Handling Finances

I know what you’re thinking — I promise not to mention politics in this post!  This isn’t about the government’s tax policies or broad economic theories.  This post is about how a little planning ahead can pay off significantly.

2007 was a year of transitions for me.  I finished a Masters program in optical engineering (laser physics) and I got a new job playing with lasers.  I got married and moved out into the scary real world.  I also started my first retirement accounts and started significantly saving for the future.  And that’s where my planning paid off.

Because I didn’t start working in my new job until the end of the summer and had only a low-paying research assistant position in the spring, I didn’t make a whole lot of money in 2007.  My wife’s nannying income certainly bumped it up but in the end, we earned just enough to start paying taxes.

My Tax Rate: 0.45%

I didn’t know exactly when tax rates would kick in, but I did know that my taxable income would be very low this year so when I started my retirement account, instead of putting 12-15% of my income into a tax-deferred 401(k), I maxed out my tax-free Roth IRA with after-tax money.  My effective tax rate for 2007 was 0.45% so assuming a 28% tax rate at retirement, I saved about $1100 in taxes — or at modest 6% return on investment, that’s 11-12 thousand dollars in retirement!

Why bring it up now?  Well, I was curious as to why I was only getting $600 in my rebate check.  There’s nothing I could have done (besides earning more) to get the full $1200 and to be fair, as a husband with a good-paying job, I wouldn’t be stimulating the economy with the extra money anyway.

The Plan for 2008

It’s a bit doubious to call low income a “tax break” but this type of year can be predicted ahead of time.  With a little planning, you can match your deductible donations with high income years (say, when you sell stock) and keep taxes as low as possible.

For 2008, I’m going to do much the same as with 2007 but for a different reason.  *warning — governmental tax-policy discussion ahead!*  With our government’s record deficit and much of the military action in Iraq funded only on an ongoing emergency basis (i.e. no budgeting for future expenses), taxes aren’t going to go down in the next decade no matter who runs the country (in my humble opinion of course).  With that in mind, I’ll continue to put as much money into my Roth IRA as possible.  Not only will I be trying to max out my Roth IRA contributions, but if I save more, I’ll be building up a reserve in my taxable account for future years.  I’m going to want as much money growing tax-free as I can get, and with tax increases on the horizon I’ll wait to put more than the minimum required to get a matching contribution until I can use that contribution to reduce my income when it’s taxed at a higher rate.

So I didn’t make it without mentioning the government and taxes, but at least I didn’t mention what I WANT to happen and which candidate I think would screw up the country the most…  Small victories I suppose.T

First of all, two of my posts were included in blog carnivals this week.  First, my post Finding the Best Value when Prices Move Fast was included in the Festival of Frugality.  Second, my post Cheaper Financing is a Funny Route to the American Dream was included in the Festival of Personal Finance.  Check out these festivals for a whole lot more really great articles!

A Raise!

I got my first minor, scheduled raise this month — rather exciting in my life, if not exactly life-changing.  It was actually rather large at 2.2% after only 6 months which is largely due to the fact that I’m at the low end of my pay scale.  I probably should have haggled over the pay, but I’m happy with both the pay and the job and a raise seems like icing on the cake of my career.

A Medical Benefits Cut.

Along with just about every other company these days, my employer is trying to cut medical costs.  Luckily for me, they only cut retiree medical benefits — something that will change a dozen times before I retire 40 years from now.  It’s awfully nice to just be able to ignore this sort of thing.  They’re looking at a huge number of older employees becoming eligible for retirement in the next two decades and I fully expect the company (as well as the economy) to start competing for new hires and increase benefits sharply before I look into retirement.

On the plus side, they also removed a rather silly (around $200) profit sharing contribution to my 401(k) and instead increased their 401(k) contribution match from 0.5% to 0.75%.  Even better, they’ll be paying it in cash rather than in company stock starting next year so I won’t end up with all my eggs in one basket with my job and my retirement savings depending on the same company!  I’d be eligible to convert these stock contributions to cash within 3 years or so, but it’s really nice to not have to bother!

Practical advice: make absolutely sure you’re contributing enough to your 401(k) to get your full employer match (if they offer one of course).  Even if it’s company stock, it represents an immediate return on investment and amounts to free money!  If your company gives out company stock as their matching contribution and doesn’t let you sell the stock… consider complaining to the trustees.  I trust that my company will not go the way of Enron, but then again, most Enron employees thought the same thing just before they lost all their retirement savings.

I’ve read a lot of commentary on the economic stimulus package that passed this week, including quite a few comments from fellow financial bloggers like My Two Dollars and I’ve Paid For This Twice Already. People generally think the stimulus package is a great idea or the stupidest thing they’ve ever heard, but I’ve rarely seen much discussion of why our government thinks it needs to prop up the economy. No, it’s not a matter of keeping the 1-2% of jobs we might lose in a recession. Quite simply, our government is one of the only governments in the developed world that has done away with state-funded retirement pensions and instead invested our retirement funds in the stock market through 401(k) and IRA plans.

Yes, we still have social security, but it was always intended to simply supplement pensions earned through employment — with average monthly payments sitting around $1000, it’s hardly enough to cover rent or mortgage payments in many communities! That’s totally fine if we assume that most retirees have significant savings, but since only 36% of workers offered 401(k) plans in 2004 participated, it’s pretty clear that there’s going to be a whole lot of retirees in poverty in the next few decades.

But here’s the kicker — if the stock market drops dramatically, even those with retirement investments will be depending on insufficient social security payments! The whole idea that government pensions (A.K.A. social security) should be privatized might make sense by itself, but history has shown that the average American is not willing or able to save for their retirement and when they do, poor investment decisions and volatile market conditions risk personal retirement savings across the board! Neither can we move back to employer-based pensions as they’ve been reduced or outright removed as corporations recognized the huge savings in paying defined contributions (i.e. 401(k)) vs. defined benefits (pensions).

I have my own opinions about the wisdom of privatizing social security (I still can’t understand why Bush says we should emulate Chile where privatization has slashed benefits and greatly increased government costs) but this article isn’t really about how we, as a culture, should take care of our elderly. The point is that we can’t just continue to ignore the elephant in the room and pretend that this is all about the economy or just blink in amazement wondering why both major political parties agree that more debt will help the nation. The real issue here is that if the market drops, our current and future retirees will suddenly face poverty with only an unfunded government pension as a safety net. Until we acknowledge this problem and find ways avoid the potential consequences (besides simply borrowing more from China to keep stock markets high), the problem will only get worse.

Of course, we could always cut social security altogether, let the stock market go where it will, and simply let the unprepared starve in the streets, but never forget that a society is judged based on how it treats the poorest, not based on how easy it is for the rich and educated to succeed!