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Term Life Insurance is a Must Have

Purpose of this article: to explain the importance of getting a term life insurance policy as soon as possible, especially if you have a spouse, partner, or dependent child (children).

Bullet Point Summary

  • We recommend a term life policy over all other types of life insurance policies.
  • Term life insurance policies provide death benefits to the policyholder’s beneficiaries if that person dies within the specified term of the policy.
  • Terms are usually set at 10, 20, or 30 years and the term you choose is specific to your needs and expectations.
  • General rule of thumb in deciding the amount of policy to take out: Take your annual salary, and multiply by 5 or 10 times.
  • If anyone in your life is financial dependent upon you and your income, term life is an absolute must have.

Overview

There are many types of life insurance policies that provide a variety of benefits to the policyholder’s beneficiaries, but our recommendation is that you consider a term life insurance policy over all the others.

Term life insurance policies are better than the rest for a few specific reasons:

  • The overall monthly premium (rate) usually costs less than the other types of life insurance options and once locked in, it will not change.
  • The period of time for the policy’s life is set in very easy to understand terms (usually 10, 20, or 30 years).
  • The policy can be cancelled at any time simply by not paying the monthly premium.
  • It’s very easy to understand and very much straightforward especially compared to the other insurance products out there.

The rest of this article will help you better understand the nuances of term life insurance policies and get you comfortable with why we believe you need to get one as soon as possible.

What Exactly is a Term Life Insurance Policy?

A term life insurance policy provides a death benefit to the policyholder’s beneficiaries if that person dies within the specified term of the policy. The specified terms are typically set at 10, 20, or 30 years. This death benefit can be paid in one lump sum or in monthly installments.

The monthly premium (rate) for your policy is determined by actuaries and underwriters who use a variety of factors like your age, health, occupation, hobbies, and driving records to calculate the risk of insuring your life. Once risk is assessed, the monthly premium (rate) will be set by the insurance company based on this assessment, the specified term, and the size of the policy.

How Much Will Your Term Life Insurance Policy Cost?

A term life insurance policy is typically the cheapest way to purchase life insurance coverage. Rates will very based on length of the policy, amount of the policy, and overall health of the insured.

Using ValuePenguin the following are visual representations of monthly premiums for term life insurance at differing levels of health (Preferred Plus, Select, Standard) and differing levels of coverage ($250K, $500K, $1M).

$250K policy varies in monthly premium from a low of $15 to a high of $140

$500K policy varies in monthly premium from a low of $22 to a high of $268

$1M policy varies in monthly premium from a low of $38 to a high of $508

You will notice that with term life insurance it can cost you as little as $15 a month to as much as $500+ a month depending on your age, health, term, and policy amount. In general, with term life insurance, it’s markedly cheaper the earlier you get it because a policy issued later in life has a greater likelihood of paying out. So, for your 20-somethings and 30-somethings reading this… GET YOUR POLICY TODAY!

What Amount Should I Choose?

Choosing the right term life insurance policy in terms of length and size is difficult because every single person’s situation is different. The amount you will need will depend on factors like your other sources of income, how many dependents you have, your debt levels, and in general your overall expectations on the lifestyle you want to live.

But with that said, you can apply the following general rule of thumb to find the starting baseline policy amount: Take your annual salary, and multiply by 5 or 10 times. The following chart details term life policy amounts based on annual salaries and the general rule of thumb:

What Term Should I Choose?

When you purchase term life insurance you will have to choose how long your coverage will last. Usually the terms are 10, 20, 30 but some insurance providers offer other terms. Based on our understanding of term life insurance policies and our work with some of our clients, the terms can be summarized as follows:

  • 10-year policies are popular for those people who are on a very tight budget and probably won’t require insurance after their term expires. We usually recommend this for someone in their late 40s to early 50s.
  • 20-year policies are the most popular, and are usually recommended for young families who often have large debt levels (school loans and mortgages) that would become troublesome if one of the breadwinners of the family happened to die unexpectedly. We usually recommend this for someone in their late 30s to early 40s.
  • 30-year policies are awesome because your monthly premium will remain unchanged during the duration of that period even though your health will likely change during the same time period. Because you lock in your rate in your late 20s and early 30s when you are healthiest, your premiums will remain the same. We usually recommend this for someone in their late 20s to early 30s.

