Spring Clean Your Finances

CNNMoney has a good reminder that your abode isn't the only thing that needs spring cleaning. Your finances could also use a good look-see.

Their five suggestions are:

* Shred paperwork you don't need. Bank/Credit Card statements after one year, paystubs other than your latest. Titles and CDs as soon as you get rid of the investment.

* Consolidate all your IRAs into one IRA so that you only need to track one set of investments.

* Consolidate savings accounts into one bank. Same reasons as consolidating IRAs.

* Close unnecessary credit cards. Keep any older than five years and one from two of the major issuers (Visa, Mastercard, AmEx, Discover). I would suggest closing any store credit cards you don't use frequently as they could be fodder for identity theft.

* Close insurance gaps. Review insurance policies and wills to see if any life changes necessitate changes in coverage.

All good ideas that people put off for far too long (like cleaning out the garage). Take one weekend to clean the garage and one weekend to tackle your financial garage. If you need help, certified financial advisors can help. But, as always, make sure they have some sort of certification.

Investimist in Carnival of Personal Finance

I am participating in the Carnival of Personal Finance this week. Go check out the Investimist post as well as all the other excellent posts. I will likely be posting on several in the upcoming week.

For anyone checking out the Investimist for the first time, welcome and get comfortable. I can be reached by leaving a comment (I will always try to respond). I welcome comments (and even the occasional criticism).

H&R Block Gets Caught

H&R Block had to restate the past two years of earnings due to "tax problems". The media, including this Reuters article takes it as being that they messed up on their own tax returns. I can tell an accountant didn't write the article.

What H&R Block fudged made an honest mistake on was in its accounting for income taxes. The story says that it's state tax rate used for its financial statements was too low and they just figured it out thanks to Sarbanes-Oxley (SOX).

Anyone that has worked on a corporate tax footnote calculation is smiling at that. Everyone knows the state effective tax rate is too low but a song and dance happens every year to show that it's just a one year anomaly. CPA firms are scared to death at getting sued out of existance thanks to SOX, so they're not letting clients get away with the wink, wink, nudge, nudge anymore. And that's why, as the article notes, that there are a lot of "it's an honest mistake, honest" restatements happening thanks to the effective tax rate.

UPDATE: No, it looks like H&R Block actually used the wrong state tax rate on its tax returns and will now owe $32 million in back taxes. Because they owe taxes and have to restate earnings down, my guess is that they used too low a rate on the financial statements and too high on its tax return. How could that be? hmm....

Don't bite off too much house

MSN Money has an excellent article on not biting off more house than you can chew. Any first time homebuyer has heard it from older relatives: "buy a little more house than you can afford right now, you'll grow into it". The article lists reasons why that advice worked last generation, but doesn't translate well now.

• Inflation. Rapidly rising prices in the 1970s and early 1980s meant you could count on hefty annual raises. Today, you can’t rely on double-digit income boosts to make your mortgage payment less of a burden each year.


• Two-income couples. A generation ago, single-income families were more common. If the breadwinner lost a job, the other spouse could go to work to save the house. With more two-income families needing both paychecks to make the mortgage payment, there’s no one on the sidelines to take up the slack -- unless you put the kids to work.


• The lending industry. Thirty years ago, it was pretty tough to get a mortgage for more than you could really afford. Today, it’s fairly commonplace. More lenders have loosened their criteria, knowing that the vast majority of their borrowers will do whatever it takes to pay their mortgage -- even if it means trashing the rest of their financial lives.


• Retirement. A much bigger proportion of the workforce was covered by traditional, defined-benefit pensions 30 years ago -- which means they didn’t have to save massive amounts of money on their own to have a decent retirement. Today, the onus is typically on you to carve enough out of your budget to fund 401(k)s and IRAs.

All of these are great points, but it doesn't help you figure out how much house you can truly afford. There are a few tables to figure out how to calculate how much house you can afford, but I prefer the budgeting method.

