Families also face an emotional decision as best intentions often run head first into the realities of paying for four years of college.  We all want what’s best for our kids and paying for their college education is certainly best for them, right?…  Maybe not.

According to a new study, Affording Emerging Adulthood: Parental Financial Assistance of their College-Aged Children, having your children help pay for their own college education can reap benefits beyond those of being debt free upon graduation.

The structure of having a job, for instance, can help to limit distractions that too much free time so often brings.  The kids who were fully funded by their parents, including discretionary spending, were more likely to be heavier drinkers and drug users.

There is, however, an implication that a balance should be sought, as too much of the burden transferred to the child can often lead to extending the amount of time it takes to complete a degree or even dropping out of school altogether.

A suggestion that comes to mind is to remain flexible.  There are a variety of paths to a four year degree, including starting in a community college.  Also, options for funding through loans are available that can help families spread resources over longer periods of time.

Sending your kids to college can be intimidating for everyone in the family, and preparing financially is only one aspect to consider.  Allowing them some ownership in the process can help them add some critical tools for when they are on campus by themselves.

Here are some more of our thoughts on college education:

• Bang for your College Buck
• College Planning in an Uncertain World

Photo credit: James Almond

* We hope these tips are helpful as you’re preparing your tax return.  If you have questions, contact your personal tax preparer.

Make your IRA contribution.

You have until April 17th (this year’s filing deadline) to make contributions to your IRA accounts (Roth or traditional) for 2011.

There are rules to follow in order to be eligible to contribute: http://www.irs.gov/retirement/participant/article/0,,id=202518,00.html?vm=r&s=1

Reduce your Adjusted Gross Income.

Some available tax opportunities, education credits for example, are dependent upon staying below a certain AGI.

One of the best ways to keep your AGI as low as possible is to take advantage of employer benefits.  Max out your 401k, and look into the cafeteria options (health, dependent care, etc.).

Taking full advantage of these opportunities can give you a chance at other tax opportunities.

Watch out for the Social Security tax bubble.

There is a fairly complicated formula that is used to determine if any of your Social Security benefits will be taxed.  Understanding where that threshold is can save you a big tax bill.

Here’s a pretty handy calculator: http://www.calcxml.com/do/inc08

Don’t forget about HSA contributions.

Speaking of benefits provided by your employer: If you have an HSA account that is sponsored through your employer you may be eligible to make additional contributions if you haven’t reached the maximum.

Make sure that you have enough qualified medical expenses before you contribute.

Watch out for new reporting rules for sales of stock investments.

Form 8949 Sales and Other Dispositions of Capital Assets has been created by the IRS in response to new regulations that require financial institutions that custody investment assets to begin reporting cost basis on form 1099B.

Consider accelerating income into 2012.

No one knows for certain what the lawmakers in Washington DC will come up with after current tax laws expire at the end of this year.  If Congress does nothing then tax rates will automatically go up as they will sunset back to higher rates that were in place before President Bush came into office.

Strategies include: deferring itemized deductions to 2013, harvesting capital gains, deferring capital losses, taking additional IRA distributions, Roth conversions.

Don’t forget mileage deductions.

For 2011, the deduction for business miles is 51 cents per mile, for charity 14 cents and for medical miles 19 cents.

Looking ahead to 2012 the IRS has issued new rates: http://www.irs.gov/newsroom/article/0,,id=250882,00.html

Photo credit: 401K

Relenting to the calls from his opponents for transparency, he recently released his tax returns.  Not only does the information shine a light on Mr. Romney, it puts the issue of fairness in our tax system back onto the front page.

The Washington Post: Mitt Romney’s tax returns shed some light on his investment wealth

Some of the highlights from the returns:

• 550 – Total pages filed for 2010
• $42.6 million – Amount of reported income for 2009 and 2010
• 13.9% – His effective tax rate
• Zero – Amount of wages earned

Mr. Romney’s tax return is being criticized as an example of how our tax system is rigged to favor those who control capital (wealth).  Much of the income that was reported on his return was in the form of something called carried interest.

