Advanced Personal Finance

I got a mailing from T. Rowe Price the other day and an article in it discussed strategies for drawing down retirement assets. Basically, it recommended using taxable accounts, tax-deferred accounts, and tax-free accounts in that order to fund your retirement. This is actually a pretty complicated subject (and one that I won’t have to actually worry about for a long time). Having read the article, I’m not sure I agree and I have lots of questions about their reasoning.

They wrote you should use taxable accounts first because they are not sheltered from taxes. So what? Ok, it’s possible that if you use an actively managed fund, you’re going to have a lot of capital gains you have to pay taxes on. But assuming you use index funds and reinvest dividends and gains, these should be negligible. Besides, if you have substantial taxable investments, some of the shares of the funds you own could have a capital loss associated with them. With detailed and careful tax planning, you could reduce your taxable income by selling them while still providing you with actual cash to live on.

Next they recommend cashing out tax-deferred accounts. I understand with these that there are rules that dictate when you start drawing these down. For example, you have to start taking required minimum distributions from traditional IRAs by the time you are 70 1/2. I guess it makes sense you’d save these because the earnings keep compounding tax-deferred.

Finally, the say to use tax-free accounts. Again I’m not really sure why except that the earnings are tax-deferred (and tax-free) and you don’t ever hit a required minimum distribution for Roth IRAs (you do for Roth 401(k)s).

On balance, I’d think a combination of tax-free and taxable accounts might make more sense. This would assume you don’t plan on leaving a large estate to posterity that you’re keeping in Roths. With this strategy, you could mitigate the tax bite but still have plenty of cash to live on. I’m sure I’m not seeing something here, but like I said, I won’t be worrying about this for a long time.

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If you own a home, it’s virtually guaranteed you have insurance to protect the dwelling and your possessions from loss. I say virtually because technically you could drop your coverage once you own your home outright. You’d be an idiot, but you could do it. What’s not virtually guaranteed is that you’re insured if you’re renting. This is a commonly overlooked aspect of personal finance for renters.

Renters insurance is a policy to protect your possessions from loss. But it’s also insurance for you from liability should anyone get hurt while in your home. This is important to understand. When someone comes into your dwelling, whether it’s rented or owned, they become your responsibility in a sense. If your dog bites them, it’s your fault. If they trip on their own shoelaces, it’s your fault.

The most common reason to buy renters insurance, of course, is to insure your stuff. Don’t overlook this insurance if you rent. Make sure that you have ample coverage and take a look at exclusions or limitations in coverage. For example, typically jewelry is capped at some low amount like $1,000. If you want coverage over that, make sure you buy a rider; they’re inexpensive. Other common exclusions are electronics and collectibles.

Just like homeowners insurance, it’s a good idea to document room-by-room what you have in as much detail as possible. I’m bad at this. I still haven’t done this and we’ve lived in our house for seven years now. (Memo to me…memo to me)

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Holy crap! Bankrate.com has an article by Elizabeth Razzi about peoples’ knowledge of their mortgages. Some of the highlights:

“In the survey conducted by Gfk Roper, homeowners with mortgages were asked what type of mortgage they had. A stunning 34 percent of the homeowners had no idea.”

What?!? How do you owe hundreds of thousands of dollars and not know the terms under which you borrowed that money?

Wait. There’s more…

“Homeowners in the poll who knew they had an adjustable-rate mortgage (ARM) were asked what they planned to do when the interest rate adjusts, 34 percent said they didn’t know what they’d do.”

They had no plan whatsoever. None.

And check out the rest of the chart. Two percent are going to get another ARM and 36% are going to refinance into a fixed-rate. How is refinancing into a fixed-rate going to help? If you do that, you’ll be paying current rates, which are in the neighborhood of your reset ARM. That’s assuming you can refinance. But I suppose that’s not an issue since in this day and age, someone is going to loan you the money regardless of what your situation is.

“Nationally, 28 percent said they worry either regularly or sometimes about how they will afford their payments.”

Again, wow.

Finally, there’s this quote regarding who is least likely to worry about making their payment. “It’s not necessarily the richest households. The most sanguine were those earning between $40,000 and $49,900 per year. Nearly 70 percent say they never worry about payments, a rate even higher than the top earners. Just under 60 percent of those earning more than $75,000 per year say they are free from worry about making housing payments.”

