Thoughts on article ‘Corporate Bond Funds Draw Record Amount of Investor Cash’

Here is the link of article - http://www.cnbc.com//id/46430171

I was looking at my short term bond allocation. I prefer to keep more money in treasury compare to corporate bond because it my understanding that treasury is more stable and liquid than corporate bonds. It is also my understanding that I will lose less than I would have otherwise (by keeping money in corporate bonds). And this will best sever my purpose to keep money in some place from where I can take money out whenever I want it and I won’t need to worry about losing a lot of real money ( if we don’t consider inflation). When I was looking at the performance of these two funds, return on corporate bond is going up and up. On the other hand, return on treasury is going down and down. Somehow I was trying to convince myself into changing my allocation. I was thinking about having more corporate bonds and keeping less money in treasury. After all return on corporate bond is higher than return of treasury and who wouldn’t like to get more return.

While thinking all these, I forgot my rules for a while. One of them says don’t chase returns and I was thinking about doing the same. One of my rules, says don’t buy into something that everyone is getting into because that’s how bubbles are created. More and more money is being invested into something that is going up. We keep pouring money into hottest thing in the market and somehow make it bubble.  We don’t realize that it is getting more and more expensive because everyone is chasing and my rule is to buy when it is cheap in my opinion.

Of course, when things are going up, people are going to talk about all positive things. Isn’t that how it works? During bubbles everything looks good and someone who is not putting his money into hottest thing is stupid because everyone is making money by getting in to hottest things.

Good thing that I read this article. It’s so hard not to get excited and get into when things are good. I need to work keeping my emotions out of it.

How does contributing to 401k reduce current tax burden?

Let’s say your federal tax bracket is 25% and your state bracket is 6%. Which means your total tax bracket is 31%.

You contribute $10,000 to your 401k.

So you will save $3,100 in your total tax this year. (31% of $10,000 is $3,100)

A couple of points on working on corp-to-corp vs W2

A couple of points on working on corp-to-corp vs W2 (with no benefits)

We are talking about scenario where no benefits are being paid by working on W2.

What are equivalent rates on W2 vs corp-to-corp?

$100k a year on W2 (with no benefits) is almost equals to $109k a year on corp-to-corp (S-corporation)

Lets understand the difference of this $9,000.

Even though we mentioned that you don’t get any benefits on W2, your employer still pays FICA (which is around 7.65% of your salary upto $110k a year) and unemployment insurance tax (http://www.workforcesecurity.doleta.gov/unemploy/uitaxtopic.asp ). So when you ask to be paid corp-to-corp compare W2, you will have to ask for amount which will cover FICA and unemployment insurance tax as you are responsible to pay them when you work on corp-to-corp by starting an s-corporation. These are basic taxes that you pay anywhere in country. Apart from this, there might be other taxes. You should research about them based on the location where you are when negotiating W2 and corp-to-corp rates.

S-corporation is basically a bypass. Company pays to your s-corp and this s-corp pays you. But by doing this, you can get some tax related advantages. Let’s understand a couple of these benefits.

Health and medical and dental expense

In W2 (with no benefits) you pay for your health insurance and you don’t get any tax deduction on it in calculating itemized deduction till your total medical and dental expenses are more than 7.5% of your total gross pay.

e.g. if you are making $100k, you won’t get any health and medical and dental expense related tax deductions till your total expenses in this category is less than $7,500 for that year. For a healthy person, it is unlikely that you are going to spend $7,500 in this category.

Let’s say your health insurance is $150 a month. $150 a month equals to $1800 a year. You don’t get any deduction on this amount when working on W2.

Now if you had established s-corp, you can take this deduction. So your taxable income will be lowered by $1080.

Unreimbursed employee expenses

One does not get full Job expense and certain miscellaneous expense deduction under itemized deduction while working on W2.  You will get deduction only on the amount which is higher than 2% of your adjusted gross income.

Let’s say your Job expense and certain miscellaneous expense is $5,000 and your adjusted gross income is $100k. The amount you will include for Job expense and certain miscellaneous expense deduction will be $5,000 - 2% of $100k = $5,000-$2,000 = $3000

How would this work when you are married?

Let’s say you are married, filing jointly and your spouse is working and your adjustable gross income is $150k. The amount you will include for Job expense and certain miscellaneous expense deduction will be $5,000 - 2% of $150k = $5,000-$3,000 = $2000

Retirement accounts

In the case of W2 (with no benefits), you can contribute maximum of $5,000 to your regular IRA. You deduct this amount from your income to calculate adjusted gross income. i.e. you can take the deduction of $5,000 by contributing it to regular IRA.

In the case of corp-to-corp, you can open SEP-IRA http://www.irs.gov/retirement/article/0,,id=111419,00.html#contributions and can contribute up to $5k. It is maximum of 25% of your compensation or $50k.

So if you are making $100k, you can contribute $25k to retirement account and it will be deducted from your income while calculating your adjusted gross income.

Salary Deferral Contribution

What if you want to contribute more than allowed maximum of 25% of your compensation?

Let say you are the only member of your s-corp. you can elect salary deferral contribution. You can choose not to pay this salary to yourself in cash. Instead, you can elect to pay this into your retirement plan upto $16,500. 

and filing free tax return saga continues..

After I wrote another email asking for allowing me to file tax return for free, I got an email saying a supervisor will contact me.

Surly after that I got a phone call. Representative confirmed offer with me by making sure that I did not fill tax return with them last year. He mentioned that I am eligible for offer, but somehow system was not allowing it. The day this conversation happened was the last day of offer. Representative told me that I can pay tax return fees for free and they will refund that fees in 10-14 days. I asked him to email me saying the same thing so that I will have something in written. He did so and I paid tax return fees. Now I am waiting for that refund.

Is filing your return for free via tax filing companies a scam?

I got an email with subject line: Submit Your FREE Federal Return!

Main content of the email was: Enter postcard code FEDERAL12 by January 25th 

to receive a FREE Federal tax return**!

Where  **File a State return for only $4.95. Free Federal Return valid for TaxSlayer.com accounts not e-filed in 2011. Not valid with any other discount or promotion. Discount not to exceed $9.95 regardless of version.

I received the similar postcard in the mail.

So I registered before January 25th, but I did not see the option to enter postcard code. So I emailed customer support asking the same. Following is the response that I got from them.

“Thank you for your email request.

That postcard was sent in error. Please ignore. We are sorry for the inconvenience.

Thank you,”

I am not satisfied with this and asked them to allow me to file return for free. Lets see what happens next…

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.