This income was from profits Mr. Romney received through his participation in Bain Capital, a private equity firm that he helped co-found in the 1990s.  There is plenty of criticism pointed at how private equity generates profits – most notably from his Republican opponents – but also at how this profit is taxed.

There is a special provision in the tax code that allows for capital gains treatment for carried interest.  This means that Mr. Romney’s tax rate is capped at 15% on this income instead of 35%, if it were treated as ordinary income (as many critics say it should be).

It’s getting harder for those in the private equity industry and their Congressional allies to argue not only that this is good tax policy, but that it is fair.  Most Americans hold their investments in tax deferred accounts which they funded through payroll contributions. When withdrawals are taken from these assets they are taxed at ordinary rates.  No loophole for the middle class here.

Income disparity is at an all time high and the anger directed at the wealthy is being stoked yet again. Higher tax rates for the Mitt Romney’s in this country are being pushed by the President and even by some of the wealthy themselves.

Warren Buffett points to the fact that his secretary pays taxes at higher rates than he does because most of her income is derived from wage compensation while his comes overwhelmingly from investments.

The decade of the 2000s saw overall tax rates decline while GDP growth rates fell.  We do believe that tax rates are going to rise, especially for those whose incomes are derived from investment sources.

Our long-term issues of entitlement funding, in particular healthcare, will likely require higher tax revenues even though some of our current political leaders lack the ability (or the nerve) to face this reality.

Photo credit: Gage Skidmore

A recent study by the Congressional Budget Office shows that the wealthiest U.S. income households have garnered a disproportionately large portion of total income growth over the last thirty years.  In the last three decades, the top 1% of U.S. earners have seen their slice of the country’s income pie double from 10.5% to over 21%.  Their real (inflation adjusted) after-tax incomes rose by 275% while the bottom 20% of income households have experienced quite a different reality as their real after-tax incomes grew by only 18 percent.  As a result, the income gap between the wealthiest and poorest Americans has grown to a level not seen since the 1920’s.

How did the Gap Become so Wide?

Much of this widening income gap is believed to have been caused to a large extent by technological advancement and to a lesser extent globalization. As this study points out, it’s imperative for policy makers to increase access to education and training in order that worker skills meet the demand from today’s rapidly changing world.

Lower skilled U.S. workers are at a disadvantage because they have faced a dual threat to their livelihoods.  Yes cheap foreign labor has contributed to U.S. job losses, but automation has been a bigger factor.

Currently much of the financial benefits from technology gains are showing up in corporate bottom lines.  At some point the benefits from technology gains, however, have to be spread further down to workers.  Henry Ford had a goal to build a car that the average American worker could afford while paying his own workers a wage that would allow them to buy the cars that they were producing.  Through his determination and ingenuity, the Model T rolled off of the first modern industrial assembly line in 1908.  The American economy and the life of the average worker were forever changed.

Corporate and political leaders need to work together to leverage advancement in technologies so that the lower and middle of the income spectrum have more of an opportunity to participate.

We will continue this discussion of factors that we think have played a role in creating the large income gap as well as some possible solutions for restoring a healthier balance in our next post on this topic.

Karl Smith writes about this post at Modeled Behavior.

In discussing the significance of this chart

He says “The center of the distribution is moving rightward. This means not only is our vehicle fleet rapidly aging but that if vehicle production actually fell the scrappage rate would skyrocket in the coming years.”

In other words, either we are headed to a highly unlikely new reality of far fewer cars per capita, or demand is building for replacing cars much the same as with housing.

In a recent LA times article, Jerry Hirsch writes, “Consumers are heading to dealerships to replace aging cars. The industry estimates that the average age of vehicles on the road is approaching 11 years as people have delayed purchases because of the recession and more recently an uncertain economy.”

At some point the pent up demand for new cars (or homes) builds up enough so that consumers will begin to buy.  And home builders and car manufacturers will then ramp up production and create jobs to meet that demand.

