# Archives for March 2008

“The editorial content on this page is not provided by any of the companies mentioned, and has not been reviewed, approved or otherwise endorsed by any of these entities. Opinions expressed here are author's alone.”

A popular theory states that something is not worth doing if it makes you less that your hourly wage. For example, if you make \$30 an hour and you can hire someone to mow your lawn for \$20 an hour, you should go ahead and pay for the service. As someone who is earning more and yet trying to combat lifestyle inflation, I’ve been struggling with this idea. According to this rule, all of a sudden I can start paying people to do all kinds of stuff for me. Laundry. Cooking. Cleaning. Or can I?

Thought #1: What Is Your Real Hourly Wage?

1. First, roughly estimate your hourly wage. If you work 40 hours per week, a quick way to estimate your hourly wage is to take your annual income, remove the trailing three zeros, and divide by two. For example, if you make \$100,000 per year, then you make \$50 per hour. A person earning \$20,000 per year = \$10 per hour. If you are using gross income then you’ll end up with gross hourly age.
2. Take taxes into account. If you earn \$50 per hour gross, that might be only \$35 per hour net. Someone earning less at around \$10 per hour gross will probably be earning more like \$8 per hour net. Try this net paycheck estimator or look at your paystub.
3. Be realistic with hours. Do you really only work 40 hours per week? If not, adjust accordingly. Now add in your commute time, the time it takes to get ready each morning, the time it takes to decompress after each day. Your job takes up a lot more hours than you might think.

Now, what is your final per-hour wage? If I made \$50k per year, but worked 50 hours per week plus 1 hour total each day for commuting + getting ready, with filing single and taking standard deductions, I’d be down to around \$13.50 an hour. Paying someone to do the lawn for \$20 an hour is not longer a mathematically prudent idea.

Thought #2: Are you salaried?
The premise of the argument implies that you can simply work instead to cover certain expenses. Hire the maid for \$20 a hour, the landscaper for \$30 an hour, restaurant food at \$20 per hour – hey you make \$40 an hour so who cares? Work in your office, and make up the difference and then some. But many of us are salaried workers. If we work 40, 50, 80 hours a week, we won’t earn any more money.

In other words, this only works if you can at the same time make more money elsewhere. Someone who works in their own business or does consulting has much more freedom in this regard. I don’t know if I’m that good at time management to pull this off, though.

Thought #3: Will you always be making as much?
I’ve come to see regard frugality as a habit, which can take years to form. Getting used to paying for everything to be done for you is going to hurt if you want to retire early. If you get used to a higher cost of living, you’ll need a much larger nest egg to generate more income. Living a simple and frugal life now will help make the same life an enjoyable one down the road.

In addition, by doing things yourself you may be learning a skill that can also pay off when you can’t justify paying for it anymore. Gardening and growing your own food is a skill. Cooking is a skill. Performing your own car maintenance. Doing your own home repairs. And so on.

Not Just Math
Obviously, if there are activities which you prefer not doing, or can simply be done by someone else for a fraction of the cost, it can definitely be worth it to outsource. Childcare is a common example, although some do it for the socialization. Besides cost and skill development, I would also adjust for personal taste.

For one, we are considering putting in our own hardwood floors in our new place instead of paying for installation. It will probably take us a lot longer than professionals to put it in. Although we’d be saving at least \$10,000 in labor costs, and we’d probably earn more in our regular jobs if calculated on an hourly basis. But I will be learning a lot about home remodeling during this project, it will be a nice respite from staring at a computer screen all day, and it will be personally satisfying.

On the other hand, I hate driving in traffic. I learn nothing from doing it more. If I had access to good public transportation, I would totally pay for it. Similarly, driving around for an hour to save \$10 on an item is not going to be worth it to me. However, I love bargain shopping online, and I might research for hours on the best model and price on a \$99 item. But I can do that while in my pajamas at odd hours.

Are there some frugal activities that you no longer do after your income increased?

## Free Ink Refill at Walgreens, \$100 Bonus at KeyBank

“The editorial content on this page is not provided by any of the companies mentioned, and has not been reviewed, approved or otherwise endorsed by any of these entities. Opinions expressed here are author's alone.”

Walgreens is having a promotion on will refill one of your ink cartridges for free on April 2nd (April 7th in Hawaii). Just look in their 3/20 Sunday ad or print out this online coupon. It usually costs \$10 for black & white, \$15 for color. Here is a list of eligible brands and models (no Canon or Epson). Via Wisebread.

