Why limit on IRA contribution is less than 401k contribution?

It’s interesting that limit on 401k contribution is 16,500 and limit on IRA contribution is 5,000. What could be the reason behind this?

Seems like 401k should be better for employees. After all policy makers want employees to prosper and they make most of their policies so the average people would benefit from it. After all it their job. It should be the logical reason why law makers did it this way. But is it really the case?  

A few employers match upto 6% for 401k contribution.  I don’t see any other advantage of 401k over regular IRA.

Employee has to choose from very limited funds available in 401k plans. One can choose whatever he/she prefer in IRA, but it is not the case with 401k.

Why are there very limited choices in 401k plans?

Would employer benefit from a financial institute whose funds are allowed in 401k plan? I don’t know! Would financial institute benefit from it? Most of the funds available in 401k plan come with expense ratios and no matter how that fund perform, financial institute who offered that plan would make money from that expense ratio. So financial institute would definitely benefit from it!

If financial institute is going to be benefited from it, why policy makers did it? Did/do policy makers get benefit from it? I don’t know if financial institutes pay policy makers or not. May be this is one of the reasons why politicians get financial help from financial institutions for their campaign during election!

Wasn’t the purpose of introducing 401k plan was to help employees? Then how did financial institutions and policy makers are benefiting from it regardless employee get benefit or not!?

Sometimes I wish that limit on regular IRA contribution would be higher so that I can contribute it more and choose whatever fund I like!

Big student debts and student debt forgiveness program

If you are working in an industry/position where you are eligible for student debt forgiveness program, all tax deferred accounts become even more important to you.

A lot of student debt repayment plans are income based. All the money you put towards tax differed accounts, are excluded from your adjusted income and your installment amount for student debt is based on your adjusted income. So it should be a good strategy to pay minimum towards your student debt in this situation.

Annual payments for a student debt are 15% of Annual Gross Income.

Let’s understand this with an example:

Let’s say you have massive student debt and 60,000 annual income.

Scenario A: were you are not putting anything into tax differed accounts.

If you don’t put anything into your tax deferred accounts, your annual payment for student debt would be 9,000. By not putting anything into tax differed accounts, you would pay 90,000 towards your student debt over ten years after which your dent is going to be forgiven.

Scenario B: where you are maximizing your tax differed accounts.

401k contribution: 16,500

HSA contribution: 1,200

Total contribution = 17,700

So your annual gross income would be: salary – total contribution = 60,000 - 17,700 = 42,300.

In this scenario your annual payment for student debt would be 6,349.

By doing so you will pay 63,490 over ten year period.

Comparison between two scenarios:

Difference between scenario A and scenario B = 27,000

That’s correct. You will save 27,000 if you maximize just 401k and HSA accounts.

Accounts like 401k, traditional IRA and HSA accounts are most common tax differed accounts.

401k

What is 401k?

401k is pre-tax retirement account offered by employer.

Lets see how does pre-tax retirement account work:

Let’s say you are making $50k a year. For the sake of simple calculation, lets assume that $50k is your adjusted gross income. You will fall under 25% tax bracket if filing single. Your total federal income tax for this year would be 8,625. This is 17.25% of your income.

Now assume that you contribute 16,500 to your 401k. In this case your taxable income will be 50,000-16,500 = 33,500. You total federal income tax for this year would be 4,600. This is 13.73% of your income.

So I person making 50,000 deciding to contribute 16,500 to 401k will pay 4,025 or less for this year in federal income tax.

401k Contribution limit:

Contribution limit for 401k for the year 2011 is 16,500 a year.

Contribution limit for the year 2011 is 17,000 a year.

The employer match in 401k does not count toward this limit.

Iphone Mania

We see more and more people are getting iphone. Apple introduces newer and hotter iphone every year and a lot of us are waiting in line to grab newest iphone and spending a lot of money to do so. If you are one of those who kept buying newer iphone as Apple kept introducing them, you might find that it might not worth to spend all those money in getting newest iphone. If you can afford it, nothing is wrong in it, but if you are not wealthy I don’t see a point in spending hundreds of dollors in buying a phone. With the announcement of iphone 4s, apple also announced that they are selling iphone 3Gs for free. Which means iphone 4 would be free one day and so will iphone 4s be! I am not in hurry and I will get newer iphone when I won’t have to pay extra to get it. I am getting iphone 3GS. I am getting it not because I need it, but I am getting it because it is for free (actually $50 when you include initiation fees and taxes) and I am going to sell my existing iphone for more than $50. So effectively I am not paying anyting from my pocket and I might make some money as it is likely that I will be able to sell my existing iphone for more than $50. This make sense financially, at least to me.

