Archives for October 2010

Retiring Wealthy On An Average Salary: The Story Of The Thrifty Engineer

A couple of times on this site I have profiled millionaires who became rich through hard work and determination, and I talked about how and why they were able to rise to such success.

While those stories can be inspiring, sometimes they can leave us average folk thinking that dreams of becoming balance sheet affluent are beyond our reach because we aren't able to create a six figure income or become wealthy within a few years.

This week I decided to start a series of posts looking at the stories of more average folks who, despite making an average salary during their working years, retired wealthy and were able to help out a lot of people when they died. I'll call this series “Retiring Wealthy On An Average Salary”.

Today I want to look at the story of Jimmie Dean, the thrifty engineer. (not Jimmy Dean the sausage magnate, who also has a great story and who we profile here.)

The Thrifty Engineer

Jimmie Dean was an engineer, who was raised in a family of modest means – in Washington County Oklahoma. He believed in hard work, individual responsibility and education, and that through those things a person could achieve their goals and dreams. After serving honorably in the Navy, he worked as an engineer at Phillips Petroleum for 33 years. While he worked hard and with distinction, he never made a six figure salary. The most he ever made was around $50,000 a year. Even with such modest means, Jimmie was able to leave a substantial amount of land and money to his family, and still have enough to create a 2 million dollar scholarship fund for Oklahoma college students. How did he do it? Through being “frugal with his money” and investing in mutual funds.

A thrifty engineer from Oklahoma who died with $2 million and has set up a scholarship foundation.

Jimmie Dean (not to be confused with the sausage magnate) worked for 33 years as a technician at Phillips Petroleum. The most he ever earned was around $50,000 a year.

But he scrimped and saved and invested in mutual funds. When he died in 2008, he had more than $2 million in the bank. His bequest was to set up a scholarship fund.

“He did it through being frugal with his money,” said Mr. Dean’s nephew, Bob Boyd, who now runs the Jimmie Dean Foundation.

The foundation is handing out scholarships of as much as $10,000 to students who show hard work and a commitment to remain in Oklahoma.

Granted, $50,000 a year in Oklahoma is decent pay. Mr. Dean was married only briefly and had one son. Still, getting to $2 million on a $50,000 a year salary is worth noting.

And at a time when giant philanthropists like Bill Gates and Warren Buffett get so much attention for their largesse, it also is worth celebrating the little-knowns who saved all their pennies over a lifetime only to give it all away when it was over.

It just goes to show that even if you aren't making a six figure income, you can still retire with a nice nest egg if you're willing to do the hard work, be frugal, save and invest.

Does this story of living on an average salary and retiring wealthy help you realize that you could retire comfortably as well? Tell us your thoughts in the comments!

SEP IRA Rules And Contribution Limits: Retirement Plans For Self Employed People

By Mr. Money 2 Comments

In the past couple of years I've been considering taking a chance and becoming a self employed entrepreneur, and something I've had to consider is how I'll be saving for retirement. As a self employed person, you won’t have the option of a 401k. You do have some other options though. Among them:

SEP IRA
SIMPLE Plan
Solo 401(k)
Keogh Plan

In this post I'll be exploring one of the more attractive options for tax deferred investing for self employed individuals, the SEP IRA

What Does SEP IRA Stand For?

Before we get too far we need to set out the basic definitions. So what does SEP IRA stand for? I assumed it meant something like “Self Employed IRA” because I had encountered this type of account when reading about being self employed. SEP IRA actually stands for Simplified Employee Pension Individual Retirement Arrangement. The SEP IRA was intended as a plan for small businesses to set up a retirement plan for their employees without al lot of hte administrative and paperwork costs normally associated with retirement plans.

The SEP IRA is similar to a traditional IRA account. The biggest differences come when you talk about the contribution limits. The contribution limits for a SEP IRA are higher.