KeyBank is offering a \$100 pre-loaded Mastercard for opening up a Free Checking account with them and making two direct deposits and/or automated payments. You must reside in a state that has KeyBank locations. There is a lot of fine print, but the free iPod Nano I’m listening to right now is from a previous offer. This is only a partial excerpt:

Must open a qualifying checking account […] between 3/29/08 and 4/25/08 and make a combination of two direct deposits and/or automated payments each of \$100 or more by 6/27/08. […] You will receive your \$100 Key Possibilities MasterCard® card within 90 days of meeting requirements. Direct deposit transactions are limited to: payroll, social security, pension and government benefits. Automated payments exclude Key Bill Pay, debit card automated payments, PayPal® transactions and account to account balance transfers. If you close your account within 180 days of account opening, you will be charged a \$25 account early closure fee.

“The editorial content on this page is not provided by any of the companies mentioned, and has not been reviewed, approved or otherwise endorsed by any of these entities. Opinions expressed here are author's alone.”

More articles from other bloggers:

• Jacob of Early Retirement Extreme explores his minimalist inspirations. I just watched the move Into the Wild this weekend, about a new college grad who abandons his possessions, gives his entire \$24,000 savings account to charity, and hitchhikes to Alaska to live in the wilderness. I always like it when people break from the norm, even if I choose not to do it myself.
• Lisa Tiffin has a guest post at Get Rich Slowly about inoculating your kids against advertising. The analogy is great, and may save me a lot of saying “No” in the years to come.
• The Finance Buff explains why he chose a Traditional 401k over a Roth 401(k). I enjoyed his explanation of how your effective tax rate in retirement may be a blend of different tax brackets, often resulting in a lower rate than you might think.
• Singla Ma of Fabulous Financials shares her notes about a workshop for The Professional Woman. After reading this and Suze Orman’s book Women & Money, I have definitely found similar differences in how my wife and I handle things in the workplace.
• JB of Get Rich or Die Trying posted his new monthly budget in detail, all the way down to his Netflix subscription. For the voyeurs.
• Finally, I’d like to congratulate my sister for shopping smart when she found a top she wanted at Gap, but a button loop was broken and it was the last one in her size. Instead of leaving it, or paying full price anyway, she remembered my Home Depot experience and asked politely for a discount… and got 50% off. Now if only I could convince her to open up that IRA on top of funding her 401k… 😉

## Prosper P2P Lending Update #2: Scary Graph and Stats

“The editorial content on this page is not provided by any of the companies mentioned, and has not been reviewed, approved or otherwise endorsed by any of these entities. Opinions expressed here are author's alone.”

I was trying to run some more recent numbers to update my most recent concerns regarding person-to-person loans at Prosper.com. Essentially I was wondering if the loan performance would continually get worse over time. I was curious because it’s one thing to advertise 8-12% returns when the loans are new, but what really matters is the performance at the end of the 3-year term.

While trying unsuccessfully to churn those numbers, I ran across this related chart from the very analytical Prosper lender Fred93’s blog. The graph is essentially % of loans defaulted vs. loan age. Fred93 explains further:

These charts show statistics for the performance of all prosper.com loans. Each curve represents the set of loans that were created in one calendar month. The vertical axis is the fraction of those loans that have “gone bad”, in other words are 1 month late or worse (up to and including default). The horizontal axis is now days since month of loan origination. All data comes from Prosper.com’s performance web page.

If you look out one year from origination (ie 360 days) you will see that about 20% of Prosper’s loans have gone bad. You can also see that this is remarkably consistent from month to month (ie the different curves). One can only conclude that the default rate of Prosper loans is in the neighborhood of 20% per year. Loans originating after Feb’07 are going bad at a slightly lower rate, probably because Prosper increased the minimum credit score required for a Prosper loan at that time.

I learned also that he makes these conclusions because (1) historically over 85% of Prosper loans that reach 1 month late eventually go into default, and (2) the recovery rate after being sent to collections is terribly low. Together, you have his statement that ~20% of loans go into default each year. For a three-year loan, that ain’t good!

The slope (default rate) does seem to be slightly lower for the newest loans, but what concerns me the most is the constant linear deterioration of loans. This confirms my fear that loan performance consistently gets worse as the loan ages.

