Financial Aid 101

Posted on April 27, 2011 by taxblogger

Tax & Money Tip of the Week: 
Financial Aid 101
April 27, 2011 | No. 40

Many parents pay for college with a combination of savings and financial aid.  Here are some of the basics.

What is financial aid?
Financial aid is money distributed primarily by the federal government and colleges in the form of student loans, grants, scholarships, and work-study jobs.  Loans and work-study must be repaid (through monetary or work obligations), while grants and scholarships do not.  A student can receive both federal and college aid.

Financial aid can be broken down into two categories, need-based and merit-based.  Need-based awards are given based upon financial need.   Merit-based awards are granted according to your child’s academic, athletic, musical, or artistic merit.

How is financial need determined?
The federal government’s aid application, the FAFSA, uses a formula known as the federal methodology.  Generally speaking, the parent and child income and assets are tallied and assessed at certain rates.  There are certain deductions and allowances against income and certain assets are excluded from consideration, specifically, home equity, retirement plans, annuities, and cash value life insurance.  The result is a figure known as your expected family contribution, or EFC.  This is the amount of money you must contribute to college costs to be eligible for aid.  Your EFC remains constant, no matter which college your child applies to.

Your EFC is not the same as your child’s financial need.  To calculate financial need, subtract your EFC from the cost at a given college. Because tuition, fees, and room-and-board expenses are different at each college, your child’s financial need will vary depending on the cost of a particular college.

Colleges have their own way of determining financial aid, but basically the process works the same as with the federal government with some exceptions.

How do I apply and when?
The FAFSA can be filed manually, but the better option is to complete and file it online at www.fafsa.ed.gov.  The online version flags suspected mistakes immediately and takes only one week to process compared to four to six weeks for paper FAFSAs.

The FAFSA can be filed beginning January 1st in the year that your child will be attending college through June 30th.  Timely submission of the FAFSA is important because some financial aid programs operate on a first come, first-served basis.

If you should have any questions, please don’t hesitate to give us a call.

Questions or Comments?

You can add comments on the blog, call 919-847-2981, or visit our web site. We look forward to hearing from you.

Mark Vitek, CPA/PFS, CFP®
mark@markvitekcpa.com

…until next week.

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Senate Approves the 1099 Repeal

Posted on April 20, 2011 by taxblogger

Tax & Money Tip of the Week: 
Senate Approves the 1099 Repeal
April 20, 2011 | No. 39

On April 5th, the Senate passed legislation to repeal both the expanded Form 1099 information and reporting requirements mandated by last year’s health care legislation. The Act (HR4) repeals the expansion of information reporting requirements for payments of $600 or more to corporations.

The Comprehensive 1099 Taxpayer Protection and Repayment of Exchange Subsidy Overpayments Act of 2011 (HR4) was approved by the Senate by a vote of 87-12. 

The House of Representatives previously passed the bill on March 3rd.  Both the House and the Senate approved the same version of the bill. 

The bill has now been sent to President Obama to be signed into law.  We will keep you posted.

If you should have any questions, please don’t hesitate to give us a call.

Questions or Comments?

You can add comments on the blog, call 919-847-2981, or visit our web site. We look forward to hearing from you.

Mark Vitek, CPA/PFS, CFP®
…until next week.

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Are You Getting the Credits You Deserve?

Posted on April 13, 2011 by taxblogger

Tax Tip of the Week: 
Are You Getting the Credits You Deserve?
April 13, 2011 | No. 38 

Tax Deductions are good….Nonrefundable Tax Credits are better….and Refundable Credits are great!

If, for example, you take a tax deduction for mortgage interest on your tax return you are simply reducing your taxable income.  This means that if your marginal tax rate is at the 25% level, you are saving $250 in taxes for every $1,000 spent on mortgage interest.

A nonrefundable credit, on the other hand, is a dollar for dollar reduction in your tax liability.
Examples of nonrefundable credits include:

Foreign Tax Credit
Education Credits
Dependent Care Expenses (Daycare)
Retirement Savings Credit
Child Tax Credit 
Residential Energy Credit
Credit for Prior Year AMT
General Business Credit

Nonrefundable credits, however, are limited to your tax liability.  For example, if you have an energy credit of $1,500 and your tax liability is only $1,000, then your credit is limited to $1,000.

