4 Reasons A Line Of Credit Is NOT A Good Emergency Fund

The following post is by MPFJ staff writer Travis, who blogs at Enemy of Debt where he candidly shares his family’s financial struggles, failures and successes. As a father and husband, he provides a unique perspective on balancing debt, finances, and family.

The subject line on the email read, “Be prepared for the unexpected.” The email from my bank was a solicitation for a line of credit. The email tried to convince me to click on the link to the online application by describing the line of credit as a way to be prepared for all those little unexpected things life throws your way.   What my bank was suggesting is that I use a line of credit as my emergency fund.

Having a line of credit for an emergency fund is a terrible idea for several reasons:


1. Used For More Than Unexpected Expenses

The marketing material claims that the bank is trying to help its customers be prepared for the unexpected with a line of credit.  I think it’s fairly obvious that they have a different motivation behind the product for a couple of different reasons:

  • Credit Limit: The standard statement is that a $1000 emergency fund will handle 90% of all unexpected expenses.  The credit limit range for the offered line of credit is $3000 to $100,000.  Except for a medical crisis, I can’t think of a single unexpected expense that would cost $100,000.  Even in that case, I certainly wouldn’t be using a line of credit with a high interest rate to pay for it.
  • Profitability : Banks make their money from customers paying interest when they carry a balance from month to month.  Unexpected expenses are by definition infrequent.  If the line of credit was truly meant to be a simply for unexpected expenses, use of the account would be infrequent, and most of the time be for a relatively small amount of money that could hopefully be paid off quickly.  These scenarios would not be a big money maker for the bank.

My bank is trying to get me to apply for a line of credit hoping I’ll use it for much more than the occasional unexpected expense.  With a potentially large line of credit, they’re hoping I use it for everyday use or for things much more grand such as home renovations or vacations.


2. Promotes Financial Laziness

A person building up an emergency fund must exhibit two very important financial behaviors:

  • Regulate Spending : A emergency fund can only be built if a person spends less than the amount of money left over after paying all bills.  This is best accomplished through paying yourself first.  Or in other words, making savings a part of your required budget, ensuring that money is directed towards savings from each and every paycheck.
  • Emergency Funds Are Off limits : Once a significant amount of money has been built up in an emergency fund, there is a temptation to use it to buy something instead.  To be fully prepared for an unexpected expense, a person has to practice financial self control to not touch those funds.

Depending on a line of credit as an emergency fund when a financial crisis arises requires neither of these behaviors.  It allows a person to spend every penny they have with reckless abandon.  It allows a person to live without planning financially for the future, with the perspective of dealing with any unexpected expenses if and when they arise.


3. Extends The Crisis

If a fully funded emergency fund is in place, not only can the unexpected expense be paid in full,  but the structure is already in place in that person’s financial behavior to begin to rebuild it.  The unexpected expense is taken care of, and a financial crisis is avoided.

A person with a line of credit for an emergency fund has not practiced the planning and self-control needed to build an emergency fund for unexpected expenses.  The expense is financed using the line of credit. They now have the difficult task of reducing their lifestyle to make line of credit payments for an indeterminate amount of time.  If only the minimum payment is made each month, it could take years to put the financial crisis fully behind them


4. Increases Cost Of The Crisis

Currently, most personal lines of credit have an interest rate of 10 to 12 percent.  Interest will start to accumulate immediately, increasing the overall cost of the financial crisis each month it takes to pay off the line of credit.  If at any time a payment is missed or late, the interest rate will likely be increased causing the cost of the unexpected expense to grow even more.

It really comes down to how a person wants to handle unexpected expenses.  A person can either be proactive, or reactive.  Using a line of credit as an emergency fund falls under the category of being reactive.  Such a methodology trades financial responsibility now, for budgetary and financial turmoil when an actual unexpected expense happens later.

How about you all? Do you have a line of credit as your emergency fund?

Share your experiences by commenting below! 

***Image courtesy of Stuart Miles at FreeDigitalPhotos.net

How your accounting business can bill for higher-value services

The following is a guest post. Enjoy! 

As accountants, we all want the same thing — more work and more money. It’s rare for people to get into the accounting business because they’re passionate about accounting. Rather, they understand it can be a profitable business that allows them to enjoy some of the finer things in life.

Now, for some accountants today, they’re satisfied with their existing clients and the level of work they provide. Most accounting businesses deal with compliance accounting — making sure tax laws are being followed and that the books are being balanced.

But some of us strive for more. We want to be more efficient. We want to take on more clients. And we want to bill more for high-value services. In the end, this means for money, but it also means a little more work.