Now, I know this chart doesn’t tell the whole story, but I do think P2P lending is still very new and has a lot of growing pains to overcome. For borrowers, it can be a great deal. But as much as I want to be grabbing some solid returns this way, I’m still wary of committing significant money given this information.

(I haven’t found similar numbers for competitor LendingClub yet. They are still young, but they seem to be doing better in defaults so far. I’m waiting for more loan data to accumulate.)

Related P2P Lending Posts

• \$25 Sign-Up Bonus For Lending On Prosper
• Free Experian Credit Score via Prosper Lending
• Lending Club P2P Initial Review, \$25 Bonus Promotion
• Update #1: Will Returns Drop As Defaults Increase Over Time?
• Prosper.com Person-to-Person Lending Review, Part 1: First Looks
• Prosper.com Person-to-Person Lending Review, Part 2: The Numbers

## How Many Points Should I Pay On My Mortgage? Do You Like To Gamble?

“The editorial content on this page is not provided by any of the companies mentioned, and has not been reviewed, approved or otherwise endorsed by any of these entities. Opinions expressed here are author's alone.”

When you look at price quotes on mortgages, you should always note both the rate and the points. A discount point is one percent of your loan. So paying 1 point on a \$200,000 mortgage costs \$2,000. Usually this is paid upfront as part of your closing costs, but some people also finance their points (roll it into an existing or new loan). The more discount points you pay, the lower the interest rate on your mortgage.

For example, here are some quotes that I pulled up today for a \$400,000, 30-year fixed-rate loan:

 Loan Rate Points #1 5.000% 3.326 #2 5.500% 0.965 #3 5.625% 0.461 #4 5.750% 0.000

So you have to ask whether you would you rather pay

1. a higher amount upfront + lower monthly payments?
2. or a lower amount upfront + higher monthly payments?

The general logic is pretty simple. Let’s say your local gas station asked you to pick between these two scenarios for buying gas:

1. \$100 upfront + \$2 per gallon.
2. Nothing upfront + \$3 per gallon.

You could probably do the math pretty quickly to see how many gallons you’d have to buy to break even. After that point, you’d be happily buying cheap gas and saving more money each subsequent fill-up. But if you don’t use much gas or might move away from the gas station soon, you may never reach that point and never make back your upfront outlay.

In reality, there are additional complications like “what would my unused money be earning?” and “what about tax-deductions?”, so the easiest way to do this calculation with mortgage rates/points combos is to use an online calculator like this one at the Mortgage Professor.

Let’s use it to compare Loan #1 and Loan #4 above. I put in the following info:

Taking Points or Not: Will You Keep Your Mortgage 4-6 Years?
So if you keep the loan less than 4.83 years, you won’t quite make up your upfront points paid. But after 4.83 years, each monthly payment you make will mean you saved more money over the higher rate loan. (\$10,000 after 10 total years in this case.)

So the question is – how long will you stay in your home? The weird thing is, almost all loan rate/point combos that I’ve seen give you a break-even period of about 4-6 years. Even if you take as little as 0.50 points. So that’s the magic number. More or less than about 5 years?

I’ve read stats that say the average mortgage lasts about 7 years. But you should know yourself better than some average. Is this a starter home? How stable is your job? Are you rooted to the area due to family or other reasons? If you think you’ll stay less than 5 years, don’t pay points.

How Many Points? Well, How Confident Is Your Guess?
Now let’s compare Loan #1 and Loan #2, only have a difference of about half a point. The breakeven period is now 4 years, with only a \$2,187 advantage over 10-years. So here both the risk and potential reward is less. If you’re wrong and you move earlier than 4 years, you might be out a thousand dollars or so. But even after 10 years, your advantage would only be about \$2,000.

So, the more points you pay, the bigger the bet you make that you’ll stay past the break-even period. You could pay 4+ points or more if you really wanted to.

Update: As commenter Ted has pointed out, paying points also reduces your ability to refinance to a lower rate mortgage before that break-even period. So room for rate drops should also be put into consideration.

As for us, we definitely felt that we were going to stay longer than 5 years, but didn’t want to “bet” that many points. So we ended up paying 1 discount point to lower the rate on our loan to 5.625% at the time. I really don’t expect for rates to drop far enough lower so that a refinance would be worth it, but I could be wrong.

Finally, you should always compare different rate quote combos from different lenders. One lender might not have the best zero-point loan, but might have a relatively awesome 2-point loan. Don’t be afraid to ask for additional rate/point combinations if you don’t get them at first.

