Personal finance SOS!

March 21, 2007 9:11 AM

My wife and I have a relatively high combined income for the first time ever (much to our surprise), but we are pretty financially unsophisticated and getting hit hard by taxes. I am beginning to think the big tax bill for 2006 is a lost cause, but can anyone in MeFi-land offer any advice about how to take better control for 2007?

It is kind of ridiculous to be soliciting anonymous advice over the Internet in this scenario, but I'm not sure where to get started in the real world. (FWIW, I know you are not my lawyer, CPA, financial adviser, priest or sweet Aunt Sally.)

Together my wife and I made about $230,000 last year, due to some career changes. In years past, our combined income was about $50,000. Due to underwithholding by our employers, we owe an additional $10,000 in taxes above the $40,000 or so paid through withholding. The silver lining of our financial unsophistication is that all the money we didn't spend from our salaries, we just left in a checking account--so we have cash to pay the taxes. The bad news is that, unless we wise up, I expect to be in the same position next year: we don't intend to be buying a residence or having additional dependents. The IRS online withholding calculator is forecasting that unless we change our withholding, etc., we will underpay by $18,000(!) next year.

Neither of us has a retirement account. Based on my research, I think our combined income puts us over the limits for traditional IRAs, and I think a 401(k) is funded only in the calendar year in question (so, no last minute deposits like you can do with an IRA, right?). We don't have a lot of expenses, so we don't itemize deductions. Vast sums of student loans, but no credit card debt.

So, a two-fold question: 1) is there anything we can do to try to reduce the taxes we have to pay for 2006, given the IRA income phaseout? and 2) who do people with money get to help them with money questions? I'm looking for advice both on taxes and on saving towards particular goals (house, kids, caring for parents, retirement, the whole list of things that keep you up at night). Do I need an accountant? A financial adviser? Both? Could they be the same person? Would such a person just try to sell me some hot new stock I don't want?

We live in NYC, if you have any personal recommendations. Email is askmefi2007 @ earthlink dot net.

This is all a new world to me, and I am a bit embarrassed both to be making so much, and to know so little. Thanks in advance for any input.

posted by anonymous to work & money (27 comments total)

Traditional IRAs are fine, but you don't qualify for Roth. If you plan to pay for anybody's college education, look into 529 plans.

And you'll get better advice for your specific situation from a financial planner.
posted by Tacos Are Pretty Great at 9:25 AM on March 21, 2007

Oh, and whatever you do, please do not take financial advice from books with the word "Rich Dad" or "Millionaire" in the title.

Just have a nice boring conversation with a financial planner and go from there.
posted by Tacos Are Pretty Great at 9:28 AM on March 21, 2007

(Oh, and make sure the financial planner is a fee-based one, not a commission-based one. The former make their money giving you their best advice. The latter do so by selling you stuff.)
posted by Tacos Are Pretty Great at 9:32 AM on March 21, 2007

Side note: how does one find a fee-based financial planner?
posted by fionab at 10:12 AM on March 21, 2007

For 2007, see if either of your employers offers a health care spending account. You can have a chunk of your paycheck deposited into that account, and then you can get reimbursed from that account for any medical expenses that your health insurance doesn't cover - glasses, contacts, over-the-counter medications, copays for prescription medications or doctor visits, etc. You don't pay tax on the amount that goes into that account. The catch is that you lose anything in that account that you don't spend in that year, so you want to estimate those expenses as well as you can, but definitely don't want to over-fund it.
posted by DevilsAdvocate at 10:14 AM on March 21, 2007

Oh, and whatever you do, please do not take financial advice from books with the word "Rich Dad" or "Millionaire" in the title.

There are a lot of crazy books out there, but Rich Dad, Poor Dad is actually a good one. If they'd been "paying themselves" as it advises, then finding the money to pay the tax bill would be simple as at least 10% of their income would be liquid.
posted by wackybrit at 10:14 AM on March 21, 2007

IThe IRS online withholding calculator is forecasting that unless we change our withholding

Can you change your withholding at work? Otherwise set aside the estimated payments into a high-yield savings account and just expect to pay up at tax time. Are you self-employed? It doesn't sound like it, but otherwise I don't see why you couldn't change your withholdings.
posted by mattbucher at 10:16 AM on March 21, 2007

You can still fund a regular old IRA account for last year.
posted by yohko at 10:20 AM on March 21, 2007

If you have any income from self-employment, you can start a SEP-IRA or other retirement fund until April 15, and the contribution caps tend to be higher than for 401(k)s.

Also, if you and your wife didn't participate in a 401(k) or other retirement or profit-sharing plan for 2006, you may be eligible to make a tax-deductible contribution to a traditional IRA, despite your high income.
posted by phoenixy at 10:20 AM on March 21, 2007

I think you need a financial planner for retirement investment and short term savings (it hurts me inside that you have 10+K languishing in a checking account) and a CPA for tax planning and filing.

