These days, everyone has a regained respect for stock market volatility. One way to maintain a more stable income in retirement is to take part of your nest egg and buy a single-premium immediate annuity (SPIA). With an SPIA, you pay a lump-sum upfront to an insurance company in exchange for a guaranteed stream of income payments for life. You’ll usually get a much higher income than from bonds or dividend-paying stocks. However, once you die, the payments stop and your upfront payment is gone.

How much income can you get?

The two main factors that affect your actual payout are your age and the current interest rate environment, but there are also additional options to consider. Here are a few of the biggies:

• Single vs. joint life. Will the payments be guaranteed for only one life, or the longer of two lives? This is a popular option for couples living together.
• Minimum guaranteed payout period. Some folks may hate the idea of losing your entire lump-sum in the event of an early death, or want a minimum payout amount. With this option, you can guarantee that payments will be made for a specific minimum period (i.e. 5 or 10 years) no matter what.
• Inflation-adjusted payments. With this option, your monthly payments will increase or decrease by a certain percentage each year, as pegged to inflation. This will protect you from decreased purchasing power in the future due to inflation, but will significantly decrease your initial payout.

Below, the July issue of Money magazine included a nice graphic that helps show how each affect your possible payouts based on a $250,000 investment. Data is from ImmediateAnnuities.com, a handy site to get free quotes.

Here is a chart of average auto insurance rates by state, via AARP.com, shaded by overage ranges. Click for an interactive map with more details and a ranking.

I wonder why rates in Louisiana are so high. $2,500 per year? Is it fear of flooding? Laws that encourage suing other drivers?

From the site: “Rates were calculated for more than 2,400 vehicles for model year 2010; based on a 40-year-old single male driver who commutes 12 miles to work; includes $500 deductible on collision and comprehensive coverage.” I wish they also shared how much liability coverage they chose, as that is the largest component of my premium.

After being asked (well, forced) by Congress recently to testify regarding the credit rating agencies Moody’s and Standard & Poor’s and their role in the last financial crisis, Warren Buffett was also asked what he saw the next big related risk. Buffett’s reply:

Well, the huge question … if I were running a rating agency now, how would I rate states and major municipalities? I mean, if the federal government will step in to help them, they’re triple-A. If the federal government won’t step in to help them, who knows what they are? If you are looking now at something where you could look back later on and say, these ratings were crazy, that would be the area.

“I don’t think Moody’s or Standard & Poor’s or I can come up with anything terribly insightful about the question of state and municipal finance five or 10 years from now except for the fact there will be a terrible problem and then the question becomes will the federal government [help]

It’s no question that many states and municipalities are in big financial trouble. But their municipal bond debt still has relatively low interest rates suggesting that the risk of default is very, very small. No doubt, this is because the historical default rate of municipal bonds is also very, very small. But Buffett points out that in the past, not very many muni bonds were insured by private insurers (such as Berkshire Hathaway). In today’s environment, it is much more likely that a local government will go “oops” and let the insurers pick up the tab. If those dominoes start falling, then a federal bailout will be needed. Then what?

As usual, Buffett summarizes the situation nicely:

“It would be hard in the end for the federal government to turn away a state having extreme financial difficulty when they’ve gone to General Motors and other entities and saved them,” Buffett told shareholders in Omaha, Nebraska, at Berkshire’s May 1 annual meeting. “I don’t know how you would tell a state you’re going to stiff-arm them with all the bailouts of corporations.”

When I wrote about investing in California municipal bonds in September 2009, the yield on the Vanguard California Intermediate-Term Tax-Exempt Fund (VCAIX) was 3.49% and exempt of both federal and CA state income taxes (avg maturity 7 years). Today, it is down to 3.02% with an average maturity of 6 years, indicating a lower overall fear of default.

Still, if you are in the 33% federal tax bracket and 9.55% CA bracket, that 3.49% would be the same as a taxable bond yielding 4.98%. Compare this to the Vanguard Intermediate-Term Investment-Grade Fund (VFICX) which invests in high-quality corporate bonds and only yields 3.70%. Treasuries yields are much lower. For me, the yield difference is so great that it would be hard to not at least consider it as part of my portfolio.

I agree that I can’t see how the federal government will refuse to help bail out the resident investors of states when they’ve already done so many corporate bailouts. But it’s not impossible.

Not exactly a hard-hitting topic, but still applicable to those trying to live efficiently. This NY Times article talks about how most people use way too much soap in their washing machines and dishwashers, which is both wasteful and can shorten the lifespan of the appliances. How do you tell if you’re using too much soap?

Take four to six clean bath towels, put them in your front-loading washing machine (one towel for a top loader). Don’t add any detergent or fabric softener. Switch to the hot water setting and medium wash and run it for about five minutes.

Check for soap suds. If you don’t see any suds right away, turn off the machine and see if there is any soapy residue. If you see suds or residue, it is soap coming out of your clothes from the last wash.

“I’ve had customers that had to run their towels through as many as eight times to get the soap out,” Mr. Schmidt said, who lives in Indiana

I’m pretty sure I’m guilty of this. I would imagine too much soap also makes clothes more irritating to the skin.

While doing some more research into a possible refinance or loan modification, I ran across this chart of historical mortgage rates from 1986 from HSH.

Before, I stated a source that said the 30-year fixed-rate mortgage (FRM) averaged 4.56% for the week ending July 22, the lowest since Freddie Mac started tracking the mortgage in 1971. But that was with 0.7 points, while HSH shows 4.97% with only 0.09 points. While we are experiencing some of the lowest rates in a very long time, I also keep reading about how underwriting has made actually getting approved for a loan harder than ever. But according to this article, some “FHA, Fannie Mae and Freddie Mac borrowers who haven’t refinanced their home before may be eligible to refinance without having to get a new appraisal.” Like I say often… it doesn’t hurt to ask!

