How To Choose 529 Investments

Finance Gourmet on November 17, 2014

If you don’t already have a 529 plan opened, you should start with the instructions for opening a 529 plan before worrying about which investments you use. Trust me, when I tell you, as a former financial planner, that the biggest drag on saving money for college isn’t choosing the wrong investments, it’s taking too long to get started.

This is not an offer buy or sell securities. This entire article is for general informational purposes only and is not specific recommendations for you to buy, sell or invest. Only you understand your individual situation. Consult an investment or tax professional for advice specific to your needs.

529 Plan Investment Options

Every 529 plan has different investment options. Even within the same state, different plans will have different investment options. We’ll continue using the Colorado 529 plan Direct Portfolio option here as our example, but the concepts apply to any 529 plan option from any state. If you are curious about a specific stat’es 529 plan investments, leave a comment below, preferably with a link to the plan you are talking about, and I’ll take a look.

Like many 529 plans, the Colorado 529 Direct Portfolio offers different investment options including an age-based investment option.

529 college investment choice screen

Before we make a choice on this screen, notice the rules that you have to follow for choosing investments in this 529 plan. You can choose up to five total investment, and each investment must have a minimum of 5 percent allocation, and you can only use whole percentages.

Age-Based Option versus Choosing Investments in a 529 Plan

There are two main choices here. Beyond this screen there are more choices as well. The concept of age-based portfolios may be familiar if you have a 401k plan with age-based (or retirement date based) options. The idea is that with an age-based investment you can set it and forget it. As your child gets older and closer to college, the plan will automatically make your investments more conservative by increasing the amount of bonds in the portfolio.

Of course, I’m not a fan of forgetting about your money or investments, no matter how much autopilot you can use. However, if the investment part is stressing you out, just go this route. Again, you’ll lose a lot more ground by not getting started than you will by picking the wrong investments.

If you select Age-Based Options on this screen you’ll see three sub-options. You can be aggressive, moderate, or conservative. You can click the little “i” in the circle to read up on the choices. Typically, most experts will tell you that age-based investments are usually too conservative in the first place. Also, remember you are really going to need the investment growth to keep up with the rising cost of college unless you can contribute a lot of money to your child’s college savings.

In this case, the conservative option starts you at a 50/50 mix of bonds and stocks when your child is under age 5. That’s WAY too conservative to get you anywhere investing wise. Stick with Moderate or Aggressive. Frankly, the only way you really have a shot of getting enough investment gains to make it worthwhile is with Aggressive. Don’t worry, it gets more conservative the closer your child gets to college. If you just must have a safe portfolio for piece of mind, the conservative portfolio probably isn’t conservative enough. There will still be plenty of ups and downs even with that allocation. If you need safety, click the next button and select Money Market Portfolio for your funds. You won’t get any growth, but you won’t lose any money either.

If you select Blended and Individual Portfolios on this screen, it will expand to show the individual portfolios. You’ll notice you can also still use the age-based options just like a regular investment choice by allocating a percentage. In this way, you could do half age-based, and half-regular investment options just by making the percentages do what you want to do.

Choosing Your Own 529 Plan Investments

In this case, you’ll notice that the good people who run the Colorado 529 plan have decided to go all out in the cause of simplification. Your only investment choices are:

  • Aggressive Growth Portfolio
  • Stock Index Portfolio
  • Growth Portfolio
  • Moderate Growth Portfolio
  • Bond Index Portfolio
  • Conservative Growth Portfolio
  • Income Portfolio
  • Money Market Portfolio.

While these are simple names, they hide what is really going on. To find out, click the little i in the circle. In the little pop-up window, you’ll notice a section called “Investment Strategy.” This tells you what you are actually investing in. In the case of the Aggressive Growth Portfolio, the actual investment is 80% in Vanguard Total Stock Market Index Fund and 20% in Vanguard Total International Stock Fund. The Stock Index Fund invests only in the Total Stock Market Index Fund (no international). And so on…

529 aggressive growth investment

 

What Investments Should I Use for My 529 Plan?

Using the information form the descriptions, you can put together a portfolio based on your own risk tolerance and situation.

