Finding Your Net Worth

When I ask people about their long-term financial goals, a common response is “I want to become a millionaire!” My follow up question is always, “So what does that look like?” I ask that question because most people respond, “I want to have $1 Million.” Having that much is great, but you still may not hit your goal. I want to focus on the definition of a millionaire. It seems that people have a misconception of the term. A lot of people view a millionaire as someone who has $1 Million or makes $1 Million per year. That’s not necessarily the case. A millionaire is someone whose net worth is greater than $1 Million.

Net worth is probably the most important personal finance number that isn’t talked about enough. Your net worth is equal to your Assets (What you own) minus Liabilities (What you owe, aka debt). This number should be the focus of most of your financial decisions in life.

Net Worth = Assets - Liabilities

Assets include your house, bank accounts, retirement accounts, car, and anything else that can be sold to someone. Liabilities/Debt include mortgages, car loans, student loans, credit cards, and anything else you owe someone.

Two great books about this topic are The Millionaire Next Door and Rich Dad, Poor Dad. They do a great job of explaining the importance of buying assets and reducing your debt. When I read them, I learned that most millionaires are self-made and did not inherit their wealth. The most successful people lived below their means and invested in assets throughout their lives. Another great topic is how to invest in assets such as stocks and real estate that will pay you back over time. Boats and cars don’t pay you back unless you sell them. They also go down in value over time which means that mere ownership decreases your net worth.

This is how people measure when they can retire. Anyone can retire when they can live off their assets for however long they expect to be alive. Retirement doesn’t have to be based on an age that you think will be a good time to stop working. It is based on the ability to pay for your expenses without needing employment.

That’s why I want you to sit down and calculate your net worth. Make it a priority in your life. Think about how your financial choices impact your net worth. If you do that, you will set yourself up for long term success. You can also figure out exactly what your wealth will look like when you become a millionaire.

Mike Zeiter, CPA/PFS

529 Plans - Q & A

Some events happen in your life that change everything. Many of these events also have a major impact on your finances. I recently encountered one when my wife came into the room and told me that we were going to have a baby! It doesn’t get any better than that.  We were in shock for few days, but the news finally set in, and I realized that I needed to update our financial plan ASAP!

I crunched the numbers for diapers, wipes, and car seats. I poured over our HSA numbers and healthcare coverage. Yes, life with me IS as exciting as it sounds. Then I started thinking about college savings, and I knew that 529 plans were the best place to start. A few Google searches later, I already had a headache. 529 plan rules are set up by the federal government, but the plans are managed by each individual state. Anything gets confusing when you have that many politicians involved so I decided to do the research and share the information with everyone.

I have put together the main questions that people have about 529 plans with some quick and simple answers. I will highlight the main structure of these plans to show you why they are generally the best college savings option. At the end, I will explain the best way to start a plan.

 

What is the purpose of a 529 plan?

529 plans are tax-advantaged savings plans that can be used for college expenses. States have separate programs, but you aren’t required to use the one offered in your state. The best use for these plans is if you have a child that is young and has more than 5 years until they will attend college. The goal is to invest money that can grow tax free for higher education expenses.

What are the tax benefits?

The easiest way to describe the benefits is by looking at a simple example. Let’s say two parents contribute $10,000 to a 529 for their child on his/her first birthday. They invest the money and it grows to $40,000 by the time the child starts college at age 18. Here is the breakdown of the tax benefits.

Year 1: Parents do not receive a Federal tax benefit. They may receive a state tax deduction if they participate in a state that offers a tax deduction. In my home state of Missouri, they would receive a $10,000 deduction on their state tax return for contributions to any state’s plan.

Years 2-17: The investment grows from $10,000 to $40,000 without any tax consequences.

Year 18: The child uses the money for qualified college expenses. No federal or state tax is paid on the gain. This is the biggest benefit. You would normally pay tax on $30,000 of investment gains which would be $4,500 for most people.

Who can contribute to an account?

Anyone! The most common form is parents or grandparents contributing for a child. However, you can contribute to a plan for yourself, your nieces and nephews, or a friend’s child.

How much can I contribute to a Plan each year?

Individuals can donate up to $14,000 per beneficiary per year (in 2017), and twice that amount if they are married and choose to split the gift. There is also a special exemption that allows donors to donate up to 5 years’ worth of gifts in one year without gift tax consequences.   

What happens if my child doesn’t go to college?

If your child decides that college is for suckers, it isn’t the end of the world. The money can be transferred to a new beneficiary that doesn’t have to be your child. If there is nobody else that you can pay for to go to college, the money can be withdrawn and you would pay the taxes along with a 10% penalty on the earnings.

What investments can be set up in the Plan?

It varies by state. Most states allow you to invest in stock or bond mutual funds. Some offer prepaid tuition plans, but those are generally not as beneficial for people.

What can the money be used for?

