Archive for the ‘Finance’ Category

I can’t sleep for some reason, so I figured I’d write a post and then start work early.  Honestly there hasn’t been a lot going on since we got back from the Bahamas.  Both Rach and I have been focused on work.  We did meet with an attorney to draft up wills, which puts us close to finishing the set of items that we wanted to take care of this year for our personal finance.  I still need to set up our money market account for our emergency fund which I’ll likely do this weekend. 

The wills process was interesting.  The part that we probably understood the least was the estate tax.  Apparently this year the federal estate tax has ‘expired’ such that if you were to pass away now, then you could leave your inheritance without that tax applying.  In general the tax is stupidly high; in 2001 for example, the estate tax was 55% of your ‘taxable estate’ – which that year was anything over $657,000.  In recent years it’s been more reasonable, in so much as the exclusion amount (the amount of money you can leave without being taxed) has gone up.  In 2009 the exclusion amount was $3.5 million and the tax was 45%.  Who knows what the estate tax will be like in 150 years when I might have to worry about it, but given the trend it will 1) exist, and 2) have a “low” exclusion amount, and 3) be a stupidly high tax rate.  This isn’t even considering a tax levied estate tax.  For WA the estate tax is decoupled from the federal tax, which ranges from 10-19% depending on your taxable estate.  So if you own property in WA and you want to leave $10 million dollars and you die next year, you would be taxed 55% on $9 million of that, and another 19% on $8 million.  That’s a lot of tax!

The investigation was enlightening.  In general I think it’s perfectly reasonable for the govt. to impose an estate tax.  I think a $1 million threshold is too low however; minimally the threshold should increase over time, and yet it 2011 its scheduled to ‘reset’ to $1 million instead of the $3.5 million that it was in 2009. 

So are there decent ways to minimize the estate tax?  I think so.  First, why die with that much money?  Amassing wealth for the joy of watching your the numbers on your bank statement go up seems silly.  I, personally, believe that if you end up collecting a lot of money, then you should try to spend some of it!  Outside of potentially helping you relax and have fun, it helps the economy when you spend money.  Second, you don’t have to wait until you die to start distributing your wealth to your heirs.  You can hand over a certain amount of money as ‘gifts’ tax-free each year.  Why not do that?  You then get to leave more money and you get to see how your heirs use it!  Third, in general it’s probably better to leave most of your money to the youngest/younger generation.  That way it’s most likely longer before that same money gets to a point where it could be eligible for the estate tax again.  Finally, there are various tax shelters that allow you to leave more money, given certain restrictions, without the estate tax applying.  For example, our lawyer suggested that one such mechanism was to create a trust if either Rach or I died.  We could ‘leave’ that trust up to $1 million (depending on the estate tax threshold at the time) without worrying about the estate tax.  In addition, another $1 million could be left tax-free to whoever is living longer.  The survivor could draw from the trust for various things (though not for everything) – medical expenses, ‘life-style maintenance’, but not things like extravagant vacations.  When the survivor passes away the money in the trust would automatically pass to our heirs without being taxed, and would no longer be limited by any of the trust restrictions.  That’s in addition to the normal amount that could be left to our heirs without being affected by the estate tax. 

I think Rach and I will mostly try to avoid dying with a huge amount of money.  We’re pretty successful at spending money to date, so maybe it won’t be a problem longer term :) 

As most of you know we recently sold our Redmond house.  We now have a stack of cash sitting in the Savings account of our bank depreciating daily, and that prodded me to do some research around personal finance.  I posted last week about analyzing our spending over the last year and deriving what I consider to be a pretty realistic budget.  That was our first step to putting together a plan moving forward. 

We have several goals.  The first is to establish a reasonable plan for retirement.  The second is to rein in our discretionary spending; or at least minimally track it better.  Our third is to make the money that we do have work for us.  Finally we want to make sure to protect against various catastrophes that might otherwise cause financial hardship/ruin.