Do a budget for six months. That is a long enough time frame to start to figure out necessary monthly expenditures (one year would be better). Using that data, figure out what you can truly afford to spend monthly on a house. Subtract 10% from that amount to give a little monthly wiggle room. Now, subtract $200/month for taxes and insurance (or figure out an approximate amount for houses in your area). Take that remaining amount and plug it into an online calculator to figure out how much house you can afford.

One important last step, though. House repairs generally cost 1-2% of the value of the home each year. So, if you purchase a $200,000 house, expect to sock away at least $2,000 per year for home repairs. Take this amount into account and re-calculate the house you can afford. This will give a little more wiggle room if the house needs major repairs, or if you want to replace carpeting or tile.

We went through a similar calculation when we bought our house. We ended up spending a tad more than we calculated initially, but the house came with a Aon Home Warranty for the first year, which gave us breathing room on repairs. It allowed us to allow our salaries to catch up and gave us a little cushion on repairs.

That's just my suggestion, however. There are tons of resources on the internet on how to determine how much house you can afford. I will suggest one more thing, get a traditional 15 or 30 year mortgage and avoid the interest-only and other bizarre mortgages that have cropped up in the past few years. It will skew your calculations and could lead to a greater chance of default and selling the house for a loss. That's not good.

Retiring without a 401(k)

CNNMoney's "Ask the Expert" column highlights one of the glaring weaknesses of the "consumer-driven retirement" idea. A worker just moved from a job that offered a 401(k) to one that doesn't. They were dutifully socking away the max under their 401(k) plan ($18,000 including catch-up contributions) but now is wondering what they can do without the 401(k).

The only answer is the IRA or Roth IRA, which allow a maximum contribution of $5,000 per year. That leaves $13,000 on the table every single year. Just because the worker happens to work for a company that chooses not to offer their employees a 401(k).

His suggestions are to invest in tax-managed funds and ETFs, mutual funds that trade like stocks. Both of these would keep taxes to a minimum. In the first case, the fund manager does not trade often or takes losses when appropriate, both of which lower the required capital gains distributions (which are taxed). ETFs trade like stocks and so capital gains are only taxed when the ETF is sold.

Additional options include index funds and tax-exempt funds. Index funds are lightly traded in because the composition of the major indexes rarely change. Tax-exempt funds are funds of municipal bonds that are exempt from Federal taxation (and sometimes state taxation as well). Municipal bond funds have lower returns, but when the tax benefit is taken into account, usually return 5-6% per year, much below the average 10% return of stock funds.

Those are your options, which is why a good 401(k) is a great benefit for employees. My employer just switched from a crappy one to a great one. It's nice not only having a 3% match, but to be able to invest in funds with high returns and low expenses, rather than the other way around.

A Weekend Conversation

“Ugh, my financial advisor called, it’s time for my yearly ‘check-up’”

“That’s good he makes you do it every year, even if it’s just more revenue for him.”

“Yeah, I should go, it’s at least less painful than the dentist”

“And just as important, can I ask you a question? Is he a ‘fee-only’ advisor?”

“I have no idea. Does it matter?”

“Well, yes. It’s really important actually and most of the big name branches like Edward Jones and Fidelity are not.”

“Uh oh, why does it matter?”

“Fee-only means they only get paid by you, not by the mutual funds they’re selling.”

“Ok”

“That’s important because they are truly independent and have no conflicts of interest if only you are paying them.”

“Why?”

“Ok, let’s say that there are two mutual funds that fit your profile. Fund A has high returns and low expenses. Fund B has lower returns and higher expenses.”

“I’d rather be in Fund A”

“Of course. But let’s say that Fund B pays a commission that’s 10% higher than Fund A. Now, does your advisor put you in the fund that’s best for you, Fund A, or the one that’s best for him, Fund B?”

“I hope the one that’s best for me.”

“Do you know that?”

“Well, no.”

“A lot of the big brokerage houses have been fined for selling their customers Fund B rather than Fund A and not telling them about Fund A. Who is your guy with?”

“xxx”

“They’re one of the ones that paid fines. I can’t tell you your guy was one of the guilty, but it seemed like they were pressured company-wide. It may be time to look into a fee-only advisor.”