Rules For The SEP IRA

As an employer opening a SEP IRA for your business is subject to rules and regulations. SEP IRAs have a lot of the same rules as a Traditional IRA. Among the SEP provisions:

All eligible employees must be provided with plan benefits, and a separate IRA account. If you are self employed with no employees besides yourself, it isn’t an issue. If you have employees, it is something to consider.
Part time employees who are 21 years of age who have worked 3 out of the preceding 5 years, earning $500 or more annually will be eligible.
Only the employer can contribute to the SEP IRA. If you work for a company that provides one, only your employer can contribute to the account.
You have until the tax filing deadline of April 15th to establish and fund your SEP IRA.
Withdrawals from a SEP IRA are treated the same as withdrawals from an IRA account – with a 10% early withdrawal penalty, and taxes charged at your current rate.
Only income from the business can be contributed. If you have a day job as well, that income can't be contributed.

Contribution Limits For The SEP IRA

Contributions to the SEP IRA are subject to yearly limits, however, they are higher than many other similar account types.

For example, for tax years 2010 you can contribute up to 25% of an eligible employee’s compensation, up to a limit of $49,000. Extrapolated from the 25% rule the income threshold for a SEP IRA is then $196,000.

Example: Let’s say you make $100,000 a year and you’re self employed. Under a SEP IRA you would be able to contribute 25%, or $25,000 to your plan.

Older employees are not allowed catch up contributions.

Pros Of The SEP IRA

There are quite a few reasons to consider having a SEP IRA account:

Any money that is contributed by your employer (you if you're self employed), you are 100% vested in right away. The money is yours!
Your money grows tax free until retirement!
Contribution limits for self employed individuals are higher than similar plans.
Setting up a SEP IRA is usually as easy as filling out IRS Model Form 5305-SEP
Administrative costs and paperwork are minimized after the plan is setup.
Contribution levels are flexible. A good plan if cash flow for your business is variable. You can contribute 5% one year, and then 20% the next if you want.

Do you have a SEP IRA that you contribute to? If so, how do you like it so far? Are there any bad points about the plan that you don't like, or benefits that we didn't mention? Tell us your thoughts in the comments!

$1500 Energy Tax Credit For Energy Efficient Home Improvements Runs Out Soon

By Mr. Money 6 Comments

As the end of the year approaches, a lot of people are scrambling to try and schedule work on their homes that they had been putting off. The reason? Most of the tax credits for energy efficient home improvements that were passed a while back will be expiring at the end of the year on December 31st, 2010.

Details Of The $1500 Energy Efficiency Tax Credit

So here are the basic details of the credit.

Tax Credit: 30% of cost of the home improvement, up to $1,500
Expires: December 31, 2010
Limitations: Must be on an existing home & your principal residence. New construction and rental homes don’t qualify for the credit.

So what that means is that for a qualified home improvement, you would get a tax credit of 30% of the covered cost up to a $1500 total credit. For instance, if you pay $3000 for a gas furnac (excluding installation costs), your credit would be $900.

How To Claim Your Tax Credit

In order to get your tax credit, it would need to be claimed on your 2010 taxes.

For products “placed in service” in 2010, you would take the tax credit on your 2010 income taxes.

Your home improvement should have been placed in service in 2010 if you plan to claim the tax credit for the 2010 tax year.

What Energy Efficient Products Are Eligible?

The tax credit for energy efficient home improvements will apply to a variety of energy star rated products, although not all.

If you purchase an energy-efficient product or renewable energy system for your home, you may be eligible for a federal tax credit. …

Please note, not all ENERGY STAR qualified products qualify for a tax credit. ENERGY STAR distinguishes energy efficient products which, although they may cost more to purchase than standard models, will pay you back in lower energy bills within a reasonable amount of time, without a tax credit

Among the most common products to be eligible:

Biomass Stoves.
Energy efficient doors and windows. Installation costs are not eligible for the credit. Other restrictions apply.
Water Heaters. Credit includes installation costs; some restrictions for energy efficiency apply.
Insulation, whether spray foam, fiberglass, or blow-in cellulose, they’re all covered so long as they meet IECC requirements. Installation cost is NOT covered.
HVAC components, including advanced air handlers, air force heat pumps, central A/C units, boilers, propane, and gas furnaces. Tax credits include installation costs.
Metal and asphalt roofs. Credit doesn’t include installation costs.