To that end, I just finished reading Personal Finance For Dummies which I can now highly recommend.  It’s a fantastic survey of the various areas that people might classify as ‘personal finance’ and I find the author to be eminently pragmatic which I appreciate.  If you’re looking for a book to understand how to ‘beat the market’ this is definitely not it; this is more about understanding your options and learning what best practices are.

This post captures the set of things that Rach and I are considering implementing in the next month or so.  Another goal that I didn’t mention is that I’d like to get something in place soon that we will only have to monitor minimally.  For example, I have no desire to try day trading.  Outside of already having a day job, I remain convinced that day trading is tantamount to gambling.  I’d rather invest our money in the best way that we can reasonably figure out now and then check up on it every year to make sure that we’ve still allocated things appropriately for our goals.


The first subject that I started looking at was retirement.  Retirement means a lot of different things to different people, but to me it means not being required to work a full time job.  In fact, in my current vision of the future I would still probably do part time work even after retirement, but I want that work to be optional.  Our goal is to be able to retire at around 60 years old (yay for 30 more years of work!).  I did spend some time crunching numbers to see whether it was realistic to retire before that… it doesn’t look good without more compromises than we’re willing to make at the moment. 

The nice thing about retirement is that the government offers some nice incentives to save for it.  Ever since I started working for Microsoft I’ve put 15% of my salary towards a pre-tax contribution to a 401k plan.  MS has a great package that includes a certain % matched.  The annoying thing about 401ks is that they have a pre-tax limit for contributions.  At the moment that limit is 16,500/year.  Rach and I have decided that for our 401k we will continue to contribute the max pre-tax per year.  The one snag that we have to be careful of is that if you happen to make enough to hit that limit early in the year, it’s possible to lose out on some of the employer matching money.  I looked around through the MS plan documentation and it turns out that it currently isn’t effecting us (yay!).

I looked into opening a separate IRA either Traditional or Roth to save a bit more, but unfortunately Rach and I cannot take advantage of any of the pre-tax benefits of those accounts because of the income limits imposed.  Frankly I think it’s silly, given the mess that is retirement for a lot of people to make it hard to save, but it is what it is.

At the moment our 401k will be our primary vehicle for retirement contributions.  When Rach starts to work full time, we’ll see if it’s possible to invest in any employer provided pre-tax program.  I’m currently unsure whether the 16,500 limit is per person or per couple.  Either way, it’s not an option for us at the moment.

Our 401k is currently split 40% in international growth stock, 40% in an index fund, and 20% in a midcap growth fund.  We’ve decided that we’re happy with that allocation.  Both Rach and I tend to be risk averse which is why so high a percentage is in an index fund. 

In case anyone is curious, the calculators that we used suggested that we have roughly $3m dollars for retirement.  Assuming consistent contributions, plus our current assets, with an estimated 8% return and 3% inflation we will get there if we wait until 60 to retire.  That’s based on a lot of things that will change of course, but it’s the best estimate that we have at the moment.  Note, I didn’t include Social Security in those calculations; when added if we start withdrawing money at 67 we’d be in good shape.

Emergency fund

We want to establish a well thought out emergency fund.  In the past several years we’ve kept our checking/savings balance quite high (over $20k).  Our checking gives us exactly 0% interest, and our savings account is currently giving us 0.25%.  In short, they are well below inflation and we’ve been wasting money by letting it sit there.  However, because of the high balance we have, in essence, had a nice cushion in the event of anything catastrophic happening (e.g. if I lost my job).  It wasn’t at all intentional though.

The recommendations for emergency fund ‘size’ range anywhere from 3 months to 1 year of expenditures held in a very liquid ‘instant access’ account.  Rach and I have decided to stow away roughly 5 months of current expenditures, though it would likely last  a fair bit longer if we did have any issue since a large chunk of those expenditures are reducible. 