Closing

Suze Orman is quoted as saying, “if you want insurance, buy term; if you want an investment, buy an investment, not insurance. As we mentioned in the beginning, there are many types of life insurance policies out there, but at Blue Elephant Financial Services, the only one we recommend is a term life insurance policy.

If you have anyone in your life that is financial dependent upon you and your income, term life insurance is an absolute must have. It will secure their future against the loss of income that your death will bring. The only thing guaranteed in life is death and taxes. Use term life insurance to plan for one of the two!

My hope in writing this article is that after reading this, you will feel more comfortable with term life insurance thus making it much easier for you to take the necessary steps to acquire your own policy.

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Doughnut Economics

Macroeconomics Explained Using Doughnuts

Matt Groening was once said, “Donuts. Is there anything they can’t do?” And for Kate Raworth, doughnutsare rewriting everything you ever learned in Economics 101. Her book, Doughnut Economics, is a simple referendum on modern day economics. Her thesis is quite simple:
Leaders of 2050 are being taught an economic mindset that is rooted in the textbooks of 1950, which in turn are rooted in the theories of 1850.
This “archaic” economic mindset has led our current world astray, and thus a new way of thinking for the 21st Century is much needed.

Enter the Doughnut

The essence of the doughnut is a social foundation of well-being that no one should fall below, and an ecological ceiling of planetary pressure that we should never go beyond. It is in between these two layers that lies a safe and just space for us all:
In order to remain within the boundaries of the doughnut, current economic thinkers and policy makers need to change their default modus operandi. Raworth identifies seven specific ways to change economic thinking and policy making for the better: 
1.      Change the Goal from GDP to the Doughnut
2.     See the Big Picture from self-containing market to embedded economy 
3.     Nurture Human Nature from rational economic man to social adaptable humans

4.     Get Savvy with Systems from mechanical equilibrium to dynamic complexity
5.     Design to Distribute from ‘growth will even it up again’ to distributive by design
6.     Create to Regenerate from ‘growth will clean it up again’ to regenerative by design
7.      Be Agnostic about Growth from growth addicted to growth agnostic
The following picture is my visual representation of what Doughnut Economics represents to me.
 
 
 

Shifting from Conventional Economics to Doughnut Economics Will Help Planet Earth and All Humankind Thrive

The current economic pursuit of GDP first pushes every consumer in our global economy to spend money they don’t have on things they don’t really need (think consumerism 101). It’s an endless hamster wheel of more for the sake of more, and it requires continual growth in income and output to support it.

By changing the goal of our global economy from GDP to the Doughnut we ignore conventional economic theory that posits every citizen’s satisfaction or happiness is based on the consumption of more goods. And this switch in focus will allow us to better advance the richness of human life on earth.
Underlying the big shift in economic focus is another underlying shift in the characterization of humans and their nature. Conventional economic theory posits that humans are rational and make decisions that solely maximize their utility which equates to driving satisfaction through consumption.
But the reality of life for each of us is we are far from solitary figures. Instead, we are social adaptive beings that thrive best in environments where we can relate to each other. Thus, our global economic machine is best served by putting the collective “WE” at the focus instead of growth in “GDP” at the focus.

It’s Clear We Have an Economic Design Problem … The Question is Will We Fix It?