“Yeah”

H&R Block sued (again) over Refund Anticipation Loans

My first real post was an explanation of the scams that "instant tax refunds" truly are. On Wednesday, California joined the legion of states suing H&R Block over their use of Refund Anticipation Loans

Lockyer wants Kansas City, Missouri-based H&R Block to reimburse customers in an amount he said could reach the hundreds of millions of dollars, and pay a civil fine of at least $20 million.

H&R Block said the lawsuit lacks merit. Lockyer filed his 20-page complaint in state superior court in San Francisco.

In December, H&R Block said it agreed to pay $62.5 million to settle four class-action lawsuits over the loans. Last May, a federal judge in Chicago rejected a $360 million nationwide settlement raising similar issues, calling the sum inadequate.

That's all well and bad, but the last part of the complaint should also draw a lot of focus.

Lockyer also accused the company of sharing customer's tax return information without consent, and using it to market other financial products and collect debts.

Holy disbarment, Batman! Sharing client's personal tax data is like numbers 1, 2, and 3 on the "Preparers Don't Do" checklist.

So, you go to H&R Block to prepare your tax return. You get strongarmed into a loan at a rate that makes Freddy the Fish jealous and then they sell YOUR TAX RETURN DATA to market other products to you.

Wow. Simply wow. The more I learn about this company, the more I have to stress that NO ONE should take their returns there. I'm so glad I didn't take a tax season job there a few years ago like I could have. I'd have an extremely guilty conscious right about now.

Marriage and Net Wealth

In honour of the day, I thought I'd point out an article that says that married people build wealth faster than single or divorced people.

[P]eople who walk down the aisle and stay hitched accumulate nearly twice as much wealth as those who are single or divorced.

Economist Jay Zagorsky of OSU's Center for Human Resource Research, tracked the financial and marital status of more than 9,000 people from 1985 to 2000. Married people amassed an astonishing 93 percent more than single or divorced people over the 15-year period.

The main reasons cited in the study was economies of scale. Single people need two homes while married couples only need one, etc...

(Though I don't think Valentine's Day costs are included in the study. That would certainly set a drag on the growth of wealth!)

5 Ways to Idiot-Proof Your IRA

The Motley Fool (which I love for general advice but not necessarily for stock picking) has a commentary on idiot-proofing your IRA.

While the list is not exhaustive, following these five ideas will go a long way to pumping up returns for retirement.

* Stop ignoring the little things
* Don't overpay The Man
* Avoid overdosing on accounts
* Keep your hand out of the cookie jar
* Don't diss dividends

The two most important items on that list are the last two. Cashing out 401(k)s when you leave a job is retirement suicide. You might as well be asking to survive on dog food in your old age.

Chasing the latest growth stock is another way to the poor house (or at least to the "not as rich" house). Why?

A Standard & Poor's study found that from 1980 to 2002, dividend-paying stocks returned an annual compounded 2.7% more than non-payers did.

Perhaps you've heard of ExxonMobil, Coca-Cola, and Johnson & Johnson? (OK, so that last one does conjure up images of Grandpop, but still.) If, in 1980, you had purchased $2,000 of each, today you'd be sitting on a portfolio worth close to $360,000 by deferring taxes and reinvesting dividends.

Not a bad return for 25 years of no work, eh? If you had cashed out that $6,000 in 1980 (see point 4) you'd have zero and whatever you spent it on you'd likely no longer have (even that sweet tv you've had your eyes on).

Easy advice to follow, but it could be worth literally hundreds of thousands of dollars in retirement.

How to shop for a tax preparer

This part five in a weekly series focusing on lowering tax bills and making the process of filing slightly easier. Today, I’ll focus on whether or not to use a tax preparer.

Throw up your hands

The CS Monitor has an excellent article on selecting a tax preparer. Several of the points in the article are worth noting.

First, tax preparers do not have to be licensed in many states. The article points out that hairstylists usually have to have a license, but only California and Oregon require tax preparers to have a license. A better idea is to use someone that is either a CPA or an Enrolled Agent (basically the IRS version of a CPA). Both titles mean they have been licensed by the state or the IRS and can not only prepare returns but can also represent you in the case the IRS has "questions" about your return.