Cash back and other reward credit cards

http://www.nerdwallet.com/ is very helpful site for people who love using credit cards for cash back and other reward credit cards. All you have to do is choosing card type (cash back, point or travel), select your credit type (poor, average, good and excellent) and enter amount for your different spending categories and it will tell you to which card will be most beneficial! You can also personalize these choices further if you are interested. And you dot need to enter any personal information for that.

Working on 1099 vs W2 and self employment tax

Person working on 1099 is required to pay self employment tax. Self employment tax is 15.3. Self employment tax includes 12.4% social security tax on earnings up to $106,800 and 2.9% Medicare taxes.

Person working on W2 pays 6.2% social security tax on earning up to $106,800 and 1.45% Medicare taxes. Employer pays the same (6.2% social security tax on earning up to $106,800 and 1.45% Medicare taxes).

You can get current information regarding these taxes at http://ssa.gov/pubs/10003.html

Social security tax deduction cap

It is the maximum amount that is being deducted for social security deduction. It is also the maximum amount that is being considered when calculating someone’s social security benefits.

In 2011, $106,800 it the maximum wage on which social security tax is being deducted. Generally 6.2% social security tax is being deducted from wage unto this limit. But for the year 2011, it is 4.2%. 6.2% is being paid by employer and 6.2% is being paid by employee.

When an employee works for more than one employer in a give year, this deduction could exceed the cap. If exceeded, employee can claim this while filing tax return. You just need top mention it on your tax return filing and you will get it in tax return. Employer can not claim this overpaid tax.

What is AMT (Alternative Minimum Tax)?

AMT stands for Alternative Minimum tax. Some people have to pay AMT in addition of regular income tax. It was introduced to prevent people with very high income to pay very little tax.

Everyone is required to calculate AMT when they file tax return. If someone is already paying that amount via regular income tax, that person doesn’t need to pay AMT. but if regular income tax is below calculated AMT, you will have to pay it.

How to calculate AMT?

There is not a clear cut answer for this as this depends on many things. Preferred deductions are added back while calculating AMT. If you are using tax software, it should calculate AMT for you. If you are not using tax software, you will need to file form 6251 in your tax return. Here is the link for this form from irs at the time of writing this: http://www.irs.gov/pub/irs-pdf/f6251.pdf instruction for the same from irs site whie write this is here: http://www.irs.gov/pub/irs-pdf/i6251.pdf filling this form Though it is not straight forward, irs website detail information to you to follow guidelines and fill up this form. You don’t need to be math expert to do so.

Who needs to file AMT?

AMT is imposed on Individuals, corporations, estates, and trusts

How and where to check credit report for free?

It is necessary to check your credit report regularly.

TransUnion, Experian and Equifax are thee credit reporting agencies. You can check your credit report for free from each of these agencies once a year – it’s required by federal law that these agencies will provide your credit report free once a year. Ideally you should check your credit report every four months – once a year from each credit reporting agency. Remember that you don’t have to pay for this. It can be done via https://www.annualcreditreport.com/

Why should I check my credit report?

Credit report contains your payment history and all credit related information. When you apply for a loan, based on your credit report lender approves or declines your application. It will also play significant part in deciding rate at which lender is going to lend you money.

Make sure that you check every detail and report any discrepancy in it.

Social security retirement benefits

Social security retirement benefits

I don’t know much about social security retirement benefits. In order to understand it, I am gathering a lot of information form social security website (www.ssa.gov) and writing it so that I can understand it better.

Contact Number: One can reach social security via 1-800-772-1213. Specific questions can be answered from 7 a.m. to 7 p.m., Monday through Friday. Information is provided by automatic phone service 24 hours a day. Their TTY number is 1-800-325-0778.

Qualification for social security retirement benefit:

• When someone works and pay social security taxes, he/she earn credits.
• If someone was born 1929 and later, he/she needs 40 credits to get retirement benefits
• 40 credits are 10 years of work in total.

How much?

• It is based earning history (lifetime earning).
• Higher the earnings, higher the benefits
• Breaks in between earnings or low earning during some years before retirements, benefits may be lower compare to steady working history.
• Retire earlier, lower the benefits. For example, retiring 4 years earlier to full retirement age might reduce benefits around 25%.
• Social security statement contains record of earnings. It includes estimated social security benefits at different ages.
• Social security website provides online retirement estimator (www.socialsecurity.gov/estimator).