Refundable Credits are those that result in Uncle Sam giving you money!  Examples of Refundable Credits include:

Making Work Pay Credit
Earned Income Credit
Additional Child Tax Credit
American Opportunity Credit (Education)
First Time Homebuyer (expired)
Fuel Tax Credit
Adoption Credit
Health Coverage Credit

I had a couple come see me this year that have five children, two of which are in college.  They also installed a new energy-efficient HVAC system.  Their gross income was around $75,000.  After taking advantage of one part of the American Opportunity Credit for college expenses, the Child Tax Credit for those children under age 17, and the Residential Energy Credit their tax liability was eliminated.  In addition, they received an $800 Making Work Pay Credit, $2,000 Additional Child Tax Credit and $1,000 refundable credit for the second part of the American Opportunity Credit.  So their refund consisted of all the federal tax they had withheld plus $3,800 in refundable credits.

If you should have any questions, please don’t hesitate to give us a call.

Questions or Comments?

You can add comments on the blog, call 919-847-2981, or visit our web site. We look forward to hearing from you.

Mark Vitek, CPA/PFS, CFP®
…until next week.

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Coverdell Education Savings Accounts

Posted on April 12, 2011 by taxblogger

Tax and Money Tip of the Week: 
Coverdell Education Savings Accounts
April 6, 2011 | No. 37 

If you meet designated income limits, you can contribute $2,000 annually to a Coverdell Education Savings Account.  Although contributions are not deductible, all earnings and withdrawals are tax-free, providing that you use the money for qualified education expenses, including those for kindergarten through high school.  In addition, you can fund your Coverdell Account with a wide variety of investments.

Along side a 529 College Savings plan, a Coverdell Account can play a big part in your college funding strategy.  Safety of principal and consistency of return are key considerations.  It’s also important to have an easy to manage program that keeps your money working all the time.

How much you invest depends on your resources and resolve.  By starting early and diversifying properly, you can achieve your goals.

If you should have any questions, please don’t hesitate to give us a call.

Questions or Comments?

You can add comments on the blog, call 919-847-2981, or visit our web site. We look forward to hearing from you.

Mark Vitek, CPA/PFS, CFP®
…until next week.

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How To Speed Up A Tax Refund

Posted on March 30, 2011 by taxblogger

Tax and Money Tip of the Week: 
How To Speed Up A Tax Refund
March 30, 2011 | No. 36 

If you file a 2010 return and you’re expecting a tax refund, there’s no reason to dawdle.

Strategy:  E-file your return.  If you file electronically and request a direct deposit into your bank account, you’ll receive your refund in less than two weeks.  In contrast, filing by paper can take almost two months.

The IRS estimates the following “turn-around times” for tax refunds:

  • Six weeks for a paper return and paper check
  • Five weeks for a paper return and direct deposit
  • Three weeks for e-filing and direct deposit
  • 10 days for e-filing and direct deposit

Clearly, if speed is your top priority, e-filing is the best approach.  But it’s not for everyone.  For instance, you might miss some tax-saving opportunities or you just may not be comfortable doing it.   If you want your return e-filed, you can have us e-file for you for a minor charge.

If you should have any questions, please don’t hesitate to give us a call.

Questions or Comments?

You can add comments on the blog, call 919-847-2981, or visit our web site. We look forward to hearing from you.

Mark Vitek, CPA/PFS, CFP®
…until next week.

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2010 IRA Contributions

Posted on March 23, 2011 by taxblogger

Tax and Money Tip of the Week: 
Deadline for Making 2010 IRA Contributions
March 23, 2011 | No. 35 

There’s still time to make a regular IRA contribution for 2010! You have until your tax return due date (not including extensions) to contribute up to $5,000 for 2010 ($6,000 if you were age 50 by December 31, 2010). For most taxpayers, the contribution deadline for 2010 is April 18, 2011. Normally, your tax return must be filed by April 15. However, the IRS has extended the deadline to April 18 this year because the 15th is a holiday in Washington D.C. (Emancipation Day).

If you should have any questions, please don’t hesitate to give us a call.

Questions or Comments?

You can add comments on the blog, call 919-847-2981, or visit our web site. We look forward to hearing from you.

Mark Vitek, CPA/PFS, CFP®
…until next week.

