’ it into a retirement account. Employees could then opt-out of the program if they didn't want it.

The Obama administration gave us a number of beneficial and needed financial programs including ABLE accounts for the disabled and making all retirement investment advisors fiduciaries (the future of the fiduciary rule is also in question). Unfortunately, the Auto-IRA isn’t high on my list of Obama administration initiatives I liked.

The Need Auto-IRA Intended to Address

Automatic enrollment in work-sponsored retirement programs have been proven to be the most successful method of 'encouraging' the public to invest. Sadly, the general public is amazingly creative in coming up with reasons not to invest for their retirement.

The Auto-IRA intended to expand work-sponsored programs by forcing small employers to join a local government-run program if they didn't offer their own 401(k) or similar program. The Auto-IRA was a needed step in the right direction, but was not the ideal solution.

Although a number of fundamental problems and concerns with the Auto-IRA program makes me OK with its death, there is still a need to address the tens of millions who don’t have an auto-enrollment retirement program at work. Republicans have begun drafting legislation which they say will solve this problem in an improved manner, but the truth will be in the details.

Concerns with Auto-IRA

Ultimately, congress needs to address the lack of participation in IRA and other self-directed programs, but I believe making personal financial education a requirement at the high-school and university levels would be the better choice.

Whether the solution is a new retirement investing account or more education, the Auto-IRA program wasn’t an ideal solution. The program lacked ERISA protection, had potentially poor management, and generally offered limited investment options. The Auto-IRA was a step in the right direction, but I won’t be mourning the death.

Exempting from ERISA Protection

The key legislation which protects consumers’ retirement funds is the Employee Retirement Income Security Act, or ERISA for short. ERISA provides a host of consumer-protection features including providing choice in investment options, protection of funds from creditors, and the fiduciary requirement.

In fact, the fiduciary-related protections found in ERISA was the legal basis for Obama's Department of Labor to require retirement plan investment advisors to adhere to the fiduciary rule. A standard which should always have been the case, and which the Trump administration sadly might be scaling back.

Strangely, though, the Auto-IRA program exempted state and city governments from ERISA, leaving consumers without these protections. Considering those most likely to ‘benefit’ from an Auto-IRA program are lower-wage earners and unsophisticated investors, it seems strange the program would exempt local governments and private investment managers from ERISA protections.

Some states have written the fiduciary standard into their Auto-IRA law, but states and cities are not necessarily required to do so. Additionally, there are more ERISA protections than just the fiduciary standard. Considering the huge number of state and local government agencies which could create their own Auto-IRA program, exemption from ERISA isn’t likely to be in the consumer’s best interest.

Proponents say ERISA regulations are too costly for small employers to handle, but the Auto-IRA is administered by state and city governments, meaning they should have no problem abiding by the regulations.

Poor Management Track Record

Many would argue ERISA protections are not necessary since states and cities are subject to the voters and therefore will act in their best interests. Unfortunately, this theoretical principle does not always play out in the real world. California gave massive water rights to the privately held Wonderful company, which uses as much water each year as the entire city of San Francisco does in a decade. The state continues to defend the arrangement despite a massive drought.

Further, state and city governments don’t have the best track record managing their own employee’s retirement plans through their pension funds. According to Stanford’s PensionTracker.com, every state has unfunded pension obligations due to a combination of inaccuracies in retirement period estimates, demographic shifts, and lower-than-expected returns on investments. Don’t get me wrong, the problems of public pensions are not all the fault of local government. But they do demonstrate workers are in need of consumer protection within state and city run investment programs.

Worse, since the programs would be administered by the states and cities, consumers could have no ability to change investment managers or investments.

Investing in Treasury Bond Fund

One of the biggest problems with state and city government investment programs are the investment options, which are often established to be far more conservative than professional financial advisers recommend.

Auto-IRA participants often only have one choice for their investing, as is the case with the California Secure Choice fund. The option: an ultra-conservative Treasury Bond Fund, which invests solely in low-yield and safe U.S. Treasury Bonds.  Comparably, the OregonSaves program shines as an outlier, offering a whopping three investment options for savers.

Don’t get me wrong, Treasuries are wonderful investments, but they will definitely not provide the returns American’s will need to secure their retirement. Yields on Treasury bonds rarely keep up with inflation, meaning, when held to maturity, the bonds will leave American’s with less purchasing power than they invested due to inflation eating away at the value of the dollar.

Treasury bond funds, however, have provided much higher returns over the past 30 years because of the steady three decade decline in interest rates. When interest rates drop, older higher-interest bonds become more valuable and sell for more in the market. And interest rates have been dropping consistently and steadily since the ridiculously high interest rates of the 1980s (mortgages were in the mid-teens). This trend made long-term bond funds more profitable than they otherwise would be.

Interest rates are currently at historic lows, however, as the constant barrage of mortgage ads will tell you. Over the next 30 years, the interest rate direction is highly likely to reverse, seeing rates climb. Just as dropping rates increased bond values, the rising rates would cause Treasury bond funds to drop in value. This double edged sword of low yield and dropping values could leave Auto-IRA investors with little to show for their hard-saved money.

Some critics have speculated part of the motivation for the Auto-IRA accounts is to create a stable and robust marketplace for Treasuries.

The Takeaway

Ultimately the Auto-IRA program wasn’t the ideal solution to a very real problem, but it did attempt to address very real problem of American's not being financially ready for retirement. Fortunately, the death of the program means little to your personal ability to invest for retirement. You still have the option of opening your own IRA or Roth IRA account and taking control of your own retirement.

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How Your Credit Data Impacts Your FICO Credit Score

The FICO scoring model takes the data in your credit report and distills it down to a numeric calculation which estimates the risk a financial institution takes when lending to a particular individual. Understanding the formula is key to determine how best to manage your debt.

Your credit score impacts multiple areas of your life. Managing your debt to improve your credit score is an important part of maintaining a solid financial foundation for your other goals.

As you make decisions with your debt, however, it is important to remember not to chase your score. "Chasing your score" is what I call it when people make financial decisions primarily to increase their score without regard to the impact on their financial health. Ideally, you want to make good financial decisions and allow your score to increase as a side-effect of your improved financial stability.

There is no sense in incurring additional interest expense to raise your score just to avoid future interest expense on a theoretical loan.

FICO Major Components

Although FICO has updated the score regularly (recent updates discussed below), the credit scoring model has maintained five major components as the drivers of your credit score calculation. These drivers include:

Payment history – 35%

Credit capacity – 30%

Age of credit – 15%

New debt – 10%

Mix of Credit – 10%

When reviewing your credit report, look at each of these areas to determine how the information in your credit report impacts your score.

Payment History: 35%

It probably isn’t a surprise that your payment history is the largest factor in your credit score. Making payments on time is the single best strategy for maintaining your score, minimizing interest charges, and avoiding late fees.

For those rebuilding their credit due to past late payments, there is good news. Although late payments can stay on your score for nearly a decade, the scoring model is more concerned with your recent payment history rather than past transgressions.

The most recent 12 months of payments account for nearly half of your overall payment history calculation. The further back the mistakes are, the less they impact the score. Late payments which are more than 3 years old account for only 10% of your payment history calculation. This means those working to rebuild their score can recover nearly all of the payment history component of their score with just three years of on-time payments.

Credit Capacity: 30%

The second largest component of your credit score is your credit capacity. Coming in at 30%, capacity is a massive portion of your score and almost as big a deal as payment history. Surprisingly, although most people understand the importance of payment history, few know of capacity and little attention is given to the concept in financial media. Don’t let the lack of media attention fool you though, the banking industry is fond of saying “Capacity is King.”