With some help from technology, however, it may not be as hard as you think.

Understanding the goal

Your whole team needs to understand how to bill for higher value services. This means moving beyond spreadsheets and helping businesses make important decisions.

  • It requires a cultural change. You now need to think outside the box. While the old way of doing business is a great foundation, it needs to serve as a springboard into what’s truly important: services that do more than report what businesses are up to, and rather, help business move forward and grow.
  • Start creating some estimates to show your team how much money could honestly be made off this idea.

Transition can be difficult

Mapping out the future is easier than actually doing it. Once you’re in a groove, it’s tough to go against the grain, but it’s a necessity if you want to make more money.

A couple of key steps can make everything easier:

  • Go with a cloud-based system that allows you to work from anywhere and allow all data from you and the client collaborate under one umbrella.
  • Don’t be too change-happy. Change is good, but you don’t want to ruin the great foundation your business has already started.
  • When building a rate structure, make sure to mix it up. Tier your services, showing clients and potential clients that you’re versatile and can offer anything they may need.

Understand client demands

Technology has sped up the world and clients have become more demanding. They want cloud technology for all client services in order to have an easy way of monitoring their accounts.

You need to aim for the top. Whenever you think you’re going above and beyond for our client, push a little harder.

Be part of the “modern accounting revolution.” It’s not easy, but it’s unavoidable. You need to work extremely hard in order to win clients and honestly, make your work more interesting.

A Review of My 2014 Income Tax Results and 2015 Tax Planning

The past year has been quite a whirlwind. I finished my PhD program in Virginia, got married, went on an awesome honeymoon to Belize (great place to go by the way!), did the post-PhD job search/interview process, moved to Colorado to start the post-PhD job, bought a house in Colorado, and now have our first child on the way (due January 12th, his name is Alex – see picture below!).

Anyhow, all of that is to say that I am a bit behind on getting this post out. Normally, I do this post in around the April-May time-frame, but better late than never, right?!

In general, the results of filing my wife and my [married filing jointly] 2014 taxes were very good, as I felt like we leveraged the tax code to the best of our ability in order to maximize wealth. As has become my habit over the past few years, I feel that by analyzing some of the finer details/numbers, I can better plan for how to approach my tax planning for the 2015 and beyond year.

Let’s get started!


2014 Income Breakdown

Our combined total 2014 gross income can be broken down in to the following components:

  • 47% from W2-reported wages / income.
  • 8% from dividends, capital gains, and interest from investments.
  • 25% from untaxed fellowship/wage income for my work as a graduate student.
  • 20% from Schedule C self-employed business income.
After subtracting out the deductible part of self-employment taxes, self-employed health insurance deduction, and a deduction for student loan interest, we arrived at an Adjusted Gross Income (AGI) that was ~4% lower than my overall gross income, so only a slight change there.


2014 Deductions

Since the married-filing-jointly standard deduction was greater than our itemized deductions, we took the standard deduction of $12,400 for 2014.

After subtracting the 2 personal exemptions we get for myself and my wife (with no kids, filing jointly), we arrived at a taxable income that was only 68% of our original/total gross income that we started with.


2014 Federal Taxes

Having established our taxable income, our total personal federal taxes were computed. Next, self-employment taxes were added on top of the personal taxes.

This resulted in our total Federal taxes owed for 2014 being ~11% of our overall/total gross income.Nice! I am surprised this percentage is so low!

If we calculate this based on our AGI or taxable income, the percentages become 11% and 16%, respectively.


2014 State Taxes

Since we lived in Virginia January-November and then Colorado during December, we got to pay state taxes in two states for the respective portions of the year.

Our 2014 total state (combined for Virginia and Colorado) taxes owed was calculated to be 4% of my overall/total gross income. If we calculate this based on my federal AGI or federal taxable income, the percentages become 5% and 6%, respectively.


2014 Total (State + Federal) Taxes

If we put everything together from both state and federal taxes, we can find something useful for planning purposes going forward:

  • We paid a total tax amount for 2014 equal to 15% of our overall/total gross income.
  • Our marginal tax bracket was 15%.


2014 Taxes Owed / Tax Refunds Received

When everything was said and done, we unfortunately had overpaid quite significantly in taxes during the 2014 year. As a result, we received almost a $3,000 in federal tax refund, $800 in a Virginia state tax refund, and we owed $93 for Colorado state tax (since we underpaid slightly).

The primary root cause for the overpayment in federal taxes was paying too much quarterly estimated taxes for my self employment income. This was due to my self employed income dropping in 2014 compared to 2013, and my 2013 taxes owed still being used as the basis for calculating 2014 taxes.


