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The Personal Finance Writer

Understanding the Different Types of Taxes

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Take a moment to think back to the days you were sitting in your first Economics class in high school. It probably started with a definition of Economics and an explanation of concepts such as scarcity, resources, opportunity cost, among others.

Three or four classes in and you probably began to learn about taxation. Some of the topics would include Adam Smith’s canons of taxation, taxation as fiscal policy, among others. Today, I want you to think back to the time you learnt about the different types of taxes – proportional, progressive, and regressive.

Perhaps you learnt them back then to pass your exams, and you have no clue how they affect your finances today.

Well, this is an opportunity to revisit that class. We will look at the three different types of taxes, how they affect your finance, and some examples of how they work in real life.

Let’s dive in.   

What are Proportional Taxes?

Proportional taxation is a tax system that levies the same tax rate on individuals irrespective of their income or wealth.

Another name for proportional taxation is flat tax.

The rate of taxation does not change with increasing or decreasing levels of income or wealth.

Some states in the United States levy income tax based on the proportional tax system. These states include Colorado, Illinois, Indiana, Kentucky, Massachusetts, North Carolina, Pennsylvania, and Utah.

For example, if you live in Colorado, your state income tax rate is 4.63% irrespective of income. The tax rate is 4.95% in Illinois and 3.23% in Indiana.

How do proportional taxes work?

Let’s say Mr Johnson is a financial analyst who earns an income of $80,000 in Colorado while Mrs Jane is a nurse who makes $60,000 in the same state.

Mr. Johnson’s tax liability is $3,704 (4.63% * $80,000) while Mrs. Jane’s tax liability is $2,778 (4.63% * $60,000).

The income tax rate does not vary with income level.

Other types of taxes that use the proportional tax system include:

  • Occupational Taxes

The financial dictionary defines occupational taxes as “Taxes and fees levied on particular jobs and businesses. A liquor license for a bar and a health permit for a restaurant are both examples of occupational taxes. In the United States, occupational taxes are assessed at the state and local levels and generally are flat fees.”

  • Per Capita Taxes:

They are taxes levied on the residents of a jurisdiction above a certain age. Per capita taxes are also known as head taxes.

They depends on residency rather than income or wealth. Per capital taxes are proportional taxes.

What are the advantages of Proportional Taxes?

Proponents of the proportional tax system believe it encourages hard work since your tax rate will not change even with a higher level of income.

They also believe it is fair. One advocate of proportional taxes is Ben Carson. He wrote, “I’ve advocated a proportional tax system. You make $10 billion, you pay a billion. You make $10, you pay one. And everybody gets treated the same way.”

Also, the proportional tax system removes the complications from tax computations. Every Tom, Dick, and Harry can compute the taxes due on their income.

Gary Cohn believes this is an essential goal for any tax system. In his words, “We want to go back to a tax system where Americans sit down at their kitchen table, and they do their taxes on a single sheet of paper. That’s what we should have in this America.”

However, critics of the proportional tax system (those on the progressive side) will argue that it does not satisfy the canon of justice and equality since it treats low-income earners in the same way as high-income earners.

Other critics (those on the regressive side) will argue that it does not incentivize hard work and higher income since there is no tax advantage from an increase in income level.

What are Progressive Taxes?

Progressive taxation is a tax system where the tax rate is directly proportional to the income level. The higher the income, the higher the effective rate of tax, vice versa.

The United States Federal Income Tax follows the progressive tax system.

The Federal Income Tax uses a tax table that begins with a 10% tax rate on income less than or equal to $9875 for single filers, $19,750 for joint filers, and $14,100 for a head of household.

The table ends with the 37% marginal tax rate for incomes exceeding $518,401 for single filers and head of household, $622,051 for joint filers, $311,026 for married couples filing separately.

How do progressive taxes work?

Say Mr Price earns $40,000 as a CPA and Miss Judith earns $90,000 as an investment banker. Let’s also assume that they are both single filers.

Mr Price’s tax liability from the tax table will be as follows:

First $9,875 –> 10% * $9875 = $987.5

Next $30,125 ($40,000-$9,875) -> 12% * $30,125 = $3,615

Total Tax Liability = $4,602.5

Effective Tax Rate = $4,602.5/$40,000 = 11.5%

Miss Judith’s tax liability from the tax table will be as follows:

First $9,875 –> 10% * $9875 = $987.5

Next $30,250 ($40,125-$9875) -> 12% * $30,250 = $3,630

Next $45,400 ($85,525-$40,125) -> 22% * $45,400 = $9,988

Next $4,475 ($90,000-$85,525) -> 24% * $4,475 = $1,074

Total Tax Liability = $15,679.5

Effective Tax Rate = $15,679.5/$90,000 = 17.4%

Miss Judith, who earns more than Mr Price does, is subject a higher tax rate (17.4%).

The estate tax is another progressive tax. They are payable on estates with assets exceeding $11.4 million at the federal level. At the state level, the limit is lower, which draws more estates into the tax pool. The tax rate on estates increases with their value.

What are the Advantages of Progressive Tax?

Advocates of progressive tax believe it promotes equality and justice since higher-income earners have a higher capacity to pay. 

Critics of the progressive tax argue that it is an income redistribution strategy that takes from the rich to sponsor programs designed for the poor (remember Robinhood?).

They argue that such programs discourage people from working hard and increasing their income since such an increase in income leads to higher tax rates.

If the calculation above seems like rocket science to you, then you are not alone. Critics of progressive tax system believe it is too complicated and stressful. Even Alfred Neuman commented that “Today, it takes more brains and effort to make out the income-tax form than it does to make the income.”

types of tax

What are Regressive Taxes?