Capacity is the percentage of your credit which you have utilized. Calculate your capacity by adding up all your balances and then adding up all your limits on your credit accounts. Dividing your total balances by your total limits will give you the percentage of credit capacity you have used up. The lower your balances as a percentage of your limits, the higher your capacity is.

Your capacity is driven primarily by your credit cards as revolving debt balances fluctuate month to month as you charge purchases and make payments. People with more stable finances and responsible habits will have lower balances, and a higher credit capacity. Conversely, people in financial distress are much more likely to run up credit card balances and other debt.

Mix of Credit: 15%

The next component of your score sees a big drop in importance, down to 15% of the score. Even with this big drop, 15% is still a significant impact on your overall score. Your mix of credit is effectively how your debt is structured. Some loan types are viewed as positive and will positively impact your score if they are on your report. Other loan types are negative and their mere presence negatively impacts your score.

How much debt you have in each positive and negative category determines the influence of Mix of Credit on your score. The more of your debt which falls into the positive categories, the better your score. As you wrack up the negative debt categories, your score drops. Don’t confuse positive and negative influences on your score with the concept of good debt verses bad debt. You can have debt which is structured to positively impact your score but is still bad debt.

Positive debt categories include installment loans and secured loans. Installment loans are where you take out a fixed loan amount and then repay it in equal payments over a set period of time.

Secured loans have an asset attached to the loan, where the bank can take the asset if you don’t pay. Student loans would be an example of an installment loan, while auto loans and mortgages are both installment and secured.

Negative debt categories include revolving loans and unsecured loans. A revolving loan is one where you have a limit you can borrow, but you get to pull money out as desired. As you pay the loan off, you can then again pull out more money resulting in a sort of revolving door of lending.

Unsecured loans are when the loan is based solely on your promise to pay with no asset attached. Your credit cards are both revolving and unsecured, making a double hit to your credit. Alternatively, a Home Equity Line of Credit is a revolving secured loan.

Making sure the majority of you debt is both secured and installment debt will help preserve your score and will also lower the interest rate you are charged.

New Debt: 10%

The last two components of your score are each worth 10% of your score. The New Debt component includes both applications for debt and new loans you have taken out. Recent applications and new debt within the previous 12 months will harm your score the most. And each new application or loan hurts your score more than the last.

Applications for debt are reflected when your credit report is pulled, but not all pulls of your credit report hurt your score. On your credit report, you will see two sections for credit pulls. One section refers to hard pulls, which harm your score. A hard pull is when you initiated the pull of your credit file (through an application) for the purpose of obtaining a new loan or other credit.

Fortunately, pulling your own credit doesn’t fit this criteria since you are trying to understand your credit rather than obtain a new loan. When you pull your own credit, this is known as a soft pull and has no impact on your credit. Similarly, when you get a pre-approved loan offer in the mail it doesn’t hurt your credit since you didn’t initiate the pull. Most credit reports have a box labeled “credit inquiries only you see” which lists all the soft pulls you have had.

Age of Credit: 10%

The final category is your age of credit, which is simply looking at how long you’ve had each loan and averaging the age of all your loans. Each loan on your credit file will have a beginning (or birth) date, which is used to calculate its age.

Cancelling old debt, paying off installment loans, and opening up new loans will all lower your average age of debt and lower your score.

 Pro-Consumer FICO Updates

Since the credit crisis of 2007/2008 and the creation of the Consumer Financial Protection Bureau, the FICO scoring model has had two major updates, both of which have been very consumer-oriented. In 2009, the FICO 8 scoring model was released, and in 2015 FICO released the FICO 9 model.

The release of new scoring models, however, doesn’t mean your credit score is automatically updated. When a bank looks at your score to determine loan approvals/rates, which scoring model is used will depend on your bank or credit union. Each financial institution determines for themselves which scoring model they want to use in coordination with the credit bureau they primarily work with.

As a result, when you apply for a loan, your score may be based on any of the previous FICO models, or even one of other product-specific models created specifically for auto lending, credit cards, or mortgages. Although most credit lending decisions will use older calculation models, the recent changes to the model are a step in the right direction and a boon for consumers.

FICO 8 Updates

The FICO 8 model, which was released January 2009, is still the most widely used credit score in America according to a 2015 press release from FICO. The model relies on the same basic formula for calculating your credit score, but according to FICO, it attempts to better predict risk amongst “subprime borrowers, new borrowers, those with few open accounts, and borrowers who are actively looking for credit.”

FICO 8 places more emphasis on credit account diversity than previous models did. Consumers with multiple account types (credit cards, mortgages, auto loans, business loans, and others) will experience a boost to their score. Consumers with only one or two types of accounts will see their scores drop.

This change makes sense as the more diverse a consumer’s credit profile is, the more experience they have managing debt without experiencing financial stress. Consumers with only credit card debt may not be prepared to handle larger amounts of debt represented by a car loan or mortgage. Similarly, a consumer with only a consistent and predictable mortgage may not have yet built the self-discipline required to handle a credit card or line of credit responsibly without running up unnecessary debt.

The FICO 8 score also looks more kindly upon single instances of late payments. Mistakenly missing one payment on an otherwise perfect payment history won’t drop your score as much as it used to. FICO 8 also punishes chronic late payers more as several past due accounts will drop your score more than it used to.

Finally, the FICO 8 model no longer punishes you heavily for small collections accounts. Original collections accounts of less than $100, what FICO calls “nuisance debt collections,” are no longer considered in the FICO 8 model.

FICO 9 Updates

Again, FICO 9, released in 2015, continues to use the basic scoring model of the FICO score. FICO 9, however, brings with it a number of pro-consumer changes which conveniently seem to address critiques levied against the lending industry by the Consumer Financial Protection Bureau.

The newest FICO score now completely ignores any paid off collections reported by third-party collections companies. This is a huge benefit for consumers who have long-suffered from being plagued by an industry which sells and resells debt so often even the collection companies can’t keep up with whether a debt has been paid off.

Another win for long-suffering consumers is a change in how the score views medical collections. These unpaid ‘debts’ no longer have as significant an impact on the new FICO score. Considering the enormous number of collections and bankruptcies tied to medical bills, this change will make a significant difference for millions of Americans as FICO 9 is adopted.

The final major change in FICO 9 is the addition of rental history payments into the score when they are reported. The inclusion of rental data in the score can allow lenders to more comfortably lend to first-time home buyers who have shown a history of making their housing payments on time. For those looking to transition from renting to buying a home, this change can be a major benefit.

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Analyzing Your Tax Returns Can Help You Avoid a Tax Refund Next Year Next Year 

Your goal in filing your taxes should not be to get to a big tax refund. The reason why is a tax refund is a return of the money you overpaid in taxes all year long, money that you could have productively used. Rather than overpay, try to pay only enough taxes to meet your income tax obligation.

Most sophisticated financial planners will ask to see a client’s tax return to assess their financial situation. The reason is simple: your tax return is a complete summary of your financial holdings. By analyzing your tax returns, you can comfortably estimate your tax obligations in advance, withhold only what is needed, and ultimately avoid a tax refund.

Are you overpaying taxes?

If you received a refund, you have allowed the government to use your money for the year making it unavailable to you. In other words, you have given the government a 0% loan by overpaying your taxes each month. Remember, the term is a refund, which means, it is your money the government is returning to you.

A refund of $6,000 equates to overpaying taxes by $500 per month. You could have given yourself a $500 raise each month throughout the year by lowering your monthly tax payments (withholdings). The money could have gone toward paying down debt, investing for retirement or any other financial goal, or simply toward enjoying your life. Any of which would be preferable to giving it to the government to hold for you interest free.

