Flexible Spending Accounts will save you money

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.

Inflation – Who Wins, Who Loses

Who wins and who loses when inflation shows itself? It’s a question that at first might seem pointless or even stupid. Inflation sucks for everyone, right?

Not so fast. It turns out, inflation is good for some and bad for others. It doesn’t affect everyone equally. People usually focus on the bad, I think, because we tend to focus on the cost of things we buy frequently. When a gallon of milk cost $2.69 a month ago and now costs $2.99 – that’s inflation and it’s bad.

Who wins with higher inflation:

  • People with fixed-rate loans. People with fixed-rate loans like mortgages and car loans enjoy a benefit when inflation rises. If you think about it, they’re paying off their loan with dollars that are worth less than the ones they borrowed. Assuming you do something productive (like buy a house) with the money you borrowed, you benefit from higher inflation.
  • Companies that produce ‘expendables.’ When inflation rises, it makes sense to spend money as fast as you can. You get more product today than you will tomorrow. So any company that makes a product that is non-durable is going to do better than one that produces something people buy infrequently, especially if demand is elastic.
  • The U.S. government. Ah, yes, the originators of inflation. As I explained in an earlier post, the Fed generates inflation through its creation of money. As the biggest borrower ever, it is the ultimate beneficiary of inflation. As inflation rises, the federal government pays less in ‘real’ money to cover its debts.

Who loses:

  • Those on fixed incomes. Anyone who is paid a fixed amount of money will get killed during periods of high inflation. Even if their payment is indexed to inflation, the reset typically only comes once or twice a year.
  • Lenders and savers. Inflation pinches lending for the reason cited above. And anyone who actually saves money will also be hurt as their purchasing power erodes.
  • First time home buyers. Anyone trying to get a loan faces a key obstacle during periods of high inflation. Interest rates will be higher as lenders attempt to get compensation for the inflation risk. This alone can price people out of the market for a new home.

So though at first it seems like a silly question, inflation most definitely affects people differently. The biggest losers are those on fixed incomes and the biggest winner is the U.S. government.

New Baby Financial Checklist

New babies get people thinking in a lot of different ways. Some anticipate with nervous excitement; some with flat-out fear, some anticipate the arrival of their baby with utter exuberance. Personal finance issues probably aren’t among the first thoughts.

Since we’ve gone through this, I can honestly give some personal advice. Some of these things we learned the hard way. Some we actually did right. It’s always helpful to learn from someone else’s mistakes, so if you’re in the market for a new person, have a look.

Pre-baby

  • Check your medical insurance. Just polling friends, it’s amazing the range of coverage different plans provide. For our daughter’s birth by planned C-section, insurance paid for everything. Well, there was the $10 charge to have a phone in the room (Huh?). Look for what’s covered prenatal, for the actual delivery, and for post-delivery well baby visits – copays, deductibles, the usual stuff.
  • Visit hospitals. The nearest hospital isn’t necessarily the one where you want to have a baby. Do some research and go on tours.
  • Buy life insurance. You’ll now have a true dependent – somebody who must count on you for everything. Everything costs money these days. Even if you’re not around, it still needs to get paid for.
  • Check your benefits. If you’re adopting, lots of bigger companies (and some small ones) offer adoption assistance, sometimes a significant amount of money. If you’re doing it the old fashioned way, check with HR about FSAs, paid/unpaid time off, and short term disability.
  • Tell your boss. This is a sensitive subject for women, and I’m not a woman so I’ll just say at some point, your boss needs to know what’s going on. For me, I needed to tell my boss and coworkers because of unpaid time off to help after the birth.
  • Start saving for college. Think I’m joking? I’m not. The cost of college has been far exceeding inflation. We started saving only a few months into the pregnancy in a 529 plan. You name yourself as the beneficiary and when the little bundle gets a name, it’s a simple paperwork change.
  • Start researching child care, if appropriate. If you both plan on going back to work, you need to have arrangements for baby care. Daycare slots for newborns/infants are notoriously difficult to find.
  • Save money. Lots of it. If this is your first, you have no idea how many diapers you’ll go through. No idea.
  • Buy baby stuff. I’m not going to lie – you’ll want to buy baby stuff. Try to restraint yourself, though. I’m chagrined to say we have one child and, at last count, five strollers. We have a stroller for all occasions. Honestly, though, we didn’t know what to look for in a stroller. You’ll find out, too.

Post-baby

  • Tell the medical insurance company. You’ll want to put your new baby on your plan right away. Depending on the plan, you’ll have a certain amount of time to do this, but don’t put it off. The doctor visits for shots start at one month.
  • Get (or update) a will. Even if you have little in the way of assets, you’ll want to do this. That life insurance you bought needs a place to go if you die.
  • Decide on a guardian. Should you and your spouse both die, you need to have someone set up to raise your child in your place. Oh, yeah, and don’t forget to tell the person you select. Very important.
  • Get a Social Security Card. A lot of hospitals will start this process automatically and/or give you the paperwork to take home. Just make sure it gets done. The turn-around on the actual card was surprisingly fast for us, by the way.
  • Finalize child care.
  • If returning to work, make contact and arrange for return. Your boss will need to know your plans as far as date of return, new hours, limited schedule, or other restrictions. Some workplaces are definitely not parent friendly. Those places suck. If your boss is not helpful on this now, you’ll likely run into issues later when you have to stay home with a sick child or leave early because their school is closing early because of snow.

