Use Caution When Borrowing from Your 401(k)

Many people who need a loan, turn to their 401(k). Although this is tempting, there are potential pitfalls that can really mess things up for you.  Here is a short discussion of the loan characteristics.

Loan Generalities:
Specifics of the loan are determined by your plan administrator. However, here are some general loan characteristics. Usually, there is a loan initiation fee, less than $100. For most loans, the term is 5 years. But, there is an exception if you are purchasing a house as your main residence, the term is longer.

You can borrow up to $50,000 or 50% of your vested balance, whichever is less. However, there is a 12 month look back period that can reduce the new loan amount by the highest balance of the previous loan.  There may be a minimum loan amount; the plan administrator does not want to be processing $100 loans.

What’s Good About It?           

In essence, you are borrowing from yourself. The interest that you are paying is going into your account. Also, the loan does not show up on your credit report (maybe good or bad).  If you meet the loan requirements, it’s pretty much a guarantee that you will get the loan.  Usually, there is no talking to a loan officer to qualify. In many cases, everything is handled online.

What’s Bad About It?

Like most loans, problems arise when you can’t pay off the loan. However, a 401(k) loan has some additional “thorns”.

If you leave your job, for any reason, you have 60 days to repay the loan in full. If you don’t, the loan becomes a distribution. This means that you are going to owe income tax on the loan balance. And, if you are under 59 ½, you will probably be assessed a 10% penalty on the balance. In a worst case scenario, you lose your job, you can’t pay back the loan, and you owe taxes and penalties on the loan. These are extra bills at a really bad time.

Remember, you are removing money from your investments. So you are losing a potential capital appreciation.

From an income tax standpoint, there are some subtle negatives. When you pay back the loan you have to do it with post-tax funds. So that post-tax money gets into you pre-tax 401(k). And, when you finally start taking distributions during your retirement you will be taxed again on that post-tax money that you paid back the loan with. So, you've kind of paid tax twice on the loan.

Brycast Financial Planning in Austin Texas --- We Can Help
Income Tax Preparation in Austin Texas
contact: service@brycast.com http://www.brycast.com/
Enrolled Agent; Investment Advisor

What Impacts Your FICO Score?

If you are like most people you’re concerned about your credit score, aka FICO score.  The score ranges from 300 to 850, with the average being about 720. A FICO score is composed of 5 data categories, with 2 categories representing 65% of the impact on the score.

Payment History:

This is number 1 in terms of importance, impacting 35% of your score.  There are many items in this category like bankruptcies, liens, late payments, amounts past due, accounts in collection, etc. In the end, you can have a positive impact on your score just by making your payments on time.

Amounts Owed:

This is a close 2^nd, impacting 30% of your score.  It has to do with how many people you owe, as well as how much you owe them. It also considers how close your credit is to being “maxed out”. You can have a positive impact on your score by not having too many loans, keep the balances low, and stay well below your credit limit.

Length of Credit History:

This is a distant 3^rd, impacting 15% of your score.  It has to do with how long accounts have been opened and the time since the most recent activity. The longer your credit history, the better it is for you.

  

New Credit:

In 4^th place is New Credit, with a 10% impact.  It looks at the number of recently opened accounts, the number of credit inquiries and time since. Also, re-establishing positive credit history following past payment problems helps your score.

Types of Credit Used:

This also impacts your score by 10%. It has to do with the types of accounts you have. For example, loans like a mortgage, credit card, and installment loan.

You can visit the FICO website, www.myfico.com, for more information.

 

Brycast Financial Planning in Austin Texas --- We Can Help
Income Tax Preparation in Austin Texas
contact: service@brycast.com http://www.brycast.com/
Enrolled Agent; Investment Advisor Representative

Not Married & Splitting Up ---- Watch Out, You May need a Divorce

If you live in Texas, you probably know about common law marriage.  It is a way to become legally married, without going through a legally recognized ceremony. Although today there are over 20 million people in the State, the area is huge and still sparsely populated in the west and panhandle. You can imagine that 100 years ago it took a long time for a circuit judge or a minister to make his way across the state and marry eager couples.  To fill in the gaps, Texas allows a common law marriage. There are myths around what constitutes a common law marriage. In Texas, there are 3 elements that create the common law marriage.

1)      You must have agreed to be married

      2)      You must have held yourselves out as husband and wife.
      3)      You must have lived together in Texas as husband and wife.

You must satisfy all 3 elements.  If you do and are splitting up, you may want to consult an attorney and see if you need a formal divorce.  For the Texas Q&A on the topic, refer to FAQ.     

