Who invented the index fund? A brief (true) history of index funds

Pop quiz! If I asked you, “Who invented the index fund?” what would your answer be? I’ll bet most of you don’t know and don’t care. But those who do care would probably answer, “John Bogle, founder of The Vanguard Group.” And that’s what I would have answered too until a few weeks ago.

But, it turns out, this answer is false.

Yes, Bogle founded the first publicly-available index fund. And yes, Bogle is responsible for popularizing and promoting index funds as the “common sense” investment answer for the average person. For this, he deserves much praise.

But Bogle did not invent index funds. In fact, for a long time he was opposed to the very idea of them!

John Bogle did not invent index funds

Recently, while writing the investing lesson for my upcoming Audible course about the basics of financial independence, I found myself deep down a rabbit hole. What started as a simple Google search to verify that Bogle was indeed the creator of index funds led me to a “secret history” of which I’d been completely unaware.

In this article, I’ve done my best to assemble the bits and pieces I discovered while tracking down the origins of index funds. I’m sure I’ve made some mistakes here. (If you spot an error or know of additional info that should be included, drop me a line.)

Here then, is a brief history of index funds.

What are index funds? An index fund is a low-cost, low-maintenance mutual fund designed to follow the price fluctuations of a stock-market index, such as the S&P 500. They’re an excellent choice for the average investor.

The Case for an Unmanaged Investment Company

In the January 1960 issue of the Financial Analysts Journal, Edward Renshaw and Paul Feldstein published an article entitled, “The Case for an Unmanaged Investment Company.”

The case for an unmanaged investment company

Here’s how the paper began:

“The problem of choice and supervision which originally created a need for investment companies has so mushroomed these institutions that today a case can be made for creating a new investment institution, what we have chosen to call an “unmanaged investment company” — in other words a company dedicated to the task of following a representative average.”

The fundamental problem facing individual investors in 1960 was that there were too many mutual-fund companies: over 250 of them. “Given so much choice,” the authors wrote, “it does not seem likely that the inexperienced investor or the person who lacks time and information to supervise his own portfolio will be any better able to choose a better than average portfolio of investment company stocks.”

Mutual funds (or “investment companies”) were created to make things easier for average people like you and me. They provided easy diversification, simplifying the entire investment process. Individual investors no longer had to build a portfolio of stocks. They could buy mutual fund shares instead, and the mutual-fund manager would take care of everything else. So convenient!

But with 250 funds to choose from in 1960, the paradox of choice was rearing its head once more. How could the average person know which fund to buy?

When this paper was published in 1960, there were approximately 250 mutual funds for investors to choose from. Today, there are nearly 10,000.

The solution suggested in this paper was an “unmanaged investment company”, one that didn’t try to beat the market but only tried to match it. “While investing in the Dow Jones Industrial average, for instance, would mean foregoing the possibility of doing better than average,” the authors wrote, “it would also mean tha the investor would be assured of never doing significantly worse.”

The paper also pointed out that an unmanaged fund would offer other benefits, including lower costs and psychological comfort.

The authors’ conclusion will sound familiar to anyone who has ever read an article or book praising the virtues of index funds.

“The evidence presented in this paper supports the view that the average investors in investment companies would be better off if a representative market average were followed. The perplexing question that must be raised is why has the unmanaged investment company not come into being?”

The Case for Mutual Fund Management

With the benefit of hindsight, we know that Renshaw and Feldstein were prescient. They were on to something. At the time, though, their idea seemed far-fetched. Rebuttals weren’t long in coming.

The May 1960 issue of the Financial Analysts Journal included a counter-point from John B. Armstrong, “the pen-name of a man who has spent many years in the security field and in the study and analysis of mutual funds.” Armstrong’s article — entitled “The Case for Mutual Fund Management” argued vehemently against the notion of unmanaged investment companies.

The case for mutual fund management

“Market averages can be a dangerous instrument for evaluating investment management results,” Armstrong wrote.

What’s more, he said, even if we were to grant the premise of the earlier paper — which he wasn’t prepared to do — “this argument appears to be fallacious on practical grounds.” The bookkeeping and logistics for maintaining an unmanaged mutual fund would be a nightmare. The costs would be high. And besides, the technology (in 1960) to run such a fund didn’t exist.

And besides, Armstrong said, “the idea of an ‘unmanaged fund’ has been tried before, and found unsuccessful.” In the early 1930s, a type of proto-index fund was popular for a short time (accounting for 80% of all mutual fund investments in 1931!) before being abandoned as “undesirable”.

“The careful and prudent Financial Analyst, moreover, realizes full well that investing is an art — not a science,” Armstrong concluded. For this reason — and many others — individual investors should be confident to buy into managed mutual funds.

So, just who was the author of this piece? Who was John B. Armstrong? His real name was John Bogle, and he was an assistant manager for Wellington Management Company. Bogle’s article was nominated for industry awards in 1960. People loved it.

The Secret History of Index Funds

Bogle may not have liked the idea of unmanaged investment companies, but other people did. A handful of visionaries saw the promise — but they couldn’t see how to put that promise into action. In his Investment News article about the secret history of index mutual funds, Stephen Mihm describes how the dream of an unmanaged fund became reality.

In 1964, mechanical engineer John Andrew McQuown took a job with Wells Fargo heading up the “Investment Decision Making Project”, an attempt to apply scientific principles to investing. (Remember: Just four years earlier, Bogle had written that “investing is an art — not a science”.) McQuown and his team — which included a slew of folks now famous in investing circles — spent years trying to puzzle out the science of investing. But they kept reaching dead ends.

After six years of work, the team’s biggest insight was this: Not a single professional portfolio manager could consistently beat the S&P 500.

Mihm writes:

As Mr. McQuown’s team hammered out ways of tracking the index without incurring heavy fees, another University of Chicago professor, Keith Shwayder, approached the team at Wells Fargo in the hopes they could create a portfolio that tracked the entire market. This wasn’t academic: Mr. Shwayder was part of the family that owned Samsonite Luggage, and he wanted to put $6 million of the company’s pension assets in a new index fund.

This was 1971. At first, the team at Wells Fargo crafted a fund that tracked all stocks traded on the New York Stock Exchange. This proved impractical — “a nightmare,” one team member later recalled — and eventually they created a fund that simply tracked the Standard & Poor’s 500. Two other institutional index funds popped up around this time: Batterymarch Financial Management; American National Bank. These other companies helped promote the idea of sampling: holding a selection of representative stocks in a particular index rather than every single stock.

Much to the surprise and dismay of skeptics, these early index funds worked. They did what they were designed to do. Big institutional investors such as Ford, Exxon, and AT&T began shifting pension money to index funds. But despite their promise, these new funds remained inaccessible to the average investor.

In the meantime, John Bogle had become even more enmeshed in the world of active fund management.

In a Forbes article about John Bogle’s epiphany, Rick Ferri writes that during the 1960s, Bogle bought into Go-Go investing, the aggressive pursuit of outsized gains. Eventually, he was promoted to CEO of Wellington Management as he led the company’s quest to make money through active trading.