I’m still excited about my new 4.75% mortgage rate (that I would never have gotten if I didn’t pick up the phone and ask) since I’m looking to stay in my house for a while, but I am also curious as to what will happen to housing prices when rates start to go back up…

Everbank has added a $50/$25 bonus on top of their existing 3-month bonus rates for their Yield Pledge Money Market and FreeNet Checking accounts. Both of these offers are targeted at new customers opening with at least $10,000, but in the end do offer some of the top rates available for an FDIC-insured bank account with these terms.

Yield Pledge Money Market

With a 3-month guaranteed introductory rate of 2.25% APY, this is higher than any available 3-month CD out there. After that, it is like other online savings accounts with a variable ongoing APY (currently 1.26%). If you deposit at least $20,000 as a new customer, you’ll get a additional $50 bonus on your 5th month’s statement.

The math is a bid tedious, but in the end the additional $50 bonus on a $20,000 balance effectively extends your 2.25% APY rate out to 6 months, which again is better than any 6-month CD offer out there.

This online savings account “pledges” to keep the yield on your account in the top 5% of competitive accounts as tracked by Bankrate. (Everbank has indeed ended up on lists of best banks with consistently high rates.) Since it is a savings account, you are still limited to 6 withdrawals or outgoing transfers each month. There is a minimum average balance of $5,000 to avoid a $8.95 monthly fee.

FreeNet Checking

A checking account version, this also has a a 3-month guaranteed introductory rate of 2.25% APY, with a tiered interest rate afterward. (Current tiers and ongoing Annual Percentage Yields are: $100,000 and up 1.26% APY, $50,000 – $99,999.99 1.20% APY, $25,000 – $49,999.99 1.16% APY, $10,000 – $24,999.99 0.70% APY and under $10,000 0.51% APY). There is no monthly fee.

If you deposit at least $10,000 as a new customer, you’ll get a $25 bonus on your 5th month’s statement. Again, if you do the math this effectively extends the bonus rate of 2.25% out to between 5 and 6 months on a $10,000 balance, which is still better than any other CD offer of the same length. This account also pledges to keep the yield on your account in the top 5% of competitive accounts, but remember in this case that checking accounts in general have slightly lower rates.

If you are looking to get high FDIC-insured interest rates on a sizable balance for between a couple months to a year, without having to jump through any hoops like required monthly transfers or 15 debit card purchases a month, then this continues to be one of the best rates out there.

We all have financial goals that we want to reach. Some of us do better with a reward attached to reaching our goal (carrot), while others may actually try harder if trying to avoid a punishment (stick). We are motivated by personal desire, by our family, by our friends… but how about a website?

For the those that need that extra bit of discipline, check out Stickk.com, which lets you create a “commitment contract” which have real penalties attached to them. For example, you could commit to saving an extra $150 each month in a separate savings account for 6 months. You could set a penalty of $250 if you don’t follow through – send to a friend, enemy, or donated to an organization that you dislike (NRA, PETA, whatever… dubbed anti-charities).

The site is serious, and started by economics professors who all agree that incentives make the world go ’round. You choose a third-party referee (input their e-mail), as well as give them your credit card information. If you don’t follow through, your card is charged!

If you do better with carrots, you can always set that up yourself. If you reach your savings goal, go out and get a manicure or a nice steak dinner.

Above is a chart of the median duration of unemployment from the past 50 years, based on data supplied by the US Department of Labor. That’s quite a scary spike we have going right now. (Chart source, via The Atlantic and Greg Mankiw.)

Not coincidentally, the Senate just voted to extend employment benefits again after much debate. This means that the federal government will continue to provide up to 99 weeks of unemployment assistance, including the first 26 weeks provided by individual states.

People will argue whether this is the best way to combat the problem. I don’t know the answer, especially with the huge deficit, but I do feel that with two years of unemployment available that there is less excuse not to learn some new marketable skills if you need it. Also, this just makes my cash hoard of a year’s worth of expenses that much more important to me. I really didn’t think an emergency fund would provoke such a strong psychological response, but it has significantly lowered my daily stress levels.

If you don’t have your warm fuzzy cash hoard yet, open a separate online savings account and start socking something away! Just look at the chart again if you need motivation.

The standard maximum insurance limits for both FDIC and NCUA-insured accounts have been permanently raised to $250,000 per depositor as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act, signed July 21st, 2010. The limits were temporarily increased from $100,000 to $250,000 effective October 3, 2008, through December 31, 2010. On May 20, 2009, the temporary increase was extended again through December 31, 2013. (FDIC press release)

The FDIC insurance coverage limit applies per depositor, per insured depository institution for each account ownership category. You may actually have more than $250,000 of coverage, depending on how you have titled your accounts and where you hold multiple accounts. Here are the official online calculators:

NCUA Electronic Share Insurance Calculator (ESIC)
FDIC Electronic Deposit Insurance Estimator (EDIE)

The new limits were made retroactive to 1/1/2008, which makes 9,500 people really happy who exceeded the FDIC limits between January 1st and October 3, 2008, which were only $100,000 at the time. Well, they got lucky. Don’t exceed the limits! (And congrats if this is still an issue for you…)

The last time I wrote about stable value funds was in late 2008, both before the 2009 crash and a time when most of my 401k was in stocks. This time around, as I was trying to figure out how to rebalance my larger portfolio in a tax-efficient manner, I took another look at this asset class found almost exclusively in defined-contribution plans like 401ks. According to the Stable Value Investment Association (SVIA), approximately 15 to 20 percent of 401(k) assets are in stable value funds.