The regressive taxation system is the opposite of the progressive system. The effective tax rate in this system increases as income level falls (inversely proportional). People with higher income levels pay taxes at a lower tax rate while those with lesser income pay taxes at a higher income rate.

The regressive tax structure occurs where tax is a fixed amount relative to income because the taxing authority calculates the tax rate on a basis (consumption, asset) other than income levels.

That is, though the tax rate is constant, it is not calculated on income levels like the proportional tax system.

In the case where it is calculated on income levels (social security tax), there is a cap on the amount of income subject to tax which makes people with higher income level enjoy a lower effective tax rate compared to people with lower income level.

The sales tax on goods is an example of a regressive tax system.

How do Regressive Taxes Work?

Let us say Mr Bauer and Mrs Chloe purchase items worth $3,000 in the grocery store on the same day. With a sales tax of 6%, they will have a tax liability of $180 each.

However, if Mr Bauer’s income is $100,000 and Mrs Chloe’s income is $50,000, the former has just paid 0.18% of his income as sales tax while the latter paid 0.36%.

If at the end of the year, they both spent $20,000 in the grocery store; their sales tax liability will be $1,200. For Mr Bauer, this is 1.2% of his income. For Mrs Chloe, this is 2.4% of her income. Mr Bauer has a lower effective tax rate even though his income is higher.

Other types of regressive taxes include:

  • Property taxes:

Property taxes are calculated on the value of a property. If two people with different income levels pay the same property tax, the proportion of tax to income will be lower for the person with the higher income and higher for the person with the lower income.

They are fixed dollar amounts added to a product on a per-unit basis.

Since the tax liability is the same irrespective of income, higher-income earners have a lower effective tax rate compared to lower-income earners.

  • Social Security Taxes:

Social Security is a 6.2% tax on income. However, the tax is not payable on income exceeding $137,700.

Therefore, for someone earning $200,000, he will only pay $8537.40 in social security tax. Someone earning $1,000,000 will only pay $8537.40.

Consider two individuals: Mr Scofield, who earns $100,000 and Mr Burrows, who earns $200,000. Mr Scofield will pay $6,200 in social security tax while Mr Burrows will pay $8537.40. The effective tax rate of the former is 6.2% ($6,200/$100,000) while the effective tax rate of the latter is 4.3%.

The example above shows that the one with the higher income has a lower effective tax rate, and the one with the lower income has a higher effective tax rate.

What are the Advantages of Regressive Tax?

Advocates of the regressive tax system believe it incentivizes hard work by rewarding high-income earners with the lower effective tax rate. 

Critics argue that the regressive system does not align with the canon of equity and justice.

types of tax

Conclusion

The three types of tax have advantages and disadvantages. Different economies use a mix of the three systems in different ways. Proportional and progressive taxes are common with taxes on income, while regressive taxes are common with taxes on consumption.

Understanding the three different tax systems will help you get a handle on your tax situation and explore ways to increase your tax efficiency.

Do you want to learn more about how taxes affect your financial situation? Subscribe to the mailing list to be notified when the next article is live.

If you are new, check the first article in this series here.

Check out last quarter’s series on retirement planning here.  

My Favourite Personal Finance Content (Week 31)

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Below are my favourite personal finance week for this week. Enjoy.

  1. Is Stock Diversification Actually Important for Your Investment Portfolio

To diversify or not, that is the question. The topic of diversification is one that divides opinions among well-respected financial experts and successful investors.

On the one hand are those who believe that diversification is for those who don’t know what they are doing. On the other hand are those who insist that diversification is crucial to maximize return relative to risk.

In this article, Joshua Rodriguez, writing for Money Crashers, examines the arguments on both sides. He outlines three factors that will help every investor decide whether to diversify or not.

It is a must-read.

Read the article here: https://www.moneycrashers.com/stock-diversification-investment-portfolio/

  • 3 401(k) Withdrawal Rules That Will help Your Retirement Savings Last

When, where, and how you withdraw from your 401(k) can have massive impacts on your finance. While a strategy like the 4% rule works, it is not flexible enough to cater to the changing situations in retirement.

In this article, Katie Brockman outlines three rules that will make your retirement savings last longer. He suggests that you do not stick rigidly to the 4% rule but rather consider the spending volatility in retirement.  Second, he advises that you consider minimum retirement withdrawals when formulating your withdrawal strategy. Third, consider how the state you reside will affect your taxes.

Read the article here: https://www.fool.com/retirement/2020/07/28/401k-withdrawal-rules-help-retirement-savings.aspx

  • 12 Ways to Increase Rental Income from your Vacation Home

A vacation home can be a huge asset if you approach it with a business mindset. Here, G, Brian Davis, writing for Money Crashers highlights twelve ways you can increase rental income from your vacation home.

Some of the strategies he suggests include strategic fixes, automating guest stay, crafting a killer listing, employing pet-friendly policies, optimizing for search engine, and considering co-hosting.

This is a must-read if you own a vacation home.

Read the article here: https://www.moneycrashers.com/increase-rental-income-vacation-home/

  • You are still playing the Credit Card Game!

What should you do if you have $30,000 in credit card debt, $8,000 in car loan debt, and $20,000 in emergency funds?

This was the dilemma of a 27-year old woman who called in to the Dave Ramsey show.  She is also vacillating between two job offers – a salary based offer without life insurance and a commissions-based job with life insurance.

In this video, the hosts at the Dave Ramsey show gives her practical advice that should resonate with anyone battling with credit card debt. They don’t attempt to pamper the listener; instead, they come out straight with the right path to tread.

If you are in a similar situation or know someone like that, please watch this video.