Now, as a former financial advisor, what I know, is that most people do not know what their risk tolerance is. They like risk when it leads to higher returns; they hate risk when it means they are losing money. Asking someone what their risk tolerance is, is like asking someone how important safety is to them. In the abstract, the answer is worthless.

Should you wear a helmet when riding a bike? When skiing? When driving? — Each yes represents a different risk tolerance. You would be safer in your car if you wore a helmet, and a five-point harness like race car drivers. Yet, you probably do neither. Don’t you care about your safety? Didn’t you say above that safety was very important to you? Of course you want to be safe, but it’s a real world choice you make based on what is going on at the time. Just saying you are safe, very safe, or extremely safe is all but nonsensical.

The same thing happens with investing risk. People say they are aggressive, then panic when they have a 20 percent loss. Other people say they are conservative, and then get angry when they have a 5 percent return in a year when more aggressive investors have a 15 percent return.

My official advice, is to figure out what is right for you while realizing that with time, the market always eventually recovers, and that most investment losses come from pulling out when the WORLD looks scary, not from when your risk tolerance changes.

Cheatsheet for 529 Investing

Right about now, you probably feel gypped. It said I was going to help you step by step and now I’m telling you to figure it out for yourself. You’re right. I have to. Otherwise, someone would sue, or something.

That being said, what I would tell a good friend (Not you, of course, you are a stranger. I would never make a specific recommendation to you. Of course, I can’t help it if you read along too…) is that you should be aggressive when your child is young. As long as you never withdraw your money, or change your investments in response to the market, you have plenty of time to recover.

Remember the super-duper Great Recession? Remember when Wall Street and sub-prime lending, and banking crisis, and so on and so forth led to the market taking a huge drop? Remember when the world was ending, and we would all never get our money back? Remember PANIC?!?

The time from when the drop started in about September, 2007 to when the S&P 500 made all its money back, about February, 2013 was a total of 5 1/2 years. In other words, in the biggest bust of our time if you left your money where it was, you got it all back in five years. Imagine how much shorter it could have been if Congress had actually helped. If a kid is four years old, that’s plenty of time to recover from a market drop.

The key is to leave your money. The way people lose money is by pulling out when it’s down. That locks in your losses.

 

stock market recovery

If you not only never took your money out, but you kept putting money in, you broke even a lot sooner, and were way ahead after 5 1/2 years. Why? Because you were buying low, below that line, all that time. That’s what it means to not time the market.

So, what I would tell a friend is, that they should use the Aggressive Growth Portfolio for 80% or more (even 100%) for their child’s 529 plan investment from age 0 until age 12. The rest should go in Growth. Then, they should switch to more in the Growth Portfolio (which is 75% stocks and 25% bonds) until they are 15. Then, switch to 50% Growth Portfolio and 50% Money Market. When you withdraw money, take it from the Money Market.

It would look like this when my friend signed up their 3-year old.

which 529 plan investments to use

What I really, REALLY emphasize to both you and my friend is that what will really matter over those years is consistently putting money in, every single month, or year, or whatever. In fact, the most important thing you can do for your 529 plan is to setup the automatic monthly investment direct from your checking account. Set it for the day after you get paid, or right when you pay your bills.

$100 a month for 15 years is worth a lot more than getting the investment allocation just right for some lower amount of inconsistent investments.

That gives my friend a solid chance to earn actual money on your investments over time while still dialing about the risk when it comes time to use the money.

Investing Advice

Here is the most important advice I can give you about investing for your kid’s college, or anything else. When I was a financial planner, I had two kinds of clients. The kind that signed up with me while the market was going up, and the kind that signed up with me when the market was going down. The former always thought I was doing a good job, even when the market did eventually go down in later years. The latter took much longer to ever trust me. Many left.

The reason is that when you start doing something and it goes up, it feels good. You will remember that, even when things start getting back. When you sign up for something and it starts going down, it feels bad. You will feel like you are doing it wrong, or like your new advisor is doing it wrong. Even when it comes back, you will have issues for a long time about it.

If you are lucky, your investments will increase in the first few years. By the time you start losing money, you’ll have the confidence that comes with losing your earnings, and not your principal. If that happens, great. You’ll be fine.