The post is a new addition to my Experiences in Buying A Home.

## Am I A Boring Investor Or What?!

“The editorial content on this page is not provided by any of the companies mentioned, and has not been reviewed, approved or otherwise endorsed by any of these entities. Opinions expressed here are author's alone.”

Yesterday I was asked by a foreign news publication some questions about my reactions to the current financial problems in the US markets. As I wrote my responses, I thought to myself “this is so boring that there is no way that it will be published”. I have no juicy stories of hoarding gold, selling all my stocks, or fleeing to ultra-safe bonds. Instead, here are my Ambien-like responses:

What have you been doing to protect your assets since last summer (when sub-prime mess hit financial markets)?

Nothing, really. I keep the same general asset allocation and haven’t sold anything. I already have investments in inflation-protected bonds and broad stock index funds, so I am not worried about short-term losses.

To avoid investing losses, in trading, what kind of financial products (like stock/bonds/REIT and so on..) did you sell? and what did you buy instead? How did you change your asset allocation?

I did not change my asset allocation at all, as I still have a long-term investing horizon.

Have you changed your thoughts about investment under current crisis in financial markets?

No. I did consider adding some commodities for additional inflation protection, but I ultimately decided against it.

Have you been negatively or positively impacted by the current financial crisis?

Negatively, I suppose. Besides the drop in my investment portfolio, my house which I bought recently will probably decrease in value over the next year or two.

“The editorial content on this page is not provided by any of the companies mentioned, and has not been reviewed, approved or otherwise endorsed by any of these entities. Opinions expressed here are author's alone.”

…A recent crisis with my cat has deeply taxed my savings. […] I have spent more than \$4500 on my pet in the last three months. She developed lymphoma and the initial hospitalization and testing to find out what was wrong accounted for the bulk of the expense. The rest has been spent on follow-up chemotherapy treatments.

I’m curious how you would handle such a crisis (heaven forbid). Do you think you’d ever get to a point where the price was too high to keep your pet alive (assuming doing so will give it a relatively good quality of life)?

I think this is an important topic, but at the same time it’s very touchy because I’ve found that people tend to have very polarized views on pets. Here is a quote from VPI pet insurance founder Jack Stephens:

Pet insurance is a nonstarter for many pet owners, simply because they take a pragmatic approach to their animals. If the cost of treatment got too high, they would choose to put the animal to sleep.

“About half see the pet as disposable. If it got really ill they just wouldn’t treat it,” said Stephens, whose company conducted research on the issue. The other half “were willing to treat, whatever it took.”

Now, I don’t think it’s nearly as black and white as that, as I think most pet owners love their pets to some degree. But the people on the “pets-as-children” camp are often just as militant as the “they’re just animals-not-humans” camp.

Economic Euthanasia
A recent Slate.com article subtitled What I wouldn’t do for my cat also addressed this issue in depth. (The editor’s choice response letters are also thought-provoking.) It refers to refusing care due to cost as “economic euthanasia”. From reading it, cultural norms seem to be shifting. But in the end, I think it still all comes down to personal priorities.

What is the benefit? Are you talking about the cat or dog coming back to 100% health like a broken bone? Or are you paying to extend its life by weeks while lying in pain? There is a time that palliative care is the most humane choice.

Where is this money coming from? Don’t just look at the number, look at what you’d be giving up. At \$2,000, is this money that would go to a vacation to Mexico otherwise? A new HDTV? Payment on your nice car? Now, let’s say it means you can’t buy gas for work or food for your kids. Different story.

Give it away? I think most vets can draw their own line as to what is “necessary”. So if you’re not willing to pay, maybe you should let one of them handle it:

Recently, I called our vet, Dr. Timothy Mann of Northside Veterinary Clinic in Brooklyn, N.Y., to ask him what would have happened if we hadn’t opted to pay for surgery.

“We don’t believe in putting animals to sleep because of money,” Dr. Mann said. “If someone can’t afford or won’t pay to save an animal who can be saved, we’ll save the animal and then keep it or find it a good home.”

Also, be sure to contact local rescue groups. They will be happy to take your sick dog, and will find some way to pay for the care. We are signed up for rescue lists for our specific breed of dog, and we would gladly take another one in if the need arose.