How to Avoid a Tax Refund

Your goal in paying your taxes through your paycheck withholdings should be to withhold only what you need to pay your taxes and receive no tax refund. Fortunately, figuring out how much you should withhold is easier than you might think. If you did receive a refund, you can look at your tax return to estimate your tax liability for next year and then adjust your withholdings with your employer accordingly.

Step 1: Estimate Next Year’s Income

If you receive a W-2 each year detailing your income, you can use this year’s and previous returns to estimate your income for the upcoming year. Those without traditional employment, such as small business owners, independent contractors, self-employed, and those who are paid primarily in commissions, may wish to work with a professional financial advisor to estimate income.

If you have traditional employment income, you can use last year’s adjusted gross income (AGI) as a beginning point. Assuming you keep your 401(k) and other pre-tax contributions the same, your AGI number will be approximately the same this year as last.

If you are expecting a raise this year because you have gotten them consistently in the past, you can review previous years’ returns to identify if a consistent trend exists regarding a percentage increase in AGI. If so, increase next year’s AGI by the same percentage accordingly.

Similarly, those with other sources of income can use the past few returns to estimate this year’s income. For each source of income, identify if you will continue to receive the income. If so, estimate if the income will stay the same, increase, or decrease. Recent tax returns can again show you if a consistent trend exists.

Step 2: Estimate Deductions

Next, estimate the total tax deductions you expect for next year. You can easily predict if you will qualify for most deductible expenses again next year, such as dependent exemptions, professional expenses, scheduled charitable giving, and mortgage interest. For deductible expenses that you will incur again in the coming year, reduce next year’s income by this year’s deduction amount.

You can reduce certain deductions slightly, such as mortgage interest, if you expect to have less deductible expenses in the coming year. You can also ask your mortgage company what next year’s interest will be. If there are deduction amounts that you are unsure of for next year, leave them off your tax estimate. This will provide you a small cushion for deductions in case you have unexpected income.

If your deductions are difficult to estimate for the coming year, or you are unsure what qualifies for a deduction, a financial planner can help you estimate them more accurately.

Step 3: Determine Tax

Once you have your taxable income (AGI less deductions), you can estimate your taxes for the coming year using the IRS tax tables. The IRS usually publishes each year’s tax table around October of the previous year. The tax tables are surprisingly easy to use once you have determined your taxable income.

Take your estimated annual tax and divide it by the number of paychecks you receive throughout the year. This will give you the amount you want withheld from each paycheck to hit a $0 return.

For example, if you estimate $18,900 in taxes owed and receive a paycheck monthly, you would want $1,575 withheld from each paycheck (18,900/12). If you are paid bi-weekly, however, you would want $727 withheld from each paycheck (18,900/26).

Step 4: Adjust Withholdings

Now that you know exactly how much you will need to withhold for taxes from each paycheck, you then must update your employer with the amount to want withheld. Filling out a new form W-4 at work will allow you to adjust your withholdings to exactly the amount you want.

Although there is no place on the form to state exactly how much you want withheld, you have two tools to make the adjustment. The first is Line 5, “Allowances” and the second is Line 6, “Additional amount.”

The W-4 is simply a tool to help you withhold the appropriate amount of taxes, and you may use any number of allowances you want. Increasing your allowances will reduce the amount of tax withheld from your paycheck each pay period.

Your Human Resources or Payroll department easily should be able to tell you how much federal tax would be withheld from each paycheck based on how many allowances you claim. Keep increasing your allowances until you are withholding slightly less than what you want to withhold. For example, say you wanted to withhold $727. If 3 allowances withholds $743 but 4 allowances withholds $712, then enter 4 allowances.

Once you have the correct allowances, use line 6 (additional amount) to bring your withholdings up to the exact tax you wish withheld. In our example, you need to withhold an additional $15 per pay period to withhold a total of $727 ($712 from 4 allowances plus $15 additional withholdings). At this rate you will increase your monthly take-home pay, hit $18,900 in taxes withheld for the year, and receive no tax refund.

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You Finished Your Taxes! Time to Start on Your Taxes

A collective sigh of relieve will be heard over the next couple of weeks as millions of tax filers send in their taxes. Most also mistakenly think tax season is over. But savvy people know the best time to start on next year’s taxes is the beginning of this year. If you are one of those who understands the benefits of filing your taxes early, continue that positive habit by starting your taxes early as well.

The following will help you understand your planning options as well as give you a concise list of things which may qualify for a tax deduction. Keeping records and documents of any expenses related to the categories in this article will help your tax preparer to maximize your deductions.

A History or A Plan

When you file your taxes, you have little ability to actually impact your taxes. The reason is your tax return is a historical document about what happened last year. Since you can’t change history, any true tax planning strategies are lost. Next year, however, hasn’t happened yet. As a result, you have complete control over the tax planning environment and can make truly substantive planning decisions.

If your tax preparer never explained this to you, don’t be upset with them. Accountants (including CPAs) are historians by their nature. Their job is to identify how they can make what happened in the past year fit into the extremely complex tax law in the most beneficial way possible for you. Financial planners and tax planners, on the other hand, focus on the future and strategizing how you can use the different elements of your financial plan to make your finances more taxes efficient. They are two very important but very different skill sets.

Plan to Substantiate Your Deductions/Credits

The most powerful tools you have in your tax plan are your tax deductions and tax credits. In order to take deductions and credits, however, the IRS requires you to substantiate them. Substantiation means keeping a document trail which can be used in tax court to prove you are entitled to the deduction.

Although the law is vague about what constitutes ‘substantiation,’ the IRS and tax court use a fair amount of common sense when determining if a tax payer has substantiated their claim. If the deduction is well documented by paperwork which was not generated by the tax payer, it is usually considered substantiated.

If the documents are vague, unofficial, or generated by the tax payer themselves, then they will hold less value as a means of substantiation. And, of course, if the documents have nothing to do with the deduction you are claiming, then they are irrelevant.

Deductions vs. Credits

Although the terms tax deductions and tax credits are sometimes used interchangeably, there is a world of difference between these two. Most are familiar with the concept that both reduce your tax burden and can increase your tax refund if you have overpaid your taxes. Deductions and credits, however, take on completely different characteristics on your tax return.

A deduction reduces your income in the eyes of the IRS; i.e. it deducts money from your gross income. As a result, the benefit you receive is equal to your highest marginal tax bracket times the deduction.

An Example: Say you make $60,000 per year and are in the 20% tax bracket. You would owe $12,000 in taxes ($60k x 20%). If, however, you gave $5,000 to charity, resulting in a tax deduction, your income would be reduced in the eyes of the IRS to only $55,000 ($60k - $5k). The new tax bill is $11,000 ($55k x 20%) instead of the original $12,000. The $5,000 deduction gave you $1,000 in tax savings.

Tax credits on the other hand are when the IRS pretends you paid taxes you actually didn’t pay; i.e. it credits your paid in taxes amount. As a result, the benefit you receive is equal to the actual dollar value of the tax credit.

An Example: You gain make the same $60,000 and are in the 20% bracket. This time, however, your get a tax credit worth $5,000. You still owe $12,000 in taxes ($60k x 20%), but now the IRS pretends you already paid $5,000 in taxes due to the credit. The credit would lower your tax bill to just $7,000 ($12k - $5k). The $5,000 credit gave you $5,000 in tax savings.

As a general rule, tax credits are more valuable than deductions, but there aren’t that many of them.