If you are not so lucky, you will start putting money in and it will decline in value. You’ll look at your statement and see that you put in $600, but it’s only worth $400. You’ll feel like this was a mistake. There will be an enormous temptation at this time to change your investments, or worse, stop investing, “until things get better.” This is the wrong move. Keep saving. Stick to your plan. Remember your time frame. Eventually, your returns will be higher, and you’ll be miles ahead for having kept saving than for pausing or quitting.

Either way, remember your time frame. That little one will keep getting bigger. When they start driving, re-evaluate. Start applying for loans and grants and scholarships. Help them out with that as well. Who knows, maybe you’ll be one of those very rare people who has to figure out what to do with left-over money in a 529 plan.

 

 

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Finance Gourmet on October 30, 2014

When it comes to saving money for college, there are a lot of options. A parents saving money for children’s college fund there are different ways to title those accounts, jointly or otherwise. Believe it or not, saving up money so your kid can go to college is a lot more about actually doing it, than how you do it. Most parents let a sizable amount of time pass in between college investments and that is a much bigger deal than exactly which kind of college savings account is right for you.

types college savings education planningWays to Save Money for College

Assuming you don’t want to stick money into a mattress, you are going to need some kind of bank account or other financial account to store up that money you need to save and invest. Here are the options.

529 College Savings Plans

If the 529 plan came first, there wouldn’t be so many other ways to save for college. It is, quite simply, the best possible way to invest for college for most people. A 529 college account works a lot like a Roth IRA plan for college. You don’t get a federal income tax deduction for your contributions, but the money you put inside grows tax deferred, meaning you don’t have to pay any capital gains taxes or taxes on interest earned. As long as you use the money for expenses at college or university, you don’t have to pay any taxes on the withdrawals as well. This is much better than coping with the difficulty of owing a few thousand dollars in taxes from selling investments to pay for school. Many states do give you a state income tax deduction for contributing and investing in a 529 plan. The limits for 529 plan contributions are also very high.

Coverdell IRA

The Coverdell IRA was a try at a tax-advantaged college savings account before the 529 plan was invented. It works in much the same way as the 529 plan. However, there are some major differences. The first is that contributions to a Coverdell IRA are limited to only $2,000 per year. Furthermore, it is only available to families with a modified adjusted growth income of $110,000 for filing individually and $220,000 for filing jointly. Transferring the money between different children is also much more difficult. However, the one advantage of a Coverdell IRA is that money from the account can be used for high school (and even elementary and middle school) education as well. In other words, this is a good way to save up for a prep school or private high school. Otherwise, the vast majority of families will be better off using a 529 plan.

Trusts UTMA UGMA and so On

Before there were 529 plans, people used trust accounts, typically a UTMA or UGMA account as a way to save for college with at least some tax advantages. Unless you are wealthy, there is no reason to go this route. Even then, a 529 plan often works better.

Regular Savings Accounts or Regular Brokerage Accounts

If you don’t want to open a specific college investing account, you can, of course, just open a regular savings account or regular brokerage account at the financial institution of your choice. There are two major drawbacks to this arrangement, and one advantage. First, someone has to pay the taxes on all interest and capital gains during the years you are saving money. This likely won’t be much at first, but if you end up building a nice chunk of money chances are that it either generates a fair amount of interest and dividends, or capital gains. Assuming you never sell any of your investments, you might get away with it for a few years. However, if you invested $10,000 and watched it grow to $30,000 over the years, you’ll owe at least 15 percent capital gains taxes on that $20,000 of growth as you withdraw the money.

You can help with the tax issues by putting the account in your child’s name, which brings us to the other big disadvantage of these accounts. While a 529 plans funds stay in control of the owner (you), that is not the case for a regular account unless it is held exclusively in your name (which means you are responsible for the taxes.) The nightmare scenario here is that your child joins a cult, turns 18 and wants to turn all the money over to them. The more likely scenario is that they buy a car, take a trip, or do something other than what was intended for the money.

Furthermore, unless you end up paying for the whole higher education experience, your child might be able to qualify for some student aid. Much student aid is calculated based on “need.” That need is calculated based upon a small percentage of the parent’s assets being used for college and a large percentage of the student’s assets being used. A big account in the name of the student will lessen the award of need based aid.

