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Check Please

November 1, 2012 1 comment

The Congressional Research Service  issued a report to the Senate Budget Committee outlining the federal spending for benefits to lower income people in the U.S. during Fiscal 2011 (year ending September 30, 2011).  The U.S. government spent $746 billion on programs for lower income people.  If you add in state spending, the total exceeds $1 trillion.

According to the Census Bureau, there were 16.8 million families living below the poverty level in 2011 ($23,000 for a family of 4).  By simple math, this means the federal and state government spent nearly $60,000 for each family in poverty, which is nearly three times the amount they earned during the year.

Less than 10% of the support is in the form of direct cash payments.  Of the $746 billion spent by the federal government, $318 billion is for Medicaid and prescription drug subsidies.  Approximately $66 billion is in the form of direct cash assistance and $73 billion is in the form of tax credits.  The remaining $290 billion of support is delivered through 80 different programs designed to help lower income families.

Given the choice, a number of families might choose to ask for a $17,000 in lieu of the other programs.

It might seem crazy, but do you think it’s efficient to have 84 different programs to help needy people?  Each program has its own objective and purpose, but there is a cost for employees, office space, computers, etc.   The more money spent on overhead, the less is being spent on actually helping people.

A few years ago I helped a school with a grant for an afterschool educational program.  I was surprised and dismayed to discover that over 20% of the grant money was going to be spent for a grant administrator, who would do nothing but complete reports and monitor the work of others.  Sadly, I think that grant is indicative of how many government programs and grants operate; a large chunk of the money is gobbled up in administrative costs.

I’m not against helping lower income families.  In fact, I think we have an obligation to help those who are most vulnerable and in need.  The issue is how the assistance is delivered.

It has been nearly 50 years since Lyndon B. Johnson declared a war on poverty and introduced the Great Society.  Trillions of dollars have been spent over the past 5 decades, yet the poverty rate in the U.S. is almost exactly the same as when this great endeavor began. 

Maybe we should consider eliminating a number of programs and giving more cash to those who are in need.  This seems outrageous to most conservatives, who often think people are abusing the system.  Many of us have witnessed people using their food stamps to purchase cigarettes and alcohol.  There will always be people who abuse the system, and they should be punished when possible.  I also believe the current bureaucratic morass often aids them in taking advantage of the system.

Conservatives frequently complain about people being dependent upon the system.  Part of the solution may be giving people more money, which will allow them to be more independent and self-sufficient.  However, this independence must be coupled with more responsibility for their choices.

Your willingness to embrace such an idea is probably influenced by your view of people.  Do you see them as lazy and untrustworthy, requiring a rigid bureaucracy to monitor and keep them in line, or do you trust people to be independent, make good decision and do what’s right when given the opportunity?  Personally, I would rather be trusted to do the right thing, than have some bureaucrat watching over me.  Given the choice, I would prefer to forego all the programs and simply say… “Check Please.”

Should I Refinance My Mortgage?

Mortgage interest rates are at historically low rates.  Consequently, you may be wondering if it makes sense to refinance your mortgage.  Although there may be a variety of reasons for refinancing your mortgage, there are probably three primary reasons for you to refinance your mortgage.

  1. Lower your payments by borrowing money at a lower interest rate
  2. Convert your adjustable rate mortgage to a fixed rate
  3. Access some of the equity in your home (this isn’t as common or easy as it was a few years ago)

Since there are costs associated with refinancing a mortgage, the decision to refinance may not be a slam-dunk.  Essentially, you are paying money today, to save more money later.  As an example, assume that refinancing reduces your monthly payments by $50 per month.  If you have 25 years remaining on your mortgage, you will save $15,000 over the life to the loan.  If you assume you will pay $5,000 in closing costs to refinance, you save $10,000… over the next 25 years.

There are many different mortgage calculators available which will help you calculate your savings.  You can click here for one, or search the internet.  Keep in mind, internet calculators are only estimates, and the computations from your lender may be different.

Here are a few additional things to consider in your decision to refinance.