Start Collecting Possible Deductions and Credits

Since you are not a tax professionals, you may not know what constitutes a tax deduction or a tax credit for your return. Instead of spending hours trying to figure this out, start collecting, organizing, and filing any and all documents related to possible tax deductions and credits. When tax time comes, your tax professional will be able to determine which deductions and credits you qualify for. Only now they will have all the documentation they need to give you the maximum benefit.

Without an organized filing system of all your possible deductions, you will leave money on the table and pay more for the tax preparation. To get the greatest benefit, use a filing cabinet and create folders for each of the following categories. Begin saving receipts, confirmation letters, and other documents for any expense related to any of the categories in their respective folders. Each of the below areas can potentially earn you a tax deduction or tax credit.

Career Expense

Since your income tax is taxed on your...well...income, many expenses which are required for your job are actually tax deductible. This includes union or professional dues, work-related expenses, professional development, and even job search expenses. Receipts and documents for any expenses you incur related to your career should be organized and filed in case you qualify for these deductions.

Education Expenses

If you currently aren’t working in your profession, or are planning to switch profession, you may be able to deduct student fees, tuition, and even books. Additionally, you may qualify for an education-related tax credit, which are even more valuable. Keeping all education-related receipts and documents will help you to substantiate both the deductions and credits you are eligible for.

Housing Expense

Most people are familiar with the home mortgage interest deduction for income taxes. There are many additional deductions you can take, however, related to your housing. Most charges or fees related to your mortgage are also potentially deductible including late payment fees, prepayment penalties, points, and mortgage insurance premiums.

Home improvements can also be tax deductible. There are numerous deductions and even credits for energy saving home improvements. And costs of most major home improvement project can be deducted from any capital gains when you sell the home in the future. Keep copies of all your home improvement receipts as well as before and after pictures to prove the improvements made to the home.

Child-Related Expenses

Again, almost everyone is familiar with the dependent exemption you are entitled to when you have a child, which acts like a deduction. There are also, however, tax credits available for both adoption expenses and child-care expenses. If you qualify, these tax credits can significantly lower your tax burden. Maintaining good records of childcare and adoption expenses will help your tax advisor to get the most out of any tax credits you qualify for.

Charitable Giving and Expenses

Again, it is well understand that charitable contributions and activities are tax deductible, but many don’t know the details about how the charitable deductions work. Charitable giving should be well documented including keeping all receipts, thank you letters, and cancelled checks. When you donate property, you should keep not only the documentation from the charity but also pictures of all items donated so you can prove what was donated. There are also some other strange rules for donating property to charity, which you should be aware of.

Taxes Paid

The federal income tax system actually allows you to deduct taxes and expenses related to paying taxes. Many state and municipal taxes qualify as tax deductions. You can also deduct the fees you paid last year to prepare and file your tax returns. Any document you get from your state, county, or city related to taxes or fees should be filed and kept for your tax professional to determine if you can deduct them.

Investment/Retirement

Expenses related to investing, including retirement investing, are tax deductible. This includes fees paid to your investment advisor, costs of purchasing the investment, and even books and tuition for educating yourself on investing wisely. If the cost is investment-related, keep the documentation of the costs for when you prepare your tax return.

Business Owners

If you own a business, almost all expenses related to the running/growing of your business are tax deductible against the income of your business. Save, organize, and add up all expenses related to your business and provide them to your tax advisor. In order for the expenses to qualify, they must be ordinary, reasonable, and necessary for running the business.

Self-employed & Home Offices

Similar to a business owner, the self-employed and those with a home office can deduct most of the associated expenses. Any costs you incur related to your self-employment and/or your home office should be documented and kept.

Medical Expenses

Once you hit a certain threshold of your income, almost every expense you pay for medical purposes becomes tax deductible.  Throughout the year, save all paperwork related to expenses for medical care and provide them to your tax advisor. There are more qualifying expenses than you might think, including things like clarinet lessons for teeth alignment. Generally speaking, if it is prescribed by a doctor or related to health insurance costs, it is potentially tax deductible.

Low Income Families

Two tax credits are available for low and moderate income individuals: the Earned Income Credit and the Savers Tax Credit. Although millions of households qualify for these credits, a small portion of those that qualify actually claim the credit on their taxes.  As a result, low income families lose out on thousands of dollars in financial support.

The rules for both are available on your tax forms and on the IRS website. If you don’t understand them, talk to a tax professional.  The $50 it costs to get your taxes professionally prepared could result in hundreds or even thousands of dollars in your pocket come tax time.

Other Deductions

The expenses listed above are not an exhaustive list of every deduction you could be eligible for, but they are the most common. Additionally, your income or other circumstances may disqualify you to receive the tax benefit of a deduction. The purpose of this article is to provide you with a foundation to know what receipts and documents you should keep in order to maximize your deductions when filing.

Seeking Professional Help

If you are itemizing your deductions, you should always consult a professional tax advisor before claiming a deduction and filing your tax return. When seeking help, avoid dropping a large box of receipts on their desk. Your tax professional will have no problem entering all of those numbers into a spreadsheet for you because they’ll charge you $100 an hour to do it.

Instead, organize the documents and enter the information into a spreadsheet organized by type of deductions. Then add up the deductions and provide the total for each category along with the spreadsheet and original documents. This will save your tax advisor hours of time and save you hundreds of dollars in tax preparation fees.

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Small Changes Each Year Can Net Huge Results in Retirement

Retirement is one of the most talked about subjects in the personal finance realm, and for good reason. Although nearly every American has the dream of retirement as one of their financial goals, most people face significant challenges to their goal of a comfortable retirement.

Understanding the truth behind the challenges is the first step to overcoming them. Then, take control of your retirement through the only vehicle you actually can control: your personal savings and investments for retirement.

Challenges to Retirement

The traditional three legged stool of retirement (Social Security, Pensions, and Personal Savings) won't be the basis for a comfortable retirement in the future. Each leg of the stool has deteriorated over the years. As a result, without significant advanced planning and preparation, the likelihood you will have enough money in retirement is about the same as Justin Bieber maturing into a fine young man. That is to say, the chance is very low.

First Leg: Social Security

Social security provides a base-level safety net, but few would consider a social security check to be a comfortable retirement. According to the Social Security Administration, in 2017 the average monthly Social Security benefit check for retirees is $1,360. With an annual benefit of just $16,320; social security provides an average annual income just above the Federal Poverty Line of $12,060 for individuals.

Compounding the meager safety net is the fact that social security has been and continues to be in danger of running out of funds for future recipients. The huge population of baby boomers is blamed for this problem, as they are now entering retirement in droves. Similarly problematic, however, is the fact the baby boomers didn’t have as many kids, meaning fewer workers are in the workforce to support current and future retirees.

According to Social Security data, there are only 2.8 workers supporting each retiree in 2013. This compares to a ratio of 16.5 workers per retiree in 1950. Granted, the worker to retiree ratio dropped dramatically in the early decades of Social Security, but the 2.8 ratio is significantly lower than the ratio of 3.3 which persisted from 1975 to 2008. As fewer workers enter the workforce even while more workers reach retirement age, the social security system will experience significant additional stress.

Second Leg: Pensions

Pensions, both public and private, aren’t fairing much better than Social Security. Private pensions have all but disappeared as companies shift from the unknown risk of future pension obligations to offering the predictable current expenses of 401(k)s.

Public pensions don't seem to be disappearing, but the pension benefits they offer are diminishing. Those who are part of the public pension system within their state should be aware of the financial difficulties and funding shortfalls the systems are experiencing.