One way to avoid such difficult decisions is to buy pet insurance. Although it can be expensive at around \$30 a month, it will definitely help soften the blow of a huge unexpected bill (although it likely won’t cover it all). Alternatively, put away money regularly in a “pet health savings account”. If you put away just \$20 a month and your animal experiences issues at 5 years old, you’d already have \$1,200 + interest to cover it.

My Own Doggie Evolution
I never had any pets growing up due to a broad parental ban. Not even a goldfish! My wife, on other hand, was always surrounded by animals. Rabbits, hamsters, guinea pigs, fish, dogs… When we got our first dog from the local Humane Society nearly 3 years ago, I didn’t really know how I would react. Would I love it? Would I ignore it? I must say that our little dude has burrowed his way into my heart. I mean, how can you say no to this buttercream-covered face?

For us, we would give up just about all of our luxuries before withholding healthcare for our dog. We are both in agreement as well, which is great because I know for other couples it can be a point of great tension. Heck, my wife the fashionista would probably wear a potato sack around while selling our car and taking the bus 2 hours to work every day if it came down to it.

However, if it meant sacrificing the health or safety of an immediate (human) family member, I would think twice. By this I mean taking on a dangerous level of debt, or cutting corners in the essentials like nutritious food, health insurance, and safe housing.

But this doesn’t mean I spend my time judging other pet owners for deciding against care due to high cost. For many people pets are not humans, and there is a line to be drawn. But again, if you can’t or aren’t willing to pay please make sure you’ve considered all your options.

## Should I Contribute To A Non-Deductible IRA, Part 2: Better Than Regular Taxable Account?

“The editorial content on this page is not provided by any of the companies mentioned, and has not been reviewed, approved or otherwise endorsed by any of these entities. Opinions expressed here are author's alone.”

Continued from Part 1: Future Roth IRA Rollover. Now we’ll consider what happens if we don’t convert to a Roth.

To recap, an non-deductible IRA everything is the same as a Traditional IRA except that the initial contribution is not tax-deductible. This means that it grows tax free, but all earnings (dividends + capital gains) are taxed as ordinary income upon withdrawal. The original contribution isn’t taxed again.

This is in contrast to regular taxable account, where you can defer taxes on capital gains until you sell. Currently, if you hold stocks or bonds for at least a year before selling, you’ll be taxed at the long-term capital gains (LTCG) rate of 15% or less. Qualified dividends are taxed when received, but are also currently taxed 15% or less. Non-qualified dividends such as from bonds or REITs are taxed as ordinary income.

So which one’s better? I decided to run a few sample scenarios to find out. Here is the IRA scenario spreadsheet I used, which you can play with as well. I’ll be assuming that current tax rules stay the same when you withdraw, which is almost guaranteed not to be the case, but hopefully we’ll get something out of it.

Assumptions
Initial Balance: \$4,000 after-tax
Ordinary income tax rate: 25%
Dividend tax rate: 15%
Time Horizon: Lump-sum withdrawal after 30 years

Scenario #1: Buy-and-Hold With Stock Index Funds
Let’s say you invest in an S&P 500 index fund, with very low turnover. You buy and hold until withdrawal. Total annual return is 8%, with 2% being in dividends each year. With a non-deductible IRA, it keeps growing as gets taxed at the end. After 30 years, you’ll end up with \$31,188.

With a taxable account, you’ll get taxed 15% on those dividends every year, but the rest is accumulated as long-term capital gains. Upon selling it and paying 15% on those gains, you end up with \$32,834. Taxable wins by \$1,646 (5%).

If you lower the ordinary tax rate to 15%, then the non-deductible IRA wins by \$1,979 (\$34,813 vs. \$32,834). If you raise your ordinary tax rate to 30%, then the taxable account wins loses by \$3459 (\$29,375 vs. \$32,834). In general, taxable wins out when your tax rate at withdrawal is about 21%.

Scenario #2: Active Trading With Stocks or Stock Funds
Now if you have lots of buying and selling in your portfolio, then you’ll be subject to short-term capital gains every year. Here, if you assume 100% turnover (holding stocks for just under a year) and you still earn 8% annually, taxable will never win regardless of ordinary tax rates. Even at 9% return in taxable vs. 8% return in IRA. The yearly drag of taxes kills your returns, so you should probably seek the shelter of a IRA if you plan on investing in moderate-to-high turnover funds.