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Home Office Deduction

Posted on March 16, 2011 by taxblogger

Tax and Money Tip of the Week: 
Home Office Deduction
March 16, 2011 | No. 34
 

We often hear people say they do not want to take the home office deduction because it is an audit “red flag.”  However, this feeling may lead to missing out on a potentially significant and legitimate deduction.

Let’s look at the rules.  First, the area of the home used for an office must be used regularly and exclusively:

  1. As the principal place of business (including administrative use);
  2. As a place to meet with clients in the normal course of business, or
  3. In connection with the business, if it is a separate structure not attached to the principal residence.
  4. If you are an employee, the business use of the home must be for the convenience of the employer.  (Meaning no other office facility exists and is a condition of employment).  Also, note that the home office deduction will not be as significant as those who are self-employed because the deduction is taken on Schedule A subject to 2% AGI limitations.

If you meet these tests, you can then deduct the business percentage use of:

  • Mortgage Interest
  • Real Estate Taxes
  • Casualty Losses 
  • Home Repairs/Maintenance
  • Rent    
  • Utilities
  • Homeowners Insurance
  • Security Systems
  • Other expenses including garbage removal, snow plowing, etc.
  • Depreciation

Note:  Choosing not to take the depreciation deduction is not an option.  It falls under the “allowed or allowable” rules.  It also means that when you sell your home you must recapture the depreciation.  This means you will have a taxable consequence on what would otherwise probably be a tax-free sale of the home. 

If you should have any questions, please don’t hesitate to give us a call.

Questions or Comments?

You can add comments on the blog, call 919-847-2981, or visit our web site. We look forward to hearing from you.

Mark Vitek, CPA/PFS, CFP®
…until next week.

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House Votes to Repeal 1099 Provision

Posted on March 9, 2011 by taxblogger

Tax and Money Tip of the Week:
House Votes to Repeal 1099 Provision
March 9, 2011 | No. 33
 

The U.S. House of Representatives voted to repeal an unpopular tax-reporting requirement affecting small business owners, in what would be the first substantial change to the sweeping health-care package signed into law last year.

In a 414-112 vote, the House approved the measure, but the Senate is unlikely to take up the bill as it is currently drafted, adding further delay to the attempt at repealing the measure.

Seventy-six Democrats joined every present Republican lawmaker in voting in favor to repeal the legislation, while 112 Democrats opposed it.

The so-called 1099 provision was included in last year’s health-care law.  Official estimates stated it would raise around $18 billion a year, money that would be used toward the cost of implementing the health-care law.

It required smaller business owners to provide an account to the IRS of far more of their business transactions.  The goal was that more money owed in taxes would be tracked this way.

But business groups and firm owners quickly attacked the measure, saying the onerous requirements it placed on smaller firms far outweighed any benefit to the Treasury.

Republicans said it would require small-business owners to spend more on tax preparation, rather than invest in their companies and hire new workers.

Congressional Democrats and President Barack Obama agreed, and pointed to efforts to repeal the measure as evidence they were willing to work with Republicans to change their controversial health-care law.

A similar bill passed through the Senate last month, but it was attached to a wider overhaul of the regulation of the aviation industry.  Due to that, and because House Republican leaders wanted to change how the revenue lost from repealing the provision would be accounted for, they brought forward their own version of repeal legislation.

If you should have any questions, please don’t hesitate to give us a call.

Questions or Comments?

You can add comments on the blog, call 919-847-2981, or visit our web site. We look forward to hearing from you.

Mark Vitek, CPA/PFS, CFP®
…until next week.

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Protecting Your Loved Ones with Life Insurance

Posted on March 2, 2011 by taxblogger

Money Tip of the Week:  Protecting Your Loved Ones with Life Insurance
March 2, 2011 | No. 32

How much life insurance do you need?
Your life insurance needs will depend on a number of factors, including the size of your family, the nature of your financial obligations, your career stage, and your goals. For example, when you’re young, you may not have a great need for life insurance. However, as you take on more responsibilities and your family grows, your need for life insurance increases.

Here are some questions that can help you start thinking about the amount of life insurance you need:

  • What immediate financial expenses (e.g., debt repayment, funeral expenses) would your family face upon your death?
  • How much of your salary is devoted to current expenses and future needs?
  • How long would your dependents need support if you were to die tomorrow?
  • How much money would you want to leave for special situations upon your death, such as funding your children’s education, gifts to charities, or an inheritance for your children?
  • What other assets or insurance policies do you have?