According to the IRS, “Qualified education expenses are tuition and certain related expenses required for enrollment or attendance at an eligible educational institution.” As you can imagine, this leaves some room for interpretation. Essentially, expenses for tuition, fees, on campus room and board cost, and required classroom material are covered. Make sure to consult with a tax professional if using the funds for expenses other than tuition and fees.

What happens if they get a scholarship?

Congrats, your child receives a full ride scholarship! If you don’t want to transfer the money to another person, you are able to withdraw the money without penalties for the scholarship amount. That means that the $30,000 in our example before would be taxed like a normal investment.

How do I set up an account?

Now that you know how they work, I am sure you are dying to know how to open an account for your child! The first step would be to research the option in your own state. If your state offers a tax deduction for using their plan, it is probably the best option. Most states have 529 websites that allow you to open a plan online with your information and the beneficiary’s information.

If your state doesn’t offer a tax deduction, or you don’t like the arrangement of the plan, start researching other states. The key items to look for are plans that offer you low cost investment options and don’t charge a commission for investing. Find a plan that allows you to use the money for any school and not just that state’s schools. The most important thing is to make sure you comprehend the plan that you choose. Don’t put money into any investment that you don’t understand!

 

I hope this has helped you gain some knowledge of 529 plans. My last caveat about 529 plans is this…don’t sacrifice your retirement savings to pay for your child’s education. There are other ways to go to college, but not having money in retirement will put the burden right back on your children.

As always, contact me if you need any help!

Mike Zeiter, CPA/PFS

Tax Deductions

I get this request all the time. “Hey Mike, I need to find more tax deductions so I don’t have to pay as much.” Depending on the person (and my mood), my  response is usually a sarcastic, “You can give half of your income to charity.” Obviously, people generally don’t want to give away half their income just to save on taxes. They are looking for deductions that allow them to reduce their taxes AND keep their money. I am going to simplify the tax code for now and just look at two different types of deductions. The first group are deductions that give you a benefit in the current year and allow you to keep your money. The second group of deductions give you a tax benefit, but you lose the money.

Keep your money and save on taxes - Traditional Individual Retirement Account (IRA), Employee Retirement Plan (401k, 403b, etc.), and Health Savings Accounts.

These are your first choices when looking to save more on taxes. Retirement plan contributions will grow in your account and you will pay tax on them in the future, but hopefully at a lower tax rate. Money that you put into a health savings account can be used for medical expenses in the future and you never pay tax on it.

Spend money to save on taxes – Mortgage interest, property taxes, charitable contributions, business expenses, etc.

This group essentially covers all other tax deductions. The amount you save from these is equal to the expense times your tax rate. These deductions are items that you need to make sure you include on your tax return if you incur them, but don’t create them for the sole purpose of reducing your taxes.

Here's why...

Example: You pay $5,000 in mortgage interest this year and your family makes $100,000 which puts you in the 25% tax bracket. You will receive a tax benefit of 25% of the $5,000 which is $1,250.

Would you trade me $5,000 for $1,250? Probably not. That’s why you shouldn’t do things just to get a tax deduction. It doesn’t mean that you are better off financially. However, some people would rather give $10,000 to a charity of their choice than $2,500 to the federal government. To each his own.

Remember to always think about the true savings when it comes to taxes. Don’t let a deduction tempt you into spending more money than you need to. And next time you hear Joe Cool in the break room talking about how he doesn’t want to pay off his mortgage early because of the tax benefits, you can explain the true financial cost of that decision.

-Mike Zeiter, CPA/PFS

P.S. – I have overly simplified this to discuss the general calculations. The tax rules are much more complicated so please consult with a professional about your specific options around tax planning.

A Beginner's Guide to Roth Accounts

Does anyone else remember the commercial where a younger woman and her grandfather are in the car talking about retirement? Am I the only retirement nerd? Guess so. Anyway, the grandfather is on the phone, gets frustrated and says, “ROTH?!?! Who’s Roth?” I won’t go into the details of the life and times of Senator Bill Roth, but he helped change the landscape of retirement savings for everyone. Roth retirement accounts can be extremely beneficial when planning for your future. 

First, let me explain how a Traditional IRA (Individual Retirement Account) works. A traditional account allows you to set aside money now without paying tax on it. You receive the benefit in the year you make the contribution, but it will be taxed when you take the money out of your account during retirement. The hope is that you are in a higher tax bracket now than during retirement, which may or may not be the case.

What makes a Roth IRA different is when you pay taxes. It allows you to pay tax now and never pay tax on that money or the gains again. These accounts allow your investments to grow tax free. For instance, let’s say you put away $5,500 a year in a Roth IRA starting at age 25 until you turn 65. You will set aside a total of $220,000 over the 40-year span and pay tax each year on the amount contributed. However, if you invest that money in the market over that time, your investments could grow to over $1.5 Million. You would never pay tax on that money when you withdraw it during retirement. Not too shabby!