Next, ask questions about the preparers background and qualifications. Ask how long they have been in business. Ask if they are open all year or if they do taxes on the side (just because they do them only on the side should not disqualify the preparer if everything else checks out). Will they help you out if you are asked questions about the return by the IRS.

Finally, if the preparer promises a large refund, walk out. If they begin to talk about the fact that you don't have to pay taxes, walk out. It is illegal for a CPA or enrolled agent to prepare returns on a contigency basis. If it is offered, walk out. Any of these arrangements could lead to a falsified return, which you are responsible for.

The Motley Fool also has several excellent suggestions on selecting a tax preparer.

Last week, I wrote about the IRS' suggestions for selecting a tax preparer. These are additional suggestions on what to ask a preparer and ways to spot a fraud.

Consider Using Tax-Prep Software

This part four in a weekly series focusing on lowering tax bills and making the process of filing slightly easier. Today, I’ll focus on whether or not to use tax software.

To Use or Not to Use

I am a firm believer in non-tax types using tax software. The major products from Intuit and H&R Block are so easy to use that most people should be able to follow along without much problem. They are definitely a step above using paper and pencil to file returns if you are unsure what you are doing.

The Motley Fool has a pretty one-sided article on the pros of using tax-prep software.

• You don't have to gather any forms; they're all in the program already.


• You can revise and revise and revise, without making a mess with whiteout or an eraser. Enter your information to see what your tax liability is, and then you can make adjustments, playing out different scenarios to see which is most cost-effective. (You might see that it's smart to realize some capital gains this year, for example.)


• The software can assist you with decisions. It asks you questions and either makes decisions for you (regarding which forms to use, for example) or offers you some information and asks you to make a choice.


• You can pay less attention to details. Once the program has certain information, it will make sure that it's carried over to and entered in all the required places. You don't have to worry about that.


• Carryovers from year to year get taken care of automatically -- if you used the same program to prepare your return last year.
  

The one disadvantage that they list is that the program may have an error or that you enter in the wrong data causing errors in the return, which you are eventually responsible for. I would add to that the cost of the software (unless you use IRS Free File) and people's unfamiliarity with tax terms (which I know that Turbo Tax Online uses since that is the software I have used the past two years).

Overall, I can't recommend enough that non-professionals use tax software. I participated in free file last year so I was able to prepare my return for free with Turbo Tax Online (I would have to pay to e-file, but I chose to paper file for free). The cost will likely be saved by the time and frustration that will be saved by non-professionals trying to grapple with form instructions. Add to that the fact that the software can find deductions non-professionals may miss and you could save the cost just in gained deductions.

Use Tax-Deferred Accounts

This part two in a weekly series focusing on lowering tax bills and making the process of filing slightly easier. Today, I’ll focus on the easiest way to lower your tax bill using money you’re already spending.

Use Tax-Deferred Accounts

This past year, I used my Dependent Care and Health Care Spending Accounts, my 401(k), and my wife’s pension in order to shelter about $10,000 from Federal taxation. Assuming a 25% tax rate, those alone saved $2,500 in taxes this past year. Missouri follows the Federal tax treatment of these items, so throw in another $600 saved in state taxes. I’ve saved $3,100 in taxes without really going out of my way.

I figure that I’m young enough that Social Security will no longer exist by the time I get to retire. Therefore, I have to save for retirement anyway. My wife has to contribute to her pension for the same reason. In both cases, we’re getting an automatic 25% return by being allowed to use tax-deferred money to fund these expenditures. In addition, my employer matches 3% of my salary, which is another automatic return on my contributions.

We fully fund the Dependent Care account since we pay more than $5,000 in child care during the year. This allows us to save $1,250 in taxes alone. Again, we’re essentially saving 25% on our child care just by using the Dependent Care account. We use the Health Care Spending Account to fund our anticipated expenses for the year. Since the rules regarding the use of the HCSA were liberalized to include over the counter drugs in 2003, it is much easier to guarantee that there will not be any money left over at the end of the year (which is forfeited).