I have had a heck of a time trying to figure out where to put that money.  Our credit union offers accounts that they call ‘Instant Access’ where we could get 1.15% return.  Honestly that return sucks.  Instead I started looking at Money Market accounts.  The major difference is that MMAs aren’t insured, and while they tend to contribute to low-risk investments there is always the chance that we can lose money with them – particularly if interest rates skyrocket when the economy recovers.  This is a risk that Rach and I have decided to take.  We’re considering one of two different accounts, and if anyone has a suggestion as to which would be better I’d love to hear it.  We’re either going to go with the Fidelity Money Market Fund (SPRXX) or the Fidelity AMT Tax-Free Money Fund (FIMXX).  This choice seems to have a lot to do with understanding the AMT and unfortunately I’m no tax expert.  To date, Rach and I have never had to pay the AMT, but this year we sold a large amount of stock to cover the down payment on our new house.  I don’t know whether that will affect our AMT status or not.  I am leaning toward the SPRXX account at the moment.

Insurance review

One of the fascinating parts about the book I just read was that it included a section on insurance.  At first I didn’t understand why that would be, but the author makes some fantastic points in the chapter.  Basically, his meta point is that insurance is the way you go about making sure that you protect yourself and your family against financial ruin.  He then enumerates the various types of situations which could result in ruin, and the various insurance that you can buy that helps prevent these situations.  A few things that I had never considered that he mentioned:

  • Life insurance is pretty pointless if you’re single with no dependents; it’s also not all that interesting to splurge on life insurance if your spouse is completely capable of continuing their current lifestyle with you gone.
  • One of the most important things to cover when you’re younger is your ability to work, so it’s critical that you consider things like accidental disability insurance (workman’s comp will only pay out if you’re hurt on the job, what if you get hurt elsewhere?)
  • It makes sense to get enough liability insurance to protect your assets.  If you don’t have very many assets, then the default liability is fine.  What if someone sues you for $1,000,000 though?  If you have $500k of assets and only $100k of protection… well, you do the math.  As your assets increase, it makes sense to consider higher liability insurance, potentially under an ‘umbrella’ plan.
  • People pay for silly insurance.  Insurance shouldn’t be used to try to smooth out every day life; if you can afford to pay a $1k deductible if you need to then get insurance that matches; only get covered for things that would be financial ruin.
    • This also makes it an easy decision when asked if you want additional ‘warrantees’ on products that you buy.

After reviewing our insurance we’re covered decently well, but I plan on making the following changes:

  • We had a rider on our auto insurance which pays for towing in the event of an accident.  Towing isn’t expensive, and it’s pointless to insure against it.  Particularly since we belong to AAA (duh!) so I’m removing it.
  • We have Personal Injury Protection on our auto insurance.  Our health insurance will cover both of us in the event of a major accident so this insurance is redundant for us.  PIP would also cover people in our car that didn’t have good health insurance, but the fact of the matter is 99% of the time we drive each other around, and the other 1% of the time we drive folks that also have good health insurance.  It’s not worth it to keep this coverage (and WA doesn’t require it).
  • We are investigating increasing our liability coverage, though I haven’t researched rates yet.
  • We have gone through our house and recorded serial numbers and taken pictures of all high cost items and stored that information up on a protected share in the cloud.  It should significantly reduce the complexity of making a claim in the future if needed.

Additional investments

Outside of the 401k I mention above, Rach and I have a couple of other investments.  In the past couple years I haven’t been contributing heavily to our employee stock purchase plan.  In retrospect that seems silly.  The ESPP allows us to buy Microsoft stock at a discount rate at various set times during the year.  We can then sell that stock immediately if we choose and get an immediate return (minus income tax).  This is an amazing deal, and we’ll be contributing the maximum to that moving forward. 

After establishing our emergency fund we will still have a large chunk of cash from the sale of our previous house.  We have gone back and forth about what to do with it.  There are really two major options.  We either invest the money in the stock market (likely a mutual fund) or we use the money to pay down the principal on our mortgage.  If we had any high interest debt then the answer would be obvious, but our mortgage has a low interest rate and nice tax benefits.  However, I know that Rach and I will procrastinate if we decide to invest this money into the stock market.  Ultimately, we’ve decided to pay down our mortgage.  It’s almost certainly not the highest return move, but I think for us it makes the most sense.

