9 Steps To Financial Freedom - Step 5

 

BEING RESPECTFUL OF YOURSELF AND YOUR MONEY

 

MONEY IS A living entity, and it responds to energy exactly the same way you do. It is drawn to those who welcome it, those who respect it. Wouldn’t you rather be with people who respect you and who don’t want you to be something you’re not? Your money feels the same way.

THE SECOND LAW OF FINANCIAL FREEDOM

RESPECT ATTRACTS MONEY - DISRESPECT REPELS MONEY

 

This is one of the reasons why the rich get richer. If you’re respectful of your money, and do what needs to be done with it, you will become like a magnet, attracting more and more money to yourself.

For some of us, this goes against the grain. We’ve all heard that “money is the root of all evil,” and it’s easy to have the notion that caring for our money is a task that should be beneath us. We know there are more important things in life—like people, as we saw in the last chapter. But that doesn’t mean you should neglect your money. Remember, your financial life is like a garden. If you tend a garden carefully, nourishing the flowers, pruning, and weeding, it’s going to be a lot more beautiful than if you simply water it halfheartedly now and then.

Wouldn’t you like your financial garden to be beautiful and bountiful? Don’t you deserve it? If you treat your money with disrespect, you are actually not giving yourself the respect that you deserve. And when you fail to respect yourself and your money, you actually repel wealth from yourself, and you block more wealth from coming your way.

The consequences of not respecting money may show up in your life in any number of ways. You might lose some of what you have just by neglecting to pay attention to it. As soon as you pay off one credit card, your car breaks down and now you owe even more. Maybe you didn’t get that job you felt certain was yours. A wonderful relationship, or so you thought, just goes out the window over money. However this repulsion takes place in your life, the root cause of it is disrespect of yourself and your money.

When I say this to some people, many of them get very defensive and say, “But Suze, I am the most respectful person I know when it comes to money.” When we look closely at all their actions relating to their money, however, we eventually see that they are not as respectful as they would like to think.

When you start really respecting yourself, those you love, and your money, the result is that you start having control over your money. What follows from that is control over your life.

 

YOUR  EXERCISE

 

Please write down all the ways in which you are both respectful and disrespectful of yourself and your money. Contemplate this for a while, and you’ll begin to see how the actions you take in your life, and with your money, can erode your relationship with yourself and your money. Some questions:

Do you spend more money on your friends than you can afford to?

Why?

Do you find yourself buying more presents for your children for the holidays or their birthdays than feels right to you?

Why?

Will you spend money on others but never a penny on yourself?

Why?

Do you send things Federal Express or next-day air because they’ll come pick it up, rather than going to the post office to mail it far more cheaply?

Why?

Have you ever bought a dress or suit and decided, when you got it home, that it really didn’t suit you, then neglected to return it to the store in time to get your money back?

Why?

Do you give to charities because you really believe in the cause or to impress people?

Why?

Do you put away as much money as you possibly can for retirement each year?

Why not?

Do you borrow things from friends and fail to return them? Why?

Do you sometimes “forget” to pay off personal loans from friends with the same regularity that you’d pay off a credit card? Why?

Do you constantly pay late fees on your bill payment?

Do you send your clothes out for dry cleaning when all they need is a quick once-over with an iron?

Why?

Do you often go out to dinner simply because you don’t feel like cooking? At what cost over time?

Why?

Do you sometimes pay your bills late when you didn’t have to?

Why?

 

After you have written your answers, go back and think of occasions when your respect led to something great happening or when your disrespect brought with it some unhappy consequences.

It’s very subtle, but the way we treat ourselves and our money touches upon every aspect of our lives.

Those people who are respectful of themselves, respectful of others who have money as well as those who do not, respectful of what money can and cannot do, are said to be people with a golden touch. I’m sure you’ve said it yourself about someone: Whatever she touches turns to gold. But a golden touch with money isn’t something you’re born with, like perfect pitch. It is something you can learn, something you must learn if you want to be blessed with financial freedom

 

YOUR  EXERCISE

 

Please take out your wallet or whatever you keep your money in right now. How are your bills organized? Are the ones mixed in with the tens? Are they all facing different ways? Are they stuffed in there in such a way that you have to unravel them to see what they are? How you actually keep your money is where respect for it starts. Keeping your bills neat and in order, caring for them the way you care for other important things in your life, will serve as a constant reminder of the respect that you and your money deserve.

This is what Step 5 of the nine steps to financial freedom is about— being respectful of yourself and of your money and taking actions to give that respect meaning.

