Should you open a Health Savings Account (HSA)? Not surprisingly, the answer depends on many factors. For instance, if you’re in good health and can afford a high-deductible insurance policy, HSAs may offer significant advantages. Think about the following as you consider an HSA:
The plus side
HSAs can reduce your tax bill. You contribute pre-tax dollars, the money grows tax-free, and you make tax-free withdrawals for qualified medical expenses.
HSAs can lower health insurance premiums. Because HSAs work in tandem with high-deductible health plans (HDHPs), premiums are generally lower. That’s because you, rather than the insurer, cover more of the costs until the deductible is met.
HSAs can bolster retirement investments. ASome HSAs allow you to invest in mutual funds after the account balance reaches a certain threshold. Because the balances accrue (unlike Flexible Spending Accounts that require you to spend the funds annually), an HSA can grow over time.
Changing insurers can be risky. If you or a family member suffers from a chronic health condition, switching to an insurance company with a high-deductible policy may not be feasible or advisable.
Out-of-pocket costs will likely increase. The upfront costs of a high deductible can sting. For 2018, the insurance deductible for a family must be at least $2,700 to qualify for an HSA. Although your insurance may cover routine preventative care, you’ll be on the hook for most medical costs until the deductible is met at the start of each coverage year.
Withdrawal options may be limited. If you withdraw funds for non-qualified expenses before age 65, you’ll be hit with a 20 percent penalty in addition to regular income taxes.
Bottom line? If you have the financial resources to cover out-of-pocket healthcare costs, an HSA can be a great tax-advantaged tool. Just be sure to compare the benefits and pitfalls alongside your own situation.
Americans hold more than $1 trillion in credit card debt and over twice that much in loans, according to the Federal Reserve. After mortgages, student loans are the second largest source of debt, and auto loans aren’t far behind. It’s no wonder many Americans have almost nothing set aside for emergencies or retirement.
Fortunately, you don’t have to be part of this trend. One recent survey found that more than 25 percent of Americans are living debt-free. It’s not an impossible dream. Of course, getting there will take discipline and a specific strategy. Here’s a starter plan for getting out of debt once and for all:
1. Know what you owe. Go to the websites of your lenders and card issuers. Identify your outstanding balances, interest rates and minimum monthly payments. Copy the information to a spreadsheet or piece of paper. Post the figures above your desk or on your refrigerator. Update the balances as they’re paid down.
2. Craft a plan. Develop a strategy for liquidating those accounts. You might opt for paying off high-interest cards first or focus on balances you can get rid of quickly. Do whatever works to maintain momentum.
3. Stop borrowing. Summer’s here. Will you splurge for a tropical vacation using credit cards? Bolster your odds of becoming financially independent by paying cash, even if that means going with a cheaper option.
4. Prepare for emergencies. Make a concerted effort to build up a rainy-day fund with enough cash to cover at least three months of expenses. An emergency stash will help you steer clear of debt when the unexpected happens.
5. Learn to budget. Besides loan and credit card payments, you need to buy groceries, put gas in the car and keep the electricity on. So it’s important to monitor cash flow. Understanding and documenting regular income and expenses can help you gauge progress toward your financial goals.
If you want a tax-advantaged retirement account outside your employer’s plan, you have two main options: a traditional IRA or a Roth IRA. You may prefer one over the other, depending on your short-term savings goals, years until retirement and assumptions about future tax rates.
Traditional IRA vs. Roth IRA basics
You can generally deduct contributions to a traditional IRA, which lowers your tax bill. On the other hand, with a Roth IRA, you pay taxes upfront. So you may have to earn $7,500 pre-tax to sock away the annual maximum of $5,500 in a Roth IRA.
With a traditional IRA, taxes are deferred. When you’re retired and withdraw money, it’s counted as regular income and taxed accordingly. However, with a Roth IRA you’re generally allowed to make tax-free withdrawals in retirement. That means that if you expect to be in a higher tax bracket in the future, a Roth IRA may make the most sense.
Roth recharacterizations: a thing of the past?