Following is the table for full retirement age:

Year of Birth:   Full retirement age

1943-1954:        66 years

1955:                66 years and 2 months

1956:                66 years and 4 months

1957:                66 years and 6 months

1958:                66 years and 8 months

1959:                66 years and 10 months

1960:                67 years

Earliest retirement age is 62

It is possible to delayed retirement beyond full retirement age. By doing so, it is possible that he/she will get increase benefits.

By working longer, lifetime earning increases, so benefits increases.

Benefit increases by certain percentage from full retirement age till age of 70 in the case of delayed retirement. Percentage increase is based on one’s year of birth. For people born in 1943 or later, this percentage is 8%.

For widows and widowers:

It is possible to get benefits at 60. it is possible to take reduce benefits at one record and switch later on.

For family members:

If one is getting social security retirement benefits, his/her family members may be eligible for benefits as well. Family members can be:

Spouses: 62 or older

Spouses: younger than 62 who is taking care of a child under the age of 16 or disable

Former spouses: older than 62

Children: upto age 18, or upto age 19 if they are full time students and are still in high school

Disabled children

For spouses:

• Spouses who never worked, or had lower income can be eligible upto half of retiree’s full benefits. If spouse is eligible for his/her own benefits as well as spouse’s benefits, they are paid combination of benefits.
• At full retirement age, it is possible to defer own benefits and take spouse’s benefits only. Later this differed benefits can be claimed which are higher because they were deferred.
• If one is getting pension and didn’t pay social security taxes, one’s spouse’s benefits may be reduced.
• If spouses elect to take benefits before reaching full retirement age, benefit amount reduced.
• If spouse is taking care of children 16 or under or disabled child, retirement benefits are full regardless age.

Maximum family benefits:

Each receive is eligible for upto half of one’s full benefits, but total benefits is 150-180 % of one benefits. If there are more receives than this, receives benefits would be decreased, but not one’s.

For divorced spouses:

One divorced spouse is eligible for one’s benefits if

• Marriage lasted for at least 10 years
• Divorced spouse is 62 yrs and older and unmarried.

Working and getting benefits at the same time:

One can work and still eligible for full retirement benefits at full retirement age.

Benefits may be taxable:

For combined income between $25,000 and $34,000 and filing jointly, one may has to pay tax on 50% of benefits. For filing jointly, this range is $32,000 and $44,000

If combined income is more than $34,000, one may has to pay tax on 85% of benefits.

Living outside United States:

For a US citizen living outside United States won’t affect social security benefits. Payment can’t be sent to few countries (Cambodia, Cuba, North Korea, Vietnam and areas that were in the former Soviet Union (other than Armenia, Estonia, Latvia, Lithuania and Russia). However certain exceptions can be made for eligible countries.

Books on investing

A Random Walk Down Wall Street by Burton G. Malkiel is my favorite book on investing.

By reading A Random Walk Down Wall Street by Burton G. Malkiel I understood that diversification and low coast investing are two most important factors behind becoming a successful investor.




I also read How to Make Money in Stocks by William O'Neil

How to Make Money in Stocks by William O'Neil is in interesting book on trading.

Capital Gain & Charity & Tax Deduction

A lot of us are doing charity. Charitable donations are popular tax deduction.

Do you know that you can donate your capital gain and save on tax?

Let’s say, it comes to December and you know that you are planning to do charitable contribution of 10k.

Let’s assume that you have 10k in unrealized long term capital gain and are interested in selling it. As this is long term capital gain, you will need to pay long term capital gain tax on this. You can donate this 10k. By doing so you won’t need to pay long term capital tax. You will still be eligible for taking tax deduction for charitable donations.

Let’s understand this with a hypothetical example.
Let’s say for a particular tax year,
Taxable income = 100k
In addition of taxable income, long term capital gain = 10k
Charitable donation = 10k
Tax bracket = 25% (Let’s assume that your tax is flat and you pay 25% on your taxable income)
Long term income tax = 15%

In this situation, you will pay 24k in tax.
A. Previous taxable income of 100k – charitable donation of 10k = new taxable income of 90k
25% tax on this taxable income = 22.5k
B. 15% tax on long term capital gain on 10k = 1.5k
Total tax = A+B = 24k

What if you donate long term capital gain of 10k in charity?

In this situation, you will pay 22.5k in tax.
A. Previous taxable income of 100k - charitable donation of 10k = new taxable income of 90k
25% tax on this taxable income = 22.5k
B. 15% tax on long term capital gain on 0(since you donated 10k) = 0

How to improve your credit score?