Scenario #3: Buy-and-Hold With Bonds or REIT Funds
Holding a bond fund or REIT (real estate) fund is actually similar to Scenario #2, because most of the earnings from bonds and REITs are due to their interest yield or dividend distributions, and those are taxed at the higher ordinary income rates.

Let’s say you have an REIT fund that also gains 8% annually, and 100% of it’s gains are in the form of unqualified dividends. (REITs have a historical average yield of about 6-8%)

At 25% income tax rates, the taxable account just can’t keep up with an final value of \$22,974 vs. \$31,188 from the non-deductible IRA. That’s a 35% increase in value by going with the IRA. As income tax rate rises, the IRA’s advantage increases. A similar result occurs for bonds, although the difference is smaller due to lower expected returns.

Liquidity or Early Withdrawal Concerns
A significant advantage of taxable accounts is that you can choose to access, or not access, the funds at any time. With an IRA, with a few exceptions you have to wait until age 59.5 to make a withdrawal without penalties. In addition, you’ll be required to make minimum distributions starting at age 70.5 even if you don’t need to. Some early retirees or those that want to leave a legacy might want to just stick with a taxable account.

Summary
Again, all of these are based on guesses as to what future tax laws will be, but for now my very general summary is:

• IRAs have less liquidity and more restrictions in general. So if the expected net returns are equal, I’d pick the taxable account.
• For low-turnover stock portfolios and index funds, the non-deductible IRA might lose out to a taxable account, but not by all that much. As your trading frequency increases, the taxable account gets less and less attractive. On the flip side, a tax-managed mutual fund might make things sway back in favor of the taxable.
• If you plan on holding any significant amount of REITs, bonds, or other tax-inefficient investments, then a non-deductible IRA can have significant tax advantages over holding them in a taxable account.

Since I do have holdings of bonds and REITs in my portfolio and need all the tax-deferred space I can get, it looks like I’ll be contributing to a non-deductible IRA before the April 15th deadline.

## Should I Contribute To A Non-Deductible IRA? Part 1: Future Roth IRA Rollover

“The editorial content on this page is not provided by any of the companies mentioned, and has not been reviewed, approved or otherwise endorsed by any of these entities. Opinions expressed here are author's alone.”

As we’ve seen, after you reach a certain income, both Roth IRAs and tax-deductible contributions to Traditional IRAs are no longer available. After you max out your 401(k) or 403(b) plan at \$15,500 per year, you start running out of tax-advantaged accounts quickly. One option is to contribute to a Traditional IRA anyways, even though the contribution will not be tax-deductible. Everything else is the same: your money will still grow tax-free, and withdrawals will be taxed at your ordinary income tax rate. You can sock away \$4,000 for 2007 and \$5,000 for 2008. So should you do it? I have less than three weeks before I need to decide!

There appear to be two primary ways to answer this question:

1. Future Roth Rollover. In 2010, there will no longer be any income restrictions for Traditional-to-Roth IRA rollovers. Could this mean Roth IRAs for everyone?
2. Compare Returns vs. Taxable Account. If you either can’t or don’t wish to convert to a Roth, will your performance at least be better than a regular taxable account?

## Future Roth IRA Rollover

According to current laws, in 2010 the income restriction for Traditional-to-Roth IRA rollover will disappear. Since you’ve already paid taxes on your non-deductible IRA contributions, you will only have to pay income tax on the earning portion when you rollover. This can be seen as effectively allowing you a way to contribute to a Roth IRA down the road. Now, instead of having to pay ordinary taxes upon withdrawal, I don’t have to pay any taxes! I even avoid required minimum distributions.

Catch #1: The Law May Change
I have seen no indication that this Roth “back door” was intentional. Some people see this as simply an oversight that a busy (or lazy) Congress simply hasn’t gotten around to changing… yet. For example, the current low 15% long-term capital gains rate is also scheduled to go up in 2011. Others think that the lure of tax revenue now gained through Roth conversions might be appealing and they’ll let it stay. Now I’ve waited until the last minute to make my decision and it’s almost mid-2008, and nothing has changed, so maybe it’ll happen…

Catch #2: Mixing Deductible and Non-Deductible Contributions
Let’s say you have \$10,000 in a Traditional IRA, \$4,000 of which was a non-deductible contribution, and \$6,000 of which was deductible contributions and earnings within the IRA. If you wanted to convert \$4,000 of it over to a Roth IRA, you can’t simply pick out the non-deductible contribution. The \$4,000 would be pro-rated to be 40% non-taxable and 60% taxable, in the same proportions as your total IRA.
The only way to convert all of your non-deductible contributions would be to convert everything together, which might not be ideal.

