Friendly Advice

We all get advice from our friends, whether we want it or not. When it comes to financial advice from your friends, take it with caution.

Many people are Do-It-Yourselfers when it comes to their finances. As a financial professional, I’ve seen people who are pretty good at it. I generally meet them when they come to see me for a sanity check. There’s always something I can recommend that they didn’t think of and they appreciate it. But some Do-It-Yourselfers are a mess – and the mess is compounded by the fact that they don’t know that they’re a mess. So your buddy who makes all his own financial decisions through reading (which may be giving him bad information) or his own brand of logic (which may be illogical) may be unintentionally giving you bad advice.

Another pitfall of friendly advice is that your friend’s situation may be different from yours. So what your BFF from college is doing may be perfect for her, but doesn’t fit you. Perhaps she has more money than you, or less money that you. Maybe you have the same saved in investments, but her tax situation is much more complex than yours, which impacts everything else she does with her money. Several years ago I was proposing a tax credit to a prospective client. It was pretty complicated and at some point as he was struggling with whether or not to get involved in the credit, I told him I owned this same tax credit. That gave him lots of comfort, but I felt like it gave him a little too much comfort, so I told him that I was also wearing a red dress, but that the red dress wouldn’t look good on him. Financial advice isn’t “one size fits all”.

So take the advice of your friends with caution. Get advice from a professional who’s looking out for you – without their own agenda clouding that advice.

Finding a Financial Advisor that’s Right for You

If you want financial planning, finding a professional to guide you through the process is a daunting proposition.   Even referrals aren’t always the solution, since many of your friends might not completely understand what their financial advisor does or whether what’s done is right for them.   Finding a financial planner can be intricate and in depth.  There are also a few simple concerns you can explore to work toward finding a professional that’s a good fit for you.  Here are four basic issues you can address. 

The first is what the planner’s credentials are.  Credentials are different from licenses.  So having a securities license, insurance license, or a title from a financial institution will not automatically provide the training to qualify an individual for financial planning.  Financial advisors who are Certified Financial Planners have the training and experience to provide financial planning.  This incorporates, but isn’t limited to, investments, taxes, retirement planning, estate planning, cash flow and insurance. 

The next step is to ask how the planner is compensated.  A fee-only planner doesn’t need to sell you products like investments or insurance to make a living.  The planner may be paid through a flat retainer, hourly, or some percentage of assets that are managed. 

The third question is what services the planner provides.  If you work for a living and all your financial needs must be met with what you earn, you might not need an advisor who specializes in people with a large inheritance.  And if you want someone who’ll incorporate all the pieces of your financial life, you won’t be best serviced by a planner who only manages investments. 

Another question to address is whether the planner has an obligation to do what’s in your best interest or if he works for a firm that requires that he provide certain products or services to all clients, even if the client doesn’t need them. 

So where can you find advisors that are likely to have answers to these questions that will make it easier for you to find one that works for you?  There are a couple of professional organizations that foster fee-only financial planners that have their clients’ best interests as their primary goal.  The National Association of Personal Financial Advisors (NAPFA) at  www.napfa.org and the Alliance of Cambridge Advisors at www.acaplanners.org have advisor search functions.  Also, the NAPFA site has a more in depth questionnaire you can use for more in depth interview questions.

Prepare for 2011 Taxes Now

While making my way through tax season, I see several items that can be done year round to make your life easier from a tax perspective.  Here are just a few that can save you time and money.

Cost basis – Technology and regulatory reform have made keeping track of what was paid for investments easier, but not perfect yet.  Any time you move investments from one financial institution to another, make sure you ask the institution that you’re leaving for the cost basis on the investments.  It’s much more difficult to go back years later and ask about an account that was closed a long time ago.  That’s especially true if the investments moved into your name from a divorce.  Get the cost basis while the paperwork from the divorce is being processed.

Items donated to charity – Each time you take a pile of used stuff to a charity for donation, make a list of the items and attach it to the receipt.  Then total the thrift store value of those items on each receipt.  The IRS wants pretty specific records for donations like these, not just an indication of how many bags or boxes of things you gave.

Tax planning – If you’re either getting a big refund or paying big every year, you’re not managing your taxes well.  If you owe a lot each year, you’re probably paying interest and penalties which is a waste of your money.  If you get a big refund each year, the IRS has your money and you need to wait until you file your return to get it back.  The IRS won’t give it to you mid-year just because you ask, nor will they pay you interest when they send your refund.  They shouldn’t have to since they’re not a bank.  A good tax professional can help you estimate what your withholdings and quarterly estimated tax payments should be during the year.  Then your refund or what you owe should be a manageable level. 

Consistent preparation – Find a good tax professional and stick with them.  This is efficient on many fronts.  If the preparer isn’t just entering data and doesn’t have too many clients, they will become familiar with your situation and be able to suggest some tax saving strategies as well as have a pretty good idea if you’ve missed reporting some income or claiming some deductions.  Even the preparer’s software helps with that by keeping track of items from one year to the next.

You don’t need to have your life revolve around your annual tax return.  But being just a little proactive can help your tax filing be more accurate and easier to prepare.

Top Ten Things To Do During Tax Season (Apologies to David Letterman)

10. Get your things organized and to your preparer as soon possible to avoid needing to file an extension.

9. If you owe a lot or are getting a big refund, adjust your withholdings or quarterly estimated payments now.

8. If you can deduct an IRA contribution and owe tax, consider making a contribution before April 15 and getting it on your 2010 tax return.