According to Stanford’s PensionTracker.com, every state has unfunded pension obligations which would fall either on the state tax payers or the pensioners to pay for either through additional taxes or reduced pension benefits. The study shows state ‘pension debt’ ranging from $14,020 to $110,528 per household in each state.

If you currently are part of a pension plan, you should consider alternatives for providing for your retirement. Public and private pensions both face a possible inability to cover pension obligations. And many have sought court approval to lower pension benefits for current and future retirees.

Third Leg: Personal Saving

That leaves one leg of the stool left, personal savings. These include your 401(k)s, IRAs, 403(b)s, income producing assets, and other savings instruments. Even with all these options, the average retirement savings for Americans is significantly less than is necessary to provide for a comfortable retirement.

Averages, of course, can be misleading, as they include both those nearing retirement and the young with 40 years of savings still ahead of them.  If we look only at those on the verge of retirement, who should have the most saved, the numbers still don’t look all that rosy.

A June 2015 Government Accountability Office study found those 55 to 64 had an average of $104,000 saved for retirement. That nest egg would result in a $347 monthly income based upon the 4% safe withdrawal rate, and even less if you were to use the money to purchase an annuity.

And although personal savings too is wobbly, this is the leg which can save your retirement as you have complete control over it.

The Opportunity for Earlier and Wealthier Retirement

The fact you are solely responsible for your retirement may seem daunting, but there is significant hope in it as well. Because it is up to you to fund your retirement, it also means you are in control of when you retire and how much money you will have to spend in retirement.

The more you save toward your retirement, the more options you have. A general rule of thumb is to save 10%-15% of your income each year toward your retirement. Most experts agree at this savings level, you will be able to replace your full income in retirement. And saving more will provide you with options for either an earlier or a richer retirement.

Whether you are just beginning a retirement investing plan or are mid-way through, the competing goals and responsibilities in your life can make it difficult to put the suggested 15% of your pay away each month toward your retirement. Fortunately, using one (or more) of the following strategies can help you achieve the 15% number without feeling pain.

Ratchet Method

Instead of attempting to jump straight to a 15% savings rate, start with something small and manageable. If all you can afford in your budget is 3% of your income to get your employer’s match, then begin there. Each subsequent year, however, move the percentage up at least 1%.

If you make $60,000 a year, at 3% you’re putting $150 a month toward your retirement. Going from that to $750 each month will likely not fit in your budget. But it will likely be easy to go from $150 a month to $200 per month (3% to 4%). Over a decade, you’ll achieve the 15% of your income number when the employer match is included.

Split Raise Method

Again, starting with the same 3% of your income, you can quickly grow your retirement savings percentage without feeling any pain to your budget by splitting any raises you get between yourself now and yourself in retirement. As your income goes up, take half of the increase and spend it, and take the other half of the increase and put it toward retirement.

Say you got a 5% raise, increasing your salary from $60k to $63k. Taking $1,500 of the raise and diverting it to your retirement account will still leave you with $1,500 to spend on new luxuries and fun. Your lifestyle will improve, but you’ll also have moved your retirement savings rate from 3% to over 5%! Adding in the 3% employer match and you’ll be closing in on the 10% figure.

Debt Diversion Method

If you are currently working through paying down consumer debt, such as credit cards and high-interest auto loans, then focusing on debt may be a better alternative. Just make sure to at least get the employer match if you have one.

As you eliminate debt, however, you can begin shifting the money from paying off debt to investing for retirement. Even if you only put half of the money toward retirement, you’ll end up with a significant increase in your retirement savings with no impact on your current lifestyle.

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A Case of The Tail Wagging The Dog

There is a big debate in personal finance circles about the need for a budget. On one side are those who argue creating and managing a budget is necessary for any level of financial success. They argue without a budget you are cast adrift, doomed to spend money with abandon on frivolous and unnecessary purchases. Under their guidance, if you are grocery shopping and run out of money in your budget or envelope or pre-paid debit card, you should begin putting groceries back.

Squared off against these pro-budget activists are financial pundits who say budgets are a waste of time. That budgets are limiting and boring, and making a budget is pointless because budgets are impossible to actually follow. They argue if you begin by putting money in your savings at the beginning of the month, you can ignore any need to budget and spend with wild abandon on whatever your heart desires. Under their guidance, you should become the financial equivalent of the dog from UP! – constantly jumping from purchase to purchase based on whatever new thing catches SQUIRREL!

A Flawed Definition

This debate, however, centers on a fundamentally flawed definition of what a budget is. The problem is it assumes budgeting is a limiting activity in which you identify how you are going to spend your money and then blindly follow stringent guidelines. Both sides view your budget as the deciding factor in your life.

A Better Definition of Budgeting

This concept that a budget is the deciding factor in your life suggests that a small part of your life should control the whole of your life; a case of the tail wagging the dog. Instead, a budget should be viewed as a living document which outlines how you want to spend your money, and should be updated and changed as necessary to meet your ever changing needs, goals, and desires.

A proper budget should list off all the things you want to spend your money on, such as groceries, rent, vacations, saving for a down payment on a home, and retirement. Your budget then simply documents how you want to allocate your income into those categories. As your desires change, so does the documentation.

The True Value of Budgeting

The value of budgeting doesn’t come from having a document to blindly follow. Instead, the value of budgeting comes from having a single page on which you can see all the things you want to spend your money on. By seeing it on one page, you can easily understand how choosing to go out for dinner an extra night will impact your other spending. The money has to come from somewhere, and a budget allows you to choose where the money will come from.

The exercise of budgeting shouldn’t be designed to limit you, but to give you the freedom to spend money in the manner you wish to spend it.

Opportunity Cost

Every time you adjust your budget to do something not in your budget, the money has to come from somewhere. Since your boss isn’t going to randomly give you extra money, the only place it can come from is another area of your budget. This concept is called your opportunity cost; all of the other opportunities you give up when you make a choice to spend money. Every dollar you spend means one less dollar you can use anywhere else in your life.

This is not to say you shouldn’t spend the money. You earn money to spend it and enjoy your life. Although you need to save money for future spending, like your retirement or a child’s education, you also need to spend money today to enjoy your life and your family. Ultimately, every dollar you ever earn will either have been spent or given away on the day you die.

The trick is to understand the concept of opportunity cost and identify which specific opportunity you want to give up in order to spend the money. Say you want to spend an extra $200 on a night out to celebrate a family member announcing a pregnancy. Without a budget, you would either spend the money without concern to how you would pay your rent, or you might be paralyzed from enjoying yourself out of fear you can’t afford it.

Having a budget allows you to quickly and easily see where the money could come from and how this decision will impact other things you want to do. You could take the money from your planned trip to Europe, from your weekly date nights, or from your savings for a new home. Or you could decide the celebration isn’t as important as your other goals and decide to send a card and small gift instead. There is no wrong choice, so long as you make the choice realizing what you are getting and what you are giving up.

Changing Costs

Another reason your budget must be seen as a living document is your costs are constantly changing. Devoting $600 and not a penny more to groceries each month sounds like a great idea. But what happens when food prices go up? In order to ‘stick to the budget’ you either have to lower the quality of your food or buy less food. Neither of these is good for the health of your family.

Many costs in your life fluctuate dramatically throughout the year and from year to year. Food, gas, utility bills, entertainment, and clothing costs all change regularly throughout the year. And even ‘set costs’ like your rent will increase over time.

A budget should adjust to account for these changing costs. Sticking to a rigid budget is neither realistic in today’s world nor is it financially sound. Instead, constantly look for how your spending is changing, and identify where you want to adjust to make up for that spending. If your food costs are going up, look for other expenditures where you can adjust your budget, such as if gas prices have dropped.