What are Stable Value Funds?

Generally, stable value funds are a bunch of bonds which have a insurance “wrapper” around them which protects it from interest rate volatility. The intended result is a product that pays the higher interest rates of intermediate-term bonds, with the liquidity and stable day-to-day price of a money market fund. Think “cash but pays higher interest”. A chart from the SVIA [pdf] illustrates:

The Attraction

Here’s my current situation. The stable value fund in my 401k has a guaranteed net interest rate in 2010 of 3.50%. The low-cost Vanguard Intermediate-Term Bond Index Fund Investor Shares (VBIIX) currently yields 3.17%, but will have a moderate amount of price volatility, especially if interest rates rise. The Vanguard Prime Money Market Fund (VMMXX) currently yields 0.11% with its high-quality, ultra-short-term holdings and Vanguard backing.

I could get the stability of money market fund, with an interest rate more than 3% higher! (All yields are net of fees.)

The Risks

Higher interest rates with no price volatility? Free lunch? Not quite. First of all, any guarantee is only as good as the entity doing the guarantee. Check the safety ratings of the insurer of your fund. Mine is Transamerica Financial Life Insurance Co. (TFLIC):

Not the greatest, but not bad. In addition, there are actually several ways an insurer can get “out” of the contract. From the SVIA FAQ:

Are there instances when book value or contract value does not apply?
There are a few, limited instances when participants do not get book value from a stable value fund. These limited instances are typically contractually defined. One such instance typically not covered is security defaults or downgrades. In order to protect the integrity of the stable value fund, most contracts incorporate investment guidelines establishing minimum credit quality requirements for the underlying securities. These contracts have established mechanisms to address downgraded or defaulted securities that fall outside the contractual guidelines.

Corporate-initiated events, which are employer-driven events such as an early retirement program, layoff, or bankruptcy, are also typically not covered. Corporate-initiated events generally cause withdrawals in masse from a stable value fund. These withdrawals can negatively impact investors and plans that choose to remain in the fund.

First up, if the underlying securities turn out to be utter crap via a default or credit downgrade, then the insurance doesn’t apply? Wait, the insurer gets to choose the securities in the first place? Sometimes smells here. In fact, this happened in 2009 to the insurer State Street, although they decided to step in to make investors whole in order to preserve their reputation. Via this CBS Moneywatch article:

In December 2008 and January 2009, State Street elected to provide support – a total of $610 million – to the bond portfolio in stable value funds the company managed. State Street was not contractually obligated to do this. As the company’s 8-K filing (a report filed with the SEC to notify investors of any events that could be of importance to shareholders) stated, “liquidity and pricing issues in the fixed income markets” so affected the accounts that the wrappers “considered terminating their financial guarantees.” State Street’s action to bolster its portfolios kept the wrappers in place.

Finally, there is the “corporate-initiated event” of a huge layoff or bankruptcy. At the end of 2008, Lehman Brothers infamously went bankrupt, which left their stable value fund managed by Invesco with a negative return of 1.7 percent in December and an annual return for 2008 of 2 percent. In April 2009, a stable value fund for Chrysler employees only paid out 89 cents on the dollar, a drop of 11% due to the company’s troubles.

As you can see, there is a lot of things that can invalidate the guarantee. So, the next step is to understand the holdings, which in the event of a liquidation can help you imagine your worst-case scenario. You should be be able to see at least an overall breakdown of the assets, and a market-to-book-value ratio must be disclosed at least once a year. This will show any discrepancies between what the insurer says is worth $1 and what the market says. My TFLIC stable value fund’s market-to-book ratio was 101.30% as of March 31s, 2010 and here is their holdings summary:

Bottom Line

In good times, the stable value fund has a pretty easy job of maintaining an image of price stability and paying out the stated interest rate. However, when the poo hits the fan there are a lot of ways the insurance wrapper can be worth less than a bubble gum wrapper. The only real good news is that you are still left with some intermediate-term, investment-grade bonds. Even with the upheaval of 2009, the worst example I could find was a drop of 11%. Even Lehman Brothers investors ended up with a overall positive return for the year. These losses are not insignificant, but something the order of the drop in other similar bond funds during that time. The key is to understand the risks that you are taking, which oftentimes people don’t (including me).

As for my personal investments, after doing my bit of due diligence, I am going to put a small percentage (less than 5%) of my total assets in my stable value fund, given the limited alternatives in my 401k. I am willing to take the risk of a small loss in order to earn 3.50% for all of 2010 in this current interest rate environment.

Sometimes saving money just involves being lucky. I don’t really keep up with mortgage rates anymore, but last week an e-mail subject line just happened to catch my eye that mortgage rates are at “record lows”. I always figured that my 5.125% rate was so low that another refinance or loan modification probably would never be worth it, but it turns out that rates are so low they just might. Here’s a quick snapshot of rates from a Wall Street Journal article on 7/16/10:

The 30-year fixed-rate mortgage averaged 4.57% in the week ended Thursday, unchanged from a week earlier and down from 5.14% a year earlier. Rates on 15-year fixed-rate mortgages were 4.06%, extending the lowest point since Freddie started tracking it in 1991, and down from 4.07% last week and 4.63% a year earlier. [...] To obtain the rates, the mortgages required payment of an average 0.7 point. A point is 1% of the mortgage amount, charged as prepaid interest.

has ads now for 4.25% fixed for 30 years and 3.75% for 15 years. As for me, I might be able to get my interest rate below 4.75% and have a “breakeven” period of less than 3 years. I’m awaiting official paperwork. Ask your loan servicer and/or mortgage broker what they can do for you. Can’t hurt to ask!