The boom years soon passed, however, and the market sank into recession. Bogle lost his power and his position. He convinced Wellington Management to form a new company — The Vanguard Group — to handle day-to-day administrative tasks for the larger firm. In the beginning, Vanguard was explicitly not allowed to get into the mutual fund game.

About this time, Bogle dug deeper into unmanaged funds. He started to question his assumptions about the value of active management.

During the fifteen years since he’d argued “the case for mutual fund management”, Bogle had been an ardent, active fund manager. But in the mid-1970s, as he started Vanguard, he was analyzing mutual fund performance, and he came to the realization that “active funds underperformed the S&P 500 index on an average pre-tax margin by 1.5 percent. He also found that this shortfall was virtually identical to the costs incurred by fund investors during that period.”

This was Bogle’s a-ha moment.

Although Vanguard wasn’t allowed to manage its own mutual fund, Bogle found a loophole. He convinced the Wellington board to allow him to create an index fund, one that would be managed by an outside group of firms. On 31 December 1975, paperwork was filed with the S.E.C. to create the Vanguard First Index Investment Trust. Eight months later, on 31 August 1976, the world’s first public index fund was launched.

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Bogle’s Folly

At the time, most investment professionals believed index funds were a foolish mistake. In fact, the First Index Investment Trust was derisively called “Bogle’s folly”. Nearly fifty years of history have proven otherwise. Warren Buffett – perhaps the world’s greatest investor – once said, “If a statue is ever erected to honor the person who has done the most for American investors, the hands-down choice should be Jack Bogle.”

In reality, Bogle’s folly was ignoring the idea of index funds — even arguing against the idea — for fifteen years. (In another article for Forbes, Rick Ferri interviewed Bogle about what he was thinking back then.)

Now, it’s perfectly possible that this “secret history” isn’t so secret, that it’s well-known among educated investors. Perhaps I’ve simply been blind to this info. It’s certainly true that I haven’t read any of Bogle’s books, so maybe he wrote about this and I simply missed it. But I don’t think so.

I do know this, however: On blogs and in the mass media, Bogle is usually touted as the “inventor” of index funds, and that simply isn’t true. That’s too bad. I think the facts — “Bogle opposed index funds, then became their greatest champion” — are more compelling than the apocryphal stories we keep parroting.

Note: I don’t doubt that I have some errors in this piece — and that I’ve left things out. If you have corrections, please let me know so that I can revise the article accordingly.

Source: getrichslowly.org

Can You Buy a House if You Owe Taxes?

January 23, 2020 &• 4 min read by Chris Birk Comments 16 Comments

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Looking for the perfect home on the real estate market? Unfortunately, it can be tricky if you have unpaid taxes. Failing to pay your federal income taxes can lead to the Internal Revenue Service placing a lien on your property or your assets. These legal tools protect the government’s ability to get its money. They also set off alarm bells for lenders.

Can you buy a house if you owe taxes? The good news is that federal tax debt—or even a tax lien—doesn’t automatically ruin your chances of being approved for a mortgage. But you do usually have to take steps to resolve the issue before a lender will look favorably upon your mortgage application.

Can You Buy a House If You Owe Taxes?

It’s still possible, but you could have to actively work on the tax debt before a bank will approve a home loan. It might be best to pay off the lien before you fill out a loan application. But if that’s not something you’re able to do, you still might be able to forge ahead, provided you’ve actually tried to make a dent in that debt.

The specific details of your situation come into play, though. And lenders typically have slightly different requirements and documentation needs, so you’ll need to work closely with your bank or mortgage lender. If you know you have tax debt you can’t pay immediately, be honest about it so the lender can let you know what you may need to accomplish to be approved.

Can You Get an FHA Loan If You Owe Back Taxes?

Yes, you may be able to get an FHA loan even if you owe tax debt. But you’ll need to go through a manual underwriting process to make this happen. During this process, the lender looks for proof that you have a valid agreement to repay the IRS. It also requires that you have made on-time payments on this agreement for at least the last three months.

Obviously, FHA loans aren’t only contingent upon your tax debt status. You’ll also have to meet any other requirements, including those related to income and credit history.

Can Military Borrows with a Tax Lien Get a Home Loan?

Lenders can view liens differently depending on the loan type and other factors. But in general, military borrowers with a tax lien may be able to obtain VA mortgage preapproval if:

  • They have an acceptable repayment plan with the IRS and have made on-time payments for at least the last 12 consecutive months.
  • They can satisfy all debt-to-income ratio requirements with that monthly tax repayment included.
  • They note their outstanding tax lien on the standard loan application.

Can You Buy a Home If You Owe Other Types of Tax Debt?

If you owe state taxes or property taxes, you could also put your dreams for homeownership at risk. The rules vary slightly for each situation, but any type of debt you owe can cause your lender to consider you a higher-risk applicant. Even if you’re approved for the mortgage, your interest rate may be higher.

The best bet with any type of tax debt is to pay it off as quickly as possible. And if you can’t resolve it before you apply for a mortgage, at least reach out to the agency you own to make arrangements.

Research and Preparation Are Important

Whether you want to buy a home while you owe federal taxes or you’re certain your credit report is squeaky clean, take time to prepare before applying for a mortgage. You may be surprised by an error or negative item on your credit report, for example. It’s better to fix credit issues before you try to buy a home than be side-swiped by them during the process.

After taking steps to pay off or make three to 12 timely payments on your taxes, check your credit reports. Then, use your score and other information to find out what types of mortgage rates you might qualify for. This helps you understand whether or not it’s the right time to apply for a loan and buy a new home. If you’re in the market for a mortgage loan, look at the options available from the lenders on Credit.com.

The Bottom Line on Buying a Home When You Have Tax Debt

So, if you’re a prospective homebuyer with a tax lien, a good first step is making sure your track record shows at least a year’s worth of on-time payments. Pay it off in full if possible, but if that’s a tall order, know that you might have diminished purchasing power and a rockier road until the slate is clean.

In the meantime, you should also be keeping tabs on your overall financial progress by checking your credit reports regularly. You can get these reports free once a year from each of the three major credit reporting agencies, and you can get your free credit score from Credit.com.

Monitor your credit scores for increases or drops. Taking an active role in your credit can help you get on track to buy a home, especially when you’re facing certain financial hurdles such as a tax lien.


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Understanding What to Do with Unfiled Tax Returns

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The IRS has taken down Al Capone, Wesley Snipes, Martha Stewart and other big names in the past for tax fraud. The federal government takes taxes very seriously.

Not filing your tax returns is a serious offense. Although there won’t be a nationwide manhunt for late returns, you may still see some hefty fines and possibly jail time.

What Happens When You Don’t File Tax Returns?

The IRS requires you to file your tax returns by April 15th every year. Filing your tax returns isn’t the most exciting think in the world but it’s important. Many people either put it off until the very last minute or fail to file altogether. Not filing your tax return can have costly consequences. Here are some of the penalties you may face when you don’t file your tax returns:

1. Late Penalties

The penalty for failing to file your tax returns or filing late takes effect on April 16th. You’ll owe the government 5% of the unpaid taxes in penalties for every month that they remain unpaid. That penalty, however, caps at 25%.