In the 21stcentury, we have transgressed at least four planetary boundaries and have created a global economy that has left billions of people still facing extreme deprivation. On top of that, the current global economy has allowed the richest 1% to own half of the world’s financial wealth.
At the heart of income and wealth inequality lies a simple design question: who owns the enterprise, and so captures the value that workers generate? Our current economic system is designed in such a way that shareholders own the enterprise and thus capture the value generated by workers as evidenced by the following:
From 2002 – 2012 worker productivity grew +30% while real wage growth remained practically non-existent. This trend was so dreadful that economists have dubbed this ten-year period the “Lost Decade for Wages.” Meanwhile, returns to shareholders grew faster than the economy as a whole.
Furthermore, it’s beyond clear now that our economic system is the actual root cause of the ecological crisis that we currently face as humankind on this Earth (see hereand here). At the heart of Earth’s ecological decline lies a simple design flaw in our current global economy:
We extract Earth’s minerals, metals, biomass, and fossil fuels and manufacture them into products. These products are eventually sold to consumers who use then but eventually throw them away. The very essence of this cradle-to-grave type industrial economic system is destructive to Earth’s ecological system. 
Given the societal and ecological challenges we face, it’s up to us to decide whether or not we want to fix the economic design problem we have.

In Closing

In 2015, world GDP was $80 trillion. An expectation of 3% indefinite growth would mean that …
(1)   By 2050 the world economy would be 3x bigger than 2015
(2)  By 2100 the world economy would be 10x bigger than 2015
(3)  By 2200 the world economy would be 240x bigger than 2015
It’s beyond clear that this expectation of indefinite growth can not be possible without destroying our Earth and society! Alarm bells should be going off in each and every one of us from citizens to politicians.
It’s time for us to accept the fact that we have reached the logical conclusion of our expansionist economic paradigm, and redesign a global economy that is focused on the promotion of human prosperity whether GDP is going up or down. This will be an extremely hard shift in paradigm, but it will be absolutely vital if we are going to make it as a planet and society for the next 100 years.

Extras

Brian Nwokedi’s Book Review on Goodreads
Brian Nwokedi’s Twitter
Direct Link to Book: Doughnut Economics
Author’s Website: Doughnut Economics
Author’s Twitter: @KateRaworth
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My Financial Habit: Coffee Shops and Lattes

Purpose of this article: to show how my afternoon latte habit adds up and give you some thoughts on things to consider if you have a similar financial habit in your life

Overview

I have a financial confession to make… I love afternoon lattes and it’s costing me dearly! And like many of you out there, I know every single time I buy my latte, I am overpaying severely. According to USA Today’s coffee calculator, the markup on my latte can be as high as 300% depending on the coffee shop. But I will not deny that there is something quite special about a hot off the press latte!

How Much Is My Latte Habit Costing Me?

Based on an analysis of my spending over the last 535 days here are my financial stats:

• I have visited my local Charlotte coffee shops 71 different times, and have spent a total of $643 on afternoon lattes. The cost per trip is $9.04 (my goodness!)

• My average monthly spend over the last 18 months is $35.67

• The most I spent in one month was $81.23 in November 2017

• Over this time period, I spent roughly $1.20 a day on my latte habit.

At a 300% markup, my afternoon latte habit should have only costed $215 if I was disciplined enough to brew my own coffee. This is a difference of $428 extra that I have spent over the last 18 months.

What Could I have Done with the $428?

So, what could I have down with this additional $428? Here are a few things I could have done with that money…

• During the time period of 3/1/17 to 8/18/18 the S&P 500 returned an approximate +19.6%. Had I invested my $428 during this time period, I could be roughly $84 richer.

• Based on the Bureau of Transportation, I could have taken a round trip ticket to almost any US city. The average round trip price during the first three months of 2018 was $346.49.

• I could have used that money to pad my emergency savings account. Recent studies show that very few of us Americans have enough savings to cover a $1,000 emergency.

There are countless other more positive money management actions I could have pursued instead of spending this extra money on my afternoon latte habit. The point I am trying to make here isn’t to pass judgement on this money spending habits. It’s to make myself more aware of an area of spending that may not truly be worth it in the long run.

