// BLOG
PMI Insurance: New Tax Break Helps with Mortgage Insurance Premiums
December 15, 2006
Uncle Sam is now going to help you pay your mortgage insurance premiums!
Mortgage insurance is typically required when home buyers purchase a new home with less than 20 percent down.
The newest tax legislation allows taxpayers to deduct premiums paid for mortgage insurance. Mortgage insurance premiums typically range from $50 to $150 per month, which could mean a $600 to $1,800 deduction on your tax return.
This deduction is only available to taxpayers who itemize, but many home owners (especially if you’ve just purchased your home) have enough mortgage insurance, real estate tax, and other deductions to itemize.
Prior to this tax law, only the interest paid on a mortgage was deductible.
This deduction won’t help everyone. The deduction will be limited to taxpayers with adjusted gross income below $110,000.
Finally, you’re out of luck if you are already paying mortgage insurance. This deduction will only apply to mortgage insurance contracts issued in 2007, and it’s set to expire on December 31, 2007.
For more information on the mortgage insurance premium deduction and the tax law, please visit:
http://www.mercurynews.com/mld/mercurynews/business/personal_finance/16217445.htm
Emergency Fund: Why You Need One
December 14, 2006
As a financial planner, I encourage my clients to have an emergency fund. This is often met with the following questions:
1. Why do I need an emergency fund? and
2. How much should it be?
To answer the first question, you need an emergency fund for the following unexpected expenses or situations:
* Car repairs
* Home repairs or improvements
* Job loss
* Job downsize (forced to work fewer hours)
* Unexpected medical expenses
By having an emergency fund, you won’t be forced to turn to credit cards to pay for these unexpected bills.
The general rule of thumb is to save between three and six months of your living expenses in an emergency fund. If you have no dependents, good credit, and a steady income, you can probably get by with three months; if you have a fluctuating income or work in a field that is not steady (home construction is a great example right now), you should aim for six months in your emergency fund.
One more thought… you should keep your emergency fund in a high interest money market or CDs (a portion, not all of your emergency fund) to earn a higher interest rate than your checking/savings account.
Educator Expense Deduction Extended
December 13, 2006
If you are a teacher, you probably know about the $250 deduction that is allowed on your income tax return. While this is a very small tax break, every little bit helps.
So, I was glad to see that Congress extended this deduction for two more years, until the end of 2007.
If you’re not familiar with this tax deduction, here’s a brief summary:
Teachers can deduct up to $250 that they spend out of pocket to buy classroom supplies. The deduction is an above the line deduction, which means you don’t have to itemize to take the deduction.
The deduction is available to teachers, instructors, counselors, aides and other educators who work with classes from kindergarten through grade 12.
Costs that are deductible include books, supplies, computer equipment, software and other materials used in the classroom.
To learn more, please visit:
http://www.bankrate.com/BRM/itax/tips/20030213a1.asp or
http://www.irs.gov/taxtopics/tc458.html
IRA withdrawal for 1st time home purchase
December 10, 2006
Q. I am making my first home purchase. Can I take money out of my IRA to help with the down payment?
A. Generally, withdrawals from a traditional IRA before the age of 59 ½ are subject to income tax and a 10% penalty. There are several exceptions to the 10% penalty, one of which is a distribution for a first time home purchase.
You can take up to $10,000 from your traditional IRA to purchase your first home without incurring the 10% penalty.
There are some rules to keep in mind, however:
1. The purchase must be for a principal residence – qualified costs include costs to build, buy or rebuild a home.
2. The person purchasing the residence must be the IRA account owner or a family member (within limits).
3. To qualify as a first-time homebuyer, you must not have owned a home at any time during the two years prior to the IRA withdrawal. If you are married, your spouse must also meet this requirement.
4. The 10% penalty exception only applies to the first $10,000 you withdraw from your IRA (this is a lifetime limit) – if you are married and both spouses qualify as first time homebuyers, you can each withdraw $10,000 from your IRAs penalty free.
5. You must use the IRA funds within 120 days of the withdrawal to qualify for the exception.
Is that CD safe?
November 28, 2006
I frequently see ads for CDs in the local newspaper with higher than normal interest rates. Many of my clients ask me if these CDs are safe.
You only want to invest in CDs, savings, or money market deposit accounts if they are insured by the FDIC.
The FDIC – short for the Federal Deposit Insurance Corporation – is a goverment agency that protects depositors against loss of deposits in the event the bank or savings institution fails.
Your accounts are insured up to $100,000, per person and per bank. Accounts covered by FDIC include checking, NOW, and savings accounts, money market deposit accounts, and time deposits such as certificates of deposit (CDs).
Investments such as stocks, bonds and mutual funds are not covered by FDIC, even if purchased through an FDIC insured bank.
To check whether a bank or savings association is insured by the FDIC, call 1-877-275-3342, or visit www2.fdic.gov/idasp.
Tips to protect yourself:
- Never buy an investment you don’t understand
- Understand the risks involved – non FDIC insured investments may earn a higher rate, but they are riskier as well
- Know who you’re investing with – is it a bank, credit union, brokerage company? What do you know about this company?
- Make sure the investment is appropriate for you – a 20-year CD is not appropriate if you need income now.
- Ask questions, ask questions, ask questions. If you’re not getting satisfactory answers, don’t invest.
Will I Owe Taxes on the Sale of My House?
October 5, 2006
Q: How do capital gains taxes work? I want to sell my home, but have only been there for 18 months. How much will I have to pay in capital gains tax? Is two years the shortest time I can stay in my house without having to pay capital gains tax?
A: Generally, the sale of your principal residence is not reported on your tax return unless you have a gain on the sale and you do not qualify to exclude the gain.