2015 Estimated Taxes – Prospective Planning

One of the nice things that my accountant does do for me each year is to calculate/prepare my estimated taxes for the following tax year (so 2014 was prepared during the 2013 tax preparation round).

Due to our significant overpayment in both state and federal taxes in 2014, our accountant advised us in April 2015 that we did not need to pay quarterly estimated tax payments for our self-employed income for 2015. He did, however, recommend that if we were “having a banner year” and earning much more self employed income than previous years, that I would need to look in to increasing my tax withholding from my post-grad school W2 income.


2015 Estimated Taxes – How It Actually Happened

So, now let’s fast forward 6 months to October 1st, 2015. This is the day I had marked on my calendar to assess our self-employed income and my regular W2 income and tax withholding year-to-date to determine if we were paying enough taxes (since the accountant advised that we didn’t need to send quarterly estimated taxes for 2015).

I proceed to add up my projected W2 income, our combined self-employed income, taxable interest, ordinary dividends, and capital gains. I then subtracted out the deductible part of self employed income taxes, student loan interest deductions, the standard married filing jointly deduction, and our two personal exemptions.

Upon arriving at our approximate taxable income and taxes owed, I was quite surprised to find out that, without changes/intervention, we were en route to be $8-10k behind in federal taxes owed for 2015 (state taxes owed were on track). As this is greater than 10% of our total taxes owed for 2015, an underpayment penalty would apply come April 2016 when we file our 2015 tax return.

Clearly, some drastic changes were needed to correct this. As such, since October, our main focus financially has been to 1) increase the amount of taxes withheld from my regular W2 income and 2) decrease our taxable income to as close as we can possibly get to the 15% marginal tax bracket level.

Specifically, listed below are the actions we took starting in October:

  • Dropped the number of exemptions for my W2 income from 2 to 0 to increase the amount of taxes withdrawn from each paycheck.
  • Requested that $1,000 additional federal taxes be withheld from each of my biweekly paychecks.
  • Contributed as much as possible to regular/pre-tax retirement accounts to reduce our taxable income:
    • As we had already maxed out our Roth IRA contributions this year, we could not contribute any additional funds to our regular IRAs.
    • We stopped contributing to my job’s Roth 401k and our Vanguard Self Employed Roth 401ks, and instead have been contributing to our regular 401ks.
      • $5,250 contributed YTD to my wife’s pre-tax self employed 401k.
      • $935 contributed YTD to my job’s pre-tax 401k.
      • $1,774 contributed YTD to my pre-tax self employed 401k.

With these drastic actions, my wife and I are now on track with our federal taxes and should not have to pay penalties when we file for 2015.


Plan for 2015 Tax Filing – Accountant or Online Software?

Overall, 2015 has been a year of big changes from a financial perspective, as I went from a graduate school income to having a real job and my wife has been earning more self-employment income the past few months, in spite of becoming increasingly pregnant! :)

Because of all these financial changes, it’s understandable that our taxes experienced a bit of a “windfall,” and we are now having to play a little catch-up. However, it sort of makes you wonder – should our accountant who did our 2014 tax return advised us a little better and anticipated these changes? After all, they did advise that estimated tax payment likely wouldn’t be required.

In thinking about it, I don’t blame the accountant for a lack of attention or not doing a complete job. However, at the same time, I am not overly impressed, and it does make me question the value proposition, especially given that the accountant tax prep fee for 2014 was $685, whereas in previous years, I was charged a prep fee of $250.

Given the considerations above and the fact that we have moved from Virginia to Colorado (and we do not yet have an accountant here in Colorado yet), I believe that I will try my hand at using an online tax preparation software for filing our 2015 taxes.

The question then becomes, which online platform should I use?

As I found in my previous detailed explorations of Tax Act, H&R Block, and Turbotax, my favorite online tax preparation platform was Tax Act. As such, I believe I will use Tax Act for filing my 2015 returns.

How about you all? Are you on track with your 2015 taxes? Do you expect to have a tax refund or owe taxes when you file? Will you file using an online tax prep platform or use an accountant?

Share your experiences by commenting below!

How to Plan for Retirement in Your 20’s

The following is a post by MPFJ staff writer, Kevin Mercadante, who is a freelance professional personal finance blogger for hire, and the owner of his own personal finance blog, OutOfYourRut.com. He has backgrounds in both accounting and the mortgage industry.

If you’re in your 20s, planning for retirement is probably not very high on your list of things to do. Starting and advancing your career certainly seems more relevant, as does buying the things that you need to live your life.