  • The time value of money – In my simple example above, you save $15,000 over the next 25 years, but you have to pay $5,000 up front.  Not only does it take you over 8 years to recoup your $5,000, you also lost the opportunity to invest that money and earn a rate of return (hopefully).  With interest rates on liquid assets near zero, the time value consideration may be nil.
  • Income taxes – The only refinance costs you can deduct are points paid to reduce the interest rate.  Unlike points you pay when you initially purchase your home, points paid on a refinanced mortgage must be amortized over the life of the loan (25 years in our example).  With a lower interest rate, your current mortgage interest deduction will also decrease, which could cause your current tax liability to increase slightly.  Although you’ll come out ahead by paying less interest over the life of the loan, your total benefit might be reduced by a smaller mortgage interest deduction.
  • Length of ownership – Since it’s likely to take you a couple of years of reduced payments to recoup the closing costs, you need to consider how long you plan to stay in your home.  If you expect to move in the next few years, the monthly savings may not be sufficient recoup your out-of-pocket costs for the refinance.
  • The loan process – The mortgage financing industry has changed dramatically.  It’s not easy for anyone to get a mortgage in today’s market.  I’ve had clients who experienced difficulties and delays in getting their refinancing approved, even though they could have easily written a check to pay off their existing mortgage.  The aggravation may be worth it, but expect the approval to be a hassle.
  • Market value – The fair market value of your home may be one of the biggest stumbling blocks to a refinance.  Market value is what prevented many people with subprime and adjustable rate mortgages from being able to refinance.  If you don’t have sufficient equity in your home, you won’t be able to refinance, even if you’re making your current payments, and the refinance will make it easier for you to continue making your payments.

Many advisors will tell you that the interest rate should at least 0.75-1.00% lower than your current rate for a refinance to be economically feasible, but depending upon your situation and long-term goals, a smaller rate differential might still be beneficial.

My advice is to run the calculation with an online calculator and see if it makes sense to you.  If the closing costs can be recouped within the next 5-7 years, and you don’t plan to sell before then, talk to a mortgage broker and get their advice.  A reputable broker will be able to give you a more accurate estimate of what it’s going to cost, the savings you can expect, and the process involved.

Refinancing your mortgage can save you money.  However, there are costs involved, and you want to make sure the benefits exceed the cost.

The Mortgage Mess: It’s Still Messy

Even though the U.S. economy officially came out of recession in mid-2009, do you wonder why it doesn’t feel that way?  There may be a lot of reasons, but I think the continued turmoil of the residential real estate market is one of the key factors.

The housing market and mortgage industry may not be as messy as it was in 2008 and 2009, but it’s still messy.  TARP, HAMP and other government policies and programs may have stabilized the banking system and the financial markets, but the financial situation of many homeowners hasn’t improved much in the past five years… and for many, it’s gotten worse.

As this article cites, Zillow estimates approximately 16 million (one-third of all U.S. homeowners) owe more than their homes are worth (a.k.a. underwater).   It’s quite discouraging to think that after years of slugging through this challenging economy, you might be further behind today than you were five years ago.  Some areas of the country have definitely been hit much harder than others, but on a national basis, if you have positive equity in your house, one of your neighbors does not.  In Las Vegas, where I live, even though thousands of people have lost their homes to foreclosure and values have decreased by approximately 50% from the peak, a whopping seven out of ten homeowners are still underwater.

There are significant economic implications for having so many homes underwater.  It impacts people’s ability to relocate, puts them in a perilous financial position if their income decreases, limits their ability to refinance, and pares back their spending.  However, I think the most significant factor is the psychological effect it has on their outlook about the economy, the nation and their future.

For many people, their homes represent a significant portion of their wealth.  They may have spent years saving up for a downpayment or building the equity in their home, and it’s frustrating to see it wiped out in a matter of months.  Granted there were some people who bought homes they shouldn’t have, took out mortgages they couldn’t afford or treated their home like a personal piggy bank.  However, for millions of Americans, they simply bought at the wrong time and their homes lost value through no fault of their own.

The psychological effects of the mortgage mess should not be underestimated.  Owning a home is considered to be part of the American Dream.  It’s one of the reasons home ownership is much higher in the U.S. than in many other industrialized nations.  Sadly, the dream of millions of Americans turned into a nightmare.  Consequently, it’s only logical for people to feel apprehensive and fearful of the economy and the future, when something they thought was a sure thing (owning their home), turned out to be much more uncertain than they could have imagined.  Furthermore, home ownership is a very personal matter.  It’s unlike any other investment, because it’s the place where your family connects and memories are made.

Unlike the empty promises politicians often make, I won’t say there is an easy solution to the mess, nor do I think it’s likely to get cleaned up any time soon.  If there were an easy solution, it would have already been done by now.  Therefore, I think it’s going to be a long and arduous process to reduce the number of homeowners who are underwater.