When Roth IRAs were originally created in the late 1990s, Congress provided a way to move or “convert” funds from a traditional IRA to a Roth account. Although taxpayers had to pay taxes on the amount converted, some considered the future benefit of tax-free withdrawals preferable to the current benefit of tax-deferred contributions. Congress also let taxpayers change their mind about Roth conversions, and “recharacterize” them back to traditional IRA accounts.
But the Tax Cuts and Jobs Act signed last year eliminated the ability to reverse a Roth conversion using the recharacterization process as of Jan. 1, 2018.
There is some wiggle room left to undo Roth conversions made during 2017, if you complete the recharacterization by Oct. 15, 2018.
Retirement planning can get complicated. If you’d like help evaluating your tax-advantaged account options, give Carl Heinemann, your Chattanooga CPA, a call.
According to a 2017 American household credit card debt study, the average American household with credit card debt has a balance exceeding $15,000. If this sounds all too familiar, you may consider consolidating several balances into a single home equity line of credit, or HELOC. Here are the pros and cons of this approach:
Interest rates tend to be lower. A HELOC is based on your home equity, the difference between the value of your home and your outstanding mortgage. Because a HELOC is secured by your home (your house becomes collateral for the debt), a lender takes on less risk and may offer a variable line of credit at a substantially lower rate than you’ll get with an unsecured credit card.
It’s easier to manage payments. By paying off credit card balances using a single HELOC, you may find it easier to keep track of monthly due dates. No more late payment fees because you missed one.
Your home is on the line. By pooling your credit card balances into a single line of credit, you’re not getting rid of debt — you’re trading one form of debt for another. If you fail to make payments on time, lenders can foreclose on your house.
Setting up a HELOC can be expensive. Depending on the financial institution, fees for setting up a home equity line of credit may approach the closing costs on a home purchase.
Before signing up for a HELOC, research all your options for consolidating and/or liquidating high credit card balances. For example, you might use the “snowball method” to pay off low balance credit cards first or implement a 3-year plan to settle your debts.
Regardless of the method you choose, taking steps to modify poor spending habits is often the smartest way to climb out of credit card debt and secure a debt-free financial future.
Ideally, you should try not to tap your 401(k) or IRA accounts before it’s time to retire. But life happens. In certain situations, you may need to withdraw a portion of your nest egg while you’re still working full time. Here are three scenarios where this may be the case — and possible alternatives to avoid tapping your retirement accounts too soon:
You’re drowning in high-interest debt. Your retirement plan may allow for a 401(k) loan that can be used to pay off expensive credit card accounts. Although the loan is paid back to your own account (paying yourself the interest), this solution has some disadvantages. For one thing, money that’s withdrawn from your 401(k) account isn’t available for long-term growth. Also, should you lose your job, the loan may become due immediately.
If you can’t settle the debt right away, you may be subject to a 10 percent early withdrawal penalty and regular income taxes on the outstanding loan balance. Consider paying off debts using other funding sources as it may be a more prudent solution.
You’re facing foreclosure on your home. The hit to your credit score can be devastating if you default on a mortgage. But, again, using your retirement nest egg should be considered a last resort. You may be better off working with your lender to revamp your mortgage. Consider extending the term or renegotiating the interest rate to reduce monthly payments.
You’re heading back to college. If you need to retool for a new career, the IRS allows you to make penalty-free withdrawals from your IRA accounts before age 59½ if the money is applied toward higher education expenses. But be aware that the same rules do not apply to 401(k) accounts. If you haven’t reached age 59½ and use funds from a 401(k) to cover college expenses, early withdrawal penalties and income taxes may apply.
The best way to avoid penalties is to understand the rules around retirement account withdrawals. Give us a call to learn more about tax penalties you may face if you withdraw funds early from retirement accounts. Carl Heinemann, your Chattanooga CPA, can help you create the best plan for your situation.
Obtaining a legitimate college degree is an expensive proposition. According to a recent Edvisors education survey, the average college student graduates with $35,000 in student loan debt. And that’s not counting people who attend graduate school. Many will be paying off student loans — month after month, year after year — for decades.
The good news? With smart financial management, graduates can liquidate their college debt in a reasonable time, freeing up cash for other priorities. Here are four tips for paying off loans quickly and efficiently:
Create a budget. Get a handle on where money is going. A budget can help prioritize, enabling you or your child to whittle down student loans more quickly. Several online tools are available. You can even use a simple spreadsheet listing monthly income and expenses.