If you are like me, you probably have some areas of money management that you wish you were better at. I hope my financial habit confession was helpful for you to hear. Please let us know what financial habits you have and wish to break.

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Open an Ally Online Savings Account NOW

Purpose of this article: to explain why you should open an Online Savings Account with Ally Bank today

UPDATE (12/20/19): the current annual percentage yield (APY) for the online savings account with Ally as of December 2019 is 1.60%.

UPDATE (6/20/19): the current annual percentage yield (APY) for the online savings account with Ally as of June 2019 is 2.20%.

Bullet Point Summary

  • Ally continues to be one of the few financial institutions that consistently gives returns back to its customers.
  • The APY that Ally offers for its online savings account is one of the best out there.
  • The Online Savings Account is easy to use, with no maintenance fees, and very few restrictions.
  • Your deposits are insured by the FDIC up to the maximum allowed by law which is $250,000.
  • The only thing to watch out for is that you will owe taxes on the interest you receive within this account. Ally will send you a 1099-INT.

Overview

Ally Bank recently announced an increase to their annual percentage yield (APY) which is the interest rate they pay you on your savings deposits with them. Over the past 12 months, they have increased this rate from 1.0% to 1.80% and have one of the highest rates of all banks out there:

With no minimum deposit requirements, and a seamless online experience, everyone should maximize their savings by opening an account with Ally Bank today.

It’s Simple… Your Money Grows More with Ally Bank

Because Ally pays a higher interest rate than most banks, your money grows much faster with Ally. The following graph shows what $1,000 is worth in 30 years across a sample of different banks. Please note that inflation has not been considered and thus the 30-year returns have not been adjusted downwards for simplicities sake:

Before consideration of the impact of inflation, a $1,000 deposit with Ally Bank today would net you $1,708 in 30 years!

Compare to the average of the big banks (PNC, Wells Fargo, and Bank of America to name a few), Ally Bank is a NO BRAINER!!!

Features of the Online Savings Account

*Taken directly from the Ally Bank website. See link here:

• No monthly maintenance fees
• Earn a rate 20x higher than the national average
• Deposit checks remotely with Ally eCheck Deposit
• Grow your money faster with interest compounded daily
• Six transactions limit per statement cycle
• Your deposits are insured by the FDIC up to the maximum allowed by law which is $250,000
• Protect your legacy. Open this account for a Trust. Learn more

Closing

Very rarely are money management decisions this easy. When it comes to maximizing your savings, an Online Savings Account with Ally Bank is simplest and most effective way to go. My hope in writing this article is that after reading this, you will visit Ally Bank and open an Online Savings Account. Your future-self thanks you!

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How to Complete Tax Form W-4

Purpose of this article: to help you feel confident in completing your Tax Form W-4

Bullet Point Summary

  • Form W-4 is the form that determines how much federal income tax is withheld from your paycheck.
  • In general, the more personal allowances you take, the less tax will be withheld from each of your paychecks.
  • This form can be updated throughout the year as your situation changes. For example, getting married and having kids during the year changes your filing status and number of dependents.
  • Given the tax reforms passed in 2018, it is vital that you review this document and ensure that you are withholding the appropriate amount. Millions of Americans faced unexpected tax surprises earlier this year.

Overview

The purpose of Tax Form W-4 is to help your employer withhold the correct amount of federal income tax from your paycheck. But if you are like most of us, you submit this form once with your employer upon being hired and never revisit it. This article will talk through why you should revisit this tax form every time your personal financial situations change.

How Does It Really Work?

In general, Form W-4 is focused on honing in on the number of “personal allowances” that you will take. The more personal allowances you take, the less tax will be withheld from each of your paychecks. Conversely, if you claim zero personal allowances you will have the most tax withheld from your take-home pay.

