Help a Reader: Sorting Out Financial Issues

I recently received this email from a reader:

Married, both husband and wife just turned 28, 1 child now, 1 on the way any moment from now. Wife is stay at home now cos of pregnancy. Use to own a child care business. I currently make $1400 base gross and $995-$1000 net after taxes and 125.05 pre-tax useless health plan. Total net weekly is $1900 ($910 per diem/wk)

Currently have a home in previous state and recently closed on a home in new state. Expenses currently with all mentioned above $3900 including $800 (tithes and offering). You are more blessed in giving than in receiving. Therefore savings of $3700-3900 monthly (2k in emergency, $500 towards a car,$500 towards a trip back home, $400/month or $100 weekly in Husband Roth,$300 temporary savings(travel,vacation etc).

Retirement account (Roth) ~$1000. Should have started a long time ago. But can't wait any longer.

In addition to above, can recently net $200 per week extra in OT and more OT coming for 2-3months due to work. But not accounting for OT now. Because pay will change in June 2011. Instead of $910 perdiem, all ($2200/wk) will be taxed. So trying to maximize tax savings and stash money away.

Wife is already looking for job. So more income and gap if she does and plan to stash that money away completely for future business plans. But not banking on it now. Just what we have or have been making.

Have a commercial property with good positive cash flow. $330/mnth on a 5 yr baloon till April 2014 @ 7.5% ($33,000 loan with $25,000 baloon payment). Plan to pay $250 or 300 bi weekly. Monthly rent income is $1000/mnt. Note that after taxes ($110/mnt) and insurance ($65/mnth), can net $400-$500 cash flow. But want to get rid of mortgage by 2014. Just discovered benefits of rentals properties/business.

Plan from Jan 1 2011-June 7-14 2011(income gross is$, net is$). No need trying to beat uncle sam

• Continue emergency (2k/mnth, total 10k) (invest in Mutual funds, esp the ones recommended by Old Limey. Not a fan of money sitting doing nothing.
• Continue Car fund ($500/mnth total $2500)(Have 1 car, plan to buy used and pay cash in the nxt month or so.Budegt of $7k-10k)
• Continue Home travel ($500/mnth, total $2500) (6k-8k budget)
• Continue Roth IRA ($100/week, total $3k)
• Continue Temp Savings ($300/mnth. total $1200-$1500)
• Total saved by June ($15K-$20k) $15k cos if we buy used car. Overtime pay will offset diff. Already have $820 in OT pay for Jan.

Proposed plan from June 8-16-Dec 31 2011(income gross is $).Really need to beat uncle sam.We have to, else we are screwed.

• Open Trad IRA ($167/week total $5k )Max out Trad IRA
• Change health plan to $100/week or cont with old ($125.05/wk). Health plan offered by employer sucks.
• Open 401k and contribute (200-400/wk) employer doesn't match. so trying to divert this money somewhere else. But good place to put big chunk $16500.
• Other plan that doesn't take advantage of Tax are continuing Roth IRA for husband and wife. But no tax savings now.

My questions are these:

1) After filling in tax info for tax filing, expecting $2400-3000 back, Planed on opening 529 for first child. Put $2400 in it. Discovered no deductions or credit from ROTH IRA contribution even if we max husband and open one for wife due to income limits. But credit of almost $600 if we open Trad IRA for Husband. Can Trad IRA be opened now for wife even though she doesn't work?I know ROTH can be opened for her.

2) Are 529 pre-tax or post tax?I know you get deductions or credit during tax filling? If they are pre-tax, plan to contritube $200/wk into two 529s, if not, still contribute that towards plan for both children.

3) Max Trad IRA for husband or half-half for both husband and wife before April 14 if we can open for wife.If we roll-over Trad to Roth after year end, do we incur penalty or do we just pay regular Fed taxes?After rolling over to ROTH, we can't access those contributions anytime onlike ROTH right?

4) If we can open TRAD for wife and we both max out contribution(10k) for 2010 tax filling in 2011 or before April 14 2011 from pre-tax, and after deduction through itemizing and we fall in 15% tax bracket instd of 25%, will the roll-over contributions be taxed at 25% or 15%?That is, if the roll-over contributions are taxed at 25%, will we get money back if we fall into the 15% tax bracket? I doubt we will fall in 15% if wife starts working.

5) What are the other ways to take advantage of pre-tax apart from the ones listed above before uncle same takes a huge chunk out of pay? Basically have almost $1000/wk that we can afford to divert. Any advice?

6) Recently called banker for refinance and he said best bet is another 5yr baloon till 2015 @ 6.5-6.75.More hoping for 5yr ARM. Refinance will cost less than $500. Should we try to aggressively pay off by 2014 or refinance?

What's your advice for them?

Comments

[HedgeHoncho]

IRA looks weak obviously, but if you plan on keeping those income properties for the long haul, then that obviously changes things.