Ask your employer. Your company or your child’s company may offer one-time loan payoffs in exchange for a lower starting wage or other concessions. Negotiate when interviewing. After taking a job, check with the human resources department about options.
Sign up for auto-deductions. Reducing payment steps makes it less likely to divert those funds to lesser priorities. As an added bonus, you or your child may develop the discipline to live on less while loans are being paid off.
Reduce your other bills. Talk to your cell phone provider. Postpone that expensive vacation. Hold off on the latest-and-greatest electronics. Instead, prioritize student loan payments. It’ll be worth it when you or your child can enjoy the benefits of a rising salary, increased cash flow and a stellar credit score in a few years from now.
Don’t forget to take advantage of possible education tax credits and deductions. Give Carl Heinemann, your Chattanooga CPA, a call for help determining what tax breaks are right for you.
Maxing out contributions to your company’s 401(k) plan is almost always a good idea. After all, when you contribute to a traditional 401(k) plan, your current tax bill is lowered. You aren’t taxed on contributions until the money is withdrawn in retirement, allowing your investments to compound tax-free until then. And if your employer matches a percentage of your contributions, you get an immediate return on investment. These are all good reasons to make regular contributions your 401(k) plan.
But sometimes forgoing 401(k) contributions, at least for a while, is the more prudent choice. Consider these three scenarios:
You haven’t established an emergency fund. The rule of thumb is to have enough cash readily available to cover six months of expenses. Otherwise, unexpected events such as job losses, medical emergencies, or personal crises may force you into excessive debt. You may find yourself paying off high-interest credit cards or personal loans long after the misfortune is over, which will set you back in your plans to save for retirement. So, before maxing out 401(k) contributions, set aside enough money from each paycheck to protect yourself with an emergency fund.
You’re laboring under a load of debt. A few hundred dollars on credit cards is no big deal. But high-interest balances of several thousand or tens of thousands of dollars may be cause for concern. It’s usually better to pay off some or all of those balances before contributing extra to a 401(k).
Your company’s investment options are limited. Any matching contribution your company offers should be considered free money. But beyond the company match, survey other places to park your retirement money such as a Roth IRA or indexed mutual fund. Your company may offer funds invested in large-cap American companies exclusively. To diversify your portfolio, look outside your firm’s 401(k) plan for additional investment choices, such as emerging market or international funds that may garner higher returns over time.
Bottom line? Save regularly for retirement, but take a hard look at your overall financial situation before maxing out contributions to your company’s 401(k) plan.
Consider this scenario: your teenage son graduates high school and heads off to college. He studies hard and finishes with a bachelor’s degree in four years flat. He accumulates $40,000 in student loan debt, struggles to find a well-paying job and decides to move back home while looking for work. He needs help with student loan payments.
At the same time, your 80-year-old mother is struggling with medical bills and a mortgage. Before long she may require long-term care. You’re on the cusp of retirement, but now you’re wondering if working another five years makes sense.
Welcome to the “Sandwich Generation.” Many baby boomers — Americans born in the two decades following World War II — are facing similar financial pressures. If this state of affairs sounds familiar, here are three suggestions for coping:
Set priorities. Focus on your own financial affairs first. If you’re struggling to make ends meet, it’s harder to be generous. Also, your kids have a lifetime of earning potential ahead of them. As you approach age 60 and beyond, options tend to be more limited. With that in mind, it’s often prudent to fully fund 401(k) and individual retirement accounts before helping kids with college costs and student loans. Pay down personal debt, especially high-interest loans and credit cards. Hone your budget with retirement in mind.
Enlist the help of relatives. If possible, talk to siblings and other family members about the needs of aging parents. Relatives may be willing to help with caregiving or chip in to cover a portion of long-term care premiums, health care costs or mortgage payments. Elderly parents may be reluctant to divulge their financial affairs — including the availability of savings accounts, pensions and health insurance — but it’s a discussion that needs to happen. Set up a planning meeting to explore options.