So, it is very important to get the right balance of personal allowances claimed. Claiming too little will mean that too much tax is sent to the government ending in a refund. But claiming too many will lead to too little tax being sent to the government ending in a possible large tax bill come April.

In order to figure out how many allowances to claim, you will need to consider the following:

1. What is your tax filing status?
(a) Married filing jointly
(b) Married filing separately
(c) Qualifying widow(er)
(d) Head of household
(e) Single

2. How many jobs do you have?

3. Do you have any dependents?

4. Will you take any credit for child tax or other dependents?

Once you gather the answers to the three questions above, you are ready to fill out the Personal Allowances Worksheet on Form W-4. Below is a screen shot of what the Personal Allowances worksheet looks like on the actual Form W-4. The next section will walk you through how to complete this form.

How Should I Fill Out Form W-4?

The following video below will walk you through how to fill out Form W-4. Please note that the assumption within this video is that you will not take itemized deductions and you will not need to fill out the Two-Earners/Multiple Jobs Worksheet on Page 4 of Form W-4.

With the new GOP tax plan, the standard deductions have increased so a lot of you may choose this route over itemizing. Always remember though, you should itemize deductions if your allowable itemized deductions are greater than your standard deduction.

[embedyt] https://www.youtube.com/watch?v=Dw8bWZsMsyc[/embedyt]

Closing

The vast majority of people will usually end up with 2 allowances (1 for themselves in Line A and 1 for their filling status in Line B-D), as the video above shows. The purpose of Form W-4 is to help ensure that you pay enough tax upfront so you don’t owe additional taxes later on in April, but this form is far from perfect as it can’t account for every single persons’ tax situation. As a result, I suggest that you always do the following at the beginning of each tax year:

1.      Use the IRS withholding calculator (see here) to calculate how much tax    you should withhold. Fill out Form W-4 with 0 allowances and withhold any additional tax needed from your paycheck by filling out Line 6.

Real example of using the IRS Withholding Calculator. Download PDF here: Mae Mae Nguyen – IRS Withholding Calculator Example.

2.      Use the Federal Income Tax Calculator (see here) from Smart Asset to further analyze your tax liability for the coming calendar year. You want to hone in on the sweet spot where you pay the correct amount upfront and neither owe nor get a refund check in April.

3.      Come see us at Blue Elephant Financial Services with any of your tax planning and tax related questions.

My hope in writing this article is that after reading this, you now feel a bit more comfortable with taxes. Filling out Form W-4 correctly will ensure a less bothersome tax season for you.

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Health Savings Accounts (HSAs)

Purpose of this Article: to explain the basics of HSAs and the benefits of using them if offered by your employer

Overview:

HSAs were created in 2003 specifically to give individuals with high-deductible health plans a tax break. As an individual, you are eligible to enroll in an HSA if you meet the following four criterion:

1.  You enroll in a high-deductible health plan

   2.  You aren’t covered by a spouse’s health plan that isn’t high-deductible

   3.  You are not enrolled in Medicare

   4.  You cannot be claimed as a dependent on someone else’s tax return

Contribution Limits:

Similar to an IRA or 401(k) there is an annual contribution limits for both you and your employer. Each year the annual contribution limits may change but for 2017 the limits are as follows:

$3,400 for individual plans
$6,750 for family plans

And similar to an IRA, there is an additional $1,000 catch up contribution that can be made for people 55 or older.

HSAs matter more because high-deductible healthcare plans are on the rise…

As healthcare and insurance costs continue to rise, more companies are looking for ways to cut their costs.
Consequently more employers are switching their sponsored healthcare plans to high-deductible plans. This move ultimately shifts more of the financial responsibility for paying for health care away from the companies to the individuals.

Put more simply, a higher deductible plan means that you as the individual are responsible for a larger amount of your health care cost. This means that your monthly contribution from your paycheck is less, but you have higher out of pocket maximum contributions when the time comes (i.e. Higher deductible).