For more details on what products are eligible, FAQs and more, check out the government site here: Federal Tax Credits for Consumer Energy Efficiency

Don’t Just Blindly Put Money In Your 401k. Get Out Of The Hammock

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You can’t just blindly put money in a 401(k) and assume that once you’re retired, it’ll all turn out perfectly. Do you even know what’s in your 401(k), or how to determine what is? It’s okay to admit that you don’t, we’re all friends here and no one will judge you (except possibly me, and I can’t see you anyway.)

If you work at a company of a certain size, then sometime in your first year on the job, a representative from Smith Barney or Fidelity or Vanguard or somewhere came to your office and held a lunch meeting in the break room. She might have brought pad thai. There’s a good chance you weren’t even there: one-third of corporate employees who are eligible for 401(k)s don’t even take advantage of them. If you were there, you almost certainly weren’t paying attention when she handed out the prosaic brochures about her company offering several exciting financial products to cater to your retirement needs, blah blah blah. At this point, the people who are still listening usually defer to whatever the company rep or the company’s chief accountant recommends. Which isn’t necessarily going to cost you money, but it does mean you’re surrendering your financial decisions to someone else. Fortunately, it’s not that difficult to regain control of where your money’s going.

Your 401(k) almost certainly owns a piece of a mutual fund, or funds. No, the two terms aren’t synonymous. The mutual fund itself isn’t a retirement plan: it’s an agglomeration of investments, which is then divided into pieces small enough for regular people to own a piece of.

Say you wanted to buy Google stock, which is trading at $514.30 as I type this. A standard order of stock is 100 shares, meaning you’d need at least $51,430 to buy in. Do you have that kind of money sitting around? If you do, do you want to invest it in the least diverse of all securities (a single stock)?

Thus mutual funds. A typical mutual fund will contain millions of dollars’ worth of Google, maybe McKesson, some Anheuser-Busch, a dollop of General Electric and a light seasoning of Safeway, among dozens of others. The fund manager then makes pieces of the fund available to individual investors (and to 401[k]s), for as little as $250. Instead of buying 100 shares of Google, you can own .00078 shares. Easy street, here you come!

I know this already. Stop talking down to me.

Really? Then what’s in your 401(k)?

Uh…er…

Here’s how you find out. Find the investment management company that holds your 401(k). You should get statements from them regularly. If you toss them out, ask the relevant person at your office exactly what your 401(k) is in.

Vanguard’s big, let’s use them as an example. There’s a place on the front page of their website where you can view all their mutual funds. We did, and picked something called the Growth Equity Fund at random. Vanguard sells 118 funds, 18 of them classified as “Domestic Stock – more aggressive” funds, which the company describes as being for people who “(seek) maximum long-term total return, without significant dividend income,…(have an) investment horizon of (>5 years), (and/or are willing to) accept wide fluctuations in share price.”

Well, then.

At the relevant page, you’ll learn a couple of important things:

the Growth Equity Fund’s holdings are worth about $562 million;
.51% of the money the fund takes in goes to expenses;
it has a ticker symbol, VGEQX, meaning you can track it daily on Yahoo! Finance or somewhere similar.

The page also lists the funds’ 10 biggest components. You know what that is? Almost useless, because it leaves ¾ of the fund unaccounted for. For the full picture, go to the “Portfolio & Management” tab and scroll down to the “portfolio holdings” link. It’ll list all 81 companies your 401(k) has a piece of, from Apple (which this fund owns about $32 million of), all the way down to Ritchie Bros. Auctioneers (about $1.6 million.) In order to stay liquid for emergencies, the fund also holds a couple of investments that are almost the equivalent of cash – $2.2 million in Freddie Mac discount notes and another $22 million in short term reserve holdings.

Most investment companies list the components by percentages, rather than raw umbers. In the case of Vanguard, you have to do a little division to know that VGEQX consists of about 5.7% Apple, 3.5% Cisco, 2.9% Microsoft…and .3% Ritchie Bros.

And hey…there’s that Google stock that’ll make you rich, about 1/3 of the way down, at 1.4%.