If you file by April 15th but owe the government and fail to pay the debt by that time, then a lesser penalty will be levied upon you. You can get charged between 0.5% to 1% of the unpaid tax debt for every month that it remains unpaid. Remember, you are required to file by the April deadline each year. In some cases, you can get an extension to file your taxes, but you’ll need to go through the proper channels and paperwork to do this.

2. You Could End Up Forfeiting Your Tax Refund

The IRS gives you three years to claim your back tax refunds. If you keep missing or failing to file your taxes, you will have effectively forfeited those back-tax refunds after the third year. You’re basically losing out on free money that you could most likely use.

3. Your Refund Can Be Delayed

The government can take time investigating your taxes when you consistently file late. Furthermore, the fact that you delayed filing your taxes means that there will be penalties levied. This can lead to your tax refund being delayed or forfeited altogether depending on the fines.

Even though the 5% per month penalty takes effect on the 16th of April, the IRS will still send letters with codes such as CP515, CP516, CP518 and CP515B. If you fail to act on these notices and don’t file your taxes or pay what you owe the government, you can end up facing jail time.

The fine for failing to comply with IRS can reach as high as $25,000. The jail time can be as long as one year for every year that you failed to file your taxes.

What Should You Do When You Have Unfiled Tax Returns?

When you don’t file your taxes on time and fail to heed the warnings sent by IRS, they will prepare a substitute tax return on your behalf. They base the information they use on the information they already have including W-2 and 1099 forms.

The letter you get from the IRS will state the sources of income that the IRS used to calculate the substitute returns.

Once the letter is prepared and sent, the IRS gives you 30 days from the official date of the letter to do the following:

  • Send in a completed tax return
  • Send in a letter consenting to the assessment and collection form
  • Send the IRS a letter explaining the reason you couldn’t file your returns

If, however, you want to file your back taxes to avoid further penalties, here are the steps that you need to take:

1. Get the Information You Need to File Your Back Taxes

You can start by requesting that the IRS send you your W-2 and 1099 forms. If, however, you are self-employed then you need to gather all the documents showing any sources of income that may not be on file with the IRS.

2. File Your Tax Return

Be sure to complete the tax return form as accurately as possible. You can even enlist the help of a qualified tax preparer to ensure that you don’t miss anything. If you need more time to complete unfiled tax returns or pay the money you owe, you can contact the IRS to see if you can get an extension or agree to a payment arrangement. This can help you avoid further penalties.

3. Monitor Return Processing and Compliance

You need to ensure that you monitor the return processing by asking for your account transcript to ensure that the IRS got your returns and that you have adhered to everything.

The IRS requires you to achieve tax compliance by filing all unfiled back taxes. In some cases, you may need to go back as far as six years. However, every account is different, and you need to be in open communication with the IRS. This will help ensure that you have fully complied to avoid jail.

There is some good news. Depending on your circumstances and how open you are with the IRS, you may qualify for IRS Amnesty or Reasonable Cause. This means that your penalties, fines and payment are either reduced or waived.

No matter the case, the IRS investigates unfiled taxes. To avoid the penalties, do your best to adhere to tax compliance by filing your tax returns by the April 15th  deadline.

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Are Social Security Disability Benefits Taxable?

Are Social Security Disability Benefits Taxable? – SmartAsset

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Social Security benefits, including disability benefits, can help provide a supplemental source of income to people who are eligible to receive them. If you’re receiving disability benefits from Social Security, you might be wondering whether you’ll owe taxes on the money. For most people, the answer is no. But there are some scenarios where you may have to pay taxes on Social Security disability benefits. It may also behoove you to consult with a trusted financial advisor as you navigate the complicated terrain of taxes on Social Security disability benefits.

What Is Social Security Disability?

The Social Security Disability Insurance program (SSDI) pays benefits to eligible people who have become disabled. To be considered eligible for Social Security disability benefits, you have to be “insured”, which means you worked long enough and recently enough to accumulate benefits based on your Social Security taxes paid.

You also have to meet the Social Security Administration’s definition of disabled. To be considered disabled, it would have to be determined that you can no longer do the kind of work you did before you became disabled and that you won’t be able to do any other type of work because of your disability. Your disability must have lasted at least 12 months or be expected to last 12 months.

Social Security disability benefits are different from Supplemental Security Income (SSI) and Social Security retirement benefits. SSI benefits are paid to people who are aged, blind or disabled and have little to no income. These benefits are designed to help meet basic needs for living expenses. Social Security retirement benefits are paid out based on your past earnings, regardless of disability status.

Supplemental Security Income generally isn’t taxed as it’s a needs-based benefit. The people who receive these benefits typically don’t have enough income to require tax reporting. Social Security retirement benefits, on the other hand, can be taxable if you’re working part-time or full-time while receiving benefits.

Is Social Security Disability Taxable? 

This is an important question to ask if you receive Social Security disability benefits and the short answer is, it depends. For the majority of people, these benefits are not taxable. But your Social Security disability benefits may be taxable if you’re also receiving income from another source or your spouse is receiving income.

The good news is, there are thresholds you have to reach before your Social Security disability benefits become taxable.

When Is Social Security Disability Taxable? 

The IRS says that Social Security disability benefits may be taxable if one-half of your benefits, plus all your other income, is greater than a certain amount which is based on your tax filing status. Even if you’re not working at all because of a disability, other income you’d have to report includes unearned income such as tax-exempt interest and dividends.

If you’re married and file a joint return, you also have to include your spouse’s income to determine whether any part of your Social Security disability benefits are taxable. This true even if your spouse isn’t receiving any benefits from Social Security.

The IRS sets the threshold for taxing Social Security disability benefits at the following limits:

  • $25,000 if you’re single, head of household, or qualifying widow(er),
  • $25,000 if you’re married filing separately and lived apart from your spouse for the entire year,
  • $32,000 if you’re married filing jointly,
  • $0 if you’re married filing separately and lived with your spouse at any time during the tax year.

This means that if you’re married and file a joint return, you can report a combined income of up to $32,000 before you’d have to pay taxes on Social Security disability benefits. There are two different tax rates the IRS can apply, based on how much income you report and your filing status.

If you’re single and file an individual return, you’d pay taxes on:

  • Up to 50% of your benefits if your income is between $25,000 and $34,000
  • Up to 85% of your benefits if your income is more than $34,000

If you’re married and file a joint return, you’d pay taxes on:

  • Up to 50% of your benefits if your combined income is between $32,000 and $44,000
  • Up to 85% of your benefits if your combined income is more than $44,000

In other words, the more income you have individually or as a married couple, the more likely you are to have to pay taxes on Social Security disability benefits. In terms of the actual tax rate that’s applied to these benefits, the IRS uses your marginal tax rate. So you wouldn’t be paying a 50% or 85% tax rate; instead, you’d pay your ordinary income tax rate based on whatever tax bracket you land in.

It’s also important to note that you could be temporarily pushed into a higher tax bracket if you receive Social Security disability back payments. These back payments can be paid to you in a lump sum to cover periods where you were disabled but were still waiting for your benefits application to be approved. The good news is you can apply some of those benefits to past years’ tax returns retroactively to spread out your tax liability. You’d need to file an amended return to do so.