In 2017, the annual out-of-pocket payments for individual and family plans are $1,300 and $2,600 respectively as defined by the IRS. For more info see here.

It is expected that over the next 5 to 10 years, more people will find themselves facing higher-deductible health plans, as more employers switch their base healthcare plans to higher deductible plans. This means it is very likely that you will be facing HSAs as an option in your employer benefits package.

Triple-Tax Advantage of HSAs:

HSAs are a way for people with high-deductible health plans to set money aside for medical expenses. These savings accounts are considered “tax-advantaged” because the money you set aside is “before tax” and thus free of federal taxes. Money saved within an HSA is allowed to grow free of federal tax, and can also be invested free of tax consequences. And finally, when money is withdrawn specifically to pay qualified medical expenses, there is no tax penalty either. On an aside, see here for a complete list of qualified medical expenses

So in practice, an HSA offers its owner three specific tax benefits:
1.    Money can be set aside before taxes thus reducing your taxable base
2.   Money can grow tax free
3.   Money used from the account for qualified medical expenses are tax free

HSAs are better than Healthcare Flexible Spending Accounts (FSAs):

While both HSAs and FSAs allow you to set aside pre-tax money today future health care expenses, there are some key differences that make HSAs slightly better:

1.    You cannot take an FSA with you to your new job if you change. Your unused funds are forfeited. This is not the case with HSAs as the money saved goes with you into future jobs.

2.    If you do not use the total amount contributed to an FSA during the calendar year, you will lose it. Your unused funds are forfeited. This is not the case with HSAs as the money saved can be spent in future years.

3.    Anyone can open an FSA as there are no special eligibility requirements. This is not the case with HSAs as you must be in a high-deductible health plan to qualify for this type of account.

4.    If you die with money still in your HSA account, you can leave it to your spouse (who can use the money free of estate taxes, and tax-free for non-medical expenses) or other heirs (who would pay taxes on the money they inherit). This is not the case with FSAs.

5.    You can use funds from an HSA account to pay for prior period medical expenses (i.e. Expenses that occurred in 2016).

6.    Technically once you reach the age of 65 or older, you can take HSA money and use it for non-medical expenses without incurring a 20% penalty. This “loophole” only exists for HSAs

 

My hope in writing this article is that after reading this, you can now see the benefits of an HSA. Chances are, you’ll be experiencing one really soon.

 

 

 

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A Simple & Legal Strategy to Reduce Your Tax Burden Today

Purpose of this article: to explain an effective strategy to reduce your taxable income and lower your annual taxes.

Overview:

Each year during tax planning with my clients, the inevitable question always arises:

How can I reduce my yearly tax bill?

And while it can seem like a daunting task, the reality is you can trim your tax bill right now by following this one simple and legal strategy:

Increase your contribution to your employer sponsored retirement plan (i.e. 401(k), 403(b) or other retirement plan).

This simple but effective strategy will allow you to reduce your taxable income and save for retirement at the SAME TIME!

How Does This Actually Work?

The rules of the 401(k) employee sponsored retirement plan are such that you are legally allowed to contribute up to $18,000 annually before tax. And if you are 50 or older, the contribution max grows to $24,000. Each paycheck, your employer will take out money from your paycheck and put it directly into your 401(k) account. Since the money is taken “before tax” it isn’t counted as taxable income when you file your taxes in April.

By increasing your 401(k) contribution, you are effectively deferring tax to a later date in retirement (thus reducing your tax today) because the money you put into the 401(k) goes in tax free, and isn’t taxed until you withdraw in retirement. Furthermore, you not only reduce the total amount you pay in income taxes, but also jump-start your retirement portfolio by putting all of your savings to work immediately.

Financial Example: Bess Napier

Bess makes $50,000 annually and has a 25% tax rate. She decides that she will contribute the maximum $18,000 annually to her 401(k). By doing this she reduces her taxable income down to $32,000 before any itemized deductions or credits, and she saves for retirement!