Meanwhile, I was playing with the Refinance Breakeven calculator over at DinkyTown and found out that there are multiple definitions of “breakeven period”. Before, I simply figured that a refinance would cost X dollars upfront in fees and closing costs, but would save me Y dollars per month. Divide X by Y, and you’d have a breakeven point. For example, if it cost you $2,400 in fees but saved you $100 per month, you’d break even in 24 months. Past that, you’re saving $100 every month. In this case, if you plan to keep your mortgage for longer than 24 months, then refinancing makes sense.

However, there are actually four possible breakeven methods presented:

1. Monthly payment savings. The simple formula described above. The number of months it will take for your monthly payment reduction to be greater then your closing costs. Doesn’t take into account that you may be making more monthly payments.
2. Interest savings (plus PMI if applicable). The number of months it will take for your interest and PMI savings to exceed your closing costs.
3. After-tax interest savings (plus PMI if applicable). The number of months it will take for the after-tax interest and PMI savings to exceed your closing costs. This takes into account that the interest and PMI being paid may be tax-deductible, while the closing costs are paid with after-tax money only. Depends on your income tax rate.
4. Total after-tax interest savings vs. prepayment. This is the most conservative breakeven measure, and will result in the longest breakeven time period. This method considers that you could take the amount spent on refi closing costs and instead make a large prepayment on your existing mortgage. Then, it calculates the number of months it will take for the after-tax interest and PMI savings to exceed both the closing costs and any interest savings from prepaying your mortgage.

Which method is best?

First, I should add that you could complicate things even further by assuming any money not paid out immediately could earn a rate of return (savings accounts, CD, etc.) But that would make my head explode, so I won’t. The calculator suggests that methods #2 and #3 are most commonly accepted, and I would tend to agree. If you are sure that your interest is 100% tax-deductible (you exceed the standard deduction provided by the IRS without it), then you should use the value from #3. Otherwise, something in between #2 and #3 is probably the most accurate.

Method #4 compares with another theoretical situation that only applies if you really want to make a lump-sum prepayment and keep the higher monthly mortgage payment over a shorter mortgage term. For many people, the goal is to lower the monthly outlay and improve cashflow as well as save money on interest.

Citibank is currently running a “back-to-school” promotion where they added a $50 statement credit in addition to their standard card features for the Citi Dividend Platinum Select Card, the Citi Forward Card, and the Citi mtvU Platinum Select Card for College Students.

Both the mtvU and Forward cards offer 5x rewards on bookstores, movies, music, and restaurants – boy do they know students. 5x ThankYou points amounts to 3.45% cash back or 5% back in the form of gift cards from certain retailers. Great deal if you can handle credit responsibly. I’m pretty sure I applied for my first credit card in college in exchange for a cheap t-shirt with a Cal logo on it and no rewards whatsoever. Good thing I’ve always hated owing other people money…

As noted previously, 5x points on bookstores also includes anything bought at Amazon.com (a bookstore!). Would go perfectly with your free year of Amazon Prime.

The mtvU appears better if you get good grades and are willing to send/fax in a transcript every semester, while the Forward card has a better sign-up bonus and ongoing rewards for simply paying your balances on time. Here are some more details and fine print. Ends 9/30/2010.

• $50 statement credit when you make $50 in purchases within 90 days.
• No annual fee.
• No cosigner required.
• 0% intro APR on purchases for 7 months.
• $0 liability on fraudulent charges (as with other credit cards).

The statement credit can only be earned by new Citi mtvU Platinum Select, Citi Dividend Platinum Select or Citi Forward cardmembers approved through this offer. In order to receive the statement credit, you must make at least $50 in purchases that are not returned within the first 3 months of account opening. The statement credit will appear on the card billing statement after the purchase has posted to the card account, not on the receipt. Please expect to see your statement credit within 8 weeks of end of promotion period.

Did you know that if you do a Traditional to Roth IRA conversion, that you can undo it? This “do-over” process is called recharacterization, and can come in very handy if the value of your investments drop significantly after your conversion since you owe income taxes based on the value of the IRA at the time of conversion. With the recent market volatility, this may apply to many investors as it did previously in 2008/2009.

Take the example below, from a 2009 CNN Money article but still applicable. Let’s say you had a Traditional IRA valued $150,000 at conversion, which later on drops to $100,000. At the end of the year, you’d have to pay taxes on $150k of income and also be stuck with the lower account value. By performing an “undo” and “redo” the conversion, you could pay income taxes on only $100,000 of income instead of $150,000 – a savings of $14,000 at the 28% tax rate. (Find your 2010 tax bracket.)

There are some ground rules, however. The IRS says you can perform a recharacterization until October 15th of the year following the year you converted. So if you converted in April 2010, you have until October 15, 2011. If you want to re-convert, you have to wait either 30 days after the recharacterization or until the tax year after the conversion year, whichever is later. Again, if you converted in April 2010, you’d have to wait until January 1st, 2011 to reconvert. If you wait too long in between, it is possible your account value might be even higher than before. Still, something I’ll be keeping an eye on.

(You must still meet the Roth conversion eligibility rules, previously based upon your modified adjusted gross income. In 2010, there are no income limits. In 2011 and beyond, there currently are no income limits either, but it is unknown if this will remain the case. Also, only for 2010 conversions are you allowed to split the income over 2011 and 2012, which can lower your overall tax bill based on tax brackets.)