Watch the video here:  https://www.youtube.com/watch?v=-pljxBniIB4&t=354s

  • INTEL Stock vs AMD Stock

Tech enthusiasts have probably had arguments over the years about Intel and AMD – the two giant manufacturers of processors. However, for investors who are tech stock enthusiasts, comparing the stocks of both companies is a useful exercise.

That is what Simranpal Singh does in this video. In the past week, Intel’s stock fell by 16%, and AMD’s rose by 16%.  He analyzes the situation and then goes deeper to evaluate the fundamentals of both companies. Which one should you buy? Find out below.

Watch the video here:  https://www.youtube.com/watch?v=nGx9MFQ-9q4&t=5s

A Beginner’s Guide to Tax Returns

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Introduction

One of the dreaded days in the calendar for many people is April 15. Many refer to it as the ‘tax day.’ April 15 is the due date for individuals, businesses, and charitable organizations to file their tax returns with the Internal Revenue Service (IRS).

N.B: If April 15 is a weekend or public holiday, the tax day for that year is the following business day.

April 15 is also the day that taxes become due for payment. The failure to file for taxes will lead to a 5% penalty on the unpaid taxes for every month the taxes remain unpaid (up to 25%). Also, failure to pay taxes owed for the previous year on tax day will lead to a penalty of 0.5% of unpaid taxes for every month the taxes remain unpaid (up to 25%).

However, filing tax returns can be a very strenuous process for many people.

In this article, we look at

  • Steps to filing a tax return
  • The different tax forms you might have to fill
  • How long you need to retain tax returns
  • When you should amend your tax returns
  • The different payment options you should consider if you cannot pay taxes by the due date

Let us dive in.

Steps to Filing a Tax Return

  • Fill the forms and complete necessary paperwork

The first step to filing a tax return is to ensure you fill all the necessary forms and provide all the required information. Below you will find the forms that apply to you as an individual, business, or nonprofit organization. You should also keep the receipts for all the donations and expenses for which you want to claim deductions (if you do not want to go with the standard deduction) or tax credits.

You can decide to fill the forms manually, use tax software like Turbo Tax or H&R Block, or hire a tax accountant. The factors to consider are your availability, your budget, and your interest in and understanding of the tax process.

  • Decide on your filing status.

There are three options available for you: single filing, joint filing, and filing as the head of household.

This is a crucial decision that will affect many aspects of the filing process. With the standard deduction, you get access to a fixed amount of deduction depending on your filing status. Itemized deductions allow you to compile and sum up your tax deductions. The resulting figure may be lower or higher than the standard deduction.

  • Pay your taxes

By now, you should know the amount you owe in taxes. Pay your taxes and breathe a sigh of relief for another year.

If you are self-employed, you will pay your taxes every quarter. Every quarter, you will estimate the amount of taxes you should owe and pay that amount to the IRS. The estimated tax system is for sole proprietors, partnerships, S corporation shareholders, and self-employed individuals. The due date for filing and payment is usually April 15 (for the first quarter), June 15 (for the second quarter), September 15 (for the third quarter), and January 15 of the following year for the fourth quarter.

N.B: If April 15, June 15, September 15, or January 15 is a weekend or public holiday, the tax day is the next business day.

What if you cannot pay your taxes on the tax day? Well, you will have to read to the end.

Tax Forms

A tax form is a document that collects relevant tax information about the taxpayer. 

The world of tax forms is very complicated. Though it is not rocket science, it does feel like that some times. Currently, there are over 800 tax forms and schedules. A schedule is an attachment to a tax form that provides important and supporting information alongside the information in the form.

The good news is you do not have to fill those 800 forms and schedules. So much relief, I guess.

Broadly speaking, there are three essential categories of tax forms:

  • Income: These tax forms collect information about your income sources. They include forms for employment and non-employment income.
  • Deductions: These tax forms collect information that helps to itemize your deductions.
  • Credits: Taxpayers use these tax forms to claim tax credits.

Below are the most popular tax forms you will need to fill:

  • W-2 Form: Businesses use this form to report wages paid to employees and the taxes withheld from them. This is one of the essential forms for the Social Security Administration (SSA).
  • W-3 Form: This is the summary page of all W-2 forms.
  • W-4 Form: Employers use this to record the amount of tax withholding to deduct from employees’ wages. 
  • Form 1040: Form 1040 is the primary form through which individuals file a personal income tax return. The form has two pages with up to 20 schedules. Not all of the schedules will apply to an individual taxpayer, though. Below are examples of some of the schedules in form 1040:
  • Schedule A: For allowable deductions
  • Schedule B: Interest and dividend
  • Schedule D: CGIT and losses
  • Schedule E: Income and expenses arising from the rental of real property, royalties, or from pass-through entities
  • Schedule EIC: For earned income credit
  • Form 1120: This is the form for C corporations to report their tax information.
  • Form 1120 S: For S corporations
  • Form 1120-C: For Cooperative associations
  • Form 1120-H: For homeowners association
  • Form 990: This is the nonprofit organizations’ version of the Form 1120.
  • Form 1065: For partnership income
  • Form 1041: For estates and taxes
  • Form 1099: There are series of Form 1099 that record income from non-employment related sources

For a comprehensive list of the available forms and schedules, check this page. Caveat! Most of the stuff there is boring. The important thing is to concentrate on the forms above that pertain to you as an individual, business, or nonprofit organization.

tax forms

Retention of Tax Returns

For how long should you keep your tax returns?

According to the IRS, it depends on the action, expense, or event that affect those records.

At the minimum, they advise that you keep your tax returns for three years. You should keep them for up to six years if you failed to report income that is more than 25% of the gross income on that return. If you file a claim for a loss from worthless securities or bad debt deductions, you should keep it for seven years.