PAYING YOUR BILLS TO YOURSELF

A few years ago I was asked to counsel the employees of a company that was offering early retirement to those employees fifty years old or over. I’ve given seminars to such employees before and also personally counseled more than one thousand people who have been offered early retirement, and I’ve seen how terrifying such an offer by an employer can be. If the employee is emotionally ready to retire, and financially ready to retire, it can be great. Seldom, though, do we have all our emotional and financial ducks in a row at such an early age. Many people are afraid to take offers of early retirement. Yet however afraid they are to say yes to the offer, they’re more afraid to say no. Why? Because if they say no, they’re at the mercy of their company, with no guarantees of employment for as long as they’ll need it. And once they turn down the offer the first time, they may not have a second chance.

This time I discovered something very interesting. Even though most of these people had worked for this company for twenty-five years, and most of them were earning the same salaries the whole time, there was an even split of the people who came for counseling, with only a few exceptions. The vast majority of people who came either had around

$400,000 in their 401(k) retirement plans or else they had around

$150,000—big difference.

What accounted for the difference? Were some simply better investors than the others? No. Nearly all these people had all their money in the company’s stock, even though they had other investment options. Had some been in the company plan longer than others? It wasn’t that, either. Most of them had been in the plan for about the same time, give or take. Had some withdrawn large amounts of money from their retirement plans, even at a penalty? There were a few of these, but they were the people who only had anywhere from $10,000 to $50,000 left in their plans, and they were a small minority.

One   single   factor   accounted   for   the   difference.   Those   who   had

$400,000 or more had from the beginning put in the maximum amount they were allowed to put into their 401(k) account. Those who had

$150,000 had simply put in 6 percent of their salaries because that was all the company matched. Their attitude was: Why put in more than the company will match? (Sound familiar?) One good reason for these people would have been $250,000 more in retirement security.

To look at it a different way, that extra $250,000 would give them an extra $850 or so a month without their ever having to touch the principal, or a hefty amount to invest for growth to cover inflation concerns, or to leave to their family when the time came. For most of the people I counseled, that $250,000 meant the difference between knowing that they would never have to find work again unless they wanted to and being afraid that one day there would be no choice.

Now, there is one scenario where I think it can make sense to not invest the maximum in your 401(k). If you are eligible for a Roth IRA (see this page) but you are too cash-strapped to contribute the maximum to your 401(k) and fund a Roth IRA, you are to scale back your 401(k) contribution. Make it your goal to contribute just enough to your 401(k) to qualify for the maximum employer matching contribution (but not a penny more), and then concentrate on investing in a Roth IRA, which in my opinion, is the best retirement investment available. But if you can manage to invest the maximum in both the 401(k) and the Roth IRA, that’s an even better move.

THE IMPORTANCE OF INVESTING

There are only three honest ways in this life to get money. The first is to work for it. The amount of time most of us are able to work will be limited—by age, health, elimination of our jobs, whatever—and there will be many years, for most of us, when we’re spending money but not earning it. Do you know that many of us will spend more time in retirement than we ever did working?

The second way to make money is to inherit it. Are you among those who are hoping that an inheritance will be your saving grace? If you’re waiting around for the heavens to rain money down on you, I hope you paid close attention to Step 4. With life expectancy inching up to the eighties and beyond, you might well hit your own retirement years before you ever see a penny. What is more, for the majority of us, inheritance is rarely a sure bet. One nursing home stay, a few investments gone bad, a large probate or estate tax bill—anything can happen.

The third way to make money is the most powerful and respectful way there is. This is to invest the money you save during your working years wisely, so that when you no longer want to or are able to work, your money will work for you. The earning years of your retirement money can go on forever—money is a living entity, remember? If invested with respect, if invested in time to let it grow, these earnings will take care of you well and go on to take care of those you leave behind.

 ADDING YOURSELF TO YOUR PAYROLL

 

It is not respectful to yourself, to others, or to your money not to plan for your future. It is not respectful to yourself, to others, or to your money not to take full advantage of the 401(k)s or IRAs or the other retirement plans that are available to you. It is not respectful to yourself, to others, or to your money not to face your debt, to learn the basics of investing, and to stand guard over your money, making sure that every penny you’re spending is a penny that must be spent. What day you pay your bills, when you send in your taxes, and what hidden costs you pay for your checking account all can make a difference in how much money you have and how much money gets attracted your way. We all think that a bigger paycheck would be the answer to our financial woes, but that is rarely the case. Respect starts with the money you are earning right now and what you do with it.

THE THIRD LAW OF FINANCIAL FREEDOM (PART 1)

THