Beating Broke

Personal Finance from the Broke Perspective

Retirement Products: What are the Differences?

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There are excellent tax benefits associated with official retirement products, but these products often come with restrictions. Always understand your options and the rules of the product upfront.

Deciding to start investing for your retirement is the first step. Next you need to choose which tools to use. This requires you to compare products and note their differences.

This step can be quite daunting since there are many products available, but the best way to approach this is to consider your needs and level of self-control.

You are locked in, but with tax benefits

Retirement products are the logical choice for most people saving for retirement due to their tax efficiency. The government provides generous tax breaks to encourage people to invest in provident funds, pension funds and retirement annuities (RA) for their retirement. The catch? Your money is not easily accessible before your retirement.
To limit investment risk, retirement products impose limits on the amount that can be invested in higher risk assets such as offshore investments and equities. These rules can hinder your growth, particularly if you start your retirement savings in your twenties.

Do you want accessibility and tax benefits?

The benefits of retirement products compared to tax-free investment (TFI) products have been heavily debated. Both products grow free of income tax on interest, dividends tax and capital gains tax.

The main difference between the two is that retirement products offer you tax savings now. You end up paying less tax now since you make contributions with earnings on which you haven’t yet paid tax. You only pay the tax later once you start drawing an income. This means you defer paying the tax. TFI products are completely tax-free. You invest money after paying tax, but you pay no tax later.

In a TFI product you are allowed to withdraw your money at any time. This is an advantage if you prefer or require accessibility. Remember though that you could also lose out of the effects of compound interest by dipping into your savings and you have an annual and lifetime limit on contributions, which cannot be replaced once withdrawn. It is important to note that using a TFI in conjunction with a normal retirement product could give you greater access to higher risk investments such as offshore investments and equities.

Do you want an investment with no limits?

You could also consider investing directly into unit trusts. Your contributions, like with TFIs, aren’t tax deductible. And, unlike the other two options, your returns will be taxed. This will reduce your returns, but you benefit from the freedom to invest as much as you want to in any assets and have access to your funds whenever you choose. Once again, the temptation to withdraw your money before your retirement might rob you of the benefits of compound interest.

Understanding the rules of a product is essential before you commit to it. Changing midway could have massive tax implications and may even result in penalties. If you’re uncomfortable doing this by yourself then consult an independent financial advisor to help you review your options.

Parents Tax Bill Rising?

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Tax season is right around the corner.  Before you know it, we’ll all be holed away in some corner of our house punching numbers into our computers as we try to squeeze a few more of our dollars back from the IRS.  That’s a task that might get a bit harder for some parents this year.

According to this CNN Money report, on January 1, 2013, several tax credits are set to expire.  And, unless Congress manages to pull it’s collective head out of a dark place and extend those credits, many of our tax returns will be quite a bit heavier come April.  For parents, specifically, this could cause quite the burden.

Specifically, the Child Tax Credit, Earned Income Tax Credit, Child/Dependent Care Credit, and the American Opportunity Credit will expire.

  • The Child Tax Credit would be reduced to $500 per child, instead of the $1000 it’s currently at, and would no longer mean a refund of any excess credit above and beyond tax liability.  It’s debatable whether it should be giving that excess credit as a refund, but I’d certainly like to see them keep the credit at the $1000 number.  This is one that we use on our taxes every year, and I know it’s been quite beneficial.
  • The Earned Income Tax Credit will have several of it’s key income thresholds reduced back to previous thresholds.  The maximum credit will also be reduced by 5%.  I believe we exceed the threshold for this one, but reducing the thresholds will eliminate it for quite a few families.
  • The Child/Dependent Care Credit, like the EIC, would see several of the maximum credit and reportable expense reduced.  This is one that I know we’ve used every year, since we’ve always had some sort of child care expenses.  Could mean a significant loss of credit on our tax return.
  • The American Opportunity Credit is a credit that replaced what was called the Hope credit.  It allowed for a higher amount of credit and for some of the credit to be refundable to the tax filer.  If it expires on January 1, it will revert back to the hope credit which means the credit will be reduced by $700, and also reduced to something that can be claimed 4 years to something that can be claimed only 2 years.  The Hope Credit is also a non-refundable credit, so if you have no tax bill, it doesn’t mean a larger refund like the American Opportunity Credit would.  Again, I don’t necessarily agree with the refundability of credits, but this could mean a huge difference for some families still paying for college expenses.  I’ve never been able to use it since I was well out of college when it was put into place.

That’s just four of the parts of the tax code that are set to expire on January 1 if Congress doesn’t act on it.  In a Presidential election year, you can bet they won’t make any moves on it until after election day, so they’ll have a very short window in order to get something done.  I truly doubt that they’d let them all expire, but depending on the outcome of the election, it could be a pretty dirty fight.

How many of you have used these credits?  Would their loss on January 1, 2013 change your tax bill considerably?

Debt Ceiling Crisis?

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If you’re even slightly interested in the US economy, and, let’s face it, most of the world is, then you’ve likely been at least marginally following the last few weeks worth of debt ceiling news.  The quick and dirty of it is that the US government has a debt ceiling that puts a cap on how much debt the US federal government can carry.  If they reach that cap, they can no longer issue treasury bonds and the like to raise money to pay for things.  Based on what I’ve read, everyone would like us to believe that it’s a major crisis, and the world will end if we don’t raise that debt ceiling and allow for more debt.  But, is it really a crisis?

Let’s think about this just a little bit.  Replace “U.S. Government” with John Doe in everything I’ve just said, and all the news you’ve read.  If we were talking about an individual, we wouldn’t be talking about how the world would end if they weren’t allowed to accumulate more debt.  We’d be talking about how they need to radically cut costs, increase income, pay off debt until they can get their finances in order.  Would  it be called a crisis?  Maybe on a personal level, John Doe would believe it was a crisis.  But, it certainly wouldn’t be world ending.

Bus1I’ll admit that it is a bit different when it’s a government entity that we’re talking about.  If the US government goes bankrupt, there will be some pretty serious problems with the economy for a while.  Which brings up another issue altogether.  The US economy needs some diversification of it’s revenue streams.  Way too much of the economy balances on how much money the US government sinks into it each month.

It’s time we start asking the same questions of the US government that we would be asking of John Doe.  Do you really need that expenditure?  That service?  All three cars?  The McMansion?  Unfortunately, those that are in charge in Washington are playing political ball instead of really trying to solve the problem.  They think way to hard about what programs they can cut that won’t lose them votes in the next cycle, or how much they can raise taxes without losing votes, when, instead, they should be looking to make the US government financially solvent and stabilizing it’s fiscal situation.  You or I would start with a balanced budget, I don’t see any reason why the government shouldn’t do the same.

What do you think?  I don’t think I’m being to idealistic in asking that they carry a balanced budget each year.  Or that they cut costs until they can do that.  Yes, they’ll likely have to raise taxes some to pay off what they’ve got for debt, but if it doesn’t come with some pretty significant cost cutting, they’ll all be looking for new jobs in 2012 anyways.

photo credit: Public Notice Media