There are times, however, when all your costs seem to be going up at the same time. A typical family will increase much of their spending during the summer months. They are dining out more, spending more on entertainment, paying higher utility bills, and paying more for gas as the price at the pump increases. In these circumstances, you’ll likely need to adjust your budget by putting less money toward savings. To deal with this problem, increase your savings rate during the ‘cheaper’ months so your average savings through the year hits the mark you’ve set.

Changing Priorities

Over time, even the perfect budget will become obsolete. The reason is your priorities, and your budget should change with them. Ask any parent and they will tell you having their first child has zero impact on their life or their priorities; everything pretty much stays the same. Or maybe I have that backwards.

Significant changes in your life will cause you to dramatically shift how you want to spend your money. Even subtle changes can have dramatic impacts on your priorities and desired spending. Few people can say they enjoy doing the exact same list of things they enjoyed 5 years past.

As your life changes, your budget will need to change and update to fit your new desired lifestyle. At least once a year you should reevaluate your priorities and identify the things you currently spend money on which are no longer important to you. As new priorities rise above old priorities, cut the spending on the old priorities so you can free up money to spend on what you now desire.

Sticking to the same budget year after year will guarantee your spending will not be consistent with the life you want. Instead, your budget will be based on someone else’s’ life; the ‘you’ from five years ago.

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The Spontaneous Combustion of Your Loan Management

If you own a garage or remember high school chemistry, you should be familiar with spontaneous combustion: when something like oil-soaked rags burst into flames without a spark or flame igniting them. If you’re not familiar with the concept, you may want to read up on it to avoid accidentally starting a fire. Just as dangerous is spontaneous debt, which can have as damaging an effect as a fire spontaneously starting in your garage.

Spontaneous Business Debt

Similar to spontaneous combustion, spontaneous debt financing happens without prior planning or forethought. When I teach entrepreneurship or advise business owners, we discuss the sources of and problems created by spontaneous debt financing. One place we look is at the accounts payable they accrue from buying raw materials on credit terms. As the business’ sales grow, there is a greater need for more and more inventory, and a corresponding increase in debt.

The danger of this type of debt is it isn’t planned for. Worse, because it is created by increasing revenues, the true costs of the debt can be hidden by a growing income statement. When circumstances change, however, the business can be put in a situation where it can no longer handle the increased debt and interest payments.

Spontaneous Personal Debt

Business owners aren’t the only people in danger of succumbing to unplanned debt. Even those who are skilled at debt management can be impacted because spontaneous debt isn’t planned. If it isn’t controlled, however, this debt can become a significant drag on achieving your financial goals.

The most common sources of spontaneous debt in your personal finances include life emergencies, lines of credit, and those attractive 0% APR loan offers for purchases.

Life Emergencies

No matter how debt averse you are, an unexpected life emergency can easily add debt to your net worth statement. The best way to manage life emergencies is with an emergency fund, but unfortunately many don’t know how much money should be in an emergency fund. As a result, unexpected emergencies can quickly burn through savings and begin accumulating debt.

A broken car results in a quick need for a new car and a new car loan. Even if the car can be fixed, the cost may be more than your emergency fund can handle. Similarly, not withholding enough for income taxes or being subject to the Alternative Minimum Tax can result in a significant unexpected tax bill come April. Without a significant emergency fund, these expenses will quickly turn into a climbing debt burden. 

The most devastating spontaneous debt stems from unexpected medical bills. Health care costs are consistently the most common cause of bankruptcy, accounting for over 60% of bankruptcies according to a study in the American Journal of Medicine. A Kaiser Family Foundation study found 53% of people without insurance will struggle paying medical bills. Even one in five families with health insurance reported struggling with paying medical bills.

Dealing with life’s emergencies isn’t as simple as ‘acting responsibly.’ To solve the problem, beef up your emergency fund to include more than just a few month’s expenses. And to deal with medical emergencies, keep a separate emergency fund for medical bills. The fund should be at least large enough to cover the annual-out-of-pocket limit on your family’s health insurance.

Lines of Credit

If you have a line of credit, there is significant risk the balance can creep up on you. Most people have a story of credit card creep, especially when they first began using their credit card. Everyday purchases like gas and groceries began the creep. But as you found it so painless to use the card, you began making larger grocery trips than you would with cash. Then you began putting dinner with friends and drinks on the card. Before you knew it, you had a much larger balance than you could pay off in a month and a downward spiral began. You may have found a way to manage credit card creep, but that doesn’t mean you are out danger.

When you get a Home Equity Line of Credit (HELOC), you are in much the same position of danger as when you got that first credit card. Many begin using a HELOC for the kitchen remodel it was originally intended for.

Of course, when you remodel the kitchen you may also want new dishware and chairs to match the fancy new look. Since technically it’s stuff that goes in the kitchen area, you rationalize it as being a part of the remodel and use HELOC money to make the purchase.

Additional purchases follow for upgrading the living room, finally finishing the garage, and taking the family on vacation. Before you know it, your ‘moderate’ HELOC loan becomes a significant drain on your finances, and the higher interest rate makes it significantly more costly than the same dollars borrowed on your home.

To stop this creep, minimize the maximum loan amount for any HELOC or other line of credit. Also, develop a plan for repayment which includes a maximum repayment period.  (Credit cards should be repaid in full each month). Keep track of the monthly payment it would take to repay the loan in that time period and as it approaches an amount which would strain your budget, stop using the line of credit. Finally, other than a credit card you pay off each month, don’t carry any line of credit debit cards or check books with you. Place them in a locked safe or filing cabinet so you have an opportunity to consider the decision before you use the line of credit.

0% APR Purchase Offers

It seems nearly every store now offers financing on purchases, and most of them offer zero interest and/or zero payments for a year or more. As you make these purchases, you’re slowly increasing your debt. And the amazing credit terms hide the potential debt crisis which could be looming over your family. You may think you are getting a great deal as an incentive to buy the store’s goods, but in reality you are getting deeper into debt.

The truth is, retail stores aren’t in the business of lending money. When you make a purchase utilizing one of these offers, you are signing up for a loan tied to a credit card. And the credit card company isn’t in the business of giving free money.

Offers at 0% have a lot of hidden catches to them, and the credit card companies expect a significant portion of the buyers to get caught. Making a late payment, forgetting a minimum payment, or not paying off 100% of the loan on the exact date the offer expires will all cancel the 0% APR. The credit card company will charge a surprisingly high interest rate, and they will do it retroactively to the day you purchased the good. That’s right, you’ll end up paying all the back interest for the entire “0% offer” period.

You can easily avoid increasing your debt by avoiding these 0% APR offers and instead saving up for the item. If you do utilize the offer, set a payment schedule for yourself where you transfer monthly payments into a savings account to be used to pay off the card. Then, send the entire payment amount at least one month before the offer expiration date. Finally, if there is a minimum payment required, set up automatic payments through your bank’s online bill pay so you can ensure every payment will be made on time. Learn how to automate your bills.

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The Ethics of Debt

There is much debate about debt and how it fits into a financial plan. Depending on whom you listen to, you may have an impression that all debt is equal.

Robert Kiyosaki, the author of the Rich Dad Poor Dad empire, has never met a loan he didn’t like. In fact, he’s been on record advising to take out as large a real estate loan as the bank will give you and if you are saving your money you are stupid. Kiyosaki’s leveraged wealth creation approach has helped many improve their financial situation, albeit at considerable risk.