Consequently, I don’t think we’ll see a resurgence in optimism about the economy, until the number of underwater homes is dramatically reduced.  It’s hard to feel positive about the future when you feel insecure or afraid of losing the place where you live and raise your family.

Can credit card debt management help you to save dollars?

People in this part of the world are used to using credit cards rather than cash for their day-to-day expenses. The proportion of credit use is far more than their retirement savings. Credit cards have given them immense portability and convenience to make frequent purchases. However, this has given rise to several financial diseases which is affecting the fragile US economy. One of the major setbacks is the accumulation of credit card debt. This makes it imperative for the people to know the ways of credit card debt management to avoid getting into a financially sticky situation.

The ways of credit card management

Here are few methods of reduce credit card debt as well as save dollars:

  1. Transfer your credit card balances – This means transferring all your multiple credit card balances into a zero interest credit card. This may be for a year or so as offered by the credit card company. This creates a great opportunity to clear out all your outstanding bills within the promotional period. In this process, you’ll be paying for the principal balance and not for the interest. However, there is a transfer fee for this procedure which hovers around 3-5% of the balance amount. By this method, you’ll save a lot of money even after paying the transfer fee.
  1. Create a budget: Start developing the habit of spending less. Vow to start living a frugal life. This is because the more you spend on useless things, the less you save. Therefore, to fight back such irresponsible behavior, plan a budget that will be comfortable for you to follow. Keep in mind that this budget should not become a burden for you; instead it should motivate you to spend smartly and save money for the rainy day. Use those savings towards debt repayment and you’ll see a remarkable decrease in the number of outstanding bills.
  1. Lower your interest rates: This is one of the most effective steps in the credit card debt management plan. Be vigilant and do your market research to learn about the recent market offers which various creditors are making. After a getting a thorough knowledge of the market offers, contact your current creditors. Request them to lower your card’s interest rate. The creditors will welcome this sort of gesture from you and will readily oblige. If you’ve been a good customer who has been punctual in making the payments, then the creditors will surely consider your request.

During the negotiation phase with your creditors, tell them that you are considering balance transfer as an alternative to lowering the interest rate. This will give them the necessary nudge to accept your terms.

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This article was written by Grace Ruskin.  Grace is a financial writer and is associated with DebtCC Community.

Tax Tips – Make an IRA Contribution

With the start of a new year, there is little that you can do to change your tax liability for last year.  It’s history now.  About all that is left is preparing your tax return correctly and making sure you don’t miss any deductions that you may be allowed. Like most tax rules, there are a few exceptions. 

One exception is making a contribution to an Individual Retirement Account (IRA).  You have until April 18, 2011 to make a 2010 IRA contribution. 

Be advised that there are many different rules regarding the amount you can contribute and deduct as an IRA contribution. 

The maximum contribution to an IRA for 2010 and 2011 is $5,000.  If you are at least age 50 by the end of the year, you can contribute an additional $1,000.

There are several rules regarding the deductibility of your IRA contribution.

  • Your deduction is limited to the lesser of the contribution limit ($5,000 or 6,000) or the amount of taxable compensation included in your gross income.
  • You can deduct the full amount if you are not an active participant in an employer-sponsored retirement plan (there is a box on your W-2 that will be checked if you are an active participant).
  • If you participate in an employer-sponsored pension plan, your contribution is fully deductible if your Adjusted Gross Income (AGI) is less than $109,000 if you’re a joint filer or $56,000 if you file as a single or head of household.  Your contribution will be limited if your AGI is above these amounts.
  • No deduction is allowed for a tax year in which the taxpayer turns 70½, or in subsequent years.
  • If your spouse doesn’t participate in an employer-sponsored pension plan, you can make a contribution on behalf of your spouse, provided that you have sufficient taxable compensation.

If you participate in an employer-sponsored pension plan, you can still make a nondeductible contribution.  The contribution will not be deductible, but the earnings of the IRA will continue to be tax-deferred, which means the earnings of the IRA will not be taxable until you withdraw the funds.

If you have not yet made a 2010 contribution to an IRA, it’s not too late.  You have until April 18th to make the contribution.  It is one thing that you can do in 2011 to reduce your 2010 tax liability.

Is It Bad to Pay Income Taxes?

I’ve been in the tax business for over 20 years.  Having dealt with scores of clients, I’ve talked with all kinds of people and dealt with a myriad of situations.  Although people may accept the requirement and necessity to pay taxes, there is a general disdain for paying taxes and filing tax returns.

