Tuesday, October 30, 2012

Fun with tax-advantaged accounts

Already it's the fourth quarter of 2012. I tend to go into review mode at the end of the year. One thing I review is my tax situation. In the past I haven't had many metaphorical tax levers to adjust, though that's been changing as my financial situation gets more and more complicated.

There are two types of tax-advantaged accounts I'm thinking of funding for tax year 2012, above and beyond my 401k which I have on auto-pilot. One is my Health Savings Account (HSA), and one is a Roth IRA. I'll start with the HSA.

Early October was benefits season at work, time for open enrollment and a question-and-answer session about most of our benefits, like health care and life and disability insurance. I've already had my HSA for a year and I'm pretty happy with it. Essentially it's a high-deductible health care plan coupled with a tax-advantaged savings account. Preventative care is free and there are no co-pays, but I pay the full amount for other doctor visits (though it's a pre-negotiated rate that's lower than the normal rate). If and when I hit the deductible of $1500/year for an individual, then all health care afterward does not cost me anything. I think there's an exception for prescription drugs but it seemed like minutia so I mostly ignored that point.

Employers like this plan, I imagine, because it costs less than traditional health care plans. I like it because my employer is paying 75% of my yearly deductible into my HSA. It's money I get to keep if I don't use it. It gives me the incentive to care about how much health care costs — for example, using an urgent care clinic instead of the emergency room for non-life-threatening emergencies. And it's money I get to keep if I leave my job, and that I can use on any qualifying medical expenses. I checked my savings account balance and found I have over $1500. That means I've got all my medical expenses covered for a whole year! It's a good feeling.

The IRS annual contribution limit for an individual's HSA is $3100 for 2012. My employer has contributed 75% of my $1500 deductible, or $1125 by the end of the year. That leaves $1975 for me to contribute (and then deduct from my taxes for 2012). I'm thinking saving up $1000 to contribute. It'll delay my loan payoff by around half a month, but the tax savings of (I expect) over $200 makes it worth it to me. Not to mention the margin of safety of having even more money in my HSA.

Now for the Roth IRA. Where an HSA is funded with pre-tax dollars, a Roth IRA is funded with post-tax dollars. But your investments get to compound tax-free, and you'll never have to pay taxes on any of that money again. I think the 2012 IRS limit for Roth IRA contributions is $5k. I'd like to be able to contribute that much for 2012. This will add months to my student loan repayment, but the way I see it, missing out on 20+ years of tax-free compound growth is something I would regret big time when I get older. Luckily I think you have until tax day in 2013 to fund your Roth IRA for 2012, so that gives me a few extra months to save up the money.

When I get the cash for a Roth IRA I'm going to open it up with Vanguard. Those guys are the best and I can't wait to have an account with them.

A final word on my student loans. What I described above is going to entail a significant slowdown from the pace I've been paying off my loans. That said, it will still be an accelerated pace. Depending on my Christmas bonus I should be student loan free before mid-2013. I have to remind myself that my goal for student loan payoff was year-end of 2013. Anything earlier than that is gravy. I don't want to sacrifice more productive uses for my money while striving for a single goal. My primary (financial) goal is financial independence ASAP and I feel that funding my HSA and Roth IRA for 2012 will be more effective than using that same money to pay down my student loans.

Thursday, October 25, 2012

Update from Stupidland

The title is an allusion to one of my favorite MMM posts.

Today I drove to work, though I should have biked. I had the radio tuned to NPR where there was some news about new car buying being down in Europe. Since new car sales are important to the economy they had a guest from Edmunds.com, an online source for car information.

I was a little miffed because the Edmunds woman talked (and was asked questions) mostly about buying new cars, when really macroeconomic analysis of car buying and its relation to the broader economy would have fit the news story more closely. I was also listening intently for the poor advice that passes for common knowledge, like that people should buy new cars at all.

When the host asked a question like "how much should a person spend on a car?", I was floored by the answer: "no more than 20% of your net income". Twenty percent?!?!? Are you crazy?! This could make sense if she meant the cost of the entire car. But no, of course she was referring to monthly payments on a car. As we all know, the real number that matters is the price of the car, not some monthly payment number. To be fair, she made sure to mention including cost of insurance and repairs, so she's not completely misleading people, but it was pretty close.