Oh, yeah, enjoy your new baby. That’s important, too.

The Personal Finance Lifecycle

You can definitely break down personal finance concerns by age. Things that are important when you’re 22 become trivial at 55. Your key concern at 65 isn’t the same one you had at 45.

As another birthday passed, I started thinking about how those things break down. Obviously, not everyone will have all of these things happen during the time-frame I show (or at all, for that matter).

20 to 30

  • Graduate from college and start repaying loans
  • Get first ‘real’ job
  • Buy first car and insurance
  • Rent an apartment
  • Get first credit cards and learn how to deal with them (or not)
  • Marry? Have a baby? Buy a house? Maybe you even manage to save something

31 to 45

  • Have kids and watch them grow up too fast
  • Get a will
  • Learn about and buy life insurance
  • Buy a house
  • Start saving for college
  • Try to fund an IRA and 401(k) in between orthodontist bills and piano lessons

46 to 55

  • Holy crap! College tuition is just around the corner (or here already)
  • The thought of retirement gains in importance and you try to ramp up saving

56-65

  • The kids are out of the house
  • The mortgage is paid off
  • These are prime earning years, and you’re able to save serious money for retirement
  • Look into long term care insurance

65+

  • Come up with a retirement fund withdrawal strategy
  • Settle in to retirement
  • Begin to think about estate planning

AMT Fix Could Delay Your Refund

I’ve read two articles in as many days about the Alternative Minimum Tax (AMT) and how it’s fix might delay refunds for everyone due one. Whether you are affected by the AMT or not, if a fix doesn’t pass soon, you’ll likely have to wait months for your refund.

The AMT ‘fix’

The back story is that the AMT, originally designed to make sure the very wealthy pay at least some tax is, in a word, broken. As the law was written, it wasn’t indexed for inflation. As a result, more and more people are falling into the AMT’s clutches every year.

Our far-sighted federal government annually does what it is best at and dodges the issue temporarily. That is, they pass a one-year fix, each year. This year’s no exception.

The problem is they’ve taken the issue up so late in the year. The IRS has to program computers and print forms based on the current tax code. If that code isn’t set, they either have to delay that work or redo it when changes are made.

The upshot of all this is that if a compromise on the AMT is not reached very soon (like, mid-December soon), it’s likely every U.S. household due a refund will have to wait months to get it.

Don’t rush to file

So you probably shouldn’t be in a hurry to file your 2007 tax return, even if you’re owed money. If you do file early (like most due a refund do), it’s entirely possible you’ll have to file again – this time filing an amended tax return, a 1040X.

I’ve had to file a 1040X before and it’s a pain. The form is short enough and it’s not especially difficult to understand. It’s just that I absolutely hate having to do something twice. I’m not sure if this is still the case, but the year I had to file a 1040X, I had to do so on a paper form, even though I’d filed electronically.
For me, I think I’ll just keep an eye on the situation and, if necessary, file later than usual once the dust settles. Grrr.

No – It’s Not a Buying Opportunity

There’s something I hate even more than a 5% drop in the S&P 500 in one week. It’s any mention of this being “a buying opportunity.” No – it’s not a buying opportunity, it’s a serious, sharp loss. And it hurts.

I hate all the platitudes and cliche phrases that inevitably get slung around when there’s a sharp drop in stocks.

“It’s alright. I’m a long-term investor.” Yeah, so am I and my long-term investments just lost 5%.

“It’s a buying opportunity.” So why wasn’t it a buying opportunity four months ago when the price was even cheaper? Somehow that wasn’t a good point to buy?

“The market was overvalued. A correction was needed.” Who says it was overvalued? And why does that mean a correction is somehow inevitable? My portfolio certainly didn’t feel ‘overvalued’ to me. I didn’t need a correction.

“If you dollar cost average, this is a good thing.” If your assets go down in value, it’s not a good thing.

“Now I can pick up some bargains.” And how are you buying these bargains? With money you kept out of the market, presumably. So if you’re such a long term investor who ignores market drops, why did you have money sitting around not in the market?

I’m not complaining about the market drop and I never will. That’s how the game is played. I’m comfortable with my risk exposure. But spare me the talk about what a good thing a sharp market drop is.

Businessweek – the perfect contrary indicator?

I was reading the cover story of the latest issue of BusinessWeek about a steel company named Arcelor Mittal. I’d never heard of Arcelor Mittal before and it was a fine article. It was glowing in its praise of the company and, more specifically, it’s father-son CEO-CFO combo. It got me thinking, though, about a theory of mine.

I believe a cover story in BusinessWeek is either the kiss of death (for apparently healthy companies) or the breath of life (for a struggling one). I believe it’s as close to the perfect contrary indicator as you can find. If BusinessWeek writes a positive story on a company, watch out.