You can probably do worse than a starter article like this one, another easy resource is ask your colleagues who are probably at a similar level to you financially. Nothing is going to save you from research because there are rip-offs, particularly in financial planning, but they are pretty easy to avoid.

Stuff you need to be figuring out:

1. Expenses you should be considering taking on, like disability insurance, additional life insurance.

2. Potential deductions - this is where a CPA could potentially do a lot for you. Your belief you don't have any significant deductible expenses is probably erroneous. You could also consider increasing charitable giving which will reduce your tax burden and potentially make you feel better about your new affluence.

3. Ways of reducing your taxable income - I think the main ways you can divert income pre-tax is to retirement investment and health care expenses (health savings account type vehicles). My household income is about a third of yours so I don't know how these things play out at that level, but they make a big difference for me. A conversation with both your planner and CPA for this.

4.Regardless of what it does for your taxes, long term investment strategies. Start planning aggressively for retirement now. Your planner should not be selling you on any hot stocks unless you want to spend part of your income on short term investing, which is not really retirement planning, it is gambling with homework. They should be setting you up with rational, traditional, low-cost investment vehicles giving you a diversified blend of risk versus yield products. Most people, for long term investment purposes, are not thinking about specific stocks at all.

5. How to save your excess income for short term (0-5 years) use now. Frankly, withholding is a bum deal. The IRS hangs on to your money and you don't get squat. It is a convenience, and forces you to keep it aside for taxes, but you would probably do a lot better applying the minimum withholding and saving for taxes (and whatever else) with something like a fully liquid, low-risk mutual fund account. You might as well earn interest on that money while waiting to pay the taxes. You might also want to consider medium term products like CDs for saving for a house or whatever.

6. You might want to crunch the numbers on the interest on your school loans and consider what sort of priority to put on paying those off. That interest might be tax deductible, incidentally. The balance between potential interest on short term investments, tax savings on deductible expenses, and interest costs on debt can get into a little bit hairy calculation, but even some back of the envelope guestimation can sometimes reveal obvious savings to be had in a particular course of action.
posted by nanojath at 10:20 AM on March 21, 2007

Definitely change your withholding. The IRS can get cranky if you underpay by too much every year.

Itemize and donate old clothes, appliances etc... This can add up to a few grand a year.

Join the Republican party and fight for more tax breaks ;-)
posted by hilby at 10:22 AM on March 21, 2007

Fee-only financial planners can be located at NAPFA.com. And of course, obligatory link to Get Rich Slowly (and the blog).

Couples with incomes over $125,000 may be vulnerable to the Alternative Minimum Tax. The internet offers plenty of ideas to avoid it, but that's another thing to research and discuss with a financial pro.
posted by junkbox at 10:29 AM on March 21, 2007

The Motley Fool has good, concise, layperson-friendly articles that can give you a good introduction/overview to wealth management.
I'd give you some advice as to what I would do if I had that kind of income, but anything I say, the Fool will say better and more thoroughly.
posted by Sprout the Vulgarian at 10:41 AM on March 21, 2007

Owing the IRS money on tax day is a good thing, if none of it is penalties. It means you've been earning interest on your cash instead of Uncle Sam. You want to pay the least amount in estimated taxes you can without incurring penalties.

Read up on the Safe Harbor rule. Basically it says that if your income spikes, you don't have to pay more in estimated taxes than you paid in taxes last year (you'll still owe the money, but it's better to be sitting in your Money Market Fund until tax day). For high income payers, the rule is something like 110% of your previous year's est. taxes.

If it looks like you'll be underpaying next year, figure out the minimum you can pay in estimated taxes, and put the rest in an account like a Money Market that earns more interest than a checking account.

Regarding deductions, sometimes itemizing can work, but you need to check that itemizing will save you more than the standard.

Finally, I suggest getting an accountant to help with tax stuff. I suggest reading up on investing, because no one will look out for your interests as well as a well-informed you.
posted by justkevin at 10:44 AM on March 21, 2007

Oh, and whatever you do, please do not take financial advice from books with the word "Rich Dad" or "Millionaire" in the title.

Honestly, a lot of the personal finance books out there have good, common-sense advice for personal finance. It's never a bad idea to read a few personal finance books to get an idea of what information is out there. Of course, most personal finance books boil down to three main points:

1) Spend less than you earn. If possible, spend a lot less than you earn.
2) Save money in an emergency fund. The size of this fund will depend on how secure your current job/income is.
3) Save money for retirement and other large expenses.

