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

I keep summarizing our finances to my wife. I let her know where our money is kept and how much money we have. We discuss our plans and goals regularly.

Still, when I asked my wife where she would find our emergency fund if I was incapacitated in an emergency, she had no clue. It turns out that while my wife is interested in our finances and in our financial future, she really couldn’t care less about the details. Before we got married, she was generally good with finances — spending less than she earned while occasionally paying a bill late due to disorganization. Now that I take care of money and keep her updated as to our general progress toward goals, she just doesn’t bother to pay further attention.

I don’t think that’s a problem — as long as we continue to communicate and align our goals, we won’t run into serious problems if just one of us takes care of financial details. Still, she does need to be able to access our money in an emergency, so I’ve begun working on my alien abduction package. It will include instructions and important account numbers for all our accounts including which accounts she owns and which (like retirement accounts) will need to be transfered to her if I’m abducted (we don’t like to talk about me dying).

We don’t yet have a safety deposit box, so I will likely be encrypting a copy I can keep in a reasonably secure online file-saving account.

It’s taking me a bit of time to get this together, but I’ll post a reasonably scrubbed version as Mrs. Micah did at the link above. It should make reasonably interesting reading as it will include both the location of my money as well as the reasoning for this location and special instructions on how accessing it may be complicated.

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.