The one advantage of this kind of account is that there are no restrictions on what the money can be used for. The bad examples of that are above, but the good examples are that this type of account could be used for down payment on a house, a wedding, or to start a business.

Best Way to Save for College

Unless you have specific, well researched, reasons for using another type of account, open a 529 plan to save money for your child’s college education. Chances are very good that any disadvantages will be outweighed by the long-term advantages. But, remember, the amount you save matters more than where you save.

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Finance Gourmet on October 22, 2014

Saving money for college has always been an important financial goal for many parents. It is only becoming more important as college tuition continues to skyrocket, and stories of people buried under huge student loan burdens become more common. Before we jump into the nuances of the many different ways to save for college, let’s start with the basics.

How Much To Save For College

paying for college graduatesI’ve talked before about how hard it is to make a financial plan for retirement because of how many variables there are. You don’t know when you will start retirement, you don’t know how long you will live once you do retire, and you don’t really know how much money you will spend each year during retirement. Add it all up, and any retirement plan is a lot of guesswork.Fortunately, making a financial plan for education comes with a little more certainty to work with. For starters, you have a pretty good idea of when your children will start college. Take the grade they are in now, and count until you get to their senior year. The next year, is the first year of college. Granted, there are always exceptions, and your child may take a year off, but unless they start skipping grades, you know when you’ll need the money.

Next, you have an idea of how long they will be in college. This number is a little more vague. Many students take five years instead of the traditional four. There is also the issue of potential graduate school or professional school. However, as we’ll look at in a minute, getting that four or five years locked down is going to be tricky enough, so let’s start there. After all, if you “over save” you can always use that for more schooling.

Finally, we need to know how much college will cost each year. This is where we have the least certainty in part because different colleges cost different amounts of money, and the cost of university tuition increases every year. As a rough estimate, you can take the current tuition at the college you want to target and then increase it at a rate of 7 percent per year to get a pretty good projection of how much each year will cost.

Calculating the Amount To Save For College

Now that we know the variables, we can calculate how much you need to save to pay for your child’s education.

OK, ready for the math?

For most people, don’t even bother.

Seriously.

Unless you have a lot of disposable income, you are not going to save enough money to pay for a full ride to a four year public university. Instead, you should just focus on saving as much as you can.

Shocked?

Yeah, I used to do very meticulous calculations and reports when I was a financial planner, but the reality is that it takes a LOT of money to pay for a full ride to college. If you have more than one kid, it takes even more. Nine times out of ten, not even couples making $250,000 a year would fully fund the educational part of the financial plan.

Let’s do a couple of examples to demonstrate:

If your kid is 5 years old, and starts college in 13 years. Now let’s say he is going to a school that costs $25,000 per year today. Let’s say tuition increases at 7 percent per year. Let’s say you do pretty well and earn 8% return on your investments. You’ll need to save $771 per month to pay for four years.

Somewhere like Harvard, of course, takes much more.

If you have two kids you have to save $1450 per month.

Now, let’s look at if you are getting started right away. Same situation as above, but instead, your child was just born. (Congratulations!)

  • Now, you’ll have to save $561 per month starting right now.

But, wait, what if you have been meaning to save for college, but you haven’t really gotten around to it yet?

  • If your kid is 10 years old, you’ll need to save $929 per month.
  • If they’re 15 years old, you’ll need to save $1,569 per month.

If you really want to do some math, here is a calculator you can use. There are dozens (probably hundreds) of them out there on the internet, and they’ll all tell you the same thing, start saving several hundreds of dollars a month, right now.

Saving for College Mentality

Whether your can save the full amount per month or not, don’t worry about that. The fact is that there are many options for financing college. In addition to whatever money you save, you’ll likely be earning paycheck when the kiddos hit college age as well. Some savings plus some discretionary income will get you closer. Remember the problem with student loans isn’t that people have ANY, it’s that they have too much. So, if you save enough to cover half, or even just one or two years, you are doing a lot to help.

Also, keep in mind this isn’t your last chance to help out. Helping with the down payment on their first home might be just as helpful.

Either way, the key is to get started right away saving as much as you can. If you want to skip ahead to the end, go open up a 529 plan and setup automatic monthly investments. Otherwise, the definitive guide to saving for college continues with the next post.