More Advanced: Multiple Roth IRAs

How can you set yourself up to best take advantage of this “redo” opportunity? I recently read in a sample issue of Kiplinger’s Retirement Report that you should split your Traditional-to-Roth conversion into multiple IRAs for each asset class you own.

For example, you might split a $200,000 IRA into $100k of stocks and $100k of bonds. If the stocks go down to $80k while the bonds go up to $120k, just to a “redo” on the stock IRA and leave the bonds IRA alone. Assuming the values stay the same upon re-conversion, that would save you income taxes on $20,000 ($5,600 at a 28% tax rate) as compared to not splitting up the IRA since if you just converted it a single IRA, the total value remained $200,000 ($80k+$120k). Tricky!

So, you’ve done your research, read the articles, crunched the numbers, and you want to convert your Traditional IRA held at Vanguard into a Roth IRA. But, how do you actually do it at Vanguard.com? There is no explicit “Convert” button or link to run this conversion. After some fumbling around, I managed to figure it out. But why not just share it here in mind-numbing detail and hopefully save folks some time.

You’ll need to have both a Traditional and Roth IRA set up at Vanguard first (mutual fund only). If you don’t have the Roth yet, click on the “Open an Account” link on the black bar on the top of every page and open an account first. Be sure to indicate that the funds you’ll use to open the new account are “At Vanguard”.

After you already have both a Vanguard Traditional IRA and a Vanguard Roth IRA:

1. Log in to your account online. Click on “My Portfolio” so that you can view all your accounts.
2. Under your Traditional IRA section, click on “Buy & Sell”.
3. Next, click on “Exchange” on any of your funds.
4. Now, you can choose to Exchange from all your Traditional IRA funds, to funds in your Roth IRA. You may need to add a new fund.
5. For the exchange amount, if you are doing a complete conversion, chose All. You may be asked to verify and accept any redemption fees.
6. You’ll also need to choose your tax withholding options. In order to maximize my balances in these tax-deferred accounts, I chose not to withhold and to pay the taxes separately myself later from a taxable account. Also, I can spread the taxes due for a 2010 conversion over two years.
7. At the end of the next available business day, your mutual funds will be exchanged into your Roth at their net asset values. Your Traditional IRA will still show up with zero balances, which you can hide from displaying.
8. Your conversion is complete! Keep your transaction confirmations for tax time.

Keep on reading below for some of the warnings and notifications that you’ll encounter during the conversion process.

A conversion is a taxable event. Generally, you’ll owe taxes on the amount you convert from your traditional, SEP-, or rollover IRA into a Roth IRA.

When you convert to a Roth IRA, you may elect to withhold Federal and certain state taxes. You can get the most benefit from the conversion if you don’t have taxes withheld and instead pay taxes from a separate nonretirement account. Keep in mind that the money withheld for taxes isn’t part of the conversion, and, if you’re under age 59½, you may have to pay a 10% federal penalty tax on it. You also can’t “recharacterize”, or restore to a traditional IRA, the amount you withhold. If you choose not to withhold, you may need to make estimated tax payments to avoid an underpayment penalty.

We encourage you to consult a tax advisor about your individual situation. For 2010 conversions only, you have the option of postponing the tax due and paying it off over two years. If you choose this option, taxable income from the conversion gets split evenly between 2011 and 2012. Alternatively, you can choose to pay all the conversion income in 2010.

Moving money out of a retirement account is a distribution, and all or a portion of your distribution may be subject to federal or state tax. You can elect to have either no federal income taxes withheld from your Vanguard IRA® distribution or a percentage between 10 and 100. If you don’t elect to have income taxes withheld from your IRA distribution, you’ll remain liable for income taxes. Tax penalties may also apply if your estimated income tax payments or income tax withholdings are insufficient under federal or state rules.

Good financial advice is hard to come by. There are so many variables, such that you have to find the balance between providing enough information, and making things digestible enough that peoples’ eyes don’t glaze over.

Check out this advice column found in the newsletter that comes in my 401k statement each month. Can you spot what’s missing?

There is no mention of what investment vehicle you should be sticking your money in, or even how much they estimate your future returns to be. Is it 100% stocks? 50% stocks/50% bonds? Orange juice futures? 6% returns? 12% returns? Who knows. Is this pre-tax or post-tax? Is it all in tax-sheltered accounts? Is my annual income supposed to rise as sharply as the chart seems to imply? I selfishly hope so!

Yet, I feel like this is what a large percentage of workers want to read. One impossibly simple chart that defines your retirement needs. So someone gives it to them. Maybe it gives them a general idea of where to start. But is a vague, possibly wrong answer better than guessing? I feel another poll coming on…

Here are another set of charts comparing the P/E10 Ratios for the S&P 500 and subsequent 10-year annualized real returns, courtesy of Mebane Faber based on Professor Shiller’s data. Can we really decide if the market is “overvalued” or “undervalued” by looking at one single number?

As noted in my earlier post about P/E ratios as a long-term predictive tool, the “P/E10 ratio” is the market’s current share price divided by average earnings over the last 10 years. By taking a long-term average as opposed to the more common single past year’s earnings, the idea is to smooth out the noise and bumps. The initial use of this ratio has been credited to famous value investor Benjamin Graham.

In the first chart above, you can see what appears to be a very strong relationship between lower P/E10 ratios and future 10-year returns. Everything is neat and tidy. High P/E10 = Bad. Low P/E10 = Good. The approximate current price of the S&P 500 is noted by the highlighted grouping. This would suggest that the median expected annualized real return for the market over the next decade would be about 5%.