One way around this is to first roll over your deductible IRA money into another qualified retirement plan like your 401(k) if they allow such transfers (and you like your investment options). Then make your non-deductible IRA contribution. That way, the deductible and non-deductible parts can be separated. I don’t have any deductible IRA funds, but I think I could rollover into my Solo 401(k) if desired.

Catch #3: More Paperwork
If you make non-deductible contributions, conversions, or withdrawals you must document them each year using with IRS Form 8606. It’s probably a good idea to simply file the form every year so that you don’t end up forgetting and having to pay extra taxes later.

In general, I think the Roth conversion option is great if it’s available, but I am still not convinced it will still be around in 2010. So I’d better make sure that’s a non-deductible IRA is still a decent deal even without that option. To be continued in Part 2…

## 2008 Roth/Traditional IRA Phase-Out Limits For High Income Earners

“The editorial content on this page is not provided by any of the companies mentioned, and has not been reviewed, approved or otherwise endorsed by any of these entities. Opinions expressed here are author's alone.”

For those people with increasing incomes, you may be wondering when either Roth IRAs and tax-deductible contributions to Traditional IRAs start being taken away from you. Here are the phase-out numbers for the 2008 tax year:

Roth IRA Phase-Out Limits
Once you reach the bottom of these phase-out ranges for your modified adjusted gross income (MAGI), your contribution limit of \$5,000 starts getting reduced. At the top of the range, you can no longer contribute at all.

 Tax Filing Status Phase-Out Range Married filing jointly or qualifying widow(er) \$159,000 to \$169,000 Single, head of household \$101,000 to \$116,000 Married filing separately (and you lived with your spouse at any time during the year) \$0 to \$10,000

Once you reach the bottom of these phase-out ranges, your full deduction starts getting reduced. At the top of the range, you can no longer deduct taxes on any contributions at all. This table assumes that both you and your spouse are covered by an employer retirement plan.

 Tax Filing Status Phase-Out Range Married filing jointly or qualifying widow(er) \$83,000 to \$103,000 Single or head of household \$52,000 to \$62,000 Married filing separately \$0 to \$10,000

If you are single and are not covered by an employer retirement plan, or you’re married filing jointly and neither of you have a employer retirement plan, then there are no income limits for deductibility. If one spouse has a plan and the other does not, then the phase out range is \$156,000 to \$166,000.

Reference: See IRS Pub 590 for way too many details.

## Haggling Down Prices At Home Depot?

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Now that we have our own home and backyard patio, we decided to buy our first propane grill and invite some people over. We had to schedule a convenient time to have my father-in-law come drive down with us since he has a truck, so we had pretty much decided to just buy whatever was cheap and in stock. No hours of research this time! Although some of our serious grilling friends told us to buy a high quality \$400+ model, which is probably good advice, we really just wanted something simple to start out with. If we grilled often enough, then later we could upgrade to something that would last a long time.

We had our eye on a \$199 Brinkmann grill with some decent BTU, grill space, and also shelf space. But when we got there, they were cleaned out except for one last box that was definitely a previous return. The box was opened, slightly ripped, and had the words “Returned – Missing Parts, Send to Dept #18577” scrawled on the side with permanent marker. It had no special price tag.

All the other sub-\$300 cheap grills were also sold out, even after spending 20 minutes searching through all the racks and the help of a Home Depot employee. Even neighboring stores were sold out. The next-cheapest one was \$319 for a basic Weber grill, but we decided against it due to price and lack of shelf space.

We finally decided to rummage through the open box and see what was in there, and couldn’t find any obvious missing parts. So we asked the employee if we could buy the “open box”. Sure, he said. Can we get a discount? It says it’s missing parts. He replied that he could give us 10% off. I actually thought about taking it, but my father-in-law said that wasn’t worth the hassle. So we asked for more. How about 35% off? He said he couldn’t do that, and that he’d have to find his manager for such a reduction. Yes, please ask! He kindly tried, explained about the missing parts, and the manager approved.