Compare that to the radio and media juggernaut Dave Ramsey, who lies on the extreme opposite end of the spectrum. Preaching that all debt is wrong, Ramsey associates religious morality with getting out of debt. Ramsey’s debt avoidance approach has also helped millions significantly improve their financial situation, even with a significant opportunity cost to both their wealth and lifestyle.

Both of these men have small amounts of genius at the foundation of their message and are worth listening to. Unfortunately, the extreme positions they take don’t account for the nuance and complexity needed to most effectively manage money in today’s society.

The truth of the ‘ethics’ of debt is found somewhere in the middle.

Good Debt

Debt is neither something to be pursued nor is it something to be afraid of. Debt is a tool in financial management, and a very powerful and useful tool. But that doesn't mean all debt is good. In order for a loan to be considered good, it must improve your financial situation.

Despite the fact debt increases you financial risk and costs you money each year in the form of interest, not ll debt is bad. By calculating your future financial position after the debt, that is the amounts your assets and cash flows will have increased as a result of the loan, you can determine if the loan is worth the interest cost and risk it creates.

Although doing math doesn't sound like fun, proper debt management and financial management requires you to understand the true cost and benefit of any decision. Fortunately, you can avoid having to do the calculations on many loan decisions by first applying an initial litmus test. Good debt either directly purchases an appreciating asset, creates or increases an income stream, or keeps you alive. If the debt doesn't fall into these categories, don't bother doing the calculation because it isn't good debt.

Categories of Good Debt

The three categories listed above (appreciating assets, income streams, and health) are the only three reasons anyone should own debt. In all three cases, the common theme is you are left in a better financial situation after the loan than you had before the loan.

Appreciating assets are assets which increase in value over time. The most common loan in this category is your mortgage loan. It is hard to argue with the wealth creation power of home ownership. And those who say they got wealthy without debt conveniently forget it was a loan which allowed them to buy their most valuable asset.

Twenty years after you’ve purchased the house the value will have doubled, but the loan payment will have stayed the same. And with inflation, the mortgage bill will slowly become an insignificant portion of your monthly income. Anytime you purchase an appreciating asset with debt, you have the potential for profit if the appreciation is greater than the interest cost.

Debt which increases your income stream can include loans used to finance rental property or start a business. Both of these are also appreciating assets, but the real benefit is the cash flow they create because cash flow can be used to offset or completely pay the loan costs.

The most common income increasing loan are student loans taken out to improve long-term earning potential. If the loan is small enough so the income it creates or adds is greater than the total cost of the debt, then you will have improved your financial stability by taking out the loan.

Finally, debt for medical bills to help you stay alive can only be viewed as good debt. If your choice is taking out a loan or dying, the loan is the preferred option. Although there are much better ways to handle medical emergencies, such as health insurance and savings, you aren’t going to improve your financial situation very much if you’re dead.

Debt as a Tool

The main purpose of debt is to move money around in time. When you take a loan out, you are sending money you are going to earn in the future back in time to the present day. With the money in the present day, you can use it to purchase homes, cars, vacations, or video games. Obviously not all of these would be good uses of debt, but you can use the money in any way you want.

Of course, the money was your money from the future. As a result, when the future comes you’ll have to send money ‘back in time’ by paying off the debt. The fuel for this time machine being the interest charges.

Viewing debt as a tool will help you to have a healthy respect of it without being afraid of it. Fire is probably mankind’s greatest tool. It cooks food so we can eat it more safely, keeps us warm in the winter, provides light so we can work in the dark, and keeps wild animals at bay. It can also burn your house down.

Too Much of a Good Thing

When you take on too much debt what you are really doing is sending too much of your future money back in time, leaving you in a difficult future position. A drink of water is refreshing on a hot day and is required to stay alive. Too much water, however, and you will drown.

Debt to buy a home is definitely a positive thing for your financial situation, but if the debt allows you to purchase more of a home than your future earnings can truly afford, the result is disastrous. Millions of families found this out during the financial crisis of 2008 when they couldn’t afford the homes they purchased.

There is no magic number for how much ‘good’ debt is OK; a baby can drown in an inch of water, after all. The question is how capable your income and finances are of handling the amount of debt and the associated interest cost and payments.

Bad Debt

Bad debt is everything else. Honestly, we are done with this section and no need to provide an exhaustive list of bad debt. There is no other debt which improves your financial situation. Credit card debt, boat or other recreational vehicle loans, or loans to finance a wedding or a vacation all place you in a worse financial situation than before you had the loan.

If you need a car to get to work, then you can take out a loan to buy a car capable of taking you to work, but most people buy far more car than they need. My wife and I currently (2017) have auto loans for our cars, but we also have the ability to transfer money from a savings account to pay off the loans in full if we wanted.

We do this so we can use the money for other more beneficial purposes, which improve our financial situation more than the cost of the interest. Before embarking on a strategy such as this, however, you should seek the advice of a professional financial planner. 

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The Statement of Your Wealth

A net worth statement is one of the key documents you’ll need in planning your finances and achieving your goals. Your net worth statement is used to track your overall wealth, but there are far more uses of your net worth statement. With just a few minutes and some simple math, you can create your own basic net worth statement.

Creating your net worth statement might seem like an intimidating task, but for most people it’s actually relatively simple. All a net worth statement does is list off your assets, your liabilities, and then subtracts the liabilities from the assets. Grab a paper and a calculator, or open up Excel, and you’ll be ready to calculate your net worth.

Assets

Assets are everything you own which has monetary value, and which you can turn into cash. These include financial accounts, physical assets like your home and your car, and even personal property like furniture and electronics. If you can turn it into cash, you can list it as an asset.

To create the assets section, start by creating subsections for liquid financial accounts, restricted financial accounts, large physical assets, and personal property. For each asset you own, you’ll also need to identify their cash value.

Valuing Assets

Valuing most of your assets will be very simple because each month you get an account statement with the value listed. For physical assets like your home and car, you’ll can find the values by going to trusted websites, like real estate websites and Kelly Blue Book. Personal property and other assets can be valued using E-Bay, or by contacting an expert appraiser if the asset is worth enough.

Identify Liquid Assets

Your liquid assets can be easily and quickly turned into cash for full value. This is a short list of assets including your checking accounts, savings accounts, and even the cash value of a life insurance policy. Normal investment accounts would also be included, but the value in your retirement accounts won’t because you have to pay a hefty penalty to get access to the cash. For this same reason CDs and other restricted accounts are also excluded.

Understanding the value of your liquid assets is extremely important as these are the major sources of funds for emergencies and debt repayment. Having sufficient liquid assets will allow your family to deal with many problems such as surprise bills, medical emergencies, and job losses.  The larger your liquid assets are, the more secure your family is if a negative life event were to occur.

Total Assets

After you’ve listed all your assets, add up the value of all your assets and enter the number in your total assets line in big bold numbers. For many, you’ll be surprised how large this number is. But remember, your assets are only half the net worth equation, now we have to deal with your debt.

Liabilities

Your liabilities are everything you owe, regardless of why you owe it or two whom you owe it. This is usually the most depressing part of the net worth statement to create. The liabilities section provides significant insight into how you spend your money, and is one of the major reasons why you need a net worth statement.

To fill out the liabilities section, you’ll need the total balance of what you owe and the interest rate expressed as an Annualized Percentage Rate (APR). For most of your liabilities, you can get all you need by simply looking at your monthly account statement.

For each liability, write down a name for the debt, the amount you owe, and the APR. Then, multiply the amount you owe by the APR.  This is the amount of money you spend every year on interest. Write that number next to each debt to give you an understanding of the true cost of each debt.