Brycast Financial Planning in Austin Texas --- We Can Help
Income Tax Preparation in Austin Texas
contact: service@brycast.com http://www.brycast.com/
Enrolled Agent; Investment Advisor Representative

Well Qualified Buyer

If you've ever seen a car sales commercial, they often end by saying a finance rate of X%, for “well qualified buyers". If you aren’t considered to be well qualified, you’ll have to pay a higher finance rate.  Why is that?

Let’s say you know two people, both of whom want to borrow money from you. Person A is really reliable. She has a high paying job, and has worked for the same company for over 10 years. She always pays her bills on time, and does not owe very much money.

Person B is pretty much the opposite of A. He just started a new job and doesn’t make very much money. You know that he is often late making payments, and some loans were never paid off and went into collection.

You see that there is a higher risk that person B won’t pay you back, compared to A. So, if you lend money to B you would want to be compensated for the higher risk of him not paying you back or making late payments.

That compensation comes in the form of the loan's interest rate. Lenders view you as a risk.  The higher risk you are, the higher the finance rate you’ll be charged.  So if you want the best finance deals available, pay your bills on time, and don’t owe much money.

Brycast Financial Planning in Austin Texas --- We Can Help
Income Tax Preparation in Austin Texas
contact: service@brycast.com http://www.brycast.com/
Enrolled Agent; Investment Advisor Representative

Eating Out, But Can’t Seem to Save Money?

Eating out is a lot more fun to do that putting your money in a savings account. Usually, all you have to do is sit down, look at the menu and order whatever you want. The food is normally delicious, and didn't require that you put any effort into its preparation. What's not to like?

One of the things I've seen is that most people don't realize how much they spend on eating out. If you use a credit card to pay for your meals, look at your credit card statements for the last three months and add up amounts paid to restaurants. Multiply by 4 to get an estimate of how much you spend in a year.

Is the number impressive? I'm not asking you to stop eating out, and put all of that money in a savings account. It may work in the short-term, but eventually you may return to your old ways. But, you should ask yourself if you can reduce your restaurant bill by either limiting the number of times you eat out, or by setting a "dining out" budget.

If you find that you are averaging $200 per month, try setting a budget of $180 per month and putting the $20 in a savings account. After a year, you'll have an additional $240 in your savings account.

Brycast Financial Planning in Austin Texas --- We Can Help
Income Tax Preparation in Austin Texas
contact: service@brycast.com http://www.brycast.com/
Enrolled Agent; Investment Advisor Representative

Trying to Hit a Moving Target -- Estate Planning

It would seem that estate planning would be easy, right? After all, events in your life should have calmed down by then. Well, unfortunately Congress has other ideas. Estate Tax laws seem to change frequently, making it hard to put together an efficient estate plan.
For people dying in 2010, there was no estate tax (if they opted for this treatment). If they had died in 2009, estate assets over $3.5 million would have been taxed at a 45% rate. For 2011, the exemption amount is $5 million, and more importantly $10 million for married couples. Also, the maximum tax rate is 35%.
How can you setup an estate plan when the rules keep changing? Well, mimic NASA. You do all of your calculations with the most accurate information you have, and launch. And just as important, you make periodic adjustments along the way.
There is no way to know what the estate tax laws will be when you die.  Estate tax laws seem to change yearly, and you probably don’t know when you are going to die. By the way, you’re personal situation could be entirely different several years from now (more kids, married, divorced, etc.).
So, set up a good estate plan today, but revisit it regularly. And talk to financial advisor about the need to alter your estate plan.
Brycast Financial Planning in Austin Texas --- We Can Help
Income Tax Preparation in Austin Texas
contact: service@brycast.com http://www.brycast.com/
Enrolled Agent; Investment Advisor Representative

Are You New to Owning a Home? Consider Itemizing Your Deductions.

If it is you first time owning a house as your main residence, you may not know about some deductions that you can take on your tax return. If you took out a loan to buy your house, then the interest paid on that loan is deductible, up to a limit. If your filing status is NOT married filing separately, and the loan is $1 million or less, the full amount of interest paid in the tax year is deductible. Real estate taxes, loan origination points, and mortgage insurance premiums may also be deductible.

If you are under 65 and your filing status is married filing jointly, then your standard deduction for tax year 2011 will be $11,600. Your itemized deductions could easily exceed the standard deduction and conequently reduce your tax bill.

Brycast Financial Planning in Austin Texas --- We Can Help
Income Tax Preparation in Austin Texas
contact: service@brycast.com http://www.brycast.com/
Enrolled Agent; Investment Advisor Representative