Final actions

I mentioned we procrastinate right?  We still haven’t written up wills.  This is something that we’re going to throw into this bucket and take care of.  We’re going to write up normal wills, as well as put in place durable power of attorney. 

I’d certainly appreciate any thoughts people might have on our plan, particularly if you see something that you think is jut plain wacko.  Keep in mind that Rach and my risk profile is generally adverse, which means that we’re going to make more conservative decisions than other people (e.g. paying down the mortgage).

I’d like to retire someday.  Not tomorrow maybe, but say 30 or so years down the road.  It occurred to me recently, after having read story after story of an entire generation who is getting ready to retire and will either live near the poverty line or simply continue working well into their 70s,  that Rach and I really need to sit down and have a coherent plan to save enough of our earnings and invest it reasonably to have a fighting chance at retiring in our 60s.  I doubt the Lottery retirement plan is going to work out (but here’s hoping!).

To that end, I’ve been reading Personal Finance for Dummies.  It seemed like a good place to start.  I’m most of the way through it, and while it hasn’t been earth shattering, it has been a good refresher and I enjoy the pragmatism of the author.  I have several goals for this project including: having a much better organization of our income, to be able to answer seemingly simple questions like “how much do you save per month?”, to keep better tabs on where it is we’re spending our money, to choose better investments for the various ‘buckets’ of money based on the timeframe in which we intend to spend it, and to finalize a retirement plan that we can check in on every once in a while and make sure things are going well.

I thought I was going to spend this weekend putting these pieces together, but I realize now it’s going to take several weekends.  I decided to spend today focused on analyzing our monthly expenses for the last year to see whether they matched my understanding of where we were spending our money.  In the past, I’ve been pretty lax about keeping track of what comes in and out.  I generally know how much money we have in our various accounts and I know whether we’ll be able to afford new expenses, but I have never really looked at how much of that money is going into any particular category.  In fact, had you asked me what the top 5 expenses for us per month were I probably would’ve only gotten three out of 5, and I probably wouldn’t even have gotten those in the correct order.

For the past year our top 5 recurring expenses per month were: our mortgage, groceries, restaurants, energy & gas, and fuel.  The mortgage being the top monthly expense isn’t much of a surprise.  I was pretty staggered by how much money we spend per month of food though.  We do eat out often; though ‘eat out’ usually means ‘order in’, but that made me think our grocery cost would be comparatively low.  That’s just not the case.  We’re averaging $600/mo. in groceries alone.  That number seems shockingly high to me.

The illuminating part about this exercise is that it really helps to understand where to invest time if we’re trying to save money.  It’s pretty clear for us that the number one place to look at it is our food purchases.  We’ll almost certainly stop ordering out as much, but our plan is to spend the next month keeping a cost book for the grocery store.  Basically tracking the items that we buy most frequently, and see what prices we’re paying.  Then we’ll see whether we can do a better job buying those items more cheaply when they are on sale, or perhaps simply selectively changing our menus based on what the discounted meat/fish is for that week. 

It’s worth noting that the groceries number includes items other than food, like cleaning supplies, kitty litter, soap, etc.  Perhaps if we split those things out, and then shopped at a bulk store like Costco, we could lower our costs.  That will depend partly on how much additional storage space we get as a result of installing our shed (it doesn’t make much sense to buy in bulk if you’ve got nowhere to put it!).

I’m curious, do other people spend this much on food per month?

The next step for us in our personal finance journey is figuring out, in broad strokes, what we’re thinking about retirement.  Things like age to retire, how long we plan on living after that :), general lifestyle that we’d like to maintain, etc.  That should give us a solid understanding of how much money we’re likely to need.  More on that when we get to it…