But somewhere in the mix there needs to be an emphasis on retirement planning. Retirement is one of those areas of life where the sooner you start, the better you finish. It has everything to do with the time value of money, and you should want to get that working in your favor as early in life as possible.

Here are some ways to plan for retirement in your 20s. Most don’t require a lot of money to do either, but are based instead on getting into good money habits.


Save Up to the Employer Match on Your 401(k) Plan

If you have an employer sponsored retirement plan, you should participate in it, at least at a very low level. The most important step when it comes to a savings plan of any kind is just getting started. If 2% of your pay is all that you can afford, then go with it, and increase it over time.

One way to do this is by increasing your retirement contribution each time you get a raise. Let’s say that you start contributing 2% of your pay into your employer’s 401(k) plan. One year from now you get a 2% increase in pay. Cut that in half, allocating 1% to your 401(k) plan contribution – increasing it to 3% – and keep the remaining 1% in your regular budget.

Under ideal circumstances, you should aim to participate in the employer plan to the point you maximize the employer matching contribution. For example, if your employer has a 50% match (3%) up to a contribution by you of 6%, your goal should be to contribute 6%. The employer match is like free money. You’ll get $1 added to your plan by your employer for every $2 that you contribute. That’s too good to a pass up.

If you delay participating in retirement savings until a time when you can afford it, you’ll probably never get started. Throughout your life, there will always be major expenses and challenges that will compete for your income. The only way to rise above it is to start saving money as soon as possible – as in now.


If You Don’t Have an Employer Plan Start an IRA – Even a Small One

Not all employers have a 401(k) plan. If yours doesn’t, create an alternative strategy by setting up a self-directed IRA. You can contribute up to $5,500 to an IRA each year, and your contributions will be tax-deductible if you do not have an employer plan (and may be partially or completely tax-deductible if your income is within certain limits).

Don’t worry that you can’t make the maximum contribution. Start by adding $50 per pay period. If you are paid twice a month, that will be $100 per month, or $1,200 per year. As your income increases, allocate a larger amount of money to go into your IRA.

Just as is the case with a 401(k), getting started is more than half the battle.


Make Getting Out of Debt a Priority

This is certainly a tall order when you’re in your 20s. After all, if you already have student loan debt, and you need to buy a car, you’re virtually guaranteed to be in debt. But as difficult as it is to avoid the debt trap as a young adult, avoid it you must.

There are two major reasons why getting out of debt is important when you’re in your 20s:

  1. Debt becomes a pattern early in life – if you “get comfortable” being in debt in your 20s, you might spend the rest of your life there, and it can get progressively worse
  2. By getting out of debt, you gain full control of your income, and free up money to invest for retirement and for your long-term prosperity.

This isn’t necessarily to say that you need to make getting out of debt an all-consuming activity – seeing it through until the last dollar of debt is paid in full. But you should establish a pattern of paying down your debts ahead of schedule. The idea to set a goal of getting out of debt within a specific time. You can make that five years from now, or at a certain age, say when you turn 30.

The sooner you defeat the debt monster, the easier it will be to do all things financial in your life, including preparing for retirement. And as you get your debt situation under control, be sure not to add any new debt to your life. Once again, you’re trying to avoid bad habits that can become a lifestyle.


Develop a Life of Thrift

Now is a good time to spend a couple of minutes on the topic of lifestyle inflation. If you’re in your 20s, you’re likely to see a steady increase in your income in the coming years. Lifestyle inflation describes a financial process in which your standard of living rises as your income increases. You get a promotion with a substantial increase in pay, and you upgrade your car, move into a more expensive living arrangement, and adopt some expensive hobbies.

That’s a typical pattern, but it’s also one of the major reasons why people find that they don’t have any more money even though they’re earning more, often a lot more. Lifestyle inflation is one of those habits that’s best avoided when planning for retirement, or working out any financial goal you can think of.

The basic idea should be to keep your living expenses as low as possible, while using pay increases to fund saving and investing, and getting out of debt. And again it’s important to remember that this point in your life, you should be trying to establish the kinds of habits that will enable you to move forward, rather than getting trapped in a financial mess.


Don’t Try to Beat the Market

Millions of people – including investment managers – try to beat the market, and fail miserably. Unless you work in investments professionally, it’s probably not worth your time to even try to figure it out. In fact, you can lose a lot of money trying to learn how to beat the market. That’s probably something you don’t want to try to do until you have a large portfolio, and can allocate a small percentage of it into a small secondary account where you can try your hand at it.