The first priority for what gets paid starts with the interest on our national debt which would take $207 billion.  The next priority would be military operations, which is budgeted at $965 billion.  The amount left over to fund all other U.S. government spending would be just shy of $1 trillion.  It would require a 60% cut across the board to all of the other federal programs in order to balance the budget.  This would affect every person who receives benefits from Social Security, Medicare and Medicaid, education, transportation and infrastructure, unemployment, low income housing, environmental services, national parks services, public safety, prison security and on and on.

Trying to predict what would happen if the politicians in Washington failed to reach an agreement is difficult.  However, because of the untenable nature of the spending cuts it doesn’t seem likely that a government shutdown would last long.  The last two times it occurred, it lasted a total of six days in 1995 and around three weeks in late 1995 to early 1996.

We believe that a deal will get done before a shutdown happens.  Our assessment of where things currently stand is that a deficit reduction package that both sides can come to an agreement on may not be possible by August 2^nd.  What can happen, however, is an agreement to punt the issue of making structural changes not only to spending but also our tax code (revenue) to the 2012 election.  The leadership in the Senate is working on a backup plan that would give the President the authority to raise the debt limit without a specific approval by Congress.  This would accomplish a short-term solution allowing more time for discussion of the two longer-term potential problems, health care costs and the appropriate level of tax revenues, to be addressed.

Photo Credit: iandavid via flickr

Recently, Fitch Ratings became the latest ratings agency to issue warnings of impending downgrade on U.S. debt.  A statement issued by Fitch’s warns that U.S. Treasury bonds would be rated as “junk” if the government misses any debt payments by August 15.  However, we interpret this as a lack of confidence based on short-term political wrangling rather than the real issue of our long term fiscal position.  Notice Fitch references the risk of “stalemate” leading to failure to raise the debt ceiling.

In other words they are afraid that in essence our government will choose to not pay its debt rather than the United States being unable to pay its debt.

Unfortunately, politicians are making hay by confusing two wholly separate financial problems- 1) the short term which is a high deficit caused by the worst recession since the Great Depression, and 2) the long term projection of US government debt.

For the short term problem we fortunately have examples of two other episodes where we had large deficits- the 1940’s and the 1980’s.  As you can see from the following chart, our current deficit is bigger than the 80’s but smaller than the 40’s.  Not only did the country not collapse after those episodes, but we thrived.

Notice that in the 1980’s we saw both decreased revenues and increased spending just like now.  Given that the 1980’s policies were successful in getting the economy going, it makes sense that we used Reaganomics on steroids to help pull us out of this deeper recession.

1940-2011 US Government Revenues & Expenses

As for the long term, the fiscal problem is mostly about two issues: 1) the appropriate level of tax revenues going forward and 2) getting a handle on rising health care costs.  We’ll be posting some additional blog posts to explain why these are not unsolvable problems.

Saving too Much?

Eligible to Contribute?

Roth IRA’s have been around since they were established by the Taxpayer Relief Act of 1997 and are named for the late Senator William Roth of Delaware who introduced the legislation.  They have grown in popularity because of the special tax treatment they receive as long as certain requirements are met.  Although you don’t receive a tax deduction for contributions to a Roth, the earnings grow tax free.  There are certain rules that you have to meet in order to contribute to a Roth; you have to have earned income and your adjusted growth income cannot be above certain limits – for 2011 those limits are $179,000 for married filing jointly and $122,000 for single filers.

I Contributed Too Much!

If you have made a contribution to a Roth IRA and find out later that you either don’t meet the requirements or that you’ve contributed too much you’ll need to take corrective action.  IRS publication 590 explains that an excess Roth contribution “withdrawn on or before the due date (including extensions) for filing your tax return for the year is treated as an amount not contributed.  This treatment only applies if any earnings on the contribution are also withdrawn.”  The earnings will be subject to a 10% early withdrawal penalty if you are under the age of 59 ½. If you have losses in the Roth account since the excess contribution was made then you’ll need to take out the excess contribution less the losses associated with the contribution. Note that the gain or loss is calculated across the account and not the individual holding that was purchased with the excess contribution.