In this next chart, Faber splits the data up into deciles instead. He notes a more precise trend of “great returns up to about 13, then decent returns up to about 20, then crappy returns over 20.” I personally just see a less convincing relationship. If there is such a strong correlation between lower ratios and higher returns, why should the fifth decile with P/E10 of 13 to 15 perform worse than P/E10s of 15 to 19? Hmm.

Finally, we have the actual data points. We see that although there is a nice trendline that can be created from such scattered data points, for any given P/E10 ratio there is a very wide variety of returns. Accordingly, in my humble opinion, I would be careful not to make P/E10 your main basis for setting asset allocations. It’s a nice idea that scores well in the common sense category, but in reality has been far from perfect.

Amazon.com has a new program called Amazon Student where you can get “exclusive deals”, the best of which is a free one-year subscription to Amazon Prime. This allows you to get the convenience of free 2-day shipping on most products (including textbooks and even some used books) with no minimum order amount. Usually costs $79 a year.

You can even keep your existing Amazon.com account, just click here, enter your .edu e-mail address, and click on the confirmation e-mail to activate. If you have an .edu e-mail, try it!

This is a really nice perk, and would go great with the Citi Forward credit card or the Citi Forward for College Students which gives you 5x points back on bookstores, of which Amazon.com counts regardless of what you are actually buying at the bookstore. This equates to 5% back in the form of gift cards at select retailers, or a 3.45% pure cashback return. Really, I’ve done it. See my Citi Forward review and rewards follow-up for more details.

With all of the current government spending, future promised spending, and the huge trillion-dollar budget deficit, there is a lot of talk about impending inflation. Many people are convinced that there is going to be a tax increase as a result, regardless of your political affiliation. However, this reminded me that we shouldn’t forget that the government can increase taxes without ever passing a bill, making you a new line on your IRS 1040 form, or even telling you about it. It simply has to keep pumping more money into the system.

The Wikipedia entry on “inflation tax” focuses on the idea of increasing prices and devalued currency as a increasing burden on people. But rising inflation itself is a hidden tax increase.

Let’s take a simple investment like a savings account or a bond earning an interest rate of 2% a year, but there is no inflation. Income tax is 25%. So you grumble about your low interest rates, pay your 2 x 0.25 = 0.5% in taxes, and keep the other 1.5% as your after-tax “real” return.

What if inflation is 3%, but you are slightly happier because you’re earning 2% above that for a total of 5%. Income tax stays the same, 25%. But now you’re paying 5% x 0.25% = 1.25% a year in taxes, and after 3% inflation you are left with 0.75% as your after-tax real return. Even worse.

Finally let’s say that inflation is now 6%, and you are still earning 2% above inflation. Income tax again is based on your nominal income, so you’re stuck paying 25% of that 8% interest. This leaves you earning 2% above inflation pre-tax, and then going and paying 8 x 0.25 = 2% in taxes. Your after-tax real return is now zero. You’re not making any money, it all went towards taxes.

All this could happen without ever raising the official income tax rate. This fact is sometimes brought up when talking about inflation-indexed bonds, but applies the same to all investment returns.

Time for another net worth update… last one was back in April.

Credit Card Debt
I used to take money from credit cards at 0% APR and place it into online savings accounts, bank CDs, or savings bonds that earned 4-5% interest (much less recently), keeping the difference as profit while taking minimal risk. (Minimal in regards that the risk was under my control.) However, given the current lack of great no fee 0% APR balance transfer offers, I am currently not playing this “game”.

Most credit cards don’t require you to pay the charges built up during a monthly cycle until after a grace period of about 14 days. This theoretically provides enough time for you to receive your statement in the mail and send back a check. As this is simply a real-time snapshot of my finances, my credit card debt consists of just these charges.

Retirement and Brokerage accounts
We recently converted our Traditional IRA balances to Roth IRAs, as the income restrictions were lifted this year. The choice to convert was rather simple for us, as we had non-deductible contributions that will now be able to be withdrawn tax-free. (We still owe taxes on very modest gains.)

Our total retirement portfolio is now $289,277 or on an estimated after-tax basis, $249,976. At a theoretical 4% withdrawal rate, this would provide $833 per month in after-tax retirement income, which brings me to 33% of my long-term goal of generating $2,500 per month.

Cash Savings and Emergency Funds
We are now a bit below a year’s worth of expenses (conservatively erestimated at $60,000) in our emergency fund. This is after withholding some money for paying taxes on the Roth IRA conversion above, and also for undisclosed, one-time recent expenses. It’d be fun to say that we picked up a convertible or something, but the reality is much less exciting.

Our cash savings is mostly kept in a combination of a rewards checking account (with debit card usage requirements), a SmartyPig account at 2.15% APY currently, or in a 5-year CD from Ally Bank, which despite the long term still provides a very competitive yield even if you withdraw early before the 5 years is up. (See here for more details.)

Home Value
I am still not using any internet home valuation tools to track home value. After using them for a year and finding them unreliable, I am back to maintaining a conservative estimate and focusing on mortgage payoff. If we get some positive cashflow after retirement savings, I do want to pay it down faster.

When you charge something on your credit card, the merchant usually pays about 2-3% in transaction fees for the convenience and benefit of accepting these cards (it makes it easier for people to spend money with them). In order to get their specific card “in your wallet”, issuers often rebate part of these fees in the form of % cashback rewards or frequent flier miles. This makes sense, because many people with good credit and/or higher spending don’t carry balances so that the primary source of profits is from these transaction fees.

