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

Now that people are starting to get their tax rebates, our economy is in for some serious stimulation!  The idea is that we’re supposed to go out and buy new stuff which will keep businesses rolling along which will keep people employed.  Some might argue that we need a recession to drive inefficient companies out of business (freeing up workers and resources for better-run companies) but it’s a rather unpopular idea — especially now that our retirement savings are almost universally invested in the stock markets after years of our government giving tax breaks for 401(k) contributions.

If we step back for a moment and consider that the economy won’t totally collapse if every penny of the 100 billion is turned into profits and wages (it won’t), it will become clear that paying off debt will actually do as much or more to stimulate the economy than simply spending on consumer products.

Increasing future spending.

First of all, with every penny you pay back on your debt, you free up the monthly interest to be spent on other things.  Putting the $600 individual rebate toward debt could save as much as $150 a year in interest at an all-to-common 25% interest rate!  Today’s politicians are no-doubt counting on the stimulus today so they can take credit for the booming economy, but if we’re willing to think just a couple years out, the sustained effect of $100 billion less debt would be huge (and wouldn’t largely be wasted in profits to foreign countries).

Free up financial markets.

One of the biggest reasons for the current recessionary scare is sub-prime lending.  Sub-prime lending is hugely profitable as long as the economy is booming because lenders can charge exorbitant interest rates that more than cover defaults.  Of course, the banks book their profit each year and don’t generally set aside some of that profit to cover future defaults if the economy goes bad (or it wouldn’t be profit) so they’re stuck with huge numbers of bad loans that are no longer profitable as people become unable to repay them.

Banks don’t really want you to pay back your loan faster since they don’t earn as much interest that way, but in this case, the financial markets are so gummed up that every dollar they get back will be one more dollar they can lend out — further greasing the skids of our economy and getting everything moving again.

Ultimately, do what’s best for you!

Nobody’s trying to tell you what to do with your money, but I hate to hear people say that you should spend it or save it.  Politicians will benefit more if you spend it ASAP and make them look like they lead the economy well.  Companies worldwide will benefit more if you spend it on consumer products and a small fraction of it will go towards jobs.  The economy will benefit if loans are repaid (especially sub-prime loans) and banks will benefit if you continue to make minimum payments no matter what else you do.

In the end, look for where the money will do the most good in your personal financial situation.  While there are no strings attached, with the government running a huge yearly deficit (it doesn’t look so bad until you add in the regular “emergency was spending” to the budget), we’ll get stuck with the tab in the form of increased taxes or decreased services (say a 50% cut in social security payments?) in the long run.  While I’m a big fan of doing what’s best for my country and the world, ultimately, what keeps you self-sufficient will benefit those around you the most in the long-run.

It’s my dream card come true!  While perusing my daily dose of blogging, I found an article about the Revolution Card at CashMoneyLife.com.  This credit card is exactly what I’ve been looking for, but as such a new service, it isn’t yet accepted by the merchants I use regularly.

The Good Side

The credit card is friendly to merchants (unlike existing credit cards in the USA) as it only charges a reasonable 0.5% per transaction rather than the more common 2+%.  As much as I like getting cash back, I’d rather not throw even more money at greedy banks and keep it circulating in my local economy!  I find the high interchange fee rather unpalatable and perhaps even immoral as the pseudo-monopoly held by visa and Mastercard has restricted any competitive cost-down pressure.

The card also has no name or number embossed on the front and even better — it can only be used with a pin number, not a signature!  That means unlike debit or credit cards that can currently be used by thieves since nobody checks signatures, this card can only be used illicitly if somebody steals both the card and your pin number (not likely).

For even more security, you can generate temporary pin numbers — great for online purchases, or a one-time thing at a store you don’t quite trust.

The Down Side

Patrick at Cash Money Life had some good criticisms of the card — namely that since it requires a pin number, it will be more difficult to process in places like restaurants and bars where they’re traditionally taken or kept as collateral for a tab.  Since you have to be present and (presumably) sober to use your pin number, this card won’t be as handy for people who regularly eat out.  Still, I feel rather nervous leaving a credit card with a waitress as the magnetic strip can be copied and stolen so I would welcome an excuse to follow the waiter to a card swiping machine.

The biggest issue for me is the short list of stores that accept the card.  While they include large chains like Kohls, CVS, Walgreens and Rainbow, they don’t include my everyday stores like Cub Foods or Target or even any gas stations as far as I can tell.  I will apply for this card as soon as I feel like I would use it regularly, but they have some recruiting to do before I personally will take the plunge.

The Verdict

The advantages to this card are not huge.  While security is highly important to me, credit card companies universally cover any fraud past the first $50 so financially it’s not a huge issue.  It’ll still be a huge hassle to get your money back, but it’s not hard to get your money back.  I’d much rather have a card that largely prevents theft, but I don’t feel my money is in danger now.

Some people with good credit might be able to get competitively low rates (the rates are largely based on credit history) but you could probably get an even lower rate with a card that charges higher merchant fees for obvious reasons.

The main advantage, then, is the low interchange fee which users never see.  Quite honestly, I’d be paying a bit more for my purchases than I do currently as I wouldn’t receive kickbacks in the form of ‘cash rewards’ for my credit card purchases.  At the same time, the more of my money that goes directly to those that provide goods and services I want, the better for the entire economy.  It’s a small effect, but barring legislation like that in Australia that limits interchange fees to 0.5%, I’d prefer to vote with my wallet and use the more efficient method.

For me, then, the main down-side is the limited acceptance of the card.  I’ll be watching this card closely and as soon as I see it being accepted by gas stations or my local supermarkets (or even better, some of the smaller stores I shop at), I’ll get myself a card and ‘be part of the revolution’ (sorry — I couldn’t resist).