8-5. SOME THOUGHTS ON FINANCIAL PLANNING
Many Americans pay more in taxes than they should simply because they use the standard deduction instead of itemizing. The solution is to maintain a personal record system (see Chapter 9) that provides the information you need when it’s time to prepare your taxes. Also, to the extent allowed by your budget, you should maximize your pretax savings. IRA and 401(k) contributions of $6,000 per year will save you $2,000 in taxes (assuming a combined federal and state tax rate of 30%). One more thought, if you own a home, you can increase your interest deduction by paying January’s mortgage before December 31st. It is important to maintain a liquid base in order to have a financial safeguard for the unexpected. To do this, set aside three to six months of normal living expenses, depending upon your financial capability. Money market mutual funds and Series EE Savings Bonds are good places to hold this reserve. The advantage of Series EE Bonds is that you do not pay taxes on the interest earnings until you cash the bonds in. Consequently, these bonds serve as an excellent tax- deferred savings account while providing immediate liquidity when needed. Most people need health, life, auto, and home insurance. The problem is that costs can vary greatly so it is important to shop around. Take the time to examine your coverage, understand what you have, and make an estimate of what you need. Then evaluate the various policies that are available, being careful to eliminate double coverage situations. These situations often occur with health insurance where the combination of TRICARE, TRICARE supplemental policies, and coverage through an existing employer can lead to the payment of multiple premiums to different companies for the same coverage. When buying a new car you may be faced with the decision between 0% financing or a rebate. The decision is influenced by a number of factors including the amount of the rebate, the interest rate, and the length of time you intend to keep the vehicle. Let’s assume that you are looking at a $30,000 automobile with no down payment and a five year financing period. Your options are 0% financing for the five year period or $2,000 price rebate and 7% financing. If you take the 0% option, you will pay $30,000 over the five year period. If you take the rebate with 7% financing, you will pay approximately $33,200 over the same period. In this case the 0% financing option is the best decision. It normally takes about 4 years for the savings associated with 0% financing to exceed the advantage of a price rebate. If you tend to hold on to your cars for longer than 4 years, the 0% financing option is normally best. However if you intend to trade in the car after a few years, the rebate approach is probably better. Offers can be evaluated by using a calculator such as the one at www.edmunds.com . This can be an expensive way to get your money — a $4.50 charge on a $60 withdrawal equates to a 7.5% service charge! To eliminate these charges only use ATM machines that are operated by your bank or use your debit card to get cash back from grocery stores or drugstores.
Automobile Financing and Rebate Offers
U.S. Treasury Securities
Avoid costly banker or broker fees ($20–50) by buying U.S. Treasury securities directly from the government at www.treasurydirect.gov .
Disability Insurance The majority of American workers are not covered by an employer-sponsored disability benefit program, yet statistically a 30-year old has about a 45% chance of incurring a 90-day disability before the age of 65. The lost income associated with a 3 to 6 month disability can be financially devastating. The bottom line is that if you can not afford to be out of work for 3 to 6 months, then it makes sense to get some type of disability coverage. Auto Insurance In some cases higher deductibles will substantially lower the cost of your insurance premium — it is something worth checking out.
When moving retirement funds from one account to another, make sure that the transaction is executed as a “trustee to trustee transfer.” If the funds flow through you, then the transfer may be subject to a 20% withholding tax.
On a monthly basis most people spend their money and then save what is left. Try the reverse. When you pay your monthly bills, make the first payment to your savings account or set up an automatic deposit. Then pay your other bills and use the amount left to live on for the month. This practice forces you to “buy into” your savings plan and insures that the plan actually gets funded.
Pay Yourself First
CHAPTER 8: PRINCIPLES OF FINANCIAL PLANNING
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