I find this interesting because it reinforces the idea that regardless of your income, it’s what you keep that makes you wealthy. Obviously, the well-off are not immune to excess or poor choices when it comes to mortgages. Those proficient at earning money aren’t necessarily good at managing it.

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What could possibly be more fun than a post about auto insurance, right? Well, if you own a car, there might be some things you want to look at on your auto insurance policy. This is the first of a three part series on auto insurance. In part one, we’ll take a look at the liability section; part two deals with personal injury protection; part three covers collision, comprehensive and the add ons.

Part I: Liability
There are three parts to the liability section: bodily injury, property damage, and uninsured motorists.

Bodily injury compensates the driver of the other vehicle and any passengers (in either vehicle) in the event of an injury-inducing accident. It comes in standard increments (e.g. $100,000/$300,000). The first number refers to the maximum amount each person could be compensated; the second is the maximum per accident.

The bodily injury coverage you should select is a function of your assets. In the event of an accident, the injured party can sue you (even if the accident wasn’t your fault) and judgment can be as high as your available assets. The insurance actually pays that money out if the injured party wins up to the cap you’ve paid for. So if you have $25,000 in a mutual fund and a house worth $250,000, you should have higher coverage than if you just got out of college and have $1,000 saved and rent. Just about everyone with any sort of assets should choose at least 100/300 coverage.

Property damage works similarly. Coverage of $50,000 per accident pays to repair or replace property (other than your own) damaged as a result of an accident caused by you up to the $50,000 maximum. What’s worth noting on this is that if you get low coverage, you’d be responsible for paying any damage over and above your coverage out of pocket. For example, if you hit a late model Mercedes and have minimal property damage coverage, you could be on the hook for part of the repair bill.

Uninsured motorist coverage, as the name implies, pays for medical bills and property damage if you’re hit by an uninsured or hit-and-run driver. This insurance covers you and your passengers. Things to consider when choosing your level of coverage are whether you have good health insurance from another source (there’s no need to insure twice) and the high cost of any out-of-pocket medical treatment.

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Mrs. KMC just started a new job and as part of the usual new job hassles, she had to sign up for benefits. We decided to keep my health and dental, but she also had the opportunity to take advantage of Flexible Spending Accounts (FSAs).

Flexible Spending Accounts

FSAs are great. If your employer offers them, take advantage of them. Here’s how they work. The company takes money out of your paycheck pretax (in the amount you designate, of course) for health care spending and dependent care. Later, you file for reimbursement of a covered expense and get a check.

How they work

We pay $800 per month for our daughter to attend daycare, so this is an opportunity to save money. You can have them deduct up to $5000 before tax. You just get your daycare provider to verify you spent the money with them (they provide tax ID and a signature), fax the form in, and get money back. My work also does this and even deposits the money into our checking account electronically. Pretty sweet.

Important note: the total amount you can put into an FSA is $5,000 for the household.  If both spouses have access to the plan, the total must be $5,000 or less for the year.

The health care version works similarly. Fill out form. Provide receipts. Fax form in. Get money.

The beauty part is that since the deduction comes out pretax, your out-of-pocket dependent and health care expenses aren’t costing you quite as much as they normally would. In other words, our $800/month daycare bill is costing us somewhat less than that in point of fact.

There is, of course, a catch. Because you have to determine at the beginning of the benefits year how much you want deducted over the course of the year, you may get the deduction wrong. If you have too little deducted compared to your actual expenses, no big deal. But if you have significantly more deducted than you actually spent, you’re in trouble because FSAs work on a ‘use-it-or-lose-it’ basis. If you don’t accrue expenses up to your deduction amount, you lose the remainder. However, don’t confuse accruing the expenses with filing for reimbursement. You’re typically allowed to file for reimbursement for a few months after the calendar year end (company policies vary). You shouldn’t be too worried about this, though, because you’d be amazed at what you can file for reimbursement. Over-the-counter drugs, glasses, Lamaze classes, rehab - they’re all covered (again, check your plan specifics).

One last thing to note about FSAs. You can typically change your deductions only under certain circumstances. For example, if your spouse loses his job, you can make changes. These ‘life events’ vary by plan.

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