May, 2009 Tax Tip
Three Tax and Retirement Tips Accumulated During the Filing Season
Unwise to use retirement money to pay off debt
As I was interviewing clients during the just-ended tax season, I learned that some of them took funds from their retirement plans to pay off credit card and other debt. Was this prudent?
Despite the economic woes you may be facing, trying to dig yourself out of a financial hole in this manner will likely just make the hole deeper. This should only be considered as a very last resort and the reason should be no less than a dire emergency. Here’s why. You’ll pay federal and state taxes at your regular rates plus, if you’re under 59½, you’ll pay a 10% federal penalty plus whatever penalty your charges. Even if your bracket is 15%, your total tax bill will likely be close to one-third of the amount you withdraw. At higher brackets (not at all unlikely as the withdrawals are taxable), the amount you lose would be an even greater fraction of your withdrawal.
Once the money has been removed from the account it cannot be restored, thus causing you to lose all future tax-deferred appreciation on the funds. Assuming an average 7% annual return over 25 years (the stock market has achieved 8% even counting the years of the Great Depression), you’ll lose over $5,400 in retirement money for every $1,000 you withdraw now.
Another very important consideration is that money in a retirement account is protected from general creditors if you ever file for bankruptcy. It does not sound prudent to take protected money to pay off a debt that could very well be extinguished in bankruptcy.
My recommendation would be to try to negotiate lower interest rates from your credit card companies and, make every effort pay an amount on your monthly credit card debt that will allow you to chip away at the principal. This must be coupled with extremely prudent use of your cards.
Special tax break available for new car purchases this year
The IRS recently announced that taxpayers who buy a new passenger vehicle in 2009 may be entitled to deduct state and local sales and excise taxes paid on the purchase on their 2009 tax returns. This provides an incentive to purchase a vehicle this year, rather than waiting until 2010.
The deduction is limited to the state and local sales and excise taxes paid on up to $49,500 of the purchase price of a qualified new car, light truck, motor home, or motorcycle. The deduction is phased out for taxpayers whose modified adjusted gross income is between $125,000 and $135,000 for individual filers and between $250,000 and $260,000 for joint filers.
To qualify, the vehicle must be purchased after February 16, 2009 and before January 1, 2010. The deduction is available regardless of whether a taxpayer itemizes deductions on his return.
Ten Ways to Wreck Your Retirement - National Center for Policy Analysis (NCPA). These can be reviewed in detail at www.ncpa.org/pub/st320
1. Not making saving a habit
2. Leaving 401(k) matching funds on the table
3. Borrowing against 401(k) savings
4. Cashing out 401(k) savings
5. Jumping in and out of the market
6. Relying on home equity
7. Not diversifying savings
8. Underestimating longevity
9. Ignoring inflation
10. Staying in debt
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