This doesn't mean that an IRA is not favorable to have, but gauranteed rental income on a property paid off is nice.

[Ken]

To write in English that is readable.

[Joshua]

Why in god's name are you getting $3000 back. Amend your W-4. That's the first thing you should do. That's money you could have had during the year to put into your IRA.

[Norm]

My head hurt reading this. I gave up halfway through. I agree with Ken, writing in English would be a great first step.

[Mark]

Where to start? First - read and understand the tax aspects of the different IRAs, 529s, etc. Roth IRA contrubutions are NEVER deductible regardless of your income.

Most of your questions are pretty basic. Find someone who knows about taxes or read a few books and articles.

[Ben]

If you can't write clearly, you are not thinking clearly. The reader is all over the place with very specific targets and no apparent understanding. His wife runs day care, but what does he do? That he receives almost half his income as per diem seems concerning to me.

If I would take a guess (based on buying a second house, rental property, and second baby) that the reader is undergoing a manic bout of trying to get there life together, and that their finances are a mess.

Advice:
1. Save your money in FDIC insured saving account, don't put anything in the stock market until you are more knowledgeable. Spend the next 6 months to a year reading about investing before you put anything at risk. Never put your emergency fund into a mutual fund, "Not a fan of money sitting doing nothing" is the completely wrong attitude for an emergency fund.

2. You seem to have a lot of spare income to put towards savings, but very little saved, especially if your wife used to work? Why the discrepancy? Be patient, a weekly budget is fine, but don't get too excited wanting your accounts to go up every week.

3. Saving is great, but with 2 young children I question the wife rushing back to work, especially to a different job, if you can really make your savings targets.

[MonkeyMonk]

I agree with the above. I tried to work my way through this mess of a posting three times and eventually just gave up.

[Old Limey]

The advice I have lived by has always been KISS - Keep It Simple Stupid.
When I was your age we had just had our third child and had just bought a brand new home with 20% down and a 25 year loan at 4.5%. We thought about becoming a member of a local church but after the minister sat down at our kitchen table all he talked about were contributions and we were in no position to make any so we nixed that idea and over the many years since then, after travelling all over the world and being exposed to all of the other religions we have both come to agree that it was the right decision for us.

At 28 I had been in my third job for two years, eventually staying there the rest of my career, retiring at 58.
My wife didn't work at that time because of caring for the children was a full time job.
We lived frugally and SAVED, SAVED, and SAVED.

After about 4 years we had a ski cabin built at Lake Tahoe, 250 miles away, so that our family could enjoy wonderful weekends and summer vacations together. When we weren't using it we rented it to friends. It ended up being a great investment, our total cost was $17,000 and we ended up selling it 13 years later for $89,950 at a time when the children preferred doing their own thing at weekends. We then took the proceeds, and with a small loan bought a tri-level beach condo for $125,000, only 25 miles away, that became our personal "getaway" for many years. The condo is now worth about $600,000 and our youngest child, his wife and 10 year old daughter now live in it rent free after spending $150K on a fantastic renovation, I just pay the property taxes, they pay everything else, and it's left to them in our will. We stopped using the condo after my wife had both hips replaced quite a few years ago.

Next question, "What did we do with our savings?" We invested them wisely through the years. During the Carter years when interest rates were sky high we bought 2nd. Trust deeds that had very high returns. In the pre-Reagan years we bought tax shelters that completely sheltered our taxes while providing nice monthly payments and returning our principal in full about 7 years later. Once tax shelters disappeared I turned to the stock market, as well as always putting the maximum into my 401K with a nice company match.

When I was 43, the most lucrative thing I could have done was to have sold our home and bought another in a more prestigious, rural area about 7 miles away but that would have entailed uprooting all three children from their schools. My wife was opposed to the idea so we compromised and instead relocated to a new development of individual custom homes less than a mile away. That also turned out well and now that we are much older our present location is far more convenient than the one that we considered moving to, since we are in a well run small city close to everything you might need such as stores, healthcare, emergency and city services. The other location we considered still contracts out its police, fire, and emergency services to the county and is quite a way from shopping malls.

As soon as it was feasible my wife went into teaching and had a nice career with the school district, now receiving a very nice retirement pension. Once I retired, also with a nice pension, I started managing all of our money which by then was all consolidated at Fidelity Investments. Now at age 76 I am totally in income funds that provide an annual return of over $300K which is either tax deferred or tax exempt.

Keep it simple, easy to manage, easy to understand, and you won't go far wrong.

[jim]

In response to the question:

1. Yes your spouse can get a IRA even if she isn't working. You talk about getting a credit from putting money into an IRA. Traditional IRA's give you a DEDUCTION, not a "credit". Roth IRAs are post-tax and give you NO tax benefits initially. That isn't dependent on your income level, that is how Roths work.