The IRS also advises that you keep employment tax records for at least four years. If you file a fraudulent return, you should keep your tax returns indefinitely.

Amended Tax Returns

There are times when you need to amend your tax returns. You may need to correct errors on the tax returns or claim a tax status that will increase your tax advantages (e.g. refund).

Below are the conditions where the IRS allows amendment of a tax return:

  • A change in filing status: An example is a change from single filing to joint filing after a marriage.
  • An inaccurate number of dependents. You can reduce or increase the number of dependents you report on your tax returns as situations warrant.
  • Tax credits or deductions not claimed or incorrectly claimed: If you underestimated your tax credits or deductions, you could request for an amendment of your tax returns.
  • Incorrect income: If you understate or overstate your income, you can amend the tax returns and correct the error.
  • If your tax liability is more than what you paid, you can amend your tax returns and avoid penalties.

You can apply for an amended return through Form 1040X. The process can take sixteen weeks or longer. Also, if the amendment process results in a tax refund, there is a three-year statute of limitation (from the day you filed the original tax return) on such claims. In other words, you cannot claim such refunds three years after you filed the original tax return.

tax returns

The Different Options for Tax Payment

If you cannot pay your taxes after filing your tax returns, there are specific options to consider:

  • Payment Plans: These are arrangements with the IRS to pay the taxes you owe within an extended timeframe. There is a short-term payment plan that allows you to pay within 120 days (plus accrued interest and penalty). The long-term plan is a monthly instalment payment agreement.  The long-term option comes with extra set-up fees ranging from $31 to $225 depending on the mode of payment. Check if you qualify for the payment plans here.
  • Offer in Compromise: This program allows you to settle the taxes you owe for less than the amount you owe. You will need to fill some forms and pay a $205 application fee (nonrefundable). The application may be successful or not. There are two payment plans: lump sum cash, where you pay 20% of the total offer during application and the rest over five instalments; periodic payment where you make an initial payment during application and pay the rest every month until you settle your account. Click here to check if you qualify.
  • Temporary Deferment: If you cannot use any of the options above, the IRS may agree to delay your payment temporarily until your financial status improves. They will keep assessing your financial situation until you can pay.  However, the penalty and interest will keep accumulating. Click here to check if you qualify.

Tax Refunds and Tax Bills

After filing your tax returns and paying the tax owed, the IRS will evaluate your returns. Upon the evaluation, they will discover if you overpaid or underpaid your taxes. 

If you overpaid your taxes, you are eligible for a refund. The IRS will deposit the refund into your bank account, send a check or use it to offset your tax liability for the upcoming year.

If you underpaid your taxes, expect a tax bill from the IRS in the mail.

Conclusion

Tax returns are simple and complicated at the same time. However, with a proper understanding of the filing process, the tax forms, the retention and amendment of returns, and the various payment options for those who cannot pay, you should get a good handle on the whole process.

You can decide to do the heavy lifting yourself, use tax software, or hire a tax accountant.

Whatever you do, ensure you file your tax returns at the right time, every time.

To be notified when the next article in the series drops, subscribe to my mailing list.

A Quick Introduction to Income Taxes

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Introduction

‘Why is my income less than the figure on my employment letter?’ Perhaps you asked this question when you got your first paycheck. Many people are left wondering when they received their first paycheck.

The reason for the difference is simple – income taxes. Benjamin Franklin once said that only two things are certain in this life: death and taxes.

Though income taxes are inevitable, filing for taxes is still a drudgery experience for many. The 15th of April is a dreaded day in most calendars.

However, for something that certain, it is proper to gain a clearer understanding of how it works.

For this quarter, we will consider different topics about taxes. The aim is to help the average person understand how the tax system works and how it affects their finance.

To begin with, this article introduces the concept of income taxes.    

Income Subject to Income Taxes

Income taxes are taxes the government charges on your income. For tax purposes, there are two types of income – earned income and unearned.

Earned income is income from employment, business activities, and work. They include income sources like wages and salaries, unemployment benefits, sick pay, and fringe benefits.

On the other hand, unearned income is income from investments, passive income sources, and income sources unrelated to employment. They include interest, dividends, profits on investments, alimony, and interest from savings accounts.

Federal Income Tax and State Income Tax

Earned and unearned income are taxable at federal, state, and local levels.

At the state level, states like Alaska, Florida, Texas, South Dakota, Wyoming, Washington, and Nevada do not receive tax on income while New Hampshire and Tennessee only tax income from interest and dividend. 

Progressive Income Tax Rate and Flat Income Tax Rate

Federal tax uses a progressive tax system where people with higher incomes are subject to a higher tax percentage.

Many states use the progressive tax system while other states (Colorado, Illinois, Indiana, Utah, Kentucky, Michigan, North Carolina, Massachusetts, and Pennsylvania) use a flat income tax rate. The flat income tax system uses the same tax rate for everyone irrespective of income.

Tax Deductions

Tax deductions reduce taxable income (the amount of your income subject to taxation). There are deductions for charitable donations, healthcare expenses, property taxes, mortgage interest, sales tax on personal property purchases, home office, and other job-related expenses. Also, businesses can deduct business expenses like travel, transport, and networking.

Contributions to retirement accounts are also tax-deductible. Taxes are payable on contribution to retirement accounts at withdrawal.

If Mr. A earned $10,000 in 2019, donated $500 to a charity, and spent $200 on mortgage interest, he will pay tax on $9,300 rather than $10,000.

There are two types of deductions: standard deductions and itemized deductions. Standard deductions as at 2020 are:

  • Single filing: $12,400
  • Head of Household: $18,650
  • Joint filing: $24,800

A taxable person can choose the standard deduction or opt for itemized deductions. The latter allows you to highlight and compile all your taxable deductions (as listed above) rather than accept the standard deductions.