Avoid the temptation to cannibalize your retirement savings plan to save for school. Unlike college, there are no retirement loans and no retirement grants or scholarships. And, unlike college, when you stop earning income, there really is no way to “make it up” later.

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Finance Gourmet on October 19, 2014

For some reason, I thought I had written about 529 plans to death. After all, figuring out a way to pay for a child’s college education is a top priority for many people, and something I worked on a lot when I was a financial planner. More than that, I’m also a dad with a couple of rug rats that I’ll want to send off to get a great education, and then on to a wonderful life in the real world unencumbered by the all too common, crushing student loan debt. So, naturally, I think a lot about how education planning and college savings fit into a person’s personal financial plan. And, usually when something money related stays on my mind, I write about it a lot.

529 plans college savings education planningThen, a family member shot me a message asking a question about paying for college for her growing sons. I figured I’d send her a dozen links to all my best college saving advice and 529 plan information. Only, it turns out, I haven’t covered near as much over the years as I thought I had.

So, starting Wednesday, I’ll be cranking out the Complete Definitive Guide to 529 Plans and College Savings in a series of blog posts here on the site. Eventually, I bundle them all into an eBook that you can buy to have a reference all in one place, but for now follow along here to get it all free, as it comes out.

I’ll cover not only what a 529 plan is, and how a 529 savings plan works, but also things like how much money you need to save each month to pay for college, and how to find money to save for college. I’ll also dip into how financial aid works, and how repaying student loans works including the various student loan forgiveness options that you might qualify for.

First up, the basics of 529 plans.

Then, check out how to open a 529 college savings plan.

You’ll need to see about the 529 contribution limits for 2014.

Up next, the ways to save money for college.

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Finance Gourmet on October 14, 2014

I occasionally get questions regarding the economy that sound frustrated in the inability to get a clear answer. That is understandable. The U.S. economy is getting better, but it isn’t really getting better fast enough for anyone to be able to benefit from the fact that it is getting better. Add in the fact that many news outlets have gone partisan and that their reporting is designed more to highlight certain aspects that make their guys look good and the other guys look bad, and you get a confusing picture about whether the economy is good or bad right now.

Doesn’t make much sense does it?

To really understand what is going on economically, it may help to read an article from The Economist. As an aside, whenever you really want a reasonable idea of what is happening in the U.S. it can be helpful to read non-U.S. publications such as The Economist, and to a lesser extent, the Guardian. The Economist leans toward the conservative side, but that doesn’t mean the same thing as it does here in the U.S. More specifically, the publication does not have an owner or readership with a dog in the hunt, so to speak, politically, so you’ll see less of the usual spin.

The article is title, When will they learn. It talks about the current problems the Fed is having regulating the U.S. economy. You see, the Great Recession was so deep and so widespread, that the Fed essentially fired every one of its usual weapons early on. That is, it reduced interest rates to essentially zero percent pretty much right away.

How fast is economy movingTo understand how interest rates work with the economy, an analogy is useful. Consider a very large truck. As the truck moves, interest rates are the brakes. Raising interest rates is applying more break, and reducing interest rates is applying less brake. However, there is a problem with only using breaks to control your speed, namely that once you have taken your foot all the way off of the brake, there is nothing more you can do to increase speed. You just have to wait for an incline, or a really strong gust of wind, or whatever.

Additionally, you don’t want to have to jam on the brakes very hard. The U.S. economy is a very large tractor trailer. Slamming on the brakes is seldom pleasant. Raising interest rates high and fast is similarly unpleasant for the economy. That means that as you take your foot off the brake to increase speed, you have to keep a wary on not letting too much speed build up.

If you’re wondering about the gas pedal in this analogy, then good for you. Traditionally, the gas for the economy come from Washington, where additional government spending is the usual gas for getting the economy back up to speed. In times past, the government could be counted on to argue over WHERE to spend the money, but not IF to spend the money to boost the economy. Unfortunately, now that Washington has broken down into nothing but a blame game and thoughts of next election’s strategy, there is no gas. In fact, the government is actually cutting spending, which is akin to taking your foot off both the accelerator and the brake at the same time, it doesn’t help you gain any speed.