Out the door with a \$199 grill for \$130 and the full standard return policy, not bad. We went home and assembled it with no problems at all. Either the parts were actually found or the last person simply lied when returning the grill. I’m not expert, but I think it’s a great starter grill for \$130. All I know is that steaks taste better outdoors. 🙂

So that’s how we walked in ready to pay full retail price, and yet ended up haggling at a big-box corporate store. While I still wouldn’t try and negotiate for new items at Home Depot, it’s definitely worth a try for “scratch and dent” items you may run across!

Update: Looks like the New York Times has more examples: Even at Megastores, Hagglers Find No Price Is Set in Stone.

## Series I Savings Bonds: Inflation Protection + Decent Interest?

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The Federal Reserve continues to slash short-term rates, so right now looks like a good time to take a second look at Series I Savings Bonds since they are not directly tied to such rates and also offer protection from inflation.

I-Bonds Quick Summary

• Series I Savings Bonds (also known as I-Bonds) are investments that have very low risk (backed by the government) and offer to pay interest in two parts: a fixed rate + a variable rate indexed to inflation. The fixed rate is known when you buy, and the variable rate changes every 6 months.
• You must hold them for at least 1 year. If you redeem within the first 5 years, you lose the last 3 month’s worth of interest. They stop paying interest after 30 years.
• Interest from savings bonds are subject to federal income tax, but are exempt from local and state income taxes. For people that live in states with high income taxes, this can make them more attractive. They also have some special exemptions when used for educational purposes. See this Tax-equivalent Yield Calculator.
• As of 2008, you can only buy \$5,000 of paper I-bonds and \$5,000 of online I-bonds per Social Security Number, per year. However, many users report still being able to buy up to \$30,000 at a time online.

Currents Rates and Predictions
Currently, the fixed rate portion of I-Bonds is 1.2%. If you buy a bond now, you will also be guaranteed an variable interest rate of 3.08% for the next 6 months, for a total interest rate of 4.28%.

After that, the rate will adjust every 6 months based on the previous 6 month’s worth of inflation data. The next adjustment will be in May, based on September-March 2008 data. Currently, we have September-February, so let’s use that to make an educated guess. Using the prediction method explained here:

Sept 2007 CPI-U was 208.490. Feb 2008 CPI-U was 211.693. 211.693/208.490 = 1.015363, or a semi-annual increase of 1.536%.

Total rate = Unknown fixed rate + 2 x Semiannual inflation rate + (Semiannual inflation rate X Fixed rate)

If we assume a fixed rate of the current 1.2%, we get
```Total rate = 0.012 + (2 x .015363) + (.012 x .015363) Total rate = 1.2% + 3.09% Total rate = 4.29%```

Now, looking at oil prices, I’m guessing that inflation is probably going to tick upwards some more in March. If we use August-February data, the variable rate would be around 3.37% (total rate 4.57%). Either way, I think it is a fair bet that the variable portion will stay around 3.1% if not higher.

Buying I-Bonds as a 12-month CD
Given these predictions, we can have an idea of what our interest earned will be if we buy now. There is one last “trick” with I-Bonds, and it is that if you buy at the end of the month, you’ll still get all the interest for the entire month as if you bought it in the beginning of the month. Let’s say we buy at the end of March (this week!), hold for the minimum of one year, and pay the 3-month interest penalty. You’ll be able to sell on March 1, 2009 for an actual holding period of 11 months.

We will get 4.38% for 6 months, and ~4.3% for 3 months taking in account the penalty. That’s equivalent to an annual rate of 3.56%. Now, if you live in a state with 9% state income tax, your equivalent yield gets bumped up to 3.9-4.05% depending on if you fully itemize your state income taxes.

Given that you can also find a traditional bank CD that pays around 4% APY currently, this rate is competitive but not a screaming deal. But if you are in the market for some inflation protection and your time horizon is more like 2-7 years, there is low downside and good upside as you can always decide to hold it longer than 11 months if inflation continues to climb and the Fed is unwilling to raise interest rates due to economic recession. I am currently considering buying some of these to hold my emergency funds for this reason, but the lack of liquidity for the first 11 months is a concern.

Buying I-Bonds as a Long-Term Investment
If you want long-term inflation protection and are willing to stray from the ease and convenience of mutual funds or ETFs, I-Bonds might also be a good option. The fixed rate of 1.2% is relatively low historically, but in the current environment it’s actually very good. Other low-risk inflation-indexed products are trading at a negative real yield right now. The next update to the fixed rate will be in May. Given the current rush towards similar products, people are betting that the fixed rate is going to drop even further.