Is Social Security Disability Taxable at the State Level?

Besides owing federal income taxes on Social Security disability benefits, it’s possible that you could owe state taxes as well. As of 2020, 12 states imposed some form of taxation on Social Security disability benefits, though they each apply the tax differently.

Nebraska and Utah, for example, follow federal government taxation rules. But other states allow for certain exemptions or exclusions and at least one state, West Virginia, plans to phase out Social Security benefits taxation by 2022. If you’re concerned about how much you might have to pay in state taxes on Social Security benefits, it can help to read up on the taxation rules for where you live.

How to Report Taxes on Social Security Disability Benefits

If you received Social Security disability benefits, those are reported in Box 5 of Form SSA-1099, Social Security Benefit Statement. This is mailed out to you each year by the Social Security Administration.

You report the amount listed in Box 5 on that form on line 5a of your Form 1040 or Form 1040-SR, depending on which one you file. The taxable part of your Social Security disability benefits is reported on line 5b of either form.

The Bottom Line

Social Security disability benefits aren’t automatically taxable, but you may owe taxes on them if you pass the income thresholds. If you’re worried about how receiving disability benefits while reporting other income might affect your tax bill, talking to a tax professional can help. They may be able to come up with strategies or solutions to minimize the amount of taxes you’ll end up owing.

Tips on Taxes

  • Consider talking to a financial advisor as well about how to make the most of your Social Security disability benefits and other income. If you don’t have a financial advisor yet, finding one doesn’t have to be complicated. SmartAsset’s financial advisor matching tool can help. By answering a few simple questions you can get personalized recommendations for professional advisors in your local area in minutes. If you’re ready, get started now.
  • While you don’t have to reach a specific age to apply for Social Security disability benefits or Supplemental Security Income benefits, there is a minimum age for claiming Social Security retirement benefits. A Social Security calculator can help you decide when you should retire.

Photo credit: ©iStock.com/kate_sept2004, ©iStock.com/JannHuizenga, ©iStock.com/AndreyPopov

Rebecca Lake Rebecca Lake is a retirement, investing and estate planning expert who has been writing about personal finance for a decade. Her expertise in the finance niche also extends to home buying, credit cards, banking and small business. She’s worked directly with several major financial and insurance brands, including Citibank, Discover and AIG and her writing has appeared online at U.S. News and World Report, CreditCards.com and Investopedia. Rebecca is a graduate of the University of South Carolina and she also attended Charleston Southern University as a graduate student. Originally from central Virginia, she now lives on the North Carolina coast along with her two children.
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Effective tax rates in the United States

I messed up! Despite trying to make this article as fact-based as possible, I botched it. I’ve made corrections but if you read the comments, early responses may be confusing in light of my changes.

For the most part, the world of personal finance is calm and collected. There’s not a lot of bickering. Writers (and readers) agree on most concepts and most solutions. And when we do disagree, it’s generally because we’re coming from different places.

Take getting out of debt, for instance. This is one of those topics where people do disagree — but they disagree politely.

Hardcore numbers nerds insist that if you’re in debt, you ought to repay high-interest obligations first. The math says this is the smartest path. Other folks, including me, argue that other approaches are valid. You might pay off debts with emotional baggage first. And many people would benefit from repaying debt from smallest balance to highest balance — the Dave Ramsey approach — rather than focusing on interest rates.

That said, some money topics can be very, very contentious.

Any time I write about money and relationships (especially divorce), I know the debate will get lively. Should you rent a home or should you buy? That question gets people fired up too. What’s the definition of retirement? Should you give up your car and find another way to get around?

But out of all the topics I’ve ever covered at Get Rich Slowly, perhaps the most incendiary has been taxes. People have a lot of deeply-held beliefs about taxes, and they don’t appreciate when they read info that contradicts these beliefs. Chaos ensues.

Tax Facts

When I do write about taxes — which isn’t often — I try to stick to facts and steer clear of opinions. Examples:

  • The U.S. tax burden is relatively low when compared to other countries.
  • The U.S. tax burden is relatively low when compared to U.S. tax burdens in the past.
  • Overall, the U.S. has a progressive tax system. People who earn more pay more. That said, certain taxes are regressive (meaning that, as a percentage of income, low earners pay more).
  • A large number of Americans (roughly one-third) pay no federal income tax at all.
  • Despite fiery rhetoric, no one political party is better with taxing and spending than the other. The only period during the past fifty years in which the U.S. government had a budget surplus was 1998-2001 under President Bill Clinton and a Republican-controlled Congress.

Even when I state these facts, there are people who disagree with me. They don’t agree that these are facts. Or they don’t agree these facts are relevant.

Also, I sometimes read complaints that the wealthy are taxed too much. To make their argument, writers make statements like, “The top 50% of taxpayers pay 97% of all federal income taxes.” While this statement is true, I don’t feel like it’s a true measure of where tax burdens fall.

I believe there’s a better, more accurate way to analyze tax burdens.

Effective Tax Burden

To me, what matters more than nominal tax dollars paid is each individual’s effective tax burden.

Your effective tax burden is usually defined as your total tax paid as a percentage of your income. If you take every tax dollar you pay — federal income tax, state income tax, property tax, sales tax, and so on — then divide this total by how much you’ve earned, what is that percentage?

This morning, while curating links for Apex Money — my second personal-finance site, which is devoted to sharing top money stories from around the web — I found an interesting infographic from Visual Capitalist. (VC is a great site, by the way. Love it.) They’ve created a graphic that visualizes effective tax rates by state.

Here’s a summary graph (not the main visualization):

State effective tax rates

As you can see, on average the top 1% of income earners in the U.S. have a state effective tax rate of 7.4%. The middle 60% of U.S. workers have a state effective tax rate of around 10%. And the bottom 20% of income earners (which Visual Capitalist incorrectly labels “poorest Americans” — wealth and income are not the same thing) have a state effective tax rate of 11.4%.

Tangent: This conflation of wealth with income continues to grate on my nerves. I’ll grant that there’s probably a correlation between the two, but they are not the same thing. For the past few years, I’ve had a low income. I’m in the bottom 20% of income earners. But I am not poor. I have a net worth of $1.5 million. And I know plenty of people — hey, brother! — with high incomes and low net worths.

It’s important to note — and this caused me confusion, which meant I had to revise this article — that the Visual Capital numbers are for state and local taxes only. They don’t include federal income taxes. (Coincidentally, I made a similar mistake a decade ago when writing about marginal tax rates. I had to make corrections to that article too. Sigh.)

GRS readers quickly helped me remedy my mistake, pointing to the nonprofit Tax Foundation’s summary of federal income tax data. With a bit of detective work, I uncovered this graph of federal effective tax rates by income from the Peter G. Peterson Foundation. (Come on. What parent names their kid Peter Peterson? That’s mean.)

Federal effective tax rates

Let’s put this all together! According to the Institute on Taxation on Economic Policy, this graph represents total effective tax rates for folks of various income levels. Note that this graph is explicitly comparing projected numbers in 2018 for a) the existing tax laws (in blue) and b) the previous tax laws (in grey).

