Archive for the 'Taxes' Category

Youth Savings Accounts, a good deal you probably aren’t taking advantage of

Recently, my wife and I celebrated the birth of our son.  Many of our friends have also recently had kids and, through casual conversation, I learned nobody really had good plans in place for saving for their children’s future.  I am not talking about 529 Plans or other college savings plans; I am talking about putting away some money that can be used for anything in the future; be it their first car, their first house, braces or maybe even their first business.

Since we live in Washington State, we are taking advantage of at least two deals for young savers:

  • BECU offers an APY of 6.17% on up to $500
  • Watermark Credit Union offers an APY of 3% on up to $500

Using this method, my son will earn an average interest rate of approximately 4.6% per year on $1000 of very liquid money and, because his total unearned income is below $950, he won’t pay income taxes on the $46 or dollars of interest.  Because it’s my son’s money, he will have $16 dollars more than I would have, even if I was able to match the interest rates, which is unlikely.  This makes for a pretty good, albeit small, tax shelter for the average family.

Note: While the interest rate on the first $500 or so is usually good, the interest after that is typically pretty low.  This means the compounding of interest earned on the $500 will be at a lower interest rate.

The deals I am taking advantage of are relatively small, but depending on what you are eligible for, there are other credit unions and banks offer the higher rate on larger sums of money.  For example, if you work for Chevron or meet other membership criteria, the Chevron Credit Union offers:

  • $25 initial deposit for newborns
  • 7% on up the first $1000 in a MySavings account
  • CFCU Youth Rewards, contests and more…

There are plenty of other youth account / kid’s accounts / early saver account deals out there.  This site provides an excellent search tool.  Some banks offer better than normal rates, and others offer other perks like sign up bonuses, reward programs and more, which (depending on the deal) could still make it worth it the effort.

Custodial Account – Advantages:

  • You are putting money away for the child – Unlike 529 or other such savings methods, savings accounts have 100% flexibility and can be used for any purpose.
  • It’s tax-free up to $950 in earnings – The money grows and earns interest federal tax free and you don’t even need to file a return for your child, so long as:
    • The total unearned income (interest / dividends) is less than $950
    • The child remains unmarried
    • The child is under 19 or a full-time student under 24

      Note: This assumes we are only talked about unearned income from Youth Savings Accounts, etc.  If your child is earning income, there are other rules that dictate whether they need to file.

      Important: Be sure to consult your tax adviser and the IRS to determine your individual tax advantages of this strategy.

  • Between $950 and $1900 of earnings it’s only taxed at 10% – For returns above $950 the child is probably in a lower tax bracket than you (usually 10%) and thus the unearned income is still taxed at favorable rates.
  • The child earns above market returns – Depending on the deal you find, the child can earn as much as 6, 7 or even 10% on between $500 and $1500 in various youth or early saver accounts.
  • The money is safe – So long as you are taking advantage of a savings account at an FDIC or NCUA insured institution, the likelihood of you losing this money is exceptional low.
  • You’re still in control (but) – Parents still have full control the money and the account until the child is 18 or 21 depending on the state.  As long as you use the money “for the benefit of the child” you are in the clear.
  • These accounts are usually free and include other goodies! – These accounts are usually free, have very low or no minimum balances, and sometimes include other goodies such as stickers, toys and bonuses designed to making “saving fun”.

    Note: If the deal you find is not free, or has too many strings attached, it is probably not worth it.  Be sure to read the fine print.

Custodial Account – Disadvantages:

  • This takes time to set up and manage – Although the time is generally pretty minimal, for our $500 Early Saver account, the process took about 20 minutes (including drive time) and we expect it to ideally take no additional effort for the next 18 years.  Because the account is for a minor, you may be required to show up in person.  BECU for example does not let you create accounts online for persons under the age of 13.
  • You are gifting the money – To take advantage of this plan, you are gifting the money to your kid.  While you still have control, legally the monies must be spent only for the benefit of the child.  In addition, there are possible tax implications, such as the $13k a year gift tax exemption that is reduced from your individual $1M life time exemption.
  • Eventual Loss of Control:    When your child no longer qualifies for the benefit, they also get full control of the money.  Young adults might not make the best decisions with the money you have saved up for them.
  • You may need to file a tax return for your child – Depending on how much you are gifting, and/or how much interest the child earns from that money, it may be necessary to file a tax return.  The following IRS site has more details on rules for filing requirements for children with unearned income such as we have discussed above.  Be sure to consult your own tax advisor.
  • Beware of the “kiddie tax” – This tax is really designed to prevent the very wealthy from moving large amounts of assets to their children to avoid taxes.  Unearned income that is earned by your child over $1,900 a year will fall under the kiddie tax and have to be carried over to your tax return and thus taxed at your tax rate.  This basically means the “shelter effect” of this tax strategy is limited.  You can read about a few gotchas of the kiddie tax here.