In the meantime, and especially as a new investor, stay with funds, particularly exchange traded index funds. You won’t beat the market with these, but you won’t get clobbered by it either.

And if you would like to try active management, look into low cost robo advisors, like Wealthfront and Betterment, that offer professional management at very low fees and are specifically tailored for new and small investors.

At this stage in your life, retirement may seem so far away that you have plenty of time to ignore it. But it’s worth repeating – when it comes to retirement planning, or any other financial endeavor, the sooner you start, the better you finish. Get working on retirement planning now.

How about you all? If you’re in your 20s, have you started saving for retirement? What age did you start your retirement planning process?

Share your experiences by commenting below! 

***Photo courtesy of https://www.flickr.com/photos/digitalsextant/4491928640/sizes/n/

Financial Planning for the Holiday Season

There is a chill in the air these days and in some parts of the country, it’s beginning to look a lot like Christmas and the holiday season! Thanksgiving is just around the corner, and before you know it, we’ll be decorating our Christmas trees, lighting our Menorahs, and spreading holiday cheer in general.

With the holiday season comes a lot of extra spending that we just don’t see during other parts of the year.  From heading out of town to see the in-laws (or to get away from them??) to planning and executing the perfect family Christmas dinner, budging for these extra expenses will go a long way in securing your financial health and keeping you sane during an otherwise stressful time of year.

Planning for Holiday Vacations

A lot of people travel over the holidays.  Going to Grandma’s house to be with the entire family this year?  Maybe you’re headed some place tropical to get away from the cold and blustery snow of home. Regardless of where you go, there is a lot that you need to plan in advance so you’re not seeing red on your credit card by the end of the year.

Before you head out anywhere, you’ll need to budget and allocate your finances appropriately.  How are you getting there?  Are you flying? Think about how much it will cost to park at the airport or take a shuttle or taxi in (as well as to your destination). How much will the flights cost? If you’re not staying with friends or family, you’ll need to factor in hotel, food, and entertainment costs. Even if you don’t have a solid itinerary, you still know you need to sleep somewhere and eat three times per day, so make some good estimates.

If you have been using a Discover it Miles card and earning 1.5x Miles for every dollar you spent, you can use those towards your holiday travel purchases to help with the cost.

Hosting Holiday Meals

Maybe you’re staying at home this year and everyone is coming to visit you! Now you don’t have to worry about flights, hotels, and other travel expenses, but now you have a new list of items to take into account.  What are you planning to cook over the holidays?  Plan your meals and use the ingredient list from the recipes to calculate how much it will cost for you to cook for whoever is coming to town to visit. Don’t forget about the wine or other adult beverages if you or your family enjoy such things. These items can add up, so try to find deals on multiple packs or bottles and try to pick brands that don’t cost an arm and a leg.

One way to save a little bit of money here would be to offer to “co-host” the holiday meals with another friend or family member.  Maybe one of you can purchase the food, while the other purchases the beverages.  Alternatively, if you have a lot of people coming from in town, consider hosting a potluck-style dinner where you provide the main dish while everyone else brings their favorite side dish and/or bottle of wine.

Budgeting for Gifts

Of course, what’s the holiday season without gifts? The more people you have in your family and close circle of friends, the more expensive gifts can become.  One way to avoid spending too much on gifts is to limit the amount that you spend per person.  Set a strict limit of $10-$20 (or more or less, depending upon your own financial abilities) per person, and do not go over that limit when purchasing gifts for each person.  Alternatively, if you have family or friends who are couples, consider purchasing just one gift for the two of them to share.

Holidays should be about more than just material gifts, so don’t feel obligated to “go all out” and buy everyone you know the most expensive thing you can find.

Check Your Credit History

Finally, with all these extra purchases this holiday season, you’re going to want to stay on top of your credit and make sure your credit history doesn’t take a big hit.  You want to budget all of your holiday spending appropriately so that you’re able to stay on top of paying your bills, and to make sure your credit score does not suffer.

Thankfully, the folks at Discover offer your FICO® Credit Score for free  on all monthly statements..

The most important thing this holiday season is to give thanks for all that you have, all your friends, family, and loved ones. It’s the company of friends and family that matter most, and everything else is just not worth hurting your credit score and sending you into debt.  Budget your holiday finances appropriately, and stay on top of your FICO® Credit Score  by checking it on your monthly statement or online.

Happy Holidays, all!

Disclosure: I am a paid brand Blogger for Discover Financial Services My views are my own and do not necessarily reflect the views of Discover Financial Services and its affiliates.