TOTAL effective tax rates in the U.S

Total Tax Burden vs. Total Income

Here’s one final graph, also from the Institute on Taxation and Economic Policy. This is the graph that I personally find the most interesting. It compares the share of total taxes paid by each income group to their share of the country’s total income.

Tax burden vs. total income

Collectively, the bottom 20% of income earners in the United States earned 3.5% of total income. They paid 1.9% of the total tax bill. The top 1% of income earners in the U.S. earned one-fifth of the nation’s total personal income. They paid 22.9% of total taxes.

Is the U.S. tax system fair? Should people with high incomes pay more? Do they pay more than their fair share? Should low-income workers pay more? Are we talking about numbers that are so close together that it doesn’t matter? I don’t know and, truthfully, I don’t care. I’m concerned with personal finance not politics. But I do care about facts. And civility.

The problem with discussions about taxation is that people talk about different things. When some folks argue, they’re talking about marginal tax rates. Others are talking about effective tax rates. Still others are talking about actual, nominal numbers. When some people talk about wealth, they mean income. Others — correctly — mean net worth. It’s all very confusing, even to smart people who mean well.

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Final Note

Under the Digital Accountability and Transparency Act of 2014, the U.S. Department of the Treasury was required to establish a website — USASpending.gov — to provide the American public with info on how the federal government spends its money. While the usability of the site could use some work, it does provide a lot of information, and I’m sure it’ll become one of my go-to tools when writing about taxes. (I intend to update a couple of my older articles this year.)

U.S. federal budget

The USA Spending site has a Data Lab that’s currently in public beta-testing. This subsite provides even more ways to explore how the government spends your money. (I also found another simple budget-visualization tool from Brad Flyon at Learn Forever Learn.)

Okay, that’s all I have for today. Let the bickering begin!

Source: getrichslowly.org

Can You Afford that New Car? Here's How to Decide

How much car can you afford? Knowing the limits of your budget can help you make a savvy decision when you head to the dealership.

By

Jim Wang
October 5, 2020

debt obligations

  • 20 percent of your budget covers unnecessary expenses and “fun” money
  • There are many ways to design a budget, but the 50-30-20 budget gives you a good place to start. It will certainly point out of there are any areas that are totally out of whack.

    What do you have in savings?

    Having a healthy savings account balance is important when making a car purchase as well. If you don’t have an emergency fund with a balance equal to three to six months’ worth of expenses, building that emergency fund up should be a priority.

    If you don’t have an emergency fund with a balance equal to three to six months’ worth of expenses, building that emergency fund up should be a priority.

    With an added car payment, having a plush savings balance will help you ensure you can cover the new payment even if you hit a financial bump. Or, for instance, if the car needs repairs.

    Determine the total cost of the car

    Once you have looked at your budget and determined the amount of money per month you are comfortable spending on a car you’ll want to be clear on the total car costs before you make your purchase. Affording a new car isn’t simply about the payment.

    There are several other costs associated with car ownership, such as:

    • Insurance policy costs
    • Fuel and parking costs
    • Maintenance and repair costs

    You can call your insurance company ahead of time and get a quote for the new vehicle you’re considering. If you are still trying to narrow down what type of car you want, check out this list of the most and the least expensive cars to insure.

    Call your insurance company ahead of time and get a quote for the new vehicle you’re considering.

    Fuel costs are fairly easy to determine. A Google search will give you the MPGs of any car you could think of. Compare that to your current car to see if your costs will change.

    Maintenance and repair costs can be harder to determine but you can get an idea by using averages across a brand. Here’s an article from Autowise that displays the cheapest and most expensive cars to maintain.

    Be sure to factor in an accurate estimate of these additional car ownership costs as you determine a purchase price and payment amount you’re comfortable with.

    Get the right kind of car loan

    Doing your due diligence as you shop for a car loan is important as well. You do not have to get financing through the dealership. You will likely do better getting a loan yourself through your bank. At the very least, have an understanding of what rate you would qualify for before heading into the dealership so you know if they are offering you a fair rate.

    Continue reading on Wallet Hacks.


    About the Author

    Jim Wang has been writing about money for over 15 years, most recently at WalletHacks.com. His software engineering background has given him the skills to distill complex financial concepts into easier-to-understand ideas people can use to take control of their lives and build wealth.

    Source: quickanddirtytips.com

    Taxes

    Best Websites for Saving on Prescriptions

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    Woman ordering prescription drugs online
    Photo by Image Point Fr / Shutterstock.com

    If you aren’t shopping around for your prescription medication or otherwise seeking a lower price, you’re probably paying too much.

    Think of it this way: You wouldn’t book a flight before comparing prices at a few different airlines. So why settle on your prescription drug costs?

    As when done with flights, comparison shopping for medication can be as simple as checking a few key websites. The following sites, some of which also have mobile apps, are among the best for saving money on prescriptions. Use them, and you may never pay full price for your prescriptions again.

    1. PharmacyChecker

    PharmacyChecker says it can help you save up to 90% on prescription medications.

    The website lists drug prices from online pharmacies in the U.S. and abroad. To find the best price for a specific prescription medication, enter the name of the drug into the search box on the PharmacyChecker homepage.

    PharmacyChecker also created a verification program for online pharmacies. To view a pharmacy’s ratings or verification information, click on its profile — the “i” symbol — after searching for a medication.

    Being verified means PharmacyChecker has confirmed the pharmacy’s licensing and standards of practice. They also monitor the pharmacy for continued compliance.

    2. GoodRx

    If this bright yellow website doesn’t get your attention, its savings will. GoodRx says it has helped Americans save $20 billion on health care and prescription drugs.

    How do they do it? GoodRx collects and enables you to compare prices from pharmacies across the country.

    All you have to do is enter a drug name in the search bar on the GoodRx homepage. GoodRx will then show you the prices of that drug at various pharmacies and, in the case of some pharmacies, generate a coupon for you to use on your prescription.

    To see prices at particular pharmacies in your immediate area, click on “Set your location” and enter your ZIP code.

    3. Blink Health

    Blink Health negotiates prices with certain pharmacy chains, and then tells you what your prescription would cost at those pharmacies if you buy it through Blink Health’s website.

    As the company explains in a blog post:

    “We cut out the middleman and offer group-discount prices directly to individuals. We work directly with drug manufacturers and pharmacies to negotiate lower prices, and pass those lower prices on to our customers.”

    No coupon is necessary — just visit the pharmacy to pick up your medication after paying for it online, or have it shipped to your home.

    To search for your medication, visit the Blink Health homepage and enter the drug name into the search box. You can select the drug form — such as capsules or tablets — and the strength and quantity you need. Then, select a pharmacy and proceed to checkout.

    4. WeRx

    Similar to GoodRx and Blink Health, WeRx provides listings of local pharmacies and their prices. But an additional feature allows consumers to report the amount they paid for a specific medication.

    To see all your options, enter a medication and your ZIP code on the WeRx homepage. From there, you can select the drug form, strength and quantity you need. A map of pharmacies near you will be displayed to the side, so you can see which is the most convenient and affordable pharmacy.