Regardless of the disadvantages, children’s accounts are still something to consider. Assuming you have the extra cash and the advantages outweigh the disadvantages, it is possible to scale this up.  The following table shows the benefits of the above strategy assuming a gift of $26,000 put into a 2-year CD at 1.5% on January 1st, 2011:

In this example, the strategy saves $277.04 in federal income taxes.  Assuming interest rates increase, you get a better CD deal, or you increase the amount gifted and took maximum advantage of this approach the results are even better:

This results in a theoretical maximum $570 in federal income taxes.

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How not to blow your tax refund

Gawker is running a fun article on How to Blow Your Tax Refund.  With the average refund expected to be approximately $3070, author Brian Maylan provides a number of ways to blow it all on a spontaneous set of expenses including a trip to Paris and one of each bit of hardware Apple has to offer.

We here at BYM have never really understood the “found money” mentality when it comes to tax refunds.  Perhaps that is because through a lifestyle of saving and spending wisely… every single item on Brian’s list can be planned and purchased easily with a little bit of thought.

For those new to living below your means, a tax refund is anything but “found money” or a gift or anything of the sort.  In fact, it is money that you overpaid to the government that is being returned to you — without interest.  It is money that would have been in your pocket each month had it not gone to the government’s coffers.

May people that plan their taxes well actually end up owing a little bit of money at tax time.  Assuming you are below the threshold for penalties and interest, this is a good thing.  It means that money was with you where it could be saved, invested, or otherwise used by you, and not a interest-free loan to Uncle Sam.

From the BYM point of view, here are the top 3 things to consider doing with your refund:

  • Pay off high interest debt – While it may not be as fun as a trip to Paris, consider this.  If you owe $10k on a credit card at 20% and only make the minimum payments of $200, it will take you 9 years to pay off the card and you will have paid $11680 in interest!If instead, you used that $3,000 towards the same credit card, and then made the same $200 a month payment, you would pay off the debt in 4 1/2 years and pay just $3593 in interest.  That’s $8,087 in savings over 9 years.  Enough to cover 2 or 3 trips to Paris.

 

  • Save it! – It may make sense to not use all of the money to pay down debt.  Having some money set aside in savings or an emergency fund is always good advice.  May experts recommend that you should be able to live off savings without any income for at least 3 months and ideally at least 6 months.  Having an emergency fund can actually save you money later and in some cases .  Perhaps put $1000 into a savings account and $2000 into the credit card.The reason for this is that access (liquidity) to money (capital) has value in and of itself.  Assuming you are not continuing to spend on the credit card, the terms of that loan are a known quantity.  If an emergency does arise and you need more money, access to credit may not be available, or it may be at terms that are worse than the terms you already have. For example, if you have a 5 year car loan at 0.9% – paying it off early doesn’t really make sense, especially if you don’t have an emergency fund.   This is because your money can be earning more interest in a CD or Money Market Account than you are paying on your auto loan.  Plus, if you do have an emergency, you’ll be paying anywhere from 13%-20% or higher on the credit card debt you’d take on to handle the emergency.

 

  • Put the money into a self-insurance fund – We here at BYM are not fans of being over insured.  Buying “warranties” on products because you can’t afford to replace them later is never a good idea.  Put the money into a savings account and use it only to pay for the replacement of items that are out of warranty.  In addition, consider raising the deductibles on your homeowners and auto insurance policies.  Do not raise the deductible more than the amount you are putting away, because if you have to borrow money to pay the deductible all the benefit is gone.Consider, raising a deductible from $250 to $1000 will reduce the cost of collision and comprehensive coverage by 10 to 30% depending on your carrier.  This can be as little as $100 or as much as a few hundred in savings per year.