2. 529's are post tax and the deductions for them depend on your state laws. There is no deduction for federal taxes on 529's.

3. Don't roll into a Roth. You'd have to pay taxes on everything out of pocket. Otherwise this question is not very clear.

4. The tax is figured when you file taxes and based on your entire income and all your deductions. So you pay the rate for what bracket you're in. However,, you're pretty far into the 25% bracket and very unlikely to hit the 15% bracket.

5. There simply aren't tons of tax dodges. You could look into an HSA health insurance option to shield around $6k a year. Are you depreciating that rental property?? If not then you should.

6. Pay off the mortgage.

Some points:

You really need a bigger emergency fund. You've got what $10k right now and thats not even 2 months expenses? What happens if you lose your job or something bad happens?

I would recommend you get yourself some books at the library about personal finance, planning for taxes and such. You seem to not understand basics on how 529's, Roths, etc work.

If you don't want to read a couple books then you should go hire yourself a CPA and have them tell you what to do. Figure it out youself or get an expert to help you.

You seem overly focused on cutting your tax bill. Stop worrying so much about your taxes. You really are not paying that much in taxes. There really aren't tons of tax dodges to be had. The more successful you are the more money you make and the more taxes you'll pay.

[Rick]

Based on the numbers in the email, the couple is solidly in the 15% tax bracket for 2010, and even in 2011 with the mid-year conversion of his per diem to taxable wages. That's with no deductions for pre-tax retirement savings.

So the husband's main question seems to be: do we max out our retirement plans pre-tax or post-tax (Roth)? For both years, it looks like they could fully deduct maximum contributions to traditional IRAs ($10k), along with $16.5k 401k contributions in 2011. That could save $1500/$3975 in federal tax in 2010/2011, plus whatever savings they might have on state tax.

To me, their situation screams Roth. They're at just about the highest income they could have while still being at the 15% federal rate. Because of the good income and everything else he says, it appears that they can afford to max out their 401k and IRA contributions and still pay the tax on them. It seems very likely that they will soon be in the 25% bracket and then I think this decision becomes more debatable. But while they can pay 15% and avoid paying anything on the earnings 30 years down the road (and avoid forced withdrawals), I think they should. With the way our government is going, and if the couple's financial picture continues down the path they're starting on, their tax rate in retirement will be much higher than 15%.

If the husband's employer offers a Roth 401k, I would suggest maxing that out too. If Roth isn't an option, then the decisions to contribute or not, pre-tax or post-tax, are less clear (since there's no match). It kind of depends on the investment options in the plan. But also, their tax rate is likely to continue to rise up to and into retirement, so it may be better to pay taxes on their retirement savings and earnings along the way -- especially now when their rate is 15% or even 25%.

I second Jim's suggestion to look into a Health Savings Account. In addition to shielding up to $6k a year from federal (and I think state) income tax, if the contributions are deducted from your paycheck, you'll also avoid FICA.

[JimL]

Does this person still own 2 homes? If so, he needs to have a much larger emergency account and needs to focus on getting rid of the other home asap. The Shiller update today was not good.

[Easychange]

Agree with above, i'd simply emphasize the point to get out of debt before investing emergency money. Interest rates are going to rise and investing is quite volatile. Good luck.

[Old Limey]

I agree with Ken, Norm, Ben, and Monkeymonk.

Muddled writing and problem stating has to come from very muddled thinking. Would anyone you know want to employ such a person?

Leading a happy and successful life in today's America requires that at least one person in a marriage have a good understanding of the complex financial issues facing a family. These issues include Taxes, Credit, Debt, Banking, IRAs, Investing, Budgeting, Compounding of Money, Healthcare etc., etc.
At least one marriage partner needs to have good math, literary, verbal, and computer skills these days. Both partners need to be on the same page when it comes to making the hard choices necessary to live within their means, build a nest egg for immediate protection, and to set and follow a long term plan that will lead to a happy retirement and a good life for their children.

The other major problem facing the young family of today is that we are no longer living in the America in which I spent my working life (1956-1992). That was the America of low unemployment, brief recessions, consistent growth, high production output, a functional government, budgets that were either balanced or had low deficits, entitlement programs such as Medicare, Medicaid, Social Security, Unemployment Benefits, Food Stamps that were in good shape.

Now that so many of our production workers jobs have been exported, and we are in the greatest recession the country has ever experienced, with an unprecedented high unemployment rate, with the Budget Deficits and National Debt spiralling out of control, energy and commodity prices rising rapidly, the Baby Boomer Bulge hitting retirement programs, homes no longer a "piggy bank" for living beyond one's means, so many homes in foreclosure, and a dysfunctional, argumentative government that has NO long term plan for getting us out of the current mess we are in, the future looks very bleak.