I often hear people bemoaning the amount of taxes that need to be paid.  You may have heard someone say that they don’t want to make more money, because they’ll have to pay more taxes.  My response to that statement is rather blunt… that is stupid.  Sorry, if I’ve offended you, but let me explain why I was so brash in my comment. 

As I tell my clients there are worse things in the world than paying taxes.  Income taxes are assessed on income.  Thus, there is a general premise that you must earn income to require the assessment of taxes.  If you don’t pay taxes, it means you aren’t making money. Think about this… if you paid any taxes in 2008, you probably paid more taxes than Ford, General Motors, Chrysler and many of the big U.S. banks combined.  All of those companies lost billions of dollars in 2008.  As they were fighting for their survival, paying income taxes was not the most important concern of the executives, employees and shareholders.

With the extension of the Bush tax cuts, the top federal rate is 35%.  Add in state, local and Social Security taxes, and your top marginal tax rate could be 50-55%.   Even if your rate is 50%, you get to keep 50% of what you make.  Thus, for every extra dollar you make, you have 50 cents to spend.  As long as the tax rate is less than 100%, you will still come out ahead if you make more money and pay taxes. 

Many years ago, one of my wealthy clients told me that he was privileged to pay $1 million in taxes each year.  At the time, he was making over $2 million.  Although he lost over one-third of his income to taxes, he still had more than $1 million to spend.  Would you prefer make $50,000 a year and pay no tax or be in his situation?

Granted, you would probably like to pay less in taxes, as would my client who paid the $1 million, but that is a different discussion. 

The simple fact is that our government raises part of its revenue by levying an income tax.  You may not like the amount of tax that you pay, but there are worse things than paying taxes.  Furthermore, the more that you more you make, the more you pay, and as a result the more you pay, the more you have to spend.

Thus, I am of the opinion that paying income taxes is a good thing.

A Financial Resolution for 2011

Happy New Year!  New Year’s resolutions often accompany the celebrations and revelry.  A majority of resolutions are related to personal health and fitness, which is understandable following a season dominated by parties and indulgent eating.  Christmas is also the time of year when people spend more money than expected.  The stress of the bills coming due can also lead to financial resolutions. 

January 1 is a great time to lose weight, get in shape and stop smoking.  It’s also a fantastic time to get your financial affairs in order.  What is one financial objective that you would like to achieve for 2011?

I won’t be surprised if your answer involves reducing debt, saving more money or living by a budget.  While these are common financial goals, they are not an exclusive list.  You can also include things like giving more money away, drafting a will, reviewing your insurance policies or buying a new home.

Whatever your objective, here are a few principles that will help to ensure your success.

  • Be Reasonable: If the goal is unreasonable, you’ll quickly become frustrated and discouraged.  It may not be reasonable to get out of debt in one year.  Instead, set a goal to reduce your debt by $__ or pay off certain credit cards.
  • Be Specific:  Vague goals like eating healthier or being a better money manager are hard to evaluate.  Your goals should be quantifiable and measurable.
  • Develop a Plan: Whatever you want to achieve isn’t going to miraculously happen.  Think about the steps needed to accomplish your goal. Your plan should also include a timetable.  Identify the actions and the dates for completion.
  • Write it Down: It’s easy for the urgent things of the day to overtake the important. Writing down your goals and plan will help keep you on track.
  • Measure Progress:  Don’t wait until December 31 to determine success or failure.  Periodically evaluate your advancement.  You may need to adjust your plan in order to still achieve your goals.
  • Be Accountable: Behavioral changes are not easy, and being accountable to someone can be the difference between success and failure.  You must have enough of a relationship to trust the person, be honest with them, and listen to their feedback.  They must also be willing to ask you the tough questions.
  • Reward Yourself: Develop appropriate rewards as you accomplish your interim goals.  It doesn’t have to be big or lavish.  It just needs to be something that motivates you.

I know it’s kind of morbid, but by December 31, 2011 you’ll either be dead or one year older. Assuming that you expect to be alive, would you rather have accomplished your financial goal or not?  If so, then develop a plan and have the resolve to see it through to completion.

If you do… it will truly be a Happy New Year… for the entire year and not just one day.

Journey of Financial Freedom

Yesterday was the 234th anniversary of the signing of the U.S. Declaration of Independence.  It’s an annual holiday intended to commemorate our independence and freedom and to honor those who sacrificed and paid a price to obtain and secure freedom for our nation.