7. If you live in Colorado, have kids in college, and don’t have a Colorado 529 plan, set one up and put this year’s tuition in it now.

6. Start your file now for 2011 tax data.

5. If you’re going through a divorce…oh shoot, taxes are the least of your problems.

4. Start a mileage log with a section for charitable miles, medical miles, and business miles.

3. Keep track of all your out of pocket business expenses.

2. Keep organized on your other financial issues, not just taxes.

1. Reward your tax preparer with chocolate – especially if it’s me!

Happy Financial New Year!

The economy still isn’t out of the woods.  Many people still feel the pressure of a sluggish financial landscape.   As the year beings, it’s good to get some financial goals in place.  Basics are a good starting point.

–          Spending – Spend less than you make.  If you need to make adjustments in your spending, buckle down and do it.  Also, you’ll want to include in your budget the next three items.

–          Debt – If you have credit card or other unsecured personal debt, work on paying it down.  Pay the biggest amount possible on the debt with the highest rate.   If you’re working on spending, the debt won’t increase.

–          Emergency savings – Put money away for emergencies.  You want to have some money that you can use to cover unexpected financial needs.  If you have no emergency funds, work toward 5% of your pre-tax income.

–          Retirement savings – Things will get better in the financial world, so save toward not having to work to cover expenses.  If your employer matches part of what you contribute, get to that level as quickly as possible. 

If you’ve got these under control, get with a fee-only financial planner to work on some bigger goals.  The financial world will get better.  The faster we all get away from the behaviors that brought on the meltdown, the faster the economy will get better.

To Roth or Not To Roth

Congress lifted the income ceiling in 2010 for conversion of a traditional IRA to a Roth IRA. So lots of people are wondering if a conversion is a good idea.  The answer is – as it so often the case – that it depends. 

What’s the difference between the two types of IRAs?  Contributions to a traditional IRA might be partially or fully tax deductable, so this type of retirement account has some or all of the balance subject to tax when the money is withdrawn.  Also, with a traditional IRA, you are required to withdraw a portion of the account every year beginning when you turn 70½ and those withdrawals are taxable.  Contributions to a Roth IRA are never tax deductible, but withdrawals aren’t subject to tax.  Also, you are never required to withdraw the money from a Roth.  Both types of IRAs have a 10% penalty if you take money out prior to your age 59½, with a few exceptions. 

Converting from traditional IRA to Roth means that the taxes need to be paid on the taxable portion of the traditional IRA, which sometimes means the entire amount.  During 2010, that converted amount can be taxed partially in 2010 and partially in 2011.  But unless you know you’re going to drop into a lower bracket in 2011 due to a life event – retirement, quitting a job to go to school full time, taking a big pay cut – spreading the tax over two years probably doesn’t make sense.  We know the tax brackets in effect for 2010 and it’s likely that they’ll be higher in 2011.

It’s important to remember that you don’t have to convert your entire IRA.  You could decide to convert just part of it.  So if the top IRS tax bracket you are subject to is 28%, you could convert enough of your IRA to a Roth that you wouldn’t have income pushed into the next tax bracket and leave the rest in your traditional IRA in place.  That Roth balance will now be available in your retirement years to be withdrawn only if you want to withdraw it and will be tax free if you do use it. 

So who is a Roth conversion most appealing to?  If you are in a lower tax bracket this year than normal, you might want to consider it.  Maybe you just retired or you’ve been laid off or had a pay cut in your household.  If you are ten or more years away from retirement and don’t expect your tax bracket to go down much when you leave the workforce, that’s another favorable thing.  So if you’ll have a pension that will pay you when you stop working or your IRA is really large, you might want to look at a conversion.  Ironically, the people who haven’t been eligible this year – high income earners – often have the hardest time justifying a conversion.  I recommend doing a Roth conversion prior to age 59½ only if you have enough cash outside the IRA to pay the tax.  So paying between 28% to 35% to the IRS (on top of any state income tax) to move into a tax free instrument is a difficult pill to swallow at just about any time.  But to do it during a recession when it’s especially important to keep lots of funds liquid in case of a loss of income or another financial emergency is too aggressive for some of these folks.  For people already in retirement, a low stock market can be a good time to do the conversion.  If you account values are down, moving some money to the Roth will allow that money to grow tax free.  Assuming growth on the account of 8%, it takes about three to five years to get back what was paid in taxes.  From then on, all the growth I  the Roth puts you ahead in the tax game on your retirement funds. 

Still undecided?  Make an appointment with a financial planner to see if your particular situation could make sense for a conversion.  Your situation is unique and one of the factors that can’t be quantified is whether or not you’re comfortable with the transaction.

Holiday Spending During a Recession

The holidays are upon us and many people are saying “Bah Humbug!”  There is a way to enjoy the holidays without overspending.  Here are a few tips:

–         Plan your shopping.  Don’t go out shopping without a list of what you’re looking for and the price range you have for each purchase.  No impulse purchases!

–         Make gifts.  Take a little time to put together gifts with materials you already have or are inexpensive.  It can be a knitted scarf, a photo collage, homemade bread, or a bird house.  The personal touch is better than anything money can buy.

–         Make personal gift certificates.  We’ve done this with family for everything from an extended curfew for our teenagers to a home cooked dinner to doing a chore for someone.  The gift is appreciated and you can make it more festive by printing the certificate on nice stationery.

While economic indicators say that we’re on the way out of the recession, many are still feeling the pinch.  It’s not a time to burrow back into debt.  The holidays are a great time to give yourself the gift of making financially responsible decisions.