Category Archives: Monthly Financial Tips

How to slash student loan debt

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.

When fully funding your 401(k) isn’t the best option

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 You aren’t taxed on contributions until the money is withdrawn in retirement, allowing your investments to compound tax-free until then.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:

  1. 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.
  2. 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).
  3. 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.

The Sandwich Generation: How to support post-college kids and aging parents

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.

A primer on Series I savings bonds

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.

How much mortgage can you afford?

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.

Tax refund — spend it quickly or use it prudently?

More than 70 percent of taxpayers will receive tax refunds this year, with refunds averaging $2,860. If you’re part of the fortunate majority, you may be wondering how to spend that extra cash. It’s tempting to use it for a down payment on a new car or a Hawaiian vacation. Before that currency flows out of your bank account, consider the following less exciting alternatives that may put you in a better financial place.

  • Pay down debt. According to the Federal Reserve, the average annual interest rate on credit card debt has been hovering around 13 percent. If you carry a balance of $5,000 for a full year and the bank charges the average rate, you’ll pay $650 in interest. Instead, why not use your refund to slash your credit card balance in half? You could save $325 this year and take one more step toward financial independence.
  • Pump up your emergency fund. Many American households carry thousands of dollars in credit card debt from month to month, and much of that debt stems from unexpected bills or reduced income. A well-funded emergency account can help you avoid high-interest debt when you’re faced with life’s inevitable struggles. Try to accumulate a balance covering three to six months’ living expenses.
  • Fund a retirement account. Hoping to retire some day? Contribute your tax refund to an individual retirement account (IRA). Again this year, you can set aside a combined $5,500 in Traditional and Roth IRA accounts ($6,500 if you’re age 50 or older). Consider this: If you contribute $5,500 every year from age 30 to age 65 and your account earns a relatively conservative 6% rate of return, your account balance when you retire at age 65 will total nearly $210,000.
  • Other ideas. Set up a 529 college savings plan for your toddler’s college tuition, allowing the money to grow tax-free for college bills. Fund a reserve for end-of-year holiday gifts. Donate all or a portion of the refund to your favorite charity. Take a college course to improve your career options.

Ultimately, the decision to spend your refund on something fun and a little more frivolous or something prudent is completely your own. But, if you have questions about what’s best for your financial situation, give Carl Heinemann, your Chattanooga CPA, a call.

Spend less and save more by changing a few old habits

For most people, wealth accumulation is a long-term proposition. If you’re counting on the lottery to fund your retirement or hoping an unforeseen windfall will put your kids through college, it might be time to reconsider. Instead, take a hard look at your current saving and spending habits. Achieving your financial goals requires tangible and specific steps taken day in and day out. By adopting a few simple practices, you can learn to save more and spend less.

  • Automate your savings. You’ve heard the expression: “Out of sight, out of mind.” This is a great way to think of your savings. Don’t deposit your entire paycheck into a regular checking account. Direct a portion to a savings account and another portion to a 401(k) or IRA account and then don’t touch them. If you don’t see these amounts in your everyday checking account you’re less likely to spend them.
  • Pay off your credit cards every month. For many people those little pieces of plastic are a toxic trap. On average, Americans between the ages of 18 and 65 carry $4,717 of credit card debt. If the average credit card’s interest rate is 15 percent, paying off that debt with the minimum payment of $189 will take more than ten years and cost more than $22,000. To build wealth, join the 35 percent of credit card users who make a habit of paying off their bill each month.
  • Curb impulse purchases. Letting emotions rule is a sure way to break the budget, max out your credit cards, and fill your home with unnecessary stuff. Make a list before you shop. Then stick to it. Eat a big meal before buying groceries. You’ll be less likely to let your hunger influence your decisions. Learn to procrastinate on non-essential purchases. If you wait a few days, you may find you don’t really need the item(s).
  • Use cash. It may be old fashioned, but paying with currency instead of plastic can short-circuit the urge to buy stuff you don’t need. Studies have shown that paying with a credit card is less painful than paying with cash. As a result, shoppers tend to spend more money when using plastic.
  • Pump up your emergency fund. Life happens. Routinely setting aside money in a rainy-day account can relieve stress today and lessen the tendency to use debt when times get tough. How much is enough? Many advisors suggest an emergency fund covering at least three months of living expenses. Automating deposits to an emergency fund is a great way to start.

The concept of spending less and saving more seems simple enough, but it requires changing old habits. If you take on these steps, perhaps one at a time, slowly you will begin to save and be better prepared for unexpected future expenses.

Facing the cost of college on a budget

Consider the following statistics: The cost of getting a higher education has risen substantially faster than the general inflation rate over the past decade. For the 2016-2017 school year, tuition and fees average over $7,100 at four-year, in-state public institutions; at private colleges average costs are substantially higher — over $32,400. Add thousands of dollars for room and board, supplies, and transportation, and it’s clear that attending college has become an increasingly expensive proposition.