The trick for issuing banks, of course, is to offer as little rewards as possible yet still convince enough people as a group to use the card. The newest trend is to offer a high 3% to 5% back (more than they take in!) but only on a specific group of rotating purchases. Usually the rest earn 1% cashback. If you pay attention to the rules, this can make for some significant savings. I think of it as a swiss army knife of credit cards; you just need to pick the right one for the job. It might even be time to dust off an old card you don’t use anymore.

Here are some popular cards and their current rotating categories. Also, new cardholders can combine with current sign-up bonuses of up to $100 upfront.

Citi Dividend Platinum Select Mastercard
Reward categories change quarterly. From July 1 to September 30, you can earn 5% cash back on

• Restaurants
• Car Rentals
• Hotels

After you get your card, you must enroll by logging into your account or calling 1-800-231-0891. There is no cap on the 5% back, except for the $300 overall cap on all dividend rewards annually. All other purchases do earn a standard 1% with no tiers, and rewards do not expire as long as you have activity once every 12 months.

Chase Freedom Card
Reward categories change quarterly. From July 1 to September 30, you can earn 5% cash back on up to $1,500 spent in the following categories:

• Gas
• Airlines
• Auto Rentals
• Hotels

You must enroll at ChaseBonus.com. All other purchases do earn a standard 1%, with no tiers or expiration of rewards. Currently, the Chase Freedom Visa card has a promotion offering a $100 check if you sign up and make $799 in purchases in your first three months.

Discover More Card
Reward categories change quarterly. From July 1 to September 30, you can earn 5% cash back on up to $300 spent in the following categories:

• Gas Stations
• Movies
• Theme Parks
• Hotels

In September, you can also earn 5% cash back on up to $200 spent in grocery stores and drugstores. You must enroll online to activate the rewards each quarter. Discover card has a tiered cashback rate (1% unlimited Cashback Bonus on purchases after your total annual purchases exceed $3000; purchases that are part of your first $3000 earn .25%.). Currently, Discover has a promotion offering a $75 cashback bonus if you sign up and make $500 in purchases in your first three months.

PenFed Platinum Cashback Rewards Card
Bonus categories appear and change regularly for this card, but not on a set schedule. Currently through August 31st, cardholders can earn 3% cashback in the following categories:

• Electronics
• Home Improvements

You can view all the eligible merchants here. You don’t need to enroll. This is in addition to the year-round rewards structure of 5% cash back on gas purchases (must pay at pump), 2% cash back on supermarket purchases, and 1% cash back on everything else. Rewards are credited monthly on your next statement.

Note: To get this card, you must also have membership to the Pentagon Federal Credit Union (you can apply for both at the same time). In general, membership is open to the military, US government employees, or the family or household of existing members. However, anyone can become eligible by joining the National Military Family Association (NMFA) for a $20 one-time fee. PenFed also offers other competitive financial products, including low-rate mortgages and long-term CD rates.

In order to keep track of all these, I usually just cut off the top part of a Post-It note with the sticky backing, and use it to label each card in my wallet. Here’s a pic of one of my cards:

Another problem with escrows is by mixing it in with your mortgage payment, it can obscure what you’re paying towards property taxes and homeowner’s insurance premiums. Do you know how much you paid in property taxes this year versus the last? Or how much of each month’s mortgage payment goes towards taxes and insurance? I probably only knew within about $500 the annual total.

Property taxes are usually based on an quick assessment of how much your home is worth. However, local governments rely on these taxes to fund much of their services, so they have an incentive to keep this value as high as possible. With housing prices dropping, the number of property assessment appeals last year doubled in many states.

Should you appeal as well? Here are some quick tips on getting your property tax bill lowered:

• You can find out how often your state does reassessments at this Tax Foundation page. It ranges from annually to 10+ years. For details on how your municipality calculated your assessment, contact your local tax assessor’s office.
• Check your assessment and county records to make sure your land size, house square footage, and other information are accurate. By correcting these measurements, your assessment may automatically be lowered (or raised!) .
• Collect documents that show your home’s value should be lower, such as recent sales of at least three comparable homes nearby. Try using real estate websites such as Zillow or Trulia. You can also see all your neighbors’ property taxes at PropertyShark.com.
• Submit any reports by inspectors or contractors, or at the minimum photos, to prove that your home needs major repairs and is thus worth less. Also document any material changes such as easements, re-zoning, heavy traffic, nearby railroad tracks, or freeways.
• If the amount is significant, you may decide to hire a lawyer or real estate appraiser to help you through the process. Many online sites have popped up that offer to do the legwork for a fixed fee of $100-$300. I have not used any of these sites, and don’t think they are necessary if you are willing to spend a few hours of your own time. If you decide to try one of them, please do your due diligence, and then let me know how it goes! Examples: EasyTaxFix.com, ValueAppeal.com, ReduceHomeTaxes.com.

Have you appealed already? Share your story in the comments below. I hope it’s a success story, but all experiences can be helpful to others.

Sources: AARP, ConsumerAffairs

In response to my earlier post on Should You Manage Your Own Mortgage Escrow?, reader James e-mailed me a trick he found to save some money even if you are required to have an escrow account:

Even if you’ve got an loan that requires an escrow account for the life of the loan, you can still save some money by beating your lender to the punch on payments. Most homeowners insurance companies provide a discount (about $50 in my case) if you pay your homeowners insurance premium yourself on-time or in advance. They get their money sooner that way. Payments made from escrow don’t usually post until 30 to 60 days past the actual due date.