Exclusion: You can exclude from your income up to $250,000 ($500,000 for taxpayers filing Married Filing Joint) of the gain from the sale of your home if you meet the following conditions:
- If you have owned and used the home as your principal residence for at least two out of the last five years prior to sale, and
- You have not sold another home in the last two years.
Click here to read more…
Stricter Rules for Gifting
September 21, 2006
If you give money or non-cash donations to charity, you’ll be interested in some of the provisions of the new Pension Protection Act.
There are two changes affecting charity: the first is that you are now required to maintain written documents for any cash gifts in order to claim a deduction. Most churches will send you a statement at the end of the year, if you use the envelopes provided, or write a check. But gone are the days of dropping cash into the collection plate or the Salvation Army bucket.
Second, if your donated non-cash items aren’t in "good" condition, you won’t get a deduction. This is to keep people from taking large deductions for items that really belong in the trash. Of course, no-one has defined what "good" condition is yet, so use your common sense when donating items.
Resources:
New pension law closes loopholes in charity deductions – LA Times
The Pension Protection Act of 2006 offers retirement tax breaks, tough rules on charity – About.com
Are ETFs Right for You?
September 17, 2006
Exchange traded funds (ETFs) are gaining in popularity, but are they right for you?
ETFs are similar to index funds, but they trade like a stock, meaning they can be bought and sold throughout the day instead of just once a day.
Advantages:
Low cost – ETFs have a lower annual expense than most mutual funds, including most index funds. According to Morningstar, the average expense ratio for ETFs is 0.30%, compared to 0.35% for no-load index funds, and 0.96% for all mutual funds.
Tax efficient – ETFs don’t have to sell stock positions to meet shareholder redemptions, which cuts down on taxable transactions. Also, redemptions by large shareholders are paid in kind, protecting investors from unnecessary taxable events.
Disadvantages:
The main disadvantage of ETFs is that they can only be bought through a broker, which means you will pay transaction costs each time you purchase an ETF.
Conclusion: ETFs can be a great way to diversify your portfolio, especially if you are making a one-time purchase. But if you make regular purchases, such as with dollar cost averaging, the transaction costs can end up costing you more than if you had purchased an index mutual fund.
To learn more about ETFs, check out the Exchange Traded Funds Center at Morningstar. In addition, you can read more about iShare ETFs managed by Barclays Global Investors, or Vanguard’s ETFs.
Deducting Roth IRA Losses
September 13, 2006
Recently, someone asked me if they could deduct losses they incurred in their Roth IRA. Here’s my response…
You can deduct losses in a Roth IRA, but the rules and treatment are different than you might expect. First, in order to claim a loss in any IRA investment, you must withdraw the entire balance from all of your IRAs of the same type. So, if you have a loss in your Roth IRA, you must liquidate all of your Roth IRAs in order to deduct the loss on your tax return.
Second, your basis in your Roth IRA includes your contributions plus conversions (from a traditional IRA) less any withdrawals you have previously taken from your Roth. Form 8606, Non-Deductible IRAs, is used to determine the basis in your account and to
report withdrawals. Note that reinvested dividends and capital gains are not part of your basis in a Roth IRA.
Finally, losses in a Roth IRA are deducted on Schedule A – Itemized Deductions, rather than on Schedule D – Capital Gains and Losses, which is where most people would expect to report the loss. Roth IRA losses are a miscellaneous deduction, subject to a 2% floor. This means that the deduction is only available if you itemize your deductions, and only the amount greater than 2% of your adjusted gross income (AGI) is deductible. In addition, miscellaneous deductions are not allowed for purposes of the alternative minimum tax (AMT), so you could lose the benefit of the deduction if you are subject to AMT taxes.
Whether it makes sense to liquidate your Roth IRA to claim the loss will depend on several factors, such as whether you itemize or not, how large the loss is compared to 2% of your AGI, whether you’re subject to AMT tax, and other factors. You should also consider how much will you lose in potential earnings if you liquidate your Roth IRA. You may want to consult with your tax advisor and financial planner to determine the best decision for you at this time.
Put Your Finances on Auto Pilot
September 9, 2006
I was at a conference recently, and learned a great tip to automate many of my email communications. After I implemented this tip, I started thinking about all the ways you can automate your finances to help achieve your financial goals.
So… this week’s tip is a list of ways to put your finances on autopilot:
1. Invest in your company’s retirement plan. This is the easiest way to put your savings on autopilot, by far. And many companies provide a matching contribution, so there’s free money involved as well!
2. If you don’t have a company retirement plan, setup your own retirement plan (IRA, Roth IRA, SEP IRA and many others) and establish an automatic withdrawal from your bank account to your retirement plan.
3. Setup an automatic withdrawal from your checking to your savings account to save for emergencies, rainy days, vacations or other short term financial goals.
4. Setup automatic withdrawals to pay for recurring bills. This way you won’t ever miss a due date.
5. Setup automatic withdrawals to pay the minimum on your credit card. There’s nothing worse than paying a late fee because you didn’t get your credit card payment in on time. This tip will make sure you always get at least the minimum payment in on time each month. You can always send in extra money when you want to.
6. If you’re self employed, transfer a specified amount each month to a savings account until it’s time to send in your quarterly tax payment. This will be much less painful than coming up with 3 months of estimated taxes at one time.
7. Adding onto #6, if you’re self employed, consider incorporating your business and putting yourself on the payroll. Then you will be required to withhold taxes and submit them periodically.
There are many more ways to put your finances on autopilot, but these will get you started. The important thing is to make it automatic, and painless, so you’ll never miss the money.