If you just have to do something with that three grand, maybe allocate 10% to something fun.  $307 can buy you a very nice evening out – or two.

Tax Time – Should you pay with a credit card?

The short answer is this is a pretty bad idea.  Let’s discuss why.  For the sake of this article, let’s assume you will not be carrying the balance on your card, have exceptional credit and are simply looking to use this option to maximize your points or rewards.

Let’s look at the economics of this method of payment.  The IRS’s web site has this handy table that provides all the options.

Service
Provider

Telephone

(English and Spanish)

Website

Convenience
Fees

(Credit Card Option)

Convenience
Fees

(ATM/Debit1 Card Option)

Customer
Service
Number

Link2Gov Corporation
1-888-PAY1040tm 

(1-888-729-1040)

2.35%3
$3.892
1-888-658-5465
RBS WorldPay, Inc.
1-888-9-PAY-TAXtm
(1-888-972-9829)
1.95%3
$3.892
1-888-877-0450    (live operator)
1-877-517-4881(automated,  24/7)
1-888-877-0450 (live operator)
2.29%3
$3.892
1-888-877-0450      (live operator)
1-877-517-4881(automated,  24/7)
Official Payments Corporation
1-888-UPAY-TAXtm
(1-888-872-9829)
officialpayments.com/fed
2.35%3
$3.952
1-877-754-4413
1.90%3
1.90%
1-866-964-2552
1 The ATM/Debit card must be a Visa Debit Card, or a NYCE, Pulse or Star Debit Card.
2
Flat fee per transaction.
3
Contact the service provider to receive up-to-date information regarding fees.  The minimum convenience fee is $3.89 for L2G and RBS, and $3.95 for OPC.

As you can see the cheapest “Convenience Fee” applies to the Official Payments MasterCard Option.  This method will cost you 1.9% of the amount charged.  This is limited only to MasterCard.  The RBS WorldPay, Inc. option via PayUSTax.com of 1.95% for credit, but offers the choice of Visa or MasterCard.

If we take a look at NerdWallet.com’s list of top rewarding MasterCard and Visa offers, for those with perfect credit, you will see that the most rewarding MasterCard is only 1% cash / value back, while with Visa you can get up to 2% back (in Venture Rewards).

So in theory, you may be able to scrap together 5/100ths of a % of value here and possible a bit more with sign up bonuses. But that is hardly worth it.  For example, if you had a huge $50k tax bill, this would only net you about $25 in bonus – hardly worth the effort.  More realistically, on $5000 in taxes that would be only $2.50.  Again, not worth it.

What if you don’t have any other choice?

First off you always have a choice and using your credit card is probably the worst possible option!

  • The interest on the credit card will more than like be 10% to 30% depending on your credit
  • Some credit cards will consider this a cash advance and charge additional fees and interest
  • There are better options

Here are some better options to consider:

  • $25,000 or less in combined tax, penalties, and interest can use the Online Payment Agreement (OPA) or call the number on the bill or notice (have the bill or notice available, along with the social security number). A fill-in Request for Installment Agreement, Form 9465 (PDF), is available online that can be mailed to the address on the bill.This does carry fees (Approximately $105) and interest (~4%), but both are way less than the credit card option.
  • More than $25,000 in combined tax, penalties, and interest may still qualify for an installment agreement, but a Collection Information Statement, Form 433F (PDF) may need to be completed. Call the number on the bill or mail the Request for Installment Agreement, Form 9465 (PDF) and Form 433F (PDF) to the address on the bill.
  • The IRS has a page on the topic here.  Note, financing through the IRS may be the best option as their rates are based on the Fed’s short-term rate + 3%… as opposed to credit cards which are usually the Fed Prime rate (3.25%) + something.  Tip: Be sure to shop around though!

  • Consider getting fixed 1, 3 or 5 year loan through a site like Prosper.com or LendingClub.com.  Here you can get loans starting at ~6% fixed for 3 years.  Way better than a credit card, assuming you have good credit.  Lower credit will have higher rates.

As always, be sure to get advise from your tax or financial adviser.

Diesel cars continued…

As a follow-up to my previous post about Diesel cars being “worth it”, I wanted to provide everyone with a list of other useful articles and links regarding Diesel and provide a simple diesel fuel savings calculator.

Here are few good links:

Cheers,