You can make this payment using a credit card, and then provide proof of payment to your lender, who will then reimburse you from escrow instead of paying the insurance company. If you time it right, you can float the payment on a credit card as a regular purchase, and not incur any interest by paying it off as soon as you receive the payment from your escrow account. Presumably, you could do the same with property taxes.

I called my homeowner’s insurance company (State Farm), and they said they don’t offer such a discount. But maybe yours does?

Housing prices. Are they still falling? Stable? Best time to buy ever?

Barry Ritholtz of The Big Picture thinks that housing prices have much further to fall. Here’s part of his analysis:

Today, residential real estate confronts numerous headwinds: Credit, once given to anyone who could fog a mirror, is now tight. Hence, demand is far below what it was during the past decade. Home prices are still unwinding from artificially high levels, and remained over-priced. Inventory is elevated. Unemployment remains high. A huge supply of shadow inventory is out there: Speculators and flippers who overpaid but have held onto their properties await modestly higher prices to sell. Bank owned real estate (REOs) continues to increase. We are barely halfway through a decade long foreclosure surge.

He also shares some historical data from 1977 to 2010 that support his view. The top graph below is home price appreciation divided by rent as measured by CPI. If the ratio is rising, it means that home price appreciation is rising faster than rent. If the ratio is falling, it means that rent is rising faster than home price appreciation. Then there is the price/income ratio, illustrated by the bottom graph below. In both cases, we are currently still above the historical mean.

From 1977 to 2010, the median US home price was 4.1 times median household income. But as the chart below shows, Home prices are still above that mean. Oh, and that mean is artificially elevated due to the 2002-07 boom. Same with home prices relative to rentals, or housing value as percentage of GDP. Further, we should not assume that prices will merely mean revert back to historic levels. In most markets, a near 3 standard deviation price move is resolved not by reverting to the mean, but by by careening far below it.

Data source: Ned Davis Research

I recently got a refund from my mortgage escrow servicer, as my property taxes decreased. This reminded me about how I always used to read that you should manage your own escrow account. I don’t think I have a choice about the matter right now, but I tried to research all the pros and cons below. Did I miss something? Share your own reasons in the comments, and don’t forget to vote in the poll below!

Escrow Definition and Background
When you borrow money to buy a house, the lender holds your house as collateral in case you stop paying them back. However, in certain cases the lender can lose control of their collateral. If nobody pays the city and/or county property taxes, the local government can seize the house and become the first lienholders on the property. Similarly, if the house burns down or becomes flooded without insurance, then they’ll be in trouble too. This is why most lenders require the funds for these types of charges to be automatically collected each month and placed in escrow, until the respective bills are actually due.

Now, most homeowners of course want to pay these things, but as with other big bills, many people may not plan ahead and later find themselves unable to pay. Some lenders may allow you to manage these things for yourself once you reach a certain amount of home equity (loan-to-value ratio) or if you pay them a fee or a higher interest rate.

The Real Estate Settlement Procedures Act (RESPA) provides several requirements regarding escrow. The maximum “cushion” a lender can accrue is for 1/6th of the total amount paid out, or approximately two months of escrow payments. While some states require interest to be paid on escrow account, RESPA does not.

Reasons To Manage Your Own Escrow

• Earn interest. This is the reason I hear most often. You pay out a lot of money ahead of time, when you could be earning interest on those funds instead. Even if you don’t have it as as lump sum, you could tuck away 1/12th of your insurance and tax bills every month on your own.
• Avoid payment errors. Even though the whole point of escrow is to pay your taxes and insurance on time, escrow servicing companies still make mistakes occasionally, resulting in lost payments and big headaches.
• Increase tax deductions. If you think that you will be able to itemize deductions in one year and not the next on your tax return, you may try to “bunch” deductions so that they end up in the preferred year and save you some money. For example, you could pay your 2010 taxes in January 2010, and your 2011 taxes in December 2010, so they both occurred in 2010.

Reason Not To Manage Your Escrow

• You have no choice. Many lenders, like the Federal Housing Administration (FHA), require escrow for the life of the loan. Others, like PenFed only allows you to manage your own escrow once you reach a 75% loan-to-value ratio. If you’re shopping for a new loan, this is a possible negotiable item.
• It costs too much. Some lenders will let you waive escrow, but only for a flat fee (possibly hundreds of dollars) or a quarter to half point (0.25%-0.5% of your loan value). That could be end up being a bad financial trade-off, especially if you don’t keep your mortgage for very long.
• Simplicity and convenience. Hey, it’s one less thing to worry about, and your monthly expenses stay more constant. Technically, if you are short on your escrow, the servicing company will even cover the difference for you and just make it up over the next year. You can view it as a service provided in exchange for any lost interest. If your annual taxes and insurance premiums total $1,500, that is $30 per year at 2% APY, which even assumes that you lose an entire year of interest. Of course, interest rates may rise later.

Poll

Amazon has dropped the price on the Ooma Core (Hub+Scout) VoIP phone system to $199 from $249. This is the older Ooma system, which still has unlimited long distance but also does not have any monthly regulatory fees/taxes charged each month, for a completely fee-free experience. They don’t make these anymore, and are increasingly hard to find. (The new Ooma Telo has higher fees of about $3/month – check them here with your zip code.)

Frys.com also has the Ooma Hub refurbished for only $129. There are differing reports online as to whether these are subject to the monthly fees, so I’d only buy it if you have a Fry’s nearby to return.

I’m still happy with mine after 9 months and counting – read about my Ooma experiences here.