How do students cover these costs? Some are fortunate enough to receive help from relatives; others apply for financial aid. Nearly 70% take out student loans to cover the cost of higher education. In fact, college students graduating in June 2016 finished their studies with average loan balances topping $37,000.

If you’re a student faced with the daunting task of paying for college, here are three tips for getting a college degree without taking on a mountain of debt.

  • Postpone school to define goals. Many young people start college without a defined goal. They jump from class to class, major to major, all the while spending money on credits that may not count in the long run. Holding off on school, getting a job in a field that interests you, and saving money for college may provide a better return for your education dollars. Many former students have learned that a few years in the workplace can provide a taste of the “real world” and motivation to pursue an education more vigorously.
  • Consider community college. Attending a local junior college for your first two years may substantially reduce overall college costs. In addition, you may benefit from smaller class sizes and a shorter commute. Just be sure to confirm that local college credits will transfer to the four-year institution of your choice.
  • Live at home while attending school. Foregoing on-campus accommodations can slash thousands of dollars from college costs. Though not a decision to be taken lightly, residing with parents or other relatives while attending school may enable you to obtain your degree with minimal debt. And without ongoing loan payments, you’ll be in a better position to start your career on a solid financial footing.

If you’d like other suggestions for reducing the cost of higher education, give Carl Heinemann, your Chattanooga CPA, a call.

TIPS can offer a prudent long-term investment alternative

Rising inflation poses a significant risk to fixed-income investments such as bonds. Treasury inflation-protected securities (TIPS) can be a good alternative to diversify your portfolio and protect your retirement funds from the risk of rising inflation.

TIPS were introduced by the U.S. Treasury Department as a special type of savings bond designed to protect against higher-than-expected inflation and are offered with terms of 5, 10, and 30 years. A normal bond with a fixed face value loses its purchasing power if the rate of inflation is higher than the amount of its annual return, also called its coupon. In contrast, the face value of a TIPS adjusts to inflation. For example:

Assume you purchase a TIPS with a $1,000 face value and a 3% coupon. If inflation was 10% during the year, the face value of the TIPS would increase by 10% to $1,100. The coupon, based on higher face value, would be $33. So, the interest payments are protected against inflation and you also receive the higher face value when the bond matures, which helps to counteract the effects of inflation.

However, there are some downsides to TIPS. The security against higher-than-expected inflation comes at the cost of a lower coupon compared with equivalent Treasury bonds. That means if you expect inflation to fall or stay the same rather than rise, standard bonds make more sense than TIPS. Second, TIPS have tax consequences. If a TIPS face value adjusts upwards because of high inflation, that adjusted amount has to be reported to the IRS as income. However, you can avoid this by buying TIPS through a mutual fund or within a tax-deferred retirement account.

TIPS can be a good investment, but they can also be complicated. Consider your options before deciding if they are right for you.

Is private mortgage insurance a good deal?

Private mortgage insurance, known as PMI, is a type of insurance that makes sure your lender gets paid back if you default on your loan. Generally, lenders require you to pay for PMI if your down payment will be less than 20% of the value of your new home. Is that a good idea? If you can’t finance your home any other way, private mortgage insurance may be worth considering. But before you sign on the dotted line, research the costs.

Here’s what to consider. PMI fees may be added to your regular mortgage payment or paid upfront during closing. Depending on the size of your down payment and the mortgage balance, insurers typically charge between 0.5% and 1% of the original loan amount on an annual basis. Here’s an illustration. Say you take out a mortgage for $200,000. PMI may add as much as $166 per month to your house payment ($200,000 x .01 divided by 12 months).

If you don’t want to pay for PMI, you have other options. For example, you could scale down your expectations and consider a less expensive home, or you can ramp up your savings and wait to buy until you can make a down payment of at least 20% of the sales price. You can also apply for a loan from the Federal Housing Administration or Veteran’s Administration. If you qualify, these lenders may require a smaller down payment or offer lower interest rates. Alternatively, you can find a lender that doesn’t require PMI. Just be aware this option may mean you’ll have to accept a higher interest rate, which may end up costing you more money.

What if you’re already paying PMI? A new appraisal may eliminate the need for the insurance. PMI premiums are typically paid until the loan-to-value ratio reaches 80% or less, which generally happens when your home increases in value or you pay down your mortgage. If your house has increased in value, the loan-to-value ratio may have dropped.

You could also prepay your loan. Paying off your mortgage faster lets you reach the 80% loan-to-value threshold sooner. Another viable alternative may be remodeling. Add a room or refurbish your kitchen, then ask the lender to recalculate the loan-to-value ratio.

For help evaluating private mortgage insurance and other financial decisions, give Carl Heinemann, your Chattanooga CPA, a call.