 

Tax Credits

While tax deductions reduce the taxable income, tax credits reduce the tax liability. Mr. A’s tax liability at $9,300 taxable income is $1,006. If he has a tax credit of $200, he will pay $806 as tax. There are three types of tax credits:

  • Refundable tax credits:  If a refundable tax credit is not exhausted after reducing your tax liability to $0, you can get a tax refund. Suppose Mr. A’s tax credit is $1,200 when his taxable income is $1,006. If the tax credit is refundable, he will get a refund of $194.

Examples of refundable tax credits include earned income tax credit and premium tax credit.

  • Non-refundable tax credits: With non-refundable tax credits, you cannot get a tax refund even if your tax credit is not exhausted. The highest tax credit you can claim is that which reduces your tax liability to $0.

Examples of non-refundable tax credits include child and development care credit, adoption, mortgage interest credit.

  • Partially refundable tax credits: For this category, you can get a refund for a portion of the tax credit that is not exhausted after reducing your tax liability to $0.

Examples of partially refundable tax credits include child tax credit and American opportunity tax credit. For the latter, you can get the lesser of 40% of the remaining tax credit or $1,000.

The Income Tax Bracket

As said before, federal tax is a progressive tax. The government uses a tax table to determine your tax liability.

To calculate your tax liability, you begin at the base of the table (10%). For single filers, the first $9,875 of your income is subject to 10%.

Let us take the example of Mr. B, a single filer, who earns $90,000.

For the first $9,875, Mr. B will pay $987.5 (10% of $9875). For every amount above $9875 and less than $40,125, Mr. B will be subject to a 12% tax rate. Consequently, for the next level, Mr. B will pay $3,630 (12% * [$40,125 – $9,875]). For every amount above $40,125 and less than $85,525, he will be subject to a 22% tax rate. Consequently, for the next level, Mr. B will pay $9,988 (22% * [$85,525-$40,125]).

For every amount above $85,525 and less than $163,300, Mr. B will be subject to a 24% tax rate. Consequently, Mr. B will pay $1,074 (24% * [$90,000-$85,525]).

Mr. B’s total tax liability equals $15, 679.5 ($987.5 + $3,630 + $9,988 + $1,074). The effective (real) tax rate on the $90,000 income is 17.42% ($15, 679.5 / $90,000).

After calculating your tax liability, you can deduct your tax credit to know the actual tax you will pay to the government.

Conclusion

Understanding some crucial concepts relating to income taxes is a positive step to understanding how taxation works and how it affects your finances.

Stay tuned for the next article as we continue to explore essential topics in personal income taxation in more detail.

If this is your first time here, check out last quarter’s articles on retirement planning. To be notified when the next article is live, subscribe to the newsletter.

My Favourite Personal Finance Content (Week 28)

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Below are my favourite personal finance content for the outgoing week.

  • 6 Ways to Prevent Emotional Investing That Can Devastate Your Returns

Nothing burns the hands of an investor more than investing with emotions. We all know about the greed-fear cycle. We sell out of fear when everyone is selling because the market is down and we buy when everyone is buying because the market is up.

Successful value investors advise that we should not use our Mr. Market-driven emotions to make investment decisions. In this article, G. Brian Davis, writing for Money Crashers, helps us with six ways to avoid emotional investing. His tips include automating your savings, automating investments with a Robo-advisor, using dollar cost averaging, diversifying with index funds, automating rebalancing, and charting a thorough retirement plan.

Read the article here: https://www.moneycrashers.com/prevent-emotional-investing/

  • Does It Really Matter When You Claim Social Security?

One of the significant retirement decisions you will need to make is the age you should start claiming social security benefits. While you are entitled to social security benefits at age 62, you do not need to claim it at 62.

In this article, Maurie Backman, writing for The Motley Fool, considers how the age you choose to start claiming social security can affect your benefits.

Read the article here: https://www.fool.com/retirement/2020/07/06/does-it-really-matter-when-you-claim-social-securi.aspx

  • The Truth About Debt Consolidation

In this video, Dave Ramsey answers a caller’s question about debt consolidation. He takes the time to differentiate between debt settlement and debt consolidation and offers a smarter way for people to pay off their debt earlier.

No one likes to be in debt, but when they come, managing them is of utmost importance. In a few minutes, Dave shows you a better debt management system.

Watch the video here: https://www.youtube.com/watch?v=pxTAyS1ZOBc

  • 7 Reasons Why It’s Time to Change Jobs During COVID-19

One of the effects of COVID-19 is that many people are considering changing their jobs. An article on Business Insider shows that people in health and retail especially are considering other fields where they can get better benefits.

In this episode of the Ken Coleman show, Ken emphasizes this article’s points, providing some other reasons why many people need to consider changing their jobs at this time.

Watch the video here: https://www.youtube.com/watch?v=qqi65b0x210

  • How to Save up to $1200 a year without sacrificing quality

We all want to save more money, but we do not want to sacrifice the things that bring us joy in life as well. The good news is that we don’t have to. We can explore significant ways to save money without sacrificing quality.

Grant Sabatier of Millennial Money looks at three things we can do to save more money right now. He unpacks the concept of recurring expenses and explains why saving money on recurrent expenses can have huge impacts.

Read the article here: https://millennialmoney.com/how-to-save-up-to-1200-a-year-on-cell-service/

My Favourite Personal Finance Content (Week 27)

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Below are my favourite personal finance content for the outgoing week.

  • Domino’s Stock is Better than FAANG stocks.