Consider but a few examples I found in 10 minutes of searching:

  • Home Depot – “Renovating Home Depot,” (3/6/2006) a glowing piece about tough-guy Nardelli. That was followed up less than a year later by this cover story, “Blowup at Home Depot,” (1/15/2007) a damning piece about too-tough-guy Nardelli.
  • Martha Stewart Living – “Martha Inc” (1/17/2000), an unrelentingly positive story preceeding a tremendous fall three years later.
  • Amazon – The breathless “Amazon.com: the wild world of E-commerce,” (12/14/1998) some year and a half before the equally dark “Can Amazon Make It?” (7/10/2000).
  • Boeing – CEO Phil Condit on the cover with the story “Booming Boeing” (9/30/1996). Though it appears to now be coming back, Boeing was on the ropes until recently.

It seems that, roughly speaking, if your company is on the cover of BusinessWeek, you have about two years to find a new job. This is a great reason to ignore the noise of the financial media.

How Real Returns Get in the Way of a Good Plan

Projecting investment returns is a common and useful thing to do when planning for retirement or any long-range goal. Having a plan is important.

It’s just not always very realistic.

When talking about market returns, most online calculators and simulations use some given rate of return. Many times, the calculator will default to 8% or something similar. Lots of times, people will put in 10% (the commonly cited return for a stock portfolio). Out comes your result – you’ll have $5 Gazillion after 30 years.

But real markets don’t work that way. Some years they’re up, some they’re way down. Volatility is the neglected factor in most all online calculators. I decided to do a quick simulation of what the effect of volatility might be.

Below are two tables showing how $200 invested monthly compounds. The table on the left shows a steady 10% return. The table on the right uses actual historical S&P data. The difference in balances is shown in the cell in bold.

So we see that assuming a constant 10% return overstates the balance by $6,894. My point is that it’s important to understand the effect of volatility on a savings plan. The real market doesn’t return 10% (or any other percent) year after year.

More TIPS

I wanted to write a bit more about TIPS (Treasury Inflation-Protected Securities) and a peculiar tax treatment quirk they have. As you recall, TIPS have an underlying rate and an inflation-adjusted rate added on top. Because they’re inflation-adjusted though, if you don’t hold them in tax-deferred accounts, you could be hit with a rather insidious tax issue.

You’re taxed on the income from your bond. If inflation is low, your apparent income, and thus taxes, are low. However, if inflation is higher, you will have an apparently larger income from the bond even though your real (after-inflation) rate of return is the same as before. For example, say you have a TIPS with a nominal rate of 4% and inflation is running 4%. You’re getting paid 8%. Say you’re taxed on that in the 25% bracket. You’re really getting 6% after taxes and your real return is 2% after inflation. Now let’s say inflation rockets to 12%. Now you’re getting paid 16% nominally (but still 4% real). Now you’re only getting 12% after taxes (75% of 16%). After inflation, you’re not making a dime. Nice, huh?

This is sometimes known as the ‘tax on the inflation tax.’ And it’s another reason why you should keep TIPS in tax-deferred accounts.

Goodwill, Ebay, or Trash

Right now, we’re undergoing a junk purging at our house. It’s kind of liberating, in a way, seeing piles of stuff you no longer use or want going out of the house. I had a bit of a dilemma with it recently though. What do I do with all that crap?

To date, whenever we do this sort of thing, we’ve generally separated things into two piles – good enough to give to Goodwill and trash. Embarrassingly often, the ‘perfectly good enough to give to Goodwill’ pile is bigger by an order of magnitude. However, as I was getting rid of a batch today, I realized some of this stuff might actually be worth something.

The stuff in question was toys, specifically, ‘collectible’ dolls. I wondered, “would it be worthwhile to try to sell any of this stuff on Craigslist and/or Ebay?” I fired up the ol’ interweb and hit Ebay to find out. Turns out that, yes, some of this stuff was being sold and for half-decent coin.

Now I had a problem. I could either separate stuff into three piles – Goodwill, Ebay, trash, or I could continue with my two-pile system. Guesses what I did?

I stuck with two categories – Goodwill and trash.

Why? Simple – I did a quick calculation of how much time I’d spend selling the stuff compared to how much I’d make. There was no contest; it’s not worth it to me to take the time to sell it. I’ve never sold anything on Ebay, but I figured these would be the steps:

  1. Separate all this stuff.
  2. Take pictures of everything I wanted to sell.
  3. Create a listing with words and everything (me not so good with words).
  4. Start auction.
  5. Wait.
  6. Wait.
  7. Wait.
  8. Deal with person who won the auction (transaction, emails back and forth, etc).
  9. Go to post office, box and mail stuff.
  10. Repeat.

No thanks. I think I’ll just stick with giving it to Goodwill and taking a small tax deduction.

There’s probably a business in there somewhere. I give you my piles of possibly-salable crap, you sell it and keep a piece for yourself. Everybody wins I guess. There are probably people who do this already, though. I’m not a very creative person, so this idea’s probably being done.