Roth accounts are offered for IRAs and some employer 401k’s. Anyone can open a Roth IRA. There are income restrictions on whether you are allowed to make contributions. However, you can always convert money from a traditional IRA to a Roth IRA. You must pay tax that year on the amount you convert. Roth 401k’s are becoming more popular now. They are great because there is no income limit for annual contributions and you are allowed to put up to $18,000 in each year.

There are many other rules and differences to consider when choosing between Roth and traditional retirement accounts, but these are the basics. The most important factors are your age and tax bracket. If you are under 40 and/or below the 25% tax bracket, a Roth account will almost always be the better option. Tax rates can always change, but there is a sense of relief knowing that the money in your Roth accounts is all yours and will never be taxed again.

Don’t forget you can make contributions for the 2016 tax year until April 15, 2017!

Mike Zeiter, CPA/PFS

 

Finding Your Slight Edge

I just finished reading a magnificent book called The Slight Edge by Jeff Olson. I highly recommend it. The idea of the book is simple. Do something small every day that will make you better off in the long run. For instance, if you decide to go to the gym today, you probably won’t have a six pack afterwards. At the same time, you most likely won’t have a heart attack today if you don’t go. But if you start working out, even if it is just 15 minutes a day, eventually you will be a lot stronger and healthier than you are today. Let’s take that concept and apply it to our finances.

You have all heard the example, “Just cut out that $5 daily latte and you will be set financially.” Is that true? Well…kind of. Let’s say you are one of those Starbucks addicts that stops by on the way to work every day and spends $5. You would save almost $2,000 over the course of a year by cutting out Starbucks. Of course, if you are anything like me, you would probably be arrested for assault before too long… but you get the point. Look at your lifestyle and find something little that you could cut out to save $20 or $30 a week. Start adding that to your savings instead.

Let’s try another example that would be even easier. Log onto your 401k at work and increase your contribution by 1%. If you don’t have a 401k, open an IRA and set up direct deposit of 1% to come out of your paycheck. I don’t want to hear the excuse that you can’t afford to contribute an extra 1%. If you make $40,000 a year, 1% is only $400 spread out over a year. You can handle it. Each year, increase your percentage by another percent. I promise that you will retire with dignity if you stick to this plan throughout your career.

These are just a couple examples but I challenge you to find your own financial “slight edge” for 2017. Do it now! Make it the one New Year’s Resolution that you won’t break by January 31st. Think of one small change that you can make in your life that won’t affect you right now, but it will set you up for long term success. You can do it! There is nothing stopping you from starting your path to financial freedom.

Happy New Year!

Mike Zeiter, CPA/PFS

$1,000 Decision

Congratulations! You have an extra $1,000 in your account at the end of the month. Maybe you got some Christmas money, maybe it’s an inheritance from an uncle, or maybe you worked hard and saved it up. The question that many people face at this moment is, “What do I do with this money?”

So how do you decide what to do with that money? Assuming you haven’t decided to spend it already, there are many places to put the money. I am going to break down the three most common options. You could 1) Keep it in the bank, 2) Pay off debt, or 3) Put it towards retirement. The good news is, there is no right answer. The bad news is, there is no right answer. Some financial experts will swear by one choice and call you an IDIOT for doing anything else. However, unless you decide to take that money and go to the mall for that new wardrobe, you are not an idiot. I am going to make the case for each of these options based on some example situations.

Save it – You live paycheck to paycheck. Every month is a struggle as to whether you will be able to make that next rent/mortgage payment. Put this money in a savings account and pretend it isn’t there. It’s always nice to have some money to fall back on if something goes wrong. Another argument for saving it is if you want to save money for a big purchase coming up; a new car, a vacation, or a home. If it is a home, I would suggest taking the time to build up enough savings for a 20% down payment.

Pay off debt – Let’s say you are an average person with credit card debt, an auto loan, student debt, and a mortgage. You should pay off your credit cards. Credit cards normally have outrageous interest rates and you will be better off getting them out of your life. If you don’t have credit cards, maybe your student loans or auto loan has an interest rate over 5%. Debt can be a major burden on your life, so take the opportunity to pay off extra when you can.

Save for Retirement – You are debt free or very little debt with low interest rates. You are saving a little each month, but don’t have any major expenses planned soon. This is a great opportunity to add to your retirement. Use this money to open up or contribute to an IRA. The money you save early will grow over time to earn much more than if you wait 5 or 10 years. In the words of Albert Einstein, “Compound Interest is the 8th wonder of the world. He who understands it, earns it ... he who doesn't ... pays it”.

The important thing is to make the decision that your are comfortable with. Any one of these decisions could be best for you. Maybe you want to split the money between two options. That's fine! It’s similar to hitting a traffic jam and deciding to stay or take a different route. When you arrive at your destination, do you actually know if you chose the fastest route? No, but you made it to your destination and you were comfortable with your decision. The important thing now is to think about it so you have a plan when this happens to you in the future.

If you have questions or need help, feel free to reach out.

Thanks,

Mike Zeiter, CPA/PFS