The Fed is using unusual efforts to try and supply some gas, but none of them are the same as using the gas pedal. So, the problem with the economy is that absent any new gas, the truck can only pick up speed very slowly, and now the Fed is taking it’s pedal off it’s kind-of gas as well by ending it’s bond buying program.

The second problem is that certain people are always more concerned about applying the brakes rather than getting the truck moving. These people are called inflation hawks, and there are always several on the Fed board. This is good, but it may be premature in this case, where job growth is really just filling the hole from the last decade and there is little or no sign of coming inflation.

In other words, while it does seem that the U.S. economy truck has started rolling forward ever so slightly, no more gas is coming, and some people are already looking to re-apply the brakes. So, yes, the economy is good right now, but not good enough. More importantly, if the slightest thing happens to slow the economy back down, no one has any gas left to get it going again.

So, it’s a good time to be worried, but if everything keeps going the way it is, we’ll hopefully have that truck moving a little faster sometime next year.

For the quickest answer, look no further than holiday spending as reported by retailers. If you see stronger than last year, but still weak overall, that’s more of the same. Anything bleaker is trouble, anything better, might mean that truck has finally caught a bit of a hill.

 

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Finance Gourmet on October 3, 2014

Every time a jobs report, or other important economic numbers, come out politician run screaming into newsrooms across the country to spin it so that it says what they want it to say. If you want to know what economic data really mean, ignore the politicians. On Wall Street, investors put their money where there mouth is. Spinning for an investor is the same thing as deliberately losing money. While a politician is more than happy to say something that isn’t true, no investor is willing to throw away their cash for the sake of appearances.

September Jobs Report Is Good News

Jobs Numbers SeptemberThe stock market is up 206 points as I write this. No matter what some politician says, this was good news. In some places, they are calling this the “Goldilocks” jobs report. It was not too hot, and not too cool. The economy added 248,000 jobs and the unemployment rate dropped below 6 percent to 5.9 percent. Wall Street wants job growth; they need job growth. An economic recovery can’t go anywhere with too many people unemployed. However, job growth can mean inflation, and no one wants inflation. More accurately, no one wants the Fed to worry about inflation and start raising interest rates.

After the August jobs numbers came in with a surprising decline, an increase in hiring was just what the Wall Street doctor ordered. The unemployment rate even fell below 6.0%. (Don’t forget that the unemployment rate does not include people who have given up looking for work, so that 5.9 percent number is a little rosier than reality.) On the other hand, there is no indication wages are rising. That’s important because more people with MORE MONEY is really what drives inflation. Without an increase in wages, this jobs report means the economy is doing well, but not too well. In other words, the Fed doesn’t need to be in any hurry raise interest rates.

What this means for Main Street is that businesses may not be rushing out to hire new people, and they certainly are not having to fend off incoming job offers for most of their existing employees, but it does suggest that they are no longer afraid to hire. An economy where employers hire what they need, instead of making do with what they have, is a strong economy.

As I mentioned yesterday in our Fourth Quarter update, this is the last jobs number that really means anything, unless there is a MAJOR change next month or the month after. Anything resembling normal will be ignored as investor focus on something more important, holiday season sales.

For many companies, the fourth quarter makes the difference between profit or loss. More importantly, the holiday sales number will show us whether all of this jobs data shows a real recovery, or just a lingering drift toward slightly better. Do people finally have money to spend this year, or are they still pulling themselves back up?

We’ll find out when Target, Wal-Mart, Amazon, and so on start talking turkey… and Black Friday… and Cyber Monday and…

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Finance Gourmet on October 2, 2014

Welcome to the fourth quarter of 2014. It’s been an interesting year so far. Let’s jump right in.

First, if you own a small business, like me, your third quarter estimated tax payments are due to your buddies at the IRS by October 15. By now, you should start having a little bit of an idea how your income might go for the year. If you are doing more business than last year, consider bumping your payment to keep up with your higher income. On the other hand, if business is off, then back that withholding off a bit too.

Also, if you are a small business owner and you don’t get your health insurance through a spouse or other plan, don’t forget about the Obamacare open enrollment period for 2015, which runs from November 15, 2014 to February 15, 2015. You got an extra extension into April this year while the government worked out some bugs. That won’t necessarily be the case this year, so double-check your plan, or see what the new ones are. You can go to HealthCare.gov and they’ll redirect you to your state exchange if necessary.