Put more specifically, investing $18,000 directly into a 401(k) each year grows your retirement nest egg quicker than getting paid the $18,000, paying 25% in taxes, and investing the $13,500 that is left.

For married couples, the math is exactly the same. Each person can contribute $18,000 taking the combined maximum to as much as $36,000. And a married couple over 50 can contribute a maximum of $48,000 ($24,000 each person).

Other Types of Employee Sponsored Retirement Plans

Please note that other employer sponsored retirement plans like a SIMPLE IRAs will have different contribution limits but function the same way as the 401(k). So if you are not maxing out your annual contribution amount, you are paying more taxes than you should. The chart below courtesy of Vanguard has all of the limits:

Courtesy of https://personal.vanguard.com/us/insights/taxcenter/contribution-limits

How can I get this same benefit if my employer doesn’t sponsor a retirement plan?

If you work for a company that does not have a sponsored retirement plan you can still take advantage of some tax deferral. You can open up an Individual Retirement Account (IRA) and make tax-deductible contribution to the IRA. The max contribution here is only $5,500, ($6,500 if 50 and over) which is much lower than the employee sponsored plans, but it is still better than nothing. The only potential problem with an IRA is the fact that tax deductibility phases out for individuals and couples at different levels of modified gross income. The following chart shows all of the various income ranges that cause IRA tax deductibility phase out:

Courtesy of the Hawaii Employees Council

While there are many factors to consider when determining whether or not you are subject to the income-phase out restrictions for IRAs, the point I want to make here is that there are many ways to reduce your taxable income and the best and simplest way to do this is to invest in some retirement vehicle before taxes (i.e. . 401(k), 403(b), other retirement plan, or Traditional IRA).

My hope in writing this article is that after reading this, you can now see the tax benefit of contributing to a retirement savings account. There is not easier way to reduce your tax liability today!

 

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Is A Tax Refund Good or Bad Thing?

Purpose of this article: to explain why tax refunds can be seen as good and bad.

Overview:

I’d like to take a moment to explain something my clients often ask me: Is getting a tax refund each year a good or bad thing?

Each year when you file your tax return with the IRS, one of two things will happen:

1.     You will owe money and have to pay the IRS or

2.     The IRS will owe you money and you will get a refund.

When you get a refund from the IRS this means that each paycheck you received during the year had too much tax withheld and taken upfront. In essence, you have overpaid your taxes during the year.

When you have to pay the IRS this means that each paycheck you received during the year had too little tax withheld and not enough was taken upfront. In essence, you have underpaid your taxes during the year.

The rate/amount that the IRS takes away from each paycheck is determined by Form W-4 [Direct Link to Form: Here], which you typically complete and file with the payroll department of your employer on day 1 of your job, and never revisit.

On an aside … I will complete another detailed write up on how to properly fill out Tax Form W-4, but the point I want to make here is this form determines a big portion of whether or not you will get a refund or pay come April.

Team Bad: Getting a refund is bad because…

• When the IRS writes your refund check, they are just giving you back your own money they owe you, without any interest.

• You have overpaid on taxes throughout the year. It’s your cash that the federal government took from you and is now returning to after months of holding on to it. Oh and they aren’t giving you interest!

• It isn’t the most effective use of your cash flow because you are giving the IRS an interest free loan.

• When we get large sums of money, we tend to splurge because of the Windfall Syndrome. This is because emotionally, our tax refund feels like a windfall, even though this is simply the government returning our money back to us, with no interest.

Team Good: Getting a refund is good because…

• Psychologically speaking, there is no better feeling than getting cash back. Especially large sums of cash.

• If you are disciplined, this huge tax refund can effectively force you to save if you can earmark the refund and send it to a savings account. Same argument can be applied to using the refund to pay down debt.

Blue Elephant’s Verdict:

Getting a refund is economically bad but psychologically good.