The FAANG stocks (Facebook, Amazon, Apple, Netflix, and Google) are well known among investors for their incredible growth rate. Over the past five years, these stocks have grown 150%, 193%, 500%, 360%, and 152%, respectively.

In this video, Simranpal Singh evaluates Domino’s stock, which also had an incredible 220% growth in the past five years. While its growth rate is comparable to the FAANG stocks, it has a very low beta (0.38), making it less volatile. Simranpal does a deep dive into the stock and the potential of the company. He gave the stock a buy after comparing its intrinsic value with the current market price.

Watch the video here: https://www.youtube.com/watch?v=VJh7aZCUZ_8

  • 7 Best Stock Screeners of 2020

Every investor knows the importance of stock screeners. They help to narrow down our list of potential investments so we can do a deep dive into a smaller number of stocks. In this article, G. Brian Davis looks at the seven best stock screeners in the market. The seven best stock screeners are Trading View, Stock Rover, Finviz, TC2000, TD Ameritrade, Zacks and Nasdaq Screener, and Trade Ideas.

Davis highlights the essential features of these screeners and dedicates a section to the factors you should consider when deciding on a screener.

Read the article here: https://www.moneycrashers.com/best-stock-screeners/

  •  The Intelligent Investor Summary

I just discovered a new channel on Youtube – Swedish Investor. On this channel, you will find animated summaries and takeaways from some of the classic finance books. In this episode, the Swedish Investor reviews one of the most important books on investing – The Intelligent Investor by Benjamin Graham.

In this video, he highlights five takeaways from the book. The first is the importance of paying attention to value rather than price, the worth of a business rather than the market. For the second and third points, he highlights Graham’s rules for defensive and enterprising investors, respectively. The fourth point explains the importance of margin of safety, and the fifth emphasizes that risk and reward are not always correlated. 

This video is a good refresher on an important book.

Watch the video here: https://www.youtube.com/watch?v=npoyc_X5zO8

  • Interpretation of Financial Statements

Excited by his summary of The Intelligent Investor, I decided to consume more content from the Swedish Investor. I found his summary of The Interpretation of Financial Statements beneficial. In this video, he makes five essential points that summarize the book. The first is the importance of financial statements, especially the income statement and the balance sheet. Secondly, he explains certain industry metrics to which investors must pay attention. Next, he explains the concept of watered stocks (companies overstating their assets) and the reason Graham ignores intangibles in his interpretation of financial statements. He discusses the idea of liquidation value or book value and how to use that figure (compared to market price) to identify potentially profitable stocks. Lastly, he explains the importance of certain qualitative factors when investors evaluate companies and their stocks.

Watch the video here: https://www.youtube.com/watch?v=cRDcAeOJn7s

  • Free Budget Software

Budgeting is an essential component of personal finance. Every good thing in personal finance must start with appropriate budgeting. In this article, Grant Sabatier examines eleven free budgeting tools that offer a wide range of features. Included in the list are Personal Capital, Mint.com, YNAB, GNUCash, Buddi, Google Sheets, Truebill, Goodbudget, Microsoft Money Plus Sunset Deluxe, PocketGuard, and Everydollar.

Granit identifies the major features and unique selling points of these software.

Read the article here: https://millennialmoney.com/free-budget-software/

Living a Full Life in Retirement

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Introduction

In this quarter, we have been looking at the topic of retirement and the various financial decisions you have to make in preparation for retirement.

Retirement is a crucial period of life, and you cannot prepare too much for it.

In this final article, we move away from planning for retirement to living in retirement.

Enjoying Retirement

When we talk about retirement planning, we tend to equate it with financial planning for retirement. However, while financial planning should be an essential part of retirement, it should not be the only thing.

More important than financial planning is planning how to enjoy your retirement. The pursuit of happiness during retirement is primary. Retirement provides you with more time, and you need to plan how to spend that time doing things that make you happy (within legal and moral boundaries, of course).

For some, enjoying retirement means the ability to travel all over the world. For others, it is the opportunity to write a bestselling story or non-fiction. Some may devote retirement to working for a charity or a mission board.

While you may not work for money during retirement, you will not be idle. Therefore, retirement planning must incorporate a solid plan for leisure and activities.

When you retire, you want to make sure you are enjoying retirement by spending time on those essential activities.

Spending and Budgeting

The whole purpose of financial planning is to ensure you have the money in retirement to live the life you desire in retirement.

By planning your leisure and activities during retirement, you can create a budget for your retirement years and decide on the amount you should be saving (and investing) to meet your retirement goals.

During retirement, you will still need to be creating a budget to keep track of your spending. There will never be a period of life when financial discipline is no longer a necessity.

If you do your retirement planning right, you can enjoy life in retirement while practicing financial discipline.

The goal is not to avoid spending ‘too much’ but to ensure you are spending within your budget (which should reflect the budget you used to determine how much you should be saving for retirement).

You can take vacations every two weeks if you like as long as you already figured that into your retirement plan and retirement savings. 

Making Withdrawals

The budget you create will determine how often and how much you withdraw from your retirement accounts. Once you have your budget, you will know how much you need for the month.

The next step is to sum up the money coming from social security, pension, annuity, and part-time income.

The money you will be withdrawing from your retirement account(s) is the difference between your budgeted expenses and the retirement income sources above.

Financial planners also advise that you keep the money in your retirement accounts in different investment buckets. The first bucket will be in liquid, non-volatile, and stable investments like bonds, savings account, and other fixed-income securities.

In this first bucket, you will hold the money you need to augment the retirement income sources above to meet your budgeted expenses. Since you need this money to meet your budgeted expenses, it should be in investment sources that are liquid and readily available.