Identify Asset Connections

For each debt, identify the assets you’ve acquired as a result of the debt. Link your mortgage to the home your family lives in and link your car loan to the family car. Understanding how your debt was incurred, and what you bought with it will help you analyze your spending habits and how you use debt in your life. Student loans may not be linked to an asset on the net worth statement, but it’s important to make an note that your income is linked to this debt.

Your credit card debt is obviously linked to a long list of personal property, lots of which you probably don’t use anymore. Seeing how much money you spend each year paying interest on unused personal property items should be great motivation to avoid making purchases you can’t afford.

Asset/Liability Relationships

Also look at the relationship between the asset’s value and the debt balance. For some assets, like a home, you will see the value of the asset increasing while the value of the liability decreases. Owning the asset, even with the associated debt, is ultimately increasing your net worth. Other assets, like cars, boats, and big screen TVs are going down in value every year, often faster than the loan balance decreases. These assets and associated loans are dragging down your net worth over time.

Carefully consider the relationship between the asset and the liability before making any major purchase decisions using debt.

Total Liabilities

After you’ve listed all your liabilities, add up the balances of all your debt and enter the number in your total liabilities line in big bold numbers. With this information you can now quickly calculate your net worth.

Before you do, however, it is also a good idea to add up the total amount you spend on interest each year. Remember, not all of that interest is bad, such as the amount you pay for your mortgage, but seeing the cost of your loans as a total annual expense can provide more motivation to better manage debt.

Your Net Worth

The final step is quite easy: simply subtract your total liabilities from your total assets. The remaining number is your total net worth. It is also the foundation of the inheritance you will leave to your family.

Update Regularly

Your net worth shouldn’t be a ‘one and done’ exercise. Updating your net worth regularly will help you better understand your financial situation, provide insights you can use to manage your money, and help you track your wealth creation over time.

I recommend updating four times a year; every three months. Set net worth milestones for yourself and follow your progress towards each milestone. Tracking your net worth in this manner will help keep you motivated and inform you of the milestones you’ve accomplished.

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Your Career Success Relies on Elevating Your Skills

Your income isn’t based on what you do or even the education you have. Your income is based on the skills you possess and how many other people can do the job you are able to do. To continually increase your income, you need to be continually developing your skills.

Whether you work for a company, a non-profit, or are an entrepreneur, your skillset is the primary driver of your income. If you aren't updating your skills and adding new skillsets, your value in the economy and in your profession will decrease.

No one wants to have a doctor who maintains the same medical knowledge they acquired twenty years ago in medical school. Every year you should look to add to your capabilities by taking at least one class which is valuable in your profession or industry.

As you explore educational opportunities, the following are the most common types of courses you can take to advance your career or grow your business. As well as resources for free or low-cost classes in these areas.

Soft Skills

Probably the biggest area for career advancement is courses in a small set of soft skills. These include interpersonal skills, teamwork skills, leadership skills, and conflict management skills, all of which can be learned through business, psychology, and behavioral science courses.

Unlike technical skills, soft skills are broadly applicable to any career or business, and are often overlooked. But they aren’t overlooked by employers. The U.S. Department of Labor studies the skills gap, which are skills which employers find highly desirable in an applicant but also see lacking in most applicants.

Professionals who close this skills gap within themselves will be at a significant advantage over others for promotions and in a job search. The U.S. Secretary of Labor identifies these “applied skills” outrank technical skills in occupational success in three separate major research studies of employers.

Two of the most important soft skills identified in research are Oral & Written Communication and Critical Thinking Skills.

Oral & Written Communication

In a 2012 Millennial Branding study of business leaders, 91% of business leaders stated candidates possessing communication skills are the hardest to find but most important to find. These results are consistent with multiple other industry, academic, and government studies over the past 20 years.

Regardless of your profession or your business, effectively communicating in both writing and orally becomes increasingly important as your career advances. The higher you ascend in any career, the more of your job involves report and memo writing, conducting meetings, professional presentations, and being able to communicate your professional .

Critical Thinking Skills

The same Millennial Branding study found 78% of business leaders identified critical thinking skills as highly desired but hardest to find in candidates. Companies don’t hire people to be dictionaries for industry terms, nor is your business success dependent upon your understanding of industry jargon.

Your success will depend significantly on your ability to gather relevant data, analyze evidence and separate immaterial facts, and then come to a proper conclusion about the next steps. Courses in critical thinking and analysis and strategic planning will help to develop this skill, even if they are not directly about your particular profession or industry.

Management & Leadership

Developing good management and leadership skills are key to demonstrating your ability to effectively lead a team. As you advance in your career or grow your business, your responsibility over others increases. As a result, your success will be directly tied to how you are able to support other’s success. Courses in management, human resources, leadership, and motivation can all make you more effective and more marketable as a leader.

Professional Development & Certification

Whatever your profession, developing more advanced skills in your profession can provide you with relevant skills which set you apart from the typical person with only a degree. Examples might include accountants looking for courses in auditing or changing tax law, architects taking courses on energy efficient technologies, or landscapers identifying classes in drought-tolerant plants. Looking for educational opportunities which can lead to new certifications can also provide you with an additional point of differentiation.

New Industry/Societal Trends

As new trends emerge in your industry or in society, an opportunity exists to differentiate yourself through new expertise. During the late 90s, professionals and business owners who learned web development skills placed themselves at a huge competitive advantage, many of them quickly advancing in their careers or growing their businesses. Similarly, in the mid twenty-teens, app development skills can provide professionals with a distinct advantage. As new technology and new trends develop, constantly look for courses to become the go-to expert for these new areas of opportunity.

Marketing, Sales, & Negotiation

Whether you own a business or are attempting to advance your career, marketing, sales, and negotiation skills will always help you to advance. Understanding how better to promote yourself and negotiate can help you gain promotions or new customers. And remember, everyone is a salesperson when selling themselves during interviews.

Where to Look For Courses

As you identify courses for advancement and growth, realize you likely have more choices than you think. Professional development courses offered through training organizations often find their way to your e-mail inbox. But with a bit of creativity, you can find even better (and often cheaper) alternatives.

Colleges and Universities

Your local community college will offer a wide variety of courses in almost every profession, as well as broader skill development and business management courses. Similarly, universities offer extension programs, usually at a higher price. Both offer the ability to take courses with experts without having to fully enroll in the school. You can simply take the courses you want.

Independent Experts

For new trends and technologies, independent experts are often the only option for education. A cottage industry has sprung up of experts selling training courses on cutting edge technologies, communication tools, and emerging trends. These experts often develop and sell classes in their expertise years before colleges and universities are able to offer curriculum.

Because they don’t need to demonstrate the value of their curriculum to administrators or undergo the rigorous review needed in academia, these experts can more quickly respond to market needs. There is also a lesser guarantee of quality in these courses as due to the lack of review. In all, however, finding a good independent expert can help push your career or business forward faster.

Industry & Professional Associations

For industry and profession specific trainings, the best place to look are the trade associations, professional associations, and industry groups relevant to your career or business. These will often offer newer and more relevant trainings than a college or university would, with a higher degree of comfort in the validity of the class and teacher. If you aren’t involved in your industry’s and profession’s associations you are likely missing out on educational opportunities which could directly increase your income.

MOOCs

MOOCs are massive open online courses, a relatively new development in education. Offering everything from courses on self-driving car technology, negotiating, entrepreneurship, and machine learning, there is likely multiple MOOCs which will be valuable to your career. Class-Central.com offers thousands of free courses from major universities including Harvard, Cornell, Yale, Princeton, and other top universities.

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