The best way to improve your credit score (FICO score) is to understand the factors affecting it. Following are the factors determining your credit score.

Payment History

It is the most important factor in deterring your credit score. It accounts for at least one third of your total score.

How long ago did you miss the last payment?

Missing payment/s negatively affects your credit score. If you missed a payment long time ago, your score will be less reduced. If you missed a recent payment, your score will be more reduced.

How many payments did you miss?

Missing more numbers of payments negatively affects your credit score. If you missed less numbers of payments, your score will be less reduced. If you missed more numbers of payments, your score will be more reduced.

How late was the payment?

Late payment negatively affects your credit score. 30 day late payment is bad. 60 day late payment is worse than 30 day late payment. Defaulting is worse than 60 days late payment.

Credit Utilization Ratio

It accounts for around one third of tour total credit score.

Lower the credit utilization ratio is, higher the credit score is.

Credit utilization ratio = 100 * utilized credit / total credit limit

For example, if your total credit limit is 10,000 and you are using 3,000, then your credit utilization ratio will be 100 * 3,000 / 10,000 = 30%

Length of Credit

It accounts for around 10-15% of your total credit score.

Longer the history, higher the credit score.

Number of Credit Inquiries

It accounts for around 10% of your total credit score.

When you apply for a credit/loan, lender check your credit report and credit score, it is called hard inquiry on your credit. A credit inquiry stays on your credit record for two years.

Higher number of credit inquiries, lowers the credit score.

Type of Credit

It accounts for around 10% of your total credit score.

Combination of auto loan, mortgage and credit card is better than concentration in just one type of credit generally credit card is better.

It doesn’t mean that I will apply for all type of credit and pay interest on them. It’s better to take less debt. In fact its better not to borrow anything and stay debt free forever.

Why is it necessary to view the detail bill?

My other half suggested that I am good at writing letter when it comes to get money back (or should I say, making sure that they don’t overcharge!) so I am including emails that I wrote personally to my phone company.

In my experience, utilities companies charge a lot of fees and we have to see our bill in detail to see their charges and need to call them for the discounts that we are eligible for!

Background: After enrolling in corporate discount plan, I was not getting it because my phone was ineligible

Letter # 1:

I was extremely satisfied with the service since I enrolled in it, but I am not satisfied with the service I am getting for last year and a half. I am getting very weak signals in some areas and so many of my phone calls are being dropped. My friends and relatives are saying that I don’t pick up the phone, but the fact is, I don’t get the ring or see missed-call so many times. I am sure that I am not the first customer to say something like this.

I am eligible for 15% employer discount, but I won’t get it because I have (model #). It sucks! You guys are saying that I can get this discount only if I get other device or new phone (latest model #). In spite of poor coverage, I am sticking with (service provider) only because of (model #). So I am not interested in getting other device. About getting (latest model #), as both of us know that it cost a lot of money. Also, if I spend that money and get (latest model #) then I will need to buy expensive data plan with that new phone and I won’t be eligible to have the data plan I have currently. So in order to get 15% discount I need to buy expensive data plan. In conclusion, I need to pay more to you guys. Isn’t 15% discount means customer save 15%? But your definition is instead of paying $70 a month, I should enroll in service which cost me $80 or $ 90 a month and then you will provide 15% discount. So I will have to pay more than $70 a month. Oops, I forgot to add the cost of buying (latest model #) and activation fees.

Isn’t 15% discount for your service? I completed my contract time with (service provider). and I am using your service. Shouldn’t you provide me your 15% discount because of this? I know you guys speak the language can and can not and not the language of should and should not.

I am sure you will have answer for this. After all, I agreed with your fine prints while enrolling your service.

Have fun enjoying monopoly of having exclusive rights to provide service for (model #) users.

Customer for 5 years now!

(Customer name)

Letter # 2:

You guys are very annoying. When I log in to my profile, it says ‘Your account type qualifies you to the following discounts. Service discounts are applied to the primary line under eligible agreements and exclude certain rate plan types and devices. * Service : 15.0%’ but I never get this discount. When I called, I came to know that I can not get this discount because I am using (model #). So you are okay to charge me $36 bucks for giving me discount when I am using (model #), but you are not okay to give me that discount because I am using (model #). That is stupid. So I asked to refund my $36 which I paid for getting this service, I was told that I can not get it back because your representative can only go three months back and I paid this in (date). You guys don’t even give refund for something you charged and are not willing me to offer that service! This is very frustrating!

Result: I got money back and was eligible for this discount when I changed my plan, but I was still using the same (model #)

Background: I wasn’t given eligible discount and was charged for activation fees ( it is necessary to see the detail bill to find this out!)