Types of life insurance policies
The two basic types of life insurance are term life and permanent (cash value) life. Term policies provide life insurance protection for a specific period of time. If you die during the coverage period, your beneficiary receives the policy’s death benefit. If you live to the end of the term, the policy simply terminates, unless it automatically renews for a new period. Term policies are typically available for periods of 1 to 30 years and may, in some cases, be renewed until you reach age 95. With guaranteed level term insurance, a popular type, both the premium and the amount of coverage remain level for a specific period of time.

Permanent insurance policies offer protection for your entire life, regardless of your health, provided you pay the premium to keep the policy in force. As you pay your premiums, a portion of each payment is placed in the cash value account. During the early years of the policy, the cash value contribution is a large portion of each premium payment. As you get older, and the true cost of your insurance increases, the portion of your premium payment devoted to the cash value decreases. The cash value continues to grow–tax deferred–as long as the policy is in force. You can borrow against the cash value, but unpaid policy loans will reduce the death benefit that your beneficiary will receive. If you surrender the policy before you die (i.e., cancel your coverage), you’ll be entitled to receive the cash value, minus any loans and surrender charges.

Many different types of cash value life insurance are available, including:

  • Whole life: You generally make level (equal) premium payments for life. The death benefit and cash value are predetermined and guaranteed (subject to the claims-paying ability of the issuing insurance company). Your only action after purchase of the policy is to pay the fixed premium.
    Universal life: You may pay premiums at any time, in any amount (subject to certain limits), as long as the policy expenses and the cost of insurance coverage are met. The amount of insurance coverage can be changed, and the cash value will grow at a declared interest rate, which may vary over time.
    Variable life: As with whole life, you pay a level premium for life. However, the death benefit and cash value fluctuate depending on the performance of investments in what are known as subaccounts. A subaccount is a pool of investor funds professionally managed to pursue a stated investment objective. You select the subaccounts in which the cash value should be invested.
    Variable universal life: A combination of universal and variable life. You may pay premiums at any time, in any amount (subject to limits), as long as policy expenses and the cost of insurance coverage are met. The amount of insurance coverage can be changed, and the cash value goes up or down based on the performance of investments in the subaccounts.
    With so many types of life insurance available, you’re sure to find a policy that meets your needs and your budget.

Choosing and changing your beneficiaries
When you purchase life insurance, you must name a primary beneficiary to receive the proceeds of your insurance policy. Your beneficiary may be a person, corporation, or other legal entity. You may name multiple beneficiaries and specify what percentage of the net death benefit each is to receive. If you name your minor child as a beneficiary, you should also designate an adult as the child’s guardian in your will.

Review your coverage
Once you purchase a life insurance policy, make sure to periodically review your coverage–over time your needs will change.

If you should have any questions, please don’t hesitate to give us a call.

Questions or Comments?
You can add comments on the blog, call 919-847-2981, or visit our web site. We look forward to hearing from you.

Mark Vitek, CPA/PFS, CFP®
…until next week.

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Retirement Annual Income

Posted on February 23, 2011 by taxblogger

Money Tip of the Week:  Investment Planning Series, Part 3 of 3
February 23, 2011 | No. 31

How Much Annual Income Can Your Retirement Portfolio Provide?

Your retirement lifestyle will depend not only on your assets and investment choices, but also on how quickly you draw down your retirement portfolio. The annual percentage that you take out of your portfolio, whether from returns or the principal itself, is known as your withdrawal rate. Figuring out an appropriate initial withdrawal rate is a key issue in retirement planning and presents many challenges.

Why is your withdrawal rate important?
Take out too much too soon, and you might run out of money in your later years. Take out too little, and you might not enjoy your retirement years as much as you could. Your withdrawal rate is especially important in the early years of your retirement; how your portfolio is structured then and how much you take out can have a significant impact on how long your savings will last.

Gains in life expectancy have been dramatic. According to the National Center for Health Statistics, people today can expect to live more than 30 years longer than they did a century ago. Individuals who reached age 65 in 1950 could anticipate living an average of 14 years more, to age 79; now a 65-year-old might expect to live for roughly an additional 19 years. Assuming rising inflation, your projected annual income in retirement will need to factor in those cost-of-living increases. That means you’ll need to think carefully about how to structure your portfolio to provide an appropriate withdrawal rate, especially in the early years of retirement.