Since this blog is primarily devoted to matters of finance, I thought it would be appropriate to write about financial freedom.  If I were to ask you if you would like to be financially free, you would probably give an affirmative-type answer.  It’s common sense.  But what does financial freedom mean?

Do a Google search and see what pops up.  You’ll see links to websites for reverse mortgages; debt management; people who teach financial seminars or sell financial resources; tips for investing; financial articles; and even one for the dummies guide to financial freedom.  If you search for “financial freedom” in Investopedia.com, which includes a dictionary of financial terms, you’ll come up empty. 

There are a plethora of financial freedom sites but no uniform definition because “financial freedom” is more of a concept than an objective standard.  It’s based upon your personal values and lifestyle, not your wealth or net worth.  Consequently, the definition and standard of financial freedom will be different for each person.

For me, the concept of financial freedom is encompassed in the idea that your decisions are not primarily motivated by money.   In my life, motivation is the critical factor.  Money will always be a consideration in making significant life decisions.  First off… I’m not that rich, so money does matter.  Secondarily, I also believe in being a good steward of my money.  In other words… just because I can afford something, doesn’t mean I should or will buy it.   

Here is a personal example regarding motivation.  We moved from Vermont to Texas nearly 18 months ago. From August 2008 to February 2009, we went from three sources of income to one.  Including the loss of employer-provided health benefits, our income dropped nearly 45%.  Moving costs (which we paid for) and the expenses associated with selling and buying a new home added to the financial drain.  Although Lady M and I considered the financial implications, we made the move because we felt it was the right thing for us to do, irrespective of what it would cost us.  Fortunately, we had the financial wherewithal to make the move, and we’re very thankful that after a difficult year, things have turned a corner.  However, if money controlled our decision-making, we would still be shoveling snow in Vermont rather than baking in the Texas sunshine.

Financial freedom is not the amount of money you make.  It is sad, but I have clients who make hundreds of thousands of dollars, yet are far from financial freedom, because they spend it as fast as they make it.  Sometimes, they even spend it faster.  You can be broke at any level of income.

One aspect of financial freedom is to be able to create margin between your income and expenses.  Let’s be honest, nobody likes to make less money, but sometimes it happens, voluntarily or involuntarily.  If you spend all that you make, you’re probably under a constant stress to maintain what you have and can easily become panicked if you think your income is about to drop.  This situation will also limit your decisions.  You may continue to work late or sacrifice precious family time because you don’t dare to take time off.  You can also become trapped in a career or business you dislike because you can’t afford to make a career change.  Spending less than you make is an important step in your journey to financial freedom.

Debt management is integrally tied to creating margin. Debt payments are very different from many other expenses and discretionary spending.  You can’t just decide not to make a payment next month, at least not without consequences.   Be cautious when taking on debt, especially in good times.  You have to consider the implications of what would happen if your income dropped, even temporarily.   A significant factor in the recent economic recession and mortgage crisis resulted from people who could only afford their mortgage payments in the best of times.  Even a slight decline in the economy, pushed people over the edge and triggered a chain reaction of mortgage defaults, falling real estate prices and a financial catastrophe.  This has been a painful lesson for millions of Americans.  As tragic as the current situation is, it will be even more horrific if we don’t learn from it.

Wealth is also not an indication of financial freedom.  Although wealth is an objective measure of value, it is fluid and can change quickly.  Falling real estate prices and declines in the stock markets have caused trillions of dollars of wealth to vanish over the past couple of years.  Bill Gates is the richest man in the world, yet a substantial portion of his wealth is tied up in Microsoft stock.  If something dramatic were to happen and Microsoft suddenly lost tremendous value or became worthless, his lifestyle could be seriously affected.  Can’t happen?  All you have to do is look at what’s happened to the price of BP shares in the last 75 days.  Even for the rich and famous, wealth can come and go rather quickly.   

Life is like a country road.  There are hills and valleys, curves and straightaways, clear visibility and blind spots.  Your ability to navigate and make a successful journey is dependent upon your ability to recognize and adapt to changing situations.  Your attitude and aptitude to adjust to the changes in life will not only determine the life you live, but also your ability to experience financial freedom. 

In my humble opinion, financial freedom is more of a journey than a destination.  There is never a point where you have fully arrived. There are just stopping points and markers along the way.  The destination is a successful, productive and happy life and family.  Financial freedom allows you to make decisions along your life’s journey that will help you to arrive at your destination. 

This is what works for me, but since it’s personal rather than universal, what does the journey of financial freedom mean to you?