September Jobs Number

The September labor report is due out from the government on Friday. Investors are looking for evidence that August was a fluke or reporting issue and that job growth is still continuing. If the September numbers look good, then we’re all set, economic reports wise anyway, until retailers start talking about how their sales numbers look for the holidays.

While you’re thinking about the holidays, start thinking about your charitable donations as well. Unpack that unused stuff from your garage and kid’s toy closets and get it donated before December 31, to take the tax deduction this year.

And, just for fun, reports say that there is a Lamborghini hybrid prototype that can do zero to 60 in 3 seconds, while getting 57 mpg. That has nothing to do with the fourth quarter, but it sure sounds awesome.

Happy Halloween!

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Finance Gourmet on September 26, 2014

Why Are There RMDs or Required Minimum Distributions?

Required minimum distributions, or RMD, is the minimum amount you must withdraw from certain retirement accounts each year. To understand why there are RMDs, it helps to look at things from the government’s perspective.

rmd rulesThe government runs by collecting tax dollars. However the government also encourages certain behaviors in its citizens and companies by permitting certain tax breaks. (One behavior this encourages is big donations to politicians by companies to get and preserve tax breaks, but that is a topic for another day.) One behavior the government tries to encourage is getting people to save for retirement. It does this by providing several tax-advantaged accounts taxpayers can use to save for retirement, including 401k plans, IRA accounts, and Roth IRA accounts.

In all three of these accounts, the interest, earnings, and capital gains are exempt from taxes each year so long as the money stays in the account. Not paying taxes is the incentive to save for retirement. If you do take the money out of the account before you turn 59 1/2 years old, then you have to pay a 10 percent tax penalty. That is the incentive to not take the money out for something besides retirement.

But, what about when you actually retire?

There is a lot of money out there in 401k plans and IRA accounts. Some estimates suggest that there is now, or will be soon, TRILLIONS of dollars in such accounts. The government wants you to save for retirement, but they don’t necessarily want to give up that much tax revenue either. So, when you do retire and start using that money, you pay taxes on the withdrawals.

However, there is a catch. If you happen to retire in a way that you don’t need the money in your IRA or 401k account, then you might not withdraw it at all. That means you wouldn’t pay taxes on that money, and with generous estate tax rules, and beneficiary rules for retirement accounts, the government might never get to tax that money. To prevent this scenario the IRS rules for required minimum distributions compel taxpayers to withdraw at least SOME money from these types of retirement accounts once they turn 70 1/2. That way, they get to start taxing at least some of the money.

The amount of RMD is based on actuarial tables, meaning you have to take a larger percentage each year as you get older.

Calculate RMD Amount

To calculate the RMD amount, you use tables in IRS Publication 590, which determine the percentage of required minimum distribution you must take. The IRA required minimum distribution table is the same as the 401k required minimum distribution table.

The easiest way to calculate, however, is to use an online RMD retirement calculator. To use the calculator, input your account balance from December 31st of the year you are calculating the RMD for. Then, input your age and you’ll get the required amount to withdraw.

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Finance Gourmet on September 23, 2014

Banks have long offered various types of checking accounts and savings accounts. Some of these accounts are actually fully developed products that are different from other offerings. Others are merely gimmicks, and some bank account types lie in between.

Youth Accounts Banking

One such niche account offered at many banks is a youth account. These accounts are typically broken up into youth savings accounts and youth checking accounts. Just what each account is, and how it differs from other accounts depends on the bank.

youth savings accountsFor the most part, special bank accounts for young people are joint accounts with limited access for one person. For most purposes, a person under the age of 18 cannot legally enter into a contract. No contract, or banking agreement, then no account, not even a kid bank account. Instead, in order to open a kid savings account or student checking account, the bank will require an adult’s signature. No matter what it gets called on the statement, what you have really just opened is a joint account with the child.

So, then what is the point of a youth accounts?