Conventional wisdom
So what withdrawal rate should you expect from your retirement savings? The answer: it all depends. A seminal study on withdrawal rates for tax-deferred retirement accounts (William P. Bengen, “Determining Withdrawal Rates Using Historical Data,” Journal of Financial Planning, October 1994) looked at the annual performance of hypothetical portfolios that are continually rebalanced to achieve a 50-50 mix of large-cap (S&P 500 Index) common stocks and intermediate-term Treasury notes. The study took into account the potential impact of major financial events such as the early Depression years, the stock decline of 1937-1941, and the 1973-1974 recession. It found that a withdrawal rate of slightly more than 4% would have provided inflation-adjusted income for at least 30 years. More recently, Bengen used similar assumptions to show that a higher initial withdrawal rate–closer to 5%–might be possible during the early, active years of retirement if withdrawals in later years grow more slowly than inflation.

Other recent studies have shown that broader portfolio diversification and rebalancing strategies also can have a significant impact on initial withdrawal rates.  In an October 2004 study (“Decision Rules and Portfolio Management for Retirees: Is the ‘Safe’ Initial Withdrawal Rate Too Safe?,”Journal of Financial Planning) Jonathan Guyton found that adding asset classes such as international stocks and real estate helped increase portfolio longevity (although these may entail special risks).

A still more flexible approach to withdrawal rates builds on Guyton’s methodology (“Using Decision Rules to Create Retirement Withdrawal Profiles,”Journal of Financial Planning, August 2007). William J. Klinger suggests that a withdrawal rate can be fine-tuned from year to year, using Guyton’s methods but basing the initial rate on one of three retirement profiles.

Inflation is a major consideration
For many people, even a 5% withdrawal rate seems low. To better understand why suggested initial withdrawal rates aren’t higher, it’s essential to think about how inflation can affect your retirement income.

Here’s a hypothetical illustration; to keep it simple, it does not account for the impact of any taxes. If a $1 million portfolio is invested in a money market account yielding 5%, it provides $50,000 of annual income. But if annual inflation pushes prices up by 3%, more income–$51,500–would be needed next year to preserve purchasing power. Since the account provides only $50,000 income, an additional $1,500 must be withdrawn from the principal to meet expenses. That principal reduction, in turn, reduces the portfolio’s ability to produce income the following year. In a straight linear model, principal reductions accelerate, ultimately resulting in a zero portfolio balance after 25 to 27 years, depending on the timing of the withdrawals.

Market volatility and portfolio longevity
When setting an initial withdrawal rate, it’s important to take a portfolio’s ups and downs into account–and the need for a relatively predictable income stream in retirement isn’t the only reason. According to several studies in the late 1990s by Philip L. Cooley, Carl M. Hubbard, and Daniel T. Walz, the more dramatic a portfolio’s fluctuations, the greater the odds that the portfolio might not last as long as needed. If it becomes necessary during market downturns to sell some securities in order to continue to meet a fixed withdrawal rate, selling at an inopportune time could affect a portfolio’s ability to generate future income.

Making your portfolio either more aggressive or more conservative will affect its lifespan. A more aggressive portfolio may produce higher returns but might also be subject to a higher degree of loss. A more conservative portfolio might produce steadier returns at a lower rate, but could lose purchasing power to inflation.

Calculating an appropriate withdrawal rate
Your withdrawal rate needs to take into account many factors, including (but not limited to) your asset allocation, projected inflation rate, expected rate of return, annual income targets, investment horizon, and comfort with uncertainty. The higher your withdrawal rate, the more you’ll have to consider whether it is sustainable over the long term.

Ultimately, however, there is no standard rule of thumb; every individual has unique retirement goals, means, and circumstances that come into play.

Don’t forget that all these studies were based on historical data about the performance of various types of investments, and that past results don’t guarantee future performance.

If you should have any questions, please don’t hesitate to give us a call.

Questions or Comments?
You can add comments on the blog, call 919-847-2981, or visit our web site. We look forward to hearing from you.

Mark Vitek, CPA/PFS, CFP®
…until next week.

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