Do your homework. Did your parent serve in the military? Under the Veterans Administration Aid and Attendance program, qualifying veterans and their spouses may be eligible for a VA pension of more than $2,800 per month to help cover the costs of elder care. Also, costs vary widely among assisted care facilities. When relocating an aging parent, consider the possibility of higher travel costs and the need to find knowledgeable health care professionals.
Want help with these long-term planning decisions? Give Carl Heinemann, your Chattanooga CPA, a call.
Although inflation has been sleeping for several years now, the tiger may be waking up. In some sectors of the economy, low unemployment is causing wage rates to climb. Global economic growth is lifting prices for raw materials and commodities. And a decade after the subprime mortgage crisis, the pressures that prompted the Federal Reserve to squelch interest rates are beginning to ease.
If you’re searching for a hedge against inflation, Series I bonds are worth a look. They’re sold by the U.S. Treasury and like EE bonds, interest on I bonds is exempt from state and local income taxes. Federal income tax on I bond earnings and interest isn’t due until the bonds are sold. Every six months the U.S. Treasury computes I bond interest rates, which consist of two components: one fixed, one variable. The fixed rate doesn’t change over the life of the bond. The variable rate is revised every six months based on the rate of inflation.
Like interest rates in general, I bond rates have declined significantly in recent years. For example, in May 2000 the fixed rate on I bonds was set at 3.6 percent and the variable rate was 3.89 percent, resulting in a compound rate of 7.49 percent. Because inflation rates fell over time (due mostly to declines in energy prices), I bond rates dropped as well. This year the Treasury set the composite rate for I bonds at 1.96 percent.
So if I bond rates have been declining, why would anyone want to purchase them? For one thing, there’s the tax benefit, which is especially enticing if you live in an area with high state and local taxes. In addition, the government will revise rates upward if inflation heats up. Because the principal is not adjusted, I bonds won’t depreciate from their face value. Another benefit: if you use I bonds to pay for college, the interest may be exempt from federal taxes.
On the other hand, I bonds are not as liquid as a money market account, for example. That’s because I bonds can’t be redeemed unless held for at least a year. If you sell before holding the I bond at least five years, you’ll forfeit three months’ interest.
For a deeper look at the pros and cons of I bonds, visit TreasuryDirect (www.treasurydirect.gov), or give Carl Heinemann, your Chattanooga CPA, a call.
In this economy, if you have good credit, a steady job, and several thousand dollars for a down payment, you’ll likely find a financial institution willing to lend you money for a mortgage. Simply fill in the blanks in an online mortgage affordability calculator to get a ballpark estimate of how much you may be able to borrow.
But online calculators don’t tell the whole story. That’s why you need to dig deeper. Scrutinize all the factors that could influence your home buying decision, some of which may be hard to quantify. Above all, don’t sign a long-term mortgage contract until you’ve asked and answered the following two questions.
Should I save for a larger down payment?
You may find a house that sells for $200,000 and a lender who will let you make a 10 percent down payment. Under that scenario, you would owe $180,000 initially (disregarding closing costs and other fees). But let’s say you choose to wait and save enough cash to make a 20 percent down payment on the same home. Your initial mortgage balance would be $160,000. Comparing these two scenarios and assuming an annual interest rate of 4 percent on a 30-year mortgage, a larger down payment would mean a smaller principal and interest payment each month (about $95 less). In addition, you’d save over $14,000 in interest over the term of the loan and could avoid paying for private mortgage insurance (PMI), which is usually required for borrowers who cannot put 20 percent down. PMI fees vary from around 0.3 percent to about 1.5 percent of the original loan amount per year.
What percentage of my take home pay will be locked into house payments?
Remember, you’ll be making mortgage payments every month for years. With that in mind, try to limit your house payment (including taxes and insurance) to 25 percent of your take-home pay. Homes are expensive to maintain. You’ll need cash to cover utilities, maintenance, and repairs. Many Americans fall into the trap of being house rich and cash poor. They resort to credit cards and personal loans for all sorts of ongoing expenses: food, transportation, insurance, health care, and emergencies. Don’t make that mistake. Build room in your budget for house payments and the routine costs of living.
If you have questions about mortgage affordability, please don’t hesitate to call Carl Heinemann, your Chattanooga CPA.