Letter # 3:

I am really tired of you guys

When I got into family plan, I was told that I will get 15% corporate discount because I am making a contract on new line ending with XXX1, but when I got the bill, there wasn’t any discount and I had to talk to you guys on the phone to make that line as my primary line to get that discount. Yeah, I got discount, but it’s after calling you guys and wasting my time. I should have got this in the first place.

When I got another line ending with XXX2, same thing happened. I was eligible to get activation fees waived, but I didn’t and I had to talk on the phone to do so. Again waste of time.

Also, I added line ending with XXX2 using my phone and without any contract. A representative told me on the phone that there is contract for this line! Are you kidding me? I went to that store in (name of city) and made it clear that I don’t want contract on this line and that is why I am using my on phone. If I had to make a contract, wouldn’t I get a free phone? A lady on the phone told me that people at store made a contract of 24 months! Come on. Give me the break. I told that I don’t want contract then why representative in the store will make a contract? Why your representative will tell me something different and do something different? May be because she wants to finish her quota, but why do I have to suffer for her? Now, representative on the phone told me that she can not undo this contract and I have to go to store! Do I have nothing to do, but to go to your store and keep talking and writing emails to you guys? Please stop harassing me. Please undo this contract.

Also, yesterday I went to store (store address) and for the same problem and I was told that this was being taken care, but when I logged into my account, it wasn’t and I had to call you guys. How much time do I have to waste for your mistakes?

Customer since (year)

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How to save money on Internet, TV and Telephone Phone bill?

Say you get promotional offer for cable TV for 25/month for first six months. After this promotional offer it is likely that this rate will rise to 50/month. There are some ways to keep getting cheaper rate. Of course nothing is free and you will have to work a bit to get cheaper rate. There are some ways to do this:

Get connection through local agent

The simplest way to get great deals is via local agent. Instead of calling 1-800 number, find a local agent in your area and ask for the deal. Local agent is likely to give you better deal than the one that you could get by directly calling service provider.

Get new connection from different provider

After 6 months of promotional period, call your service provider and tell that you will terminate service if they won’t give you further discount. It is likely that they will give you discount, if not be prepared to terminate connection and call another service provider and get their introductory rate. Keep doing this every 6 month and you will always able to get promotional rate. Installations charges can be lowered or dismissed upon asking, but you need to ask for that.

Ask your spouse to get new connection

After 6 months of promotional period, call your service provider and tell that you will terminate service if they won’t give you further discount. It is likely that they will give you discount, if not be prepared to terminate the connection and ask your spouse to get a new connection on his/her name. Keep doing this every 6 month and you will always able to get promotional rate.

Upgrading it to higher plan with promotion

Let’s say a service provider provides three packages: 30/month, 50/month and 75/month. You feel like 30/month plan doesn’t have enough channels and you needed to get 50/month plan. It is likely that you will get promotional offer of 25/month. After six months, you can call and ask for upgrade, from 50/month plan to 75/month plan. You make sure to ask for promotion. That promotion will be 37.5/month for 6 months. So after 6 months, instead of paying 50/month, you will pay 37.5/month.

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Pay Yourself First

The single most important tip in personal finance and investing is to Pay Yourself First.

In order to become financially independent it is necessary that you have enough money. In order to have enough money it is necessary that you invest enough. In order to invest enough it is necessary that you save enough. To save enough make sure that you pay yourself first. Make sure that you save certain amount from you income.

What is that certain amount? Is it 5% of you income or 15%? Is it $250/month or $500/month? The short answer is higher the better. Higher the amount is, faster financial independence is.
For example, Rob and Bob started working at the age of 25. Rob decided to save $500/month and Bob decided to save $550/month. At the age of 65, at 8% rate of annual return, Rob will have $1,635,511.48 and Bob will have $1,799,062.62. Bob will have $163,551.14 more by saving $50/month more! That’s the beauty of compound interest.

You will think that you are just 25 and there won’t be much difference if I save after a while. Earlier the better.
For example, Rob and Bob started working at the age of 25. Both want to save $500/month. Bob decided to save at the age of 25, but Rob decided to wait for a while and started contributing at the age of 35. Who will have more money at the age of 65? You are right. Bob will have more money. But how much more? Bob will have $1,635,511.48 and Rob will have $715,040.62, that is the difference of $920,470.86. That’s right. By start saving 10 years earlier Bob will have a little under a million more than Rob! That’s the beauty of compound interest

For more information, go to www.themoney101.com