The second bucket is where you want to hold money for long-term growth. In this bucket, you can invest in stocks and mutual funds. The money here will grow at a high rate of return compared to the first bucket. When the money in the first bucket is getting low, you can make some withdrawals from the second bucket to the first bucket to bolster liquidity.

The third bucket should be where you keep funds you intend leaving for your children, dependent relatives, and favourite charities. You will want to invest these funds in growth stocks and real estate.  

The goal here is to avoid excess liquidity when you could be earning higher returns and prevent illiquidity, which may lead you to sell a stock in an upward trajectory or borrow money at a high interest rate to avoid the sale.

Conclusion

Life in retirement does not have to be boring. All you need is to make concrete plans for the life you want and take the financial decisions that will get you there.

Once in retirement, ensure you stay faithful to those plans, create budgets around them, and develop the financial discipline to withdraw money from your retirement accounts in the most financially rewarding manner.

If you have not followed this series on retirement, here is an excellent place to start.

Stay tuned to this blog as we begin another series for next quarter. To know when we get started, subscribe to the mailing list.  

My Favourite Personal Finance Content (Week 25)

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Below are my favourite personal finance content for the outgoing week. I hope you find them helpful.

  1. The 3 Basic Money Skills You Need To Know

In this video, Dave Ramsey answers the question of a listener regarding buying a particular type of car. The questioner is an ardent saver and finds it difficult to bring herself to make this purchase. Dave Ramsey explains the three basic money skills that everyone has to develop – spending right, saving, and giving. He underscores that we cannot make spending and purchasing decisions apart from a consideration of the others. He also emphasizes the importance of prioritizing quality and difference in personal circumstances when it comes to purchases like cars.

Watch the video here: https://www.youtube.com/watch?v=3m3-lMdIlJw

  • 16 Best Online Colleges With Accredited Degree Programs

Online degree programs are becoming a mainstay. High cost, commute, flexibility are among the considerations responsible for this trend. In this article, Brian Martucci of Money Crashers examines sixteen of the best online colleges that offer accredited degree programs. He gives us important details about the institution type (public or private), possible cost, the available degree programs, and some other considerations. This is helpful for those considering an online degree.

Read the article here:  https://www.moneycrashers.com/best-online-colleges-accredited-degree-programs/

  • 10 Types of Soft Skills to Develop to Stay Competitive in the Workplace

Technological developments are changing the nature of the job. The expectation is that progress in AI will lead to further changes. However, there are certain soft skills you need irrespective of the job environment. These skills will help you stay relevant no matter the time or the industry. G. Brian Davis of Money Crashers introduces us to ten of these important skills, including negotiation, time management, conflict management, emotional intelligence, effective writing, and financial literacy. He also gives practical guidelines and additional resources to develop your competence in each area.

Read the article here: https://www.moneycrashers.com/soft-skills-list-workplace/

  • Discounted Cash Flow (DCF) Valuation

Stock valuation is crucial to stock investing. One of the popular valuation methods is the DCF valuation. There are different methods investors use to value stocks with this method. In this video, Simranpal Singh explains the essential elements of the DCF valuation and the data sources that will help you value any stock. He uses Delta Airlines as an example to show how the DCF valuation works.

Watch the video here: https://www.youtube.com/watch?v=1i9eAVaP9yM

  • 9 Ways To Save Money From the Comfort of your Own Home During the COVID-19 Pandemic

Many people have to cut down on spending because of the pandemic. Though this is an old article, I found it helpful when I read it this week. Sarah Sharkey, writing for the Money under 30 blog, examines nine ways to save money during the pandemic. Some of her tips include reducing life insurance, moving your savings to a high yield savings account, using cheap tax software, exploring discounts, coupons, and cash backs when shopping, reducing your bill, among others. Some of her tips might be common sense, but they are good reminders.

Read the article here: https://www.moneyunder30.com/ways-to-save-money-during-the-covid-19-pandemic/

How to Manage Your Retirement Savings for a Satisfying Retirement

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Introduction

While it is essential to save money for retirement, it is even more important to know how to manage your retirement savings to enjoy the retirement you deserve.

Opening and operating retirement accounts is a good step in the right direction. However, effective management of those accounts is crucial to a satisfying retirement.

How do you manage your retirement savings for a satisfying retirement?

Evaluating Asset Allocation

The first step is to review and evaluate the asset allocation in your retirement accounts. This evaluation includes your savings in a 401(k) and your savings in an IRA. You should evaluate your investments in the former even though the latter provides you with broader investment options.

This evaluation aims to ensure that there is sufficient diversification in your investments to match your time horizon. By the time horizon, I mean the years you have until retirement. 

Generally, the farther away you are from retirement, the more you want to invest in stocks and stock mutual funds that provide higher returns in the long run. Because these types of investments are subject to market fluctuations, you need to have enough time to weather those short-term fluctuations.

As you come closer to retirement, you want to increase investments in fixed-income securities like bonds, high yield savings accounts, bond funds, etc.

A useful formula is to subtract your current age from 100 (or 110) to derive the percentage of your investments that should be in growth stocks. For a 30-year-old, between 70-80% of investments should be in stock. For a 60-year-old, between 40-50% should be in stock while the rest should be in fixed income securities.

Do not choose an asset allocation formula at 30 and leave it there until you retire. Ensure you are regularly evaluating your asset allocation formula to match your current time horizon.

The Bucket Approach

Some financial planners suggest a bucket approach to managing your investments. In this approach, there are three buckets of investments. The first bucket consists of low risk, fixed-income investments like bonds. On the second bucket, you have high yield, moderate risk, fixed-income securities like dividend-paying stocks, and balanced mutual funds (mutual funds that balance stocks with fixed-income securities). The third bucket consists of high growth, high-risk investments like growth stocks, stock mutual funds, and ETFs.