Here's some better advice. How about: "You NEVER, EVER borrow money to buy a car." This is fantastic advice I freely admit I did not follow, though it was a calculated bit of wussypants stupidity on my part. (The non-wussypants option is to bike literally everywhere.)

My monthly take-home pay is around $4700. Twenty percent of that is $940. At 0% interest, for a 5-year loan, that's over $55k of car, if I ignore maintenance and insurance. Maybe with maintenance and insurance that translates into a $40k car, give or take. That is crazy. I'm getting the heebie jeebies just thinking about it.

There was talk about leasing and when it makes sense to lease. Leasing makes sense if you're the kind of person who wants to have a new car every two years, but in that case, what the hell are you doing? I think of leasing as the most efficient means of throwing one's money away on cars. Stop treating cars like status symbols and show off your badassity instead.

The Edmunds woman kept mentioning fuel efficiency. It sounds like car people think of fuel efficiency as just another feature, like power steering or a sun roof. I don't understand why people would care much about fuel efficiency when they're buying a new car. You're wasting thousands of dollars to "save" a few tens of dollars a month in gas from a baseline of a gas-guzzling SUV or pick-up truck. And even then, fuel efficiency will only really come to play when you do a crap ton of driving, like way more driving than people should be doing.

And yet this is how many Americans think about cars. What is a monthly payment that fits into my budget? How much will I have to spend on gas for my commute? How swanky a car can I finance?

It is so important for people to have the right mindset when it comes to automobiles and related issues like commuting. By my estimation, getting this right will get you half of the way to a golden Mustachian existence, if not measured in badassity then at least measured in money saved.

Thursday, October 4, 2012

My other emergency fund is a personal line of credit

I was planning on writing today about saving money in tax-sheltered accounts. I'm still going to write about that but something came up that's much more exciting, and I wanted to share it with you.

Today I was on PenFed's website scheduling our mortgage payment for October. I like to pay it manually because it's a large enough sum of money that I feel I should be taking a little time from my busy day to say goodbye (and to make sure I don't overdraw our checking account). On the sidebar a couple of pre-screened offers caught my eye. Now, I already have a mortgage, an auto loan, and a credit card with PenFed — and a checking account. But I figured I might as well look at the looong list of other products they offer and see if anything looked interesting.

And boy did I ever find an interesting product! They offered me a "personal line of credit", basically a home equity line of credit except that it's unsecured. I was so excited I just had to apply right then and there.

The default amount offered was $15k, so I went ahead and applied for that. Denied! they said. Too many hard inquiries in the past 12 months, accounts not open long enough, too many balances on accounts. "Oh well," I thought, "I guess I'll have to try later." But no! Instead, five minutes later, I applied for $5k, because the worst that could happen is they turn me down again. The response was that my application was "under review", and just this evening I found I was approved.

I love lines of credit. I love the idea of some amount of money I can tap if I need it, and that I don't have to pay for when I don't. I love the feeling of more possibilities, of more security, and like I'm being trusted with something valuable.

I don't have a personal emergency fund, so that's what my line of credit is going to be. Just in case any big expense comes up I've got another $5k I can tap in a hurry. Most likely I'll never use it. Every time I buy something big I'll consider paying for it with my line of credit — and then I'll say "No, not worth it". I've neglected to tell you the interest rate: 6% above the prime rate, which makes it somewhere around 9% (I can't find the exact number on the website for some reason). 9% is a high interest rate, and that's why I'm using my personal line of credit for emergencies only.

In the medium term it should help increase my credit score as well. I'm not sure why I'm so interested in increasing my credit score since I've already got all the credit I need. One reason could be I keep telling myself I'm going to be looking at buying a rental property in two to five years from now. And I tend to wear such things as badges of pride.

Last, I want to talk about how awesome credit unions are. I cannot stress enough how happy I've been with PenFed. They go out of their way every day to help me out. If you're not with a credit union, #1 priority in the banking area of your life should be finding a credit union you can join. It will save you money, and more importantly it will offer you a much nicer experience than the traditional Too Big To Fail banks offer.

What do you guys think? If you had access to a personal line of credit, would you want one?