As far as paying less in taxes, there may be deductions you're eligible for that a financial planner can help you with, but the bottom line is that the government is always going to want to take their chunk of your income, and they have the resources to collect that chunk if you don't pay it to them - you don't want to get into that situation.

If your employer isn't withholding the right amount of tax from your pay, you can always ask that the withholding be increased.

Get Rich Slowly is definitely a good place to look for some information, and it's run by our very own jdroth.
posted by gwenzel at 10:47 AM on March 21, 2007 [1 favorite has favorites]

There are a lot of crazy books out there, but Rich Dad, Poor Dad is actually a good one. If they'd been "paying themselves" as it advises, then finding the money to pay the tax bill would be simple as at least 10% of their income would be liquid.
posted by wackybrit

They did, no matter if they called it "paying themselves" or not. From the post:

The silver lining of our financial unsophistication is that all the money we didn't spend from our salaries, we just left in a checking account--so we have cash to pay the taxes

The question wasn't how to find the money, it was how to reduce the tax bill, and where to find good advice.
posted by NotMyselfRightNow at 10:53 AM on March 21, 2007

Definitely look at the AMT. If you file a regular return, and later find out you needed to do the AMT you will be fined.
Check out the Uniform Gift to Minors, I am not sure if you can give to anyone other than your children, but if you can, and you have nieces and nephews you could start a college fund. Be careful you don't screw up though. the 529 plans have some restrictions on who can fund them. Giving the money to a minor and having them stash it may be the way to go.
There may be ways to pre-fund certain types of retirement accounts. And it may be too late for this year, but you may be able to defer future compensation until you are ready to buy a house.
posted by Gungho at 10:53 AM on March 21, 2007

There are a lot of crazy books out there, but Rich Dad, Poor Dad is actually a good one.

No. It isn't.

Much of the advice it contains is wrong. Some of it is downright illegal (it advocates insider trading.)

It downplays the risk involved in almost all of the advice.

It is truly one of the worst financial books available in any bookstore today. John T. Reed has a more thorough analysis on the subject.

The Motley Fool books, or the WSJ's Personal Finance guidebook are far more useful. I've never read Get Rich Slowly prior to today, but the few things I looked at seemed quite reasonable.
posted by Tacos Are Pretty Great at 11:06 AM on March 21, 2007

Side note: how does one find a fee-based financial planner?

The best way is to talk with colleagues.

The OP really just needs some initial assistance, and if they are motivated learners, probably won't need to go to a planner again unless there is a significant life change.

As it stands, they probably need to learn about wills, marital trusts, trusts for children, balancing risk (and learning what that might mean in terms of week to week portfolio fluctuations), analyzing investments and any number of other niggly things.
posted by Tacos Are Pretty Great at 11:17 AM on March 21, 2007

I actually think that a financial planner is kind of a waste when people don't know the basics themselves first. They're just going to charge you money to teach you things that you can teach yourselves.

First, I would say that you should get educated about the basics of personal finance. Motley Fool has some drawbacks, but it's as good a free site as any to learn the basics. Spend a few hours a day there for a week, and you'll be fine.

Second, you can significantly minimize tax liability and save for retirement by maximizing the tax-deferred options available to you. Before you pay your taxes, you should contribute to a traditional IRA (which has no income limits) or a Roth IRA (but I think that you are over the limits or partially phased out), plus any 401(k) options that are available to you (note that you have to reduce 401(k) contributions by the amount that you contribute to a 401(k). Obviously, make sure that you are going to have enough money to pay your taxes, though. IRAs can definitely be funded for a given tax year up until tax day of the next year, but I'm not sure this is the case for 401(k)s, and you probably can't make contributions to one if you're not in the plan already.

Third, that tax situation sounds strange to me. Who did your taxes? Have you appropriately deducted the fantastically high NY city and state taxes? You still have $10k in tax liability after your jobs withheld the correct amount proscribed for the number of exemptions you are claiming? Did you increase your exemptions to get a higher paycheck? Something seems wrong to me here. Unless your situation is very complicated, I think that, after you educate yourself, TurboTax or something similar will he helpful for you to understand things, and it also does a great job of addressing AMT issues.

Fourth, note that charitable deductions are great, but giving cash or something else liquid to a charity is still a losing proposition, from a purely financial standpoint. You get a deduction that will be 39% at most of what you are giving to the charity. Stuff that has value but which you're not using and can't otherwise convert to something of value to you (i.e. old clothes) are the best things to donate. Make sure to get a written receipt and you will have to value the things yourself using on-line resources or whatever. But, since you have to make the deductions during the year in question, do that this year for your 2007 taxes.