Dividing your investments into these buckets and identifying an asset allocation formula that works with the different time horizons will help you manage your retirement savings for a satisfying retirement.

    

Spending Plan

On the expenses side, you need to create a viable spending plan for retirement. This might be hard to do, depending on how close you are to retirement. Some financial planners suggest you budget for 80% of your current spending.

However, many people will love to spend time in retirement doing some things that will be expensive – traveling, vacations, etc. Therefore, it is possible your expenses are the same or even higher at retirement.

The goal here is to spend enough to enjoy retirement but not to deplete your savings quickly.

Striking this balance needs a realistic spending plan. You will do well to divide your retirement expenses into needs and wants. The former include the daily expenses on food, clothing, and others. For this category, you will most likely spend less than you currently do. The latter category (wants) include traveling, hobbies, new car, new home, donations, etc.

Understanding your expected retirement expenses (the life you want to live at retirement) will help you decide if you need more savings or you need to be more aggressive with your investments. 

Making Withdrawals from Retirement Accounts

Perhaps the most crucial decision during retirement is how you will make withdrawals from your retirement accounts.

For retirement accounts like a 401(k) and traditional IRA, there is a required minimum withdrawal (there is a penalty for not making the withdrawals) when you reach age 72. Roth IRA, on the other hand, does not have a required minimum withdrawal.

There are specific ways you can get around the minimum withdrawals (and their tax implications) if you do not need the money.  You can delay retirement, convert your accounts to Roth, donate the money to charity, or limit distributions in the first year.

Before making withdrawals from your retirement accounts, you should consider retirement income from social security, pension, and annuity. When these income sources cannot meet your expenses requirement, you can tap into your retirement account.

The rate at which you withdraw from your retirement accounts should be flexible rather than fixed. Some may withdraw a higher amount earlier in retirement when they have the strength to travel around the world. Others may withdraw a higher amount later in retirement when the medical troubles begin to set in.

The important thing here is to have a plan and stick to that plan as much as possible.

   

Leaving a Legacy

If you implement a sound retirement plan, you should have enough retirement savings to last you until you die.

The issue that surfaces then is what you will do with the money remaining in your retirement accounts.

No matter how young you are, you cannot shelve away the issue of legacy. The most important thing when you plan to leave a legacy is that the money will go to the causes and the people you want.

This is where you want to enter the murky waters of estate planning. Estate planning can be very complicated. Consequently, you might need an expert to handle it for you. However, instead of seeing estate planning as an independent financial plan you can pick up when you are very old; see it as part of your retirement planning.

Conclusion

You may decide to manage your retirement savings by yourself or employ financial advisors to do it for you. Whatever you choose, you cannot have a hands-off approach to retirement planning (set it up and wait until retirement). 

To enjoy a satisfying retirement, you need to keep a tab on your retirement savings, managing it for maximum results.

In the next article, we draw our series on retirement planning to a close. If you have enjoyed the ride, watch out for the conclusion. 

My Favourite Personal Finance Content (Week 24)

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Below are my favourite personal finance content for the outgoing week. I hope you find them helpful.

  • 5 Reasons It’s Smart to Lease a Car Right Now

The situation with the pandemic means many people do not have the cash to pay down on a car purchase. This (among other reasons) is why Philip Reed believes that now is a good time to consider lease rather than an outright purchase. A lease requires lesser upfront fees, shorter commitment, more affordable payments, and provides more manufacturer incentives and protection against depreciation.

Read the article here: www.nerdwallet.com/article/loans/auto-loans/5-reasons-smart-lease-car-right-now

  • 16 Best Passive Income Apps To Make Money

Everyone is looking for more opportunities to make passive income. Grant Sabatier, writing for Millennial Money, offers sixteen opportunities to make passive income. Some of these apps include investment management apps, apps that give cash back for purchases, and apps that pay people for simple activities like surveys.

Read the article here: https://millennialmoney.com/passive-income-apps/

  • Personal Finance: 10 Money Rules

Everyone should have philosophies and guidelines that drive their financial decisions. Ramit Sethi, author of I Will Teach You To Be Rich, lays down ten money rules that he uses in his personal life. Some of his rules include saving 10% and investing 20% of his gross income, always have 1-year emergency funds in cash, never question spending money on books, appetizers, health, a donation to a friend’s charity, buy the best and keep it for as long as possible.

I learned from Ramit the importance of having specific rules to guide our money decisions. These rules make it easy to deal with the smaller choices we make daily.

Watch the video here: https://www.youtube.com/watch?v=DLU2o96tOu4

  • Planning to Delay Social Security Until 70? Here’s Why You May Need to Rethink That

The headline of the article was irresistible. It is conventional personal finance wisdom to delay social security to maximize the monthly payment. Even though you can start withdrawing by 62, some benefits come from delaying the withdrawal (at least until age 70).  Maurice Backman’s point in this article is that circumstances can change, leading to retirement before age 70. Therefore, depending on the higher social security benefits at age 70 while relaxing on your savings can be disastrous, given those circumstances.

Read the article here: https://www.fool.com/retirement/2020/06/10/planning-to-delay-social-security-until-70-heres-w.aspx

  • Investing for Beginners ꓲ Advice On How To Get Started

When it comes to investing, sometimes it is good to max out tips and strategies from many successful people. In this video, Stefan of the Project Life Mastery gives some good advice on how to get started investing. The video contains tips from his twelve years’ experience. He touches on essential principles like paying yourself first, dollar-cost averaging and starting early.

Watch the video here: https://www.youtube.com/watch?v=lBDhvRYk-OA