Making the Correction

In the IRS instructions for form 8606 you can find an explanation that a corrective distribution includes the excess Roth contribution plus earnings and must be reported on form 1040, lines 15a and 15b for the year that the excess contribution was made and you should attach a statement explaining the distribution.  You cannot deduct a loss that occurred.  If you were under the age of 59 ½ the earnings generally will be subject to a 10% penalty which is calculated on form 5329.  The following year you will receive a 1099R from the custodian of the Roth account with a distribution code P in box 7 which indicates return of contribution taxable in a prior year.  If you have already filed your return you still can withdraw the contributed amount plus earnings as long as you do it within six months of the due date of the return.  You’ll need to file an amended return in this case.
The other option for correcting the excess contribution is to apply them to the following year.  Be sure, however, that you expect to qualify based on the earned income and AGI limitations for the year you want to apply the excess contribution as there is a 6% excise tax for each year that it is considered an excess contribution.  If you have chosen to apply the excess contribution to the next year the tax reporting is treated differently.   You will report the excess contribution on form 5329 where the excise tax of 6% of the smaller of the excess contribution or the value of your Roth IRAs as of the end of the tax year is calculated.

Take Advantage

Roth IRA’s are a great vehicle for retirement funding.  There are some rather complex rules associated with Roth’s, however, that can trip you up so you should seek out some professional advice if you are uncertain what applies to you.

Photo Credit: Lummmy

Take Steps Now

The end of the year is drawing ever closer and that can mean only one thing … tax planning.  Well, of course there are other things to worry about before the clock strikes midnight on Dec 31, however, making the right moves where Uncle Sam is concerned can save you money and that makes for a Happy New Year.   The current uncertainty in Washington regarding future tax laws makes tax planning that much more difficult, but there are still opportunities if you know where to look.  This article does a good job of highlighting a few of those opportunities.

Photo Credit: MudflapDC

Lots of people have made money in gold, right?  How about collectibles?  Hedge funds?  Wine?  As many investors discover, the world of alternative investing is cluttered with hard to understand rules that can create an uphill climb from the outset.  Take for example this recent story in Businessweek:

http://www.businessweek.com/magazine/content/10_31/b4189050970461.htm

The investor’s urge to do something different was driven by his desire to make up for losses in his portfolio.  So as he watched the price of oil plummet in early 2009 to $34 a barrel, he saw an opportunity to get in at a low price (buy low thinking is good!) and had his broker invest in an exchange traded fund, or ETF, that is designed to track the price of crude oil.

What he didn’t know about was something called contango.  Not only does this word sound like the famous dance, but it also a figurative dance as well.

As this investor learned, the contango trap happens when the price of oil, or other commodity, is rising, but the ETF designed to track the price of oil loses money.  Huh?…

It basically comes down to an inability to take delivery of the oil.  The ETF is a pool of investment dollars, not an empty oil tanker.  In order for the ETF to stay in the game, it has to renew its futures contracts.  So when the contract it currently holds is close to expiration, it buys another one at (you guessed it) a higher price, thus eroding the value of your original investment.

It’s not just individual investors learning hard lessons by using strategies involving alternative investments, there are plenty of examples of big pension and endowment funds gambling their assets on risky and overly complicated investments.

http://www.tampabay.com/news/politics/state-pension-funds-266-million-investment-disappeared-in-2-years/1034097

http://noir.bloomberg.com/apps/news?pid=newsarchive&sid=aHQ2Xh55jI.Q

The moral of the story is to control the impulse to go in a different direction just for the sake of trying something different.  If you are going to go down a new investment path be sure that you have charted the course by using a sound, straight-forward strategy.

As a rule of thumb, the more complicated an investment is the less likely the investor fully appreciates the risks they are taking.  As Warren Buffett once said, “Never invest in a business you cannot understand.”

Photo Credit: Rndoam