    5. Gift card marketplace websites

    Gift card marketplaces like Raise sell gifts cards for less than their face value. For example, you could buy a gift card worth $50 for $40. Essentially, that means buying a discounted gift card gives you free money to spend.

    Discounted gift cards can be purchased for many popular pharmacy chains, such as CVS.

    To learn more about using discounted gift cards to save on prescriptions, check out “5 Ways I Slashed My Drug Costs up to 50%.”

    Disclosure: The information you read here is always objective. However, we sometimes receive compensation when you click links within our stories.

    Source: moneytalksnews.com

    Investing Taxes

    Betterment Review

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    Algorithms seem to be in control of everything these days, from the ads we see on Facebook, the shows we watch on Netflix, to what we find when we search on Google.

    But what if there were an algorithm that could help you invest smarter? Something that could maximize returns and minimize risk, while possessing smart features such as automatic rebalancing and tax-loss harvesting?

    Especially for new investors, wouldn’t it make sense to give this a try?

    That’s the idea behind the newest crop of automated investment platforms called robo-advisors – and Betterment is one of them.

    What is Betterment?

    Formed in 2008 by Jon Stein, Betterment was one of the first online investing and financial advising platforms available. With currently $16.4 billion in assets under management, it’s also one of the largest firms out there.

    Commonly called “robo-advisers”, these investing platforms are designed to take the fear and guesswork out of investing in the stock market by actively investing, managing, and trading stocks and bonds on your behalf. Their goal is to make investing super easy for novices.

    But Betterment’s goal isn’t just to get you to start investing – they want you to get your entire financial house in order.

    How Does Betterment Work?

    Betterment uses “Modern Portfolio Theory” to make investments based on the risk tolerance of the investor.

    When you sign up, Betterment will ask you a number of different questions – such as your goals and timeline for investing – to determine your risk tolerance. This risk profile determines your asset allocation, which Betterment uses to pull together a unique portfolio for you, picking an optimal amount of stocks and bonds based on your particular situation.

    What Does Betterment Invest in?

    Betterment uses globally diversified Exchange Traded Funds (ETFs) to build your portfolio. An exchange traded fund is a collection of funds that tracks an index, like the S&P 500, but trades like a stock.

    These stocks and bonds are highly diversified across market caps, in emerging or developing markets, and long term or short term.

    By purchasing baskets of stocks and bonds that hold assets from hundreds of different companies, we can diversify our portfolio, which helps to minimize risk while maximizing returns.

    While every customer will have a portfolio completely unique to them based on their risk tolerance, time until retirement, etc., every portfolio uses a mixture of the following 14 funds:

    Stocks:

    Bonds:

    Based on your goals, Betterment will pick an asset allocation for you.

    Betterment does not currently offer investing in assets such as real estate, gold/silver or cryptocurrency.

    Additional Portfolio Strategies

    Betterment does offer a few different portfolio options for those who have specific goals or needs that can’t be met with a standard portfolio.

    A few of the portfolios available are:

    Types of Accounts

    Whether you want to save for retirement, fund your child’s education or just beef up your emergency fund, Betterment offers a wide range of accounts that can accommodate many of your personal goals, including joint accounts for spouses and trust accounts for beneficiaries.

    Betterment offers the following types of accounts:

    You can choose any of these account types when you sign up. You can also align each of your accounts to a different investment goal, whether that’s investing, saving, or setting up a beneficiary.

    What Features Does Betterment Have?

    How Do Pricing and Fees Work with Betterment?

    Betterment has two tiers of service, each with their own account minimums and fees: digital and premium.

    To most people, these fees probably sound like peanuts. But properly understanding fees goes a long way to understanding how much of your money gets eaten up by fees. For an investor with $1,000 in a portfolio, you’ll be paying $2.50 per year to have Betterment manage a portfolio with the basic digital service.

    Premium also comes with unlimited access to Betterment’s certified financial planners, who can give you advice on your portfolio, whether your assets are inside or outside of Betterment. They can also advise you on events outside of investing, such as saving for a child’s education, or helping newlyweds merge their finances together (more on that below).

    Choosing between Betterment digital or premium will depend on how much you plan on investing with Betterment and if you want access to Betterment’s more robust features.

    Betterment Financial Planning Features and Pricing

    Whether you’ve reached a new stage of life or just need some general guidance, Betterment financial advisors can help you plan for many of life’s most common milestones. If you’re a premium member, you’ll pay no additional fees for these calls.

    Each financial package comes with a phone call, an action plan written by your expert and exclusive educational content.

    You can speak to a financial adviser about the following topics:

    And if you need more regular and comprehensive financial planning than what’s offered above, Betterment can set you up with your own dedicated certified financial planner via the Betterment Advisor Network (minimum $100,000 investment).

    Betterment Everyday Cash Reserve Account

    In addition to investing, Betterment also offers users a high-yield savings account that earns 1.83% APY*. It requires just $10 to sign up and has no additional account fees. Deposits are FDIC insured up to 1 million dollars, and the account comes with several noteworthy features, such as unlimited withdrawals and deposits (you can typically only withdraw from a savings account six times per month).

    Betterment is also preparing to launch a checking account with a host of cool features, such as no overdraft fees, no minimum balances, ATM-reimbursement and FDIC-insurance protection for up to $250,000, but it’s not yet available in every market. You can join the waitlist here.

    *You can see the current APY here.

    Is Betterment Safe?

    While no financial advisor can keep your portfolio from losing value in the stock market, Betterment’s algorithms do their best to help reduce your exposure to risk.

    Additionally, Betterment takes precautions to safeguard your money. One of the ways they do this is by making sure your assets and Betterment’s assets are kept completely separate. This way, you have full access to your assets, and can add, withdraw and transfer them as you wish.

    Furthermore, your Betterment account is protected by insurance from the Securities Investor Protection Corporation (SIPC), insuring each of your Betterment accounts up to $500,000 in the event of a broker error or the failure of the company. (Note that market losses are not SIPC covered).

    Betterment also encrypts all of your personal data, such as your financial information like bank account and your tax identification number, to personal data such as your social security number and security questions. This ensures that your data is kept private as it makes its way through the Internet.

    A few additional ways you can keep your assets safe:

    Who should use Betterment?

    People who should use Betterment:

    People who shouldn’t use Betterment:

    Is Betterment Worth It?

    If you’re a beginner investor just starting to build wealth and are looking for an automated, hands-off approach to investing with tons of extra features, then Betterment may work great for you. Whether you need general investment advice or financial planning for many of life’s significant events, Betterment can help.

    Betterment also offers investing at a great price, as its fees are right in line with similar robo-advisers like Wealthfront, who charges an identical management fee of 0.25%.

    Betterment offers additional features such as financial planning and two-way sweep you can’t get from places like Wealthfront, making it an even more attractive option among robo-advisors.

    Final Thoughts

    Before you decide where to place your money, it’s crucial to identify your long-term goals. For investors looking to get their feet wet in the world of investing, you could do a lot worse than Betterment. Their investments are highly diversified, charge low fees, and are fully-automated.

    If you’re wanting to actively trade stocks or want a little more control over your portfolio, then a robo-advisor like Betterment may not be the investing platform for you. But if you’re a new investor and want someone to manage your money for you, Betterment may be right up your alley.

    Sign up and deposit $10 to get started.

    Source: getrichslowly.org

    Money Tips Taxes

    Should We Employ Our Own Kids? (and How Much to Pay Them)

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    My Brother Wax Mannequin, training the next generation of workforce last summer.

    Way back in 2015, I had a nine year old boy. Even back then, I could see him showing some early flashes of adulthood and maturity, and it got me wondering about his future as it relates to money and freedom.

    So I wrote a post called What I’m Teaching My Son About Money, which shared some ideas about how we can raise our next generation of kids to be happy masters of money rather than the stressed-out slaves that most people (even those with high incomes) are today. And now, four years later, some of my predictions and questions from that article are starting to come true, and I’m wondering what to do about it.

    To me, the biggest question is this:

    Where is the balance between giving your kids a helpful boost, and “helping” them so much that you distort their view of the world and create a generation of Whining Complainypants Adults?

    Opinions on this subject can vary widely, and in fact even you and I might have rather different views. But hopefully we can at least agree that the whole thing sits on a spectrum, and that even that spectrum itself is slippery because every child and every upbringing is unique.

    So let’s get onto the same page with an attractive and scientific-looking diagram.

    Almost any parent would agree that the left side of the spectrum is a bad place for kids to be born. Because it affects not just their childhoods, but their entire lives. So we strive to provide a life that is further to the right, keeping our kids fueled with food, love, and opportunities.

    But as with all human pursuits, we have a tendency to go too far and get into the “Too Easy” end of the spectrum. We may be smothering our kids with too much “help”, or perhaps compensating for being so busy with our fancypants careers that we don’t have much time to spend with them.

    While this all feels like common sense, there’s also some biology behind it. Babies and young kids who experience a harsh environment during this critical part of development will tend to grow up more optimized for survival and street smarts, with lower levels of trust and a harder time blending in with a peaceful society*.

    And on the more fortunate side of the divide, children raised in peace and security will optimize more for “book smarts” intelligence as well as being more trusting and less prone to violence. The entire apparatus of our brain will end up wired differently, based on the experiences we have in early childhood.

    The problem for wealthy people is that the human brain is not wired to stop at “enough”, because enough has not been a big part of our shared history.

    So we tend to overdo it when creating a comfortable life for our own kids, often justifying it with this exact sentence:

    “We work hard, so we can give our kids some of the opportunities and the nice things that we didn’t have in our own childhood.”

    It sounds noble and honorable on the surface, but be careful, because we can ratchet that same justification up far beyond any reasonable lifestyles without realizing we are just stoking our own egos or compensating for our own fears (and perhaps battling our peers/competitors in the Who’s-the-Best-Parent Competition on Facebook).

    And then these kids respond by developing in a different way that can have its own downsides. Not understanding what it means to be poor. A lack of life’s most valuable skill – the skill of efficiency, optimization and reducing waste. And even a lack of life satisfaction and balance in later adulthood, because of a focus on easy consumption rather than the joy of creation.

    So with such a slippery slope and those two pointy arrowheads to navigate, what’s the ideal strategy for us parents?

    I don’t have all the answers, but one idea I have been interested in for years seems to have a lot of advantages: Hiring your children to work in your own small business.

    Just think about it. You get to do all of these things and more:

    Of course, there are also a few traps to watch out for in running a family business:

    Still, the potential benefits clearly outweigh the risks to me, so the idea remains an exciting one in my mind.

    Little MM and the Budding YouTube Project

    I have been dabbling with this with my own son for several years – he helped me with the arduous task of mailing out over 1200 MMM T-shirts a few years ago and occasionally helps his mother in her soap production enterprises. His earnings have typically been on a per-shirt or per-soap basis

    But things really took a step up this past January when he talked me into dusting off the neglected MMM YouTube Channel and actually starting to produce some shows together. Because we started with the good luck of a partially established audience and we have put some real effort into it (13 episodes over these first six months), it has taken off a little bit and we now have over 27,000 subscribers and the channel has earned about $1600 in YouTube ad revenue so far.

    As a fun incentive, I offered at the beginning to pay him a flat (low) fee for editing and producing each episode, then split the income from this venture equally beyond that. So now, the little dude has made $800 on top of his base fees for the work.

    If this continues, it could grow into a real income, which is quite exciting but also brings up some interesting tax questions. After all, right now he is a dependent for tax purposes, which means at least one of his parents get a tax deduction for raising him. But if he earns his own money, he might rise out of this dependence and even start owing taxes on his own. So is it worth it?

    Hey, Let’s Ask my Accountant!

    Outsourcing my taxes to someone younger and more enthusiastic about it than me has worked wonders.

    To get better advice, I decided to run this by my own business and personal tax accountant, Chris Care who runs his own firm called Care CPA. We talked over the ideas of family businesses and employing a child in greater detail.

    In summary, the results are better than I expected, which explains why people are so keen to hire their children.

    Here’s my brief Q&A with him. Thanks for your help Chris!

    MMM – So the first question is, what are the basic rules about employing one’s own child in a family business. My first instinct is that it sounds smart, because you are shifting income from parents in a potentially high tax bracket, to kids in a low tax bracket. So overall as a family, your tax bill falls.

    But Is it a good idea? How old do they have to be? Any things to watch out for?

    Chris Care: The biggest thing to watch out for is making sure the children are old enough to actually work. A lot of business owners want to pay their 1-year-old $15,000 a year for “modeling” by putting their picture on the company website. To me, this is a stretch.

    You also want to make sure you’re paying them in accordance with the tasks they’re doing. If they are 12 years old and filing paperwork for you, or cleaning your office, or other administrative tasks, you probably can’t justify paying them $50 an hour. You should make sure there is a clear job description, and keep an accurate record of the number of hours worked and the tasks performed, just like any other employee does at their job

    MMM –  What is the current child tax credit amount, and how would it phase out if he started making his own money? And does this scale up and down with the parents income as well?

    Chris Care – Currently, the child tax credit is up to $2,000 per child, with up to $1,400 being refundable if the credit exceeds your tax amount.

    In general, as long as you can claim the child as a dependent, and your income is below $400k if married filing jointly ($200k otherwise), you can claim the child tax credit no matter how much money your child makes. Above this income, the child tax credit phases out, but it is still not related to the child’s own income.

    MMM –  Oh wow, I didn’t realize that. And at what level would he need to start incurring his own income taxes? And as an employer, would I be on the hook for stuff like quarterly tax payments, unemployment insurance, worker compensation, and so on? Could he be more like a contractor and avoid these complexities?

    Chris Care – It’s unlikely you could classify your own son as a contractor. The IRS used to have a 20-factor test, but recently they have been narrowing and cracking down on this issue – more details here: Behavior, Financial, and Type of Relationship

    Aside from that, you’d have to handle things in the standard employee way:

    Just like any other taxpayer, the child will need to file a federal tax return if their earned income is above the standard deduction ($12,000 for 2018, and $12,200 for 2019). Note that state filing thresholds are often much lower than federal thresholds – check with your own accountant!