Look, 401(k)s are a great way to save for decades down the road. One of the features about 401(k)s people like is that they can “set-and-forget” them. But it’s not that simple.

Would you hire a nutritionist to feed you, then strap on a blindfold at mealtime every day, certain that whatever the nutritionist was putting in your mouthwas good for you? Maybe, but presumably you’d want to at least take a look yourself. The same should go for investments. You don’t want to check your 401(k) composition and how its components are doing every day, but bimonthly or quarterly won’t kill you. Especially since it’s so easy to do.

Greg McFarlane is an advertising copywriter who lives in Las Vegas and Lahaina. He recently wrote Control Your Cash: Making Money Make Sense, a financial primer for people in their 20s and 30s who know nothing about money. Buy the book here (physical) or here (Kindle) and reach Greg at greg@ControlYourCash.com.

Should Married Couples Have Joint Bank Accounts?

By Mr. Money 10 Comments

One of the most common discussions that I hear from people considering walking down the isle, or those who have already gotten hitched, is the age old topic of whether or not couples should have joint bank accounts – and whether they should share their finances. It can be a touchy topic to discuss because it really digs down deep to the core of a relationship, the levels of trust that there is for the partners, and just how strong the relationship is. It's can often lead to arguments, so it's no wonder that people often avoid the topic like the plague before they get married. I believe, however, that it should be discussed.

Have The “Joint Finances Discussion”

It's a discussion that my wife and I have had in the past, and to some degree we've not completely agreed upon. I have always been of the belief that when you get married, two become one. You should become one in that you share everything, including joining your finances to become a family financial situation. If one partner has debt, the other partner takes that debt on as well. If one has a large savings account, you both have it now. Everything should be shared -both the good and the bad.

My wife, while she theoretically believes in two partners becoming one, has come from a household where that hasn't always been practiced. One parent came from an abusive first marriage, and as a result ended up not being as trusting in a lot of things, especially financial things. Because of that my wife learned that you need to be wary of sharing finances, and always have your own accounts and money – “just in case”. That belief that was engendered in her from an early age wasn't an easy one to overcome.

Because of that level of mis-trust that she had learned from her parents, we never joined our finances completely. We had a joint budget, family budget meetings and we had joint financial goals, however, we never actually joined our bank accounts. We just each had our own checking accounts, and savings accounts. It seemed to work ok, but it just left me with a sour taste in my mouth for some reason. Probably because I felt like I wasn't trusted by my spouse.

We Finally Joined Our Accounts

This year after we had our first child we finally had the discussion again. We were at a crossroads in our relationship, and we're now heading down the road of being parents, and embracing other challenges. My wife is now a stay at home mom, and as a result we started talking once again about having joint accounts. This time she was more agreeable to the idea, mostly I think because she has matured in the relationship and has a higher level of trust in me. I believe now that we have joint accounts it will lead to a greater sense of unity in our relationship, mean less mis-communication about our money, and force us to have less of an individualistic outlook on our relationship – one where there is a “mine vs. yours” outlook. We might even end up with a better bank balance!

Reasons I Think Joint Accounts Are A Good Idea

There are a lot of reasons I think joint accounts are a good idea.

Fosters greater unity and less individualism in the relationship: When you join your finances, and other aspects of your relationship it means you have to become more united, and less individualistic. I know for me remembering that I was now in a relationship where I had to think more about the other person than myself was hard. Joining finances helps that.
Creates better communication about money: When you are sharing an account, you have to communicate more about what's coming in and going out by necessity. More communication is a good thing, however, and you'll probably find you're in a better financial situation as well.
Gives a different perspective on money: Forcing yourselves to be accountable to the other person, and giving up some ownership of your money is a good reminder that “our money” really isn't our money anyway, it's all God's. Remembering that it all belongs to God makes it easier to release some of that control for me.

Now I should also mention that I don't think joint accounts are ever a good idea unless and until you are married. The same goes for other financial arrangements like mortgages and loans. I would never enter into any of those arrangements until I was married as it can cause more problems than you could imagine.

So what do you think? Are joint accounts a good idea like I lay out, or do you think having separate accounts is alright as well? Tell me your thoughts on joining finances in the comments!

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