There are other ways to achieve the same result. An IRA could be used, but the deductions are limited to $3,000 and are severely limited if you are covered under an employer sponsored pension plan. Additionally, a deduction is available for child care expenses if a Dependent Care Flexible Spending account is not utilized (Form 2441).

However, I believe the easiest way to achieve these savings is simply to invest in a 401(k) and use the Flexible Spending Accounts so that the money is available throughout the year rather than simply after you file your tax return.

Keep Those Receipts!

I finished my taxes over the weekend (would have had them done last weekend, but was waiting on a W-2). This week I will focus on tax-related items for preparing your returns this year and making next year's process that much easier. Today's installment is for next year.

Keep Those Receipts!

I managed to do my Federal and State taxes in under two hours on Saturday and Sunday. While it has something to do with the fact that I do it for a living, but it was also because I was organized.

My wife and I keep all of our receipts that could potentially have tax consequences. Chartiable donations, my wife's classroom expenses, contributions to our daughter's college fund, etc. All year we have a manilla 9x12 envelope in the same area as our unpaid bills and we drop the receipts into the envelope. Come tax time, all of our receipts are in one location and we just have to organize them.

We use Microsoft Money to manage our finances (checkbook and credit cards). Money has a feature that allows you to check a box when a payment is recorded to identify it as a tax-related item. At the end of the year, a report can be run where all of your tax-related payments are on one sheet. This doesn't replace receipts (which are the best record for IRS purposes) but can be a nice way to reconcile the receipts to make sure that nothing is missed.

How complicated is our system of receipt keeping? Not at all. How easy does it make tax time? Much easier.

IRS Issues Annual Help Guide on Preparers

The IRS has issued it's annual guide on finding the right tax preparer. It includes helpful hints such as:

* Avoid preparers who base their fee on a percentage of the amount of the refund.

*Use a reputable tax professional who signs your tax return and provides you with a copy for your records.

*Consider whether the individual or firm will be around to answer questions about the preparation of your tax return months, or even years, after the return has been filed

Of course, they remind taxpayers that they are ultimately responsible for what's on the tax return and then have snippets of various taxpayers and tax preparers that have been sent to jail (the IRS, never known for it's tact).

Then Roth, CPA (one of my favorite tax sites) follows with it's own helpful hints for finding a tax preparer.

* Avoid preparers who base their fee on the unused amount of your credit card borrowing limit.

* Use a reputable tax professional who doesn't sign his returns as "Brett Favre."

* If your your tax professional prepares returns out of his car, the presence of cases of pseudoephedrine in the back seat is a classic warning sign.

* Don't use a tax preparer whose web site is hosted here.

* Don't hire this guy to prepare your return. Or this guy. Not this guy, either.

Ha! Seriously, though, if you are hiring a paid preparer make sure the person is a CPA. While not all CPAs are quality, it will show that at the very least they have to do enough to maintain credentials. Asking for references are also key. If they start to promise you that you'll pay no taxes because they're illegal or some such run as fast as you can and then refer to the IRS page with the penalties for fraud.

Squirm, baby, squirm

One of the reasons I love listening to Bloomberg Radio on XM is that I love to hear analysts squirm. Some of the hosts are particularly good at putting the screws to analysts that do ridiculous things. This morning they had on a UBS analyst that cut his price target on Google this morning after the earnings they reported didn’t meet analyst expectations.

That’s not all that unusual. Feeding new data into models will make price targets fluctuate over time. Usually the fluctuations are hardly noticed. This analyst, however, has to take the cake for the ultimate momentum analyst.

He cut his price target on Google from $500/share to $225/share. Yup, more than half based on one quarter of earnings. Listening to him try and justify both his initial price target and the cut after the price dropped 10% overnight was hilarious. “It’s impossible to predict in such a growing market” was the usual refrain.

He claims his price targets and subsequent revision due to fundamentals and not due to the market reaction. Right, and I’m the Queen of England. This is why I advise people to stay away from individual stocks and stick with mutual funds and ETFs. These paid analysts (the “experts”) are so full of it they are ready to blow. And they’re the ones we’re supposed to listen to?