    MMM –  If a kid is living at home with no expenses, he might be wise to put as much of this into retirement accounts and otherwise defer taxes. If my company offered an employee 401k plan, could he put away the full $19,000 per year, or is there an even better option? Maybe his own tax-deferred college savings plan?

    Chris Care – As with any other employee, the child can participate in the company’s retirement plan, as long as the plan is written to allow minors to participate. The contribution limits will depend on the type of retirement plan. In your example of a 401k, the child could defer the full employee amount ($19,000 in 2019) as long as wages were at least that amount. He would also get the employer match if your company established one.

    College savings plans are an option, though whether or not he can open his own would be a question for your specific provider. Financial service firms tend to get a little hesitant opening accounts for minors. You could always open one, and he could contribute to it.

    MMM Summary: Wow, this is much better than I had even hoped. In rough terms terms, it sounds like if I can pay my son $30k from my company’s income, I might save about $10k in marginal income taxes, while his resulting tax bill would be quite minimal.

    Thus, it makes sense for me to start paying him as a real employee, rather than just paying all the taxes at my own marginal rate and keeping it in our own family spreadsheet, as I do now. 

    Chris Care – Yes, there are some good opportunities for tax optimization by hiring kids.

    In general, if you can justifiably pay your child a wage from the family business, it is an excellent way to lower the family’s tax burden, and give them a massive boost in retirement savings (since 401k contributions add up way faster than IRA contributions).

    Also, by owning the business, you can administer your own 401k plan – which means you don’t have to wonder if your employer’s plan will allow for a mega backdoor Roth, since you can design it that way! Just keep in mind, that 401k plan is for all employees, so any attributes you establish for family members would also be there for non-family members that you may hire.

    Another optimization: if you were a sole proprietorship, or a partnership where both partners are parents of the child being employed, the child’s wages would not even be subject to SS/Medicare taxes.

    This means you could pay them the $12,000 standard deduction plus $19,000 401k deferral, with zero income tax, zero SS/Medicare taxes, and zero Federal Unemployment tax. They may still be subject to state income tax and state unemployment tax, but those would be relatively minor.

    You can essentially shove $31k into a zero tax situation, from potentially a ~35% situation.
    This means it may be worth operating the youtube channel as a separate company, and employing your son as a real employee…

    MMM – hmmm, lots to consider! For now, YouTube is still only a few hundred bucks per month so we are not there yet. But it sounds like little MM’s future is bright, as long as he remains motivated to work hard and be creative and keep producing.

    Which is a good general philosophy for any of us: keep some good hard work as part of every day, whether you’re ten or one hundred years old. Doing good work and producing good things tends to lead to a good life.


    A Few More Thoughts and Disclaimers from Mr. Care:

    A Final Thought from MMM:

    If all this sounds like wishful thinking to you because you don’t own your own business yet, I strongly encourage to start one! For the great majority of early retirees, having a small entrepreneurial pursuit is both a reassuring security blanket and a fascinating and fun way to explore life after the cubicles and commuting stage is over. The Joy Of Self Employment.


    * This one of many interesting and sometimes untintuitive insights I got into Human nature when reading the rather excellent book Sapiens.

    Source: mrmoneymustache.com

    Apartment Decorating Taxes

    Does Paying Taxes Late Affect Credit?

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    November 27, 2019 &• 4 min read by Christine DiGangi Comments 3 Comments

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    Disclaimer

    NOTE: Due to the COVID-19 coronavirus pandemic, the IRS has extended the federal tax filing and payment deadline to July 15, 2020. The recent relief package passed by Congress may have additional tax implications. Please contact a tax adviser for information you may need to complete your taxes this year. Learn more.

    It’s a good thing to be punctual, especially when it comes to your finances. Your credit score relies heavily on your payment history, so developing a habit of making on-time payments helps you improve and maintain high credit scores.

    While tax information isn’t generally reported to credit bureaus, missing the deadline for paying the IRS could result in a tax lien, which could seriously damage your credit score. But in general, that’s the only way tax-related information goes on your credit report.

    How Taxes Affect Your Credit Score

    Everything from how long you’ve had credit accounts to your payment history and credit utilization ratio affects your credit score. If you’re trying to keep your credit on the upswing, you also want to ensure you understand how taxes can affect your score. Here are a few common questions when it comes to taxes and credit.

    • Does paying taxes build credit score? No, taxes aren’t generally reported to your credit unless there’s a problem, such as a tax lien. Paying your taxes every year or making payments as promised as part of an agreement with the IRS won’t help you build credit.
    • Do taxes affect your credit score? Taxes only affect your credit score when a lien is placed. When this happens, it can mean a hit to your score. If you currently have a tax lien on your credit report, your credit score will increase once it’s paid off and removed.
    • Does a late payment for property taxes affect credit score? Paying your property taxes late won’t immediately go on your credit report or affect your credit score like it does when you don’t make a credit card or loan payment. When you’re late on your property taxes, the county you live in can eventually put a lien on your house. Once the lien is in place, it will show up on your credit report and can take down your credit score by quite a bit.

    As a general rule, it’s important to pay your taxes promptly. For property taxes, many people take advantage of an escrow account that handles this for them. If you’re paying on your own, it’s easy for that annual or twice-yearly bill to sneak up on you.

    As for income tax, if you’re left with an end-of-year tax bill, pay by the April 15th deadline. Or, make payment arrangements with the IRS to protect your credit and avoid a tax lien.

    What’s a Tax Lien?

    If you don’t pay your taxes, the IRS can file a notice of federal tax lien with the credit bureaus. That’s a huge negative on your credit reports. If you owe more than $10,000, the IRS automatically files the lien after taxes have gone unpaid for 30 days. At that point, you could see a dip in your credit scores.

    But this doesn’t mean there’s nothing you can do. The IRS has plan that automatically deducts monthly payments from your bank account until the taxes have been paid. If an eligible taxpayer has enrolled in the installment plan, they can request the lien be withdrawn. Unlike other debts, the IRS installment plan payments will not be reported to the credit bureaus, so that aspect of the lien will not impact your credit.

    Other Consequences

    There are other ways unpaid taxes could hurt your credit score, which is why you should carefully consider your payment options. Failing to pay your taxes on time may not always hurt your credit score, but it could contribute to credit problems.

    Missing the April 15 deadline may subject you to late-payment penalties, which the IRS outlines on its website. You’ll end up having to pay more, and the effect of added expenses could put a wrinkle in your ability to meet other debt obligations. If you owe a lot, your payments could be sizable, which can make it harder to make your regular monthly budget work. If you start getting behind on other payments, such as a credit card and auto loan, because of your tax payments, your credit score can be seriously impacted.

    What Happens If I Owe More Taxes Than I Can Pay?

    If you decide to pay your taxes with a credit card or personal loan, there’s the potential you could see some negative impact on your scores. Adding to your debt load can affect your credit scores as it raises your credit utilization. If you end up struggling to repay the loan, a poor payment history will have a similarly negative effect.

    When considering paying your taxes, take a look at your credit score. You can see a score for free using Credit.com’s Credit Report Card. It could help you determine whether you can afford to temporarily add to your debt load or if you can qualify for a personal loan.


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    Source: credit.com