As an adult, you might not like the idea of joint account with your child. Maybe that sounds like “too much” or something “too formal.” A youth account, specially designed for a parent-child relationship (or grandparent-child, or any adult to child) just sounds better. But, make no mistake. In the end what you have is a joint savings account or joint checking account. If you read the fine print, all the window dressing in the world does not change the fact that you, the adult, are liable for the account and all activities within. That means you’ll need to control access to things like online banking passwords and the child account’s debit cards or ATM cards.

However, youth accounts are a good way for banks to both start creating mind share in future customers, as well as providing an inexpensive service to make parents happy. Youth accounts frequently have very low, or no minimum amounts to open or minimum balances to maintain. So, just the $20 bill from Grandma could be all it takes. Some banks offer other perks. Bellco Credit Union offers a higher interest rate on youth savings accounts, up to $500, and Beth Page Credit Union currently offers a whopping 3.0% interest on the first $1,000 in a youth account. This offers a great way for little Billy or Susie to learn about interest and what it can and can’t do. While 3.0% interest is way higher than you’ll get on any adult savings account, 3% on $1,000 is a mere $30, and you won’t keep getting 3.0% on the amounts over $1,000. This is a good time to teach youngsters about fine print, too.

Many banks and credit unions offer various educational tools or newsletters to account holders as well.

Another difference comes from limiting the actions the child can take. Theoretically, as a person on a regular joint account the child would have access to all the funds. Practically, however, until the child has ID such access would be difficult at best. No teller will hand over a fifty dollar bill to an 8-year old without a nod (and ID) from a parent first. However, a child account typically formalizes this, restricting all withdrawals to require parental consent.

Youth Checking Accounts

As the child approaches 15 or 16, the option of a youth checking account opens up. Obviously, the point of a checking account involves more potential for spending money. Again, for contract and liability purposes, this is a joint account. If your teen is bouncing checks, you are responsible for any fees and debits. Make sure you are getting real free checking with your youth checking account, or another account (or another bank) is probably a better option.

These days, the better route for many teens is to have a debit card associated with the account that is not setup to allow overdrafts. In this case, just like with an adult debit card, the merchant swipes the card and verifies sufficient funds before completing the transaction. In this way, kids learn about managing money and balancing their checking account (it’s still embarrassing to be declined, even as a kid), without the possibility of getting under water and racking up bounced check fees or other debts. Even if you are protecting them from money problems with this account, take the time to explain the importance of good credit and maintaining a clean credit report.

Again, the best youth checking accounts offer low, or no, minimum balance and no monthly fees.

Youth accounts are a great way to prepare kids for a financial future, and an important step in getting them used to dealing with financial institutions, especially high schoolers who will be turning 18 and getting into the world as adults on their own very soon.

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Finance Gourmet on September 20, 2014

Fall is coming.money.jpg

OK, it’s not as dramatic as winter is coming, but let’s be honest. It’s season 4 of the TV show, and Book 6 in the series, and winter still hasn’t actually come. Fall will be here much sooner as the yellow leaves on the trees out front can attest.

Let’s get down to some personal finance. Coming this fall on FinanceGourmet, we have some interesting topics, some misunderstood topics, and a look at whatever financial news or economic data come out.

We’ll take a look at different types of bank accounts and whether any of them are worth anything, or if they are just banking marketing gimmicks. Do you need a Christmas club account, a youth account, or other niche banking accounts. We’ll take a look at what they have to offer and if they actually have any advantages.

Also soon we’ll start a roundup of free credit score services like Credit Karma, Credit Sesame, and Credit Check Total to see what is new, and if one of these free credit score services is better than the other. We’ll also look at other options for getting a credit score for free including how some credit cards now offer a monthly credit score right on your statement.

As the fourth quarter approaches, it makes sense to start looking at your taxes and what you can do to save money on taxes this year. If you’re self-employed, creating tax deductions is easier, but there are plenty of ways to reduce your regular income taxes as well. One of those ways is with payroll deductions to your 401k plan. Now is a good time to review where your taxes and contributions will shake out as the year comes to an end. There are still three months to make an adjustment in. Getting that right could be all you need.

We’ll also look at 2014 tax numbers such as IRA contribution limits, 529 plan contributions limits and Roth IRA limits.

Of course, there will be plenty more as well. Grab the RSS feed so you don’t miss anything.

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