In 2015, the average tax refund was roughly $2,860 and approximately 70% of all tax returns resulted in refund checks being issued. The 2016 numbers are not yet published but there is a high degree of likelihood that they will match the 2015 numbers.

Put another way, 7 out of 10 US households that were issued refunds,gave the government $238 each month interest free. This is money that could have been spent building an emergency savings fund. And even if it earned 1% in an Ally Online Savings Account, that would be better than nothing. On top of this, this is money that could have been spent paying down high interest credit card debt.

No matter how you slice it, getting a tax refund is not the best economic use of your precious resource known as cash. But it’s clear that the vast majority of Americans will continue to love their tax refunds. My hope in writing this article is that after reading this, you can now see the economic benefits of saving NO to the tax refund!

 

 

 

 

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The Five Pillars of Net Worth

While it may be a hassle to create a financial plan, not knowing where you stand now makes it much harder to plan for where you need to be later in life, especially for retirement. At Blue Elephant Financial Services, we start our personal financial plan by taking a snapshot of your current Net Worth.

Your Net Worth is the sum of all of your Assets (i.e bank accounts, investments, car, home, etc.) minus your Liabilities or Outstanding Debts (i.e credit card debt, student loans, mortgage, car note, etc.)

The ultimate goal of the Blue Elephant Financial Services personal financial plan should be to drive towards increasing your Net Worth. The steps outlined below are my approach and strategy that will give you a sense of control, ultimately giving you the tools to drive towards financial stability:

1. Evaluate Your Spending Habits to see where we can trim expenses. The equation is relatively simple: Income – Expenses = Remainder. This remainder is positive when you spend less than you make. My job is to make you aware of how you spend your money, and work with you to cut out the “habitual & mindless” spending that ultimately hurts your long-term financial stability. Regardless of where your spending is, there is always an opportunity to trim and save/invest more.

2. Build an Emergency Savings Account that can sustain 3 to 6 months of expenses. While other financial planners will tell you to pay down your debt first, it is my belief that a lack of emergency funds leads to a perpetual cycle of more debt in the long-term, especially when emergency expenses arise. I always suggest that each of my clients save a minimum of $1,000 before turning their attention to paying off debt. This builds cash which increases your Net Worth. We make sure to automate this by contributing a minimum of $25.00 a month to an online savings account such as Ally. Set it then forget it. This simple step will trick your brain into feeling self-motivated.

3. Pay off all High Interest Credit Card Debt. Any outstanding debt that is above 10% needs to be a primary focus of your financial plan. Paying off your credit will (+) increase your Net Worth, ultimately freeing up more of your funds to do other things with. Once you pay off your credit card debt, you will no longer be held back by principal, interest payments, and finance charges. This then frees up more of your funds to build your emergency savings and/or invest in your retirement account, which leads to better long-term growth in your Net Worth. On an aside, utilization rate of your credit card should never go above 30%.

4. If applicable, you should Pay of Any Outstanding car notes, student loans, and other non-mortgage debts with interest rates below 10%. Once you have eliminated your high interest credit card debt, you will now have a decision to make. I always suggest that extra funds should go towards paying off outstanding non-mortgage debt. The sooner you can get out of debt, the better off your future returns will be, ultimately driving significant gains in your Net Worth.

5. Once you have eliminated mindless spending, built an emergency fund, paid off high interest debt, and eliminated other outstanding non-mortgage debt, you are ready to Rapidly Ramp Up Your Retirement Savings. Your goal should be to save enough money so that you can live at 50% -70% of your current income. If your employer has a matching 401 (k), you should contribute enough from day one to get the match. Keep your investment allocation simple by picking a blended index fund as your retirement vehicle.

Blue Elephant is here to tailor your financial plan to meet your needs. Our plans always focus our efforts on maximizing your Net Worth which helps you ultimately meet your current and ongoing financial obligations.