Fifth, for cash savings, put money, at a minimum, in a savings account earning 5% or so. There are many available. Your $10k would be $10.35k or so after taxes had you done that last year. I would also soon think about investing in mutual funds and equities after you learn something about them - I know that they are unpopular around here because everyone thinks they are OHMYGOD! risky when you can earn 5% in a savings account, but a lifetime of compounded growth at 12% or so is going to make you a lot richer than the same at 5%.
posted by jcwagner at 11:18 AM on March 21, 2007

Do you have a good accountant? They will make the paperwork and estimates for this very easy. You should ask them to do a tax forecast for you for 2007 so you know now what you will pay.

There aren't a lot of legal options for sheltering wage income from taxes. Get an AMT estimate as soon as possible; you can choose which year you pay various state taxes in to help with AMT. Take full advantage of tax advantaged investments (IRAs, 529s, 401ks, etc). But otherwise, suck it up, taxes are an obligation. And pay your taxes on time this year, either by increasing your withholding or paying quarterly estimates. You'll probably avoid penalties for 2006 because of the safe harbour provision, but you probably won't for 2007.

If you're going to keep making much more money, congratulations! Buy a house; the tax break is phenomenal. Invest the extra wisely. Investments give you various opportunities for sheltering income; the two most common are municipal bonds and deferring capital gains. There's a whole world of crooks out there to advise you on investments; avoid them. If you don't have someone you trust, call up Vanguard. They're a good firm and can give you advice to get started.

If your income is not just simple wages you may want to look into setting up a corporation. Everyone I've known who's tried to do it finds it doesn't help them. But if your livelihood involves significant expenses, look into it.
posted by Nelson at 11:24 AM on March 21, 2007

Check out the Uniform Gift to Minors, I am not sure if you can give to anyone other than your children, but if you can, and you have nieces and nephews you could start a college fund. Be careful you don't screw up though. the 529 plans have some restrictions on who can fund them. Giving the money to a minor and having them stash it may be the way to go.

I don't think the UGMA is a good option. Sure you can deduct it on your taxes, but unlike the 529, you (the gifter) have no control over the funds once the the minor turns 18.
posted by mattbucher at 11:52 AM on March 21, 2007

Unless it is put into the 529 by the giftee...
posted by Gungho at 1:26 PM on March 21, 2007

I think you're getting a lot of really good advice, and I'd second going to The Motley Fool and reading around, and then once you feel like you're not totally ignorant, talking to a fee-based financial planner. If you have a good full-service bank or credit union, you might start by asking there, but be careful since they might be "free" (commission-based) planners and not fee ones. Remember: TNSTAAFL. Nobody (professional) is going to give you advice for free.

The other thing I think you need to do sooner rather than later, is get that money out of a low-interest checking account! I mean, ten grand? That's a whole lot of interest you could have been making. You don't want to be risky with it, but get it into a secured money-market account or high-yield savings at least, with a few months worth of expense money in checking. If you keep your savings in the same bank as your checking, it's trivial to go on their website and slosh a few hundred or thousand bucks out to checking if you ever need it.

Also, if I was making that much (getting close to hitting the AMT), I'd be thinking about getting a good CPA to sit down and do my taxes with. Unless you really are into reading the tax code as a hobby (don't laugh: I know people that are), you're making enough that the $300 or $500 that you're going to spend on tax-prep (which is deductible, BTW) may be easily justifiable if it helps you to avoid the AMT or penalties. And in many cases, a good independent tax-prep/CPA may also do financial advice during the "off season." Just like finding any other professional (doctor, lawyer, dentist), make sure you find somebody you can talk frankly to.
posted by Kadin2048 at 2:06 PM on March 21, 2007

Btw, you can only deduct tax preparation fees if it (in combination with certain other miscellaneous deductions) exceeds 2% of your adjusted gross income. I'm assuming for most people this isn't happening, especially people making over 200K.
posted by alkupe at 3:03 PM on March 21, 2007

Living in NYC you definitely want to itemize instead of doing the standard deduction. The city+state taxes way overwhelm the standard deduction.
I wouldn't worry about the AMT unless you have kids or a morgage-- it only hits you when you take too many deductions. I don't make quite as much as the two of you but I have no kids or morgage and have managed to deduct my NYC state + local taxes and a bunch of charitable donations just fine without hitting it.
Looks like you're really getting bitten by the marriage penalty. What a bitch of a law that is.
posted by ch1x0r at 6:00 PM on March 21, 2007

I actually think that a financial planner is kind of a waste when people don't know the basics themselves first. They're just going to charge you money to teach you things that you can teach yourselves.

In part this depends on where they stand right now.

I'd just hate to see them make the incredibly common error of learning a little, thinking they learned it all, and missing something very important. It happens a LOT.
posted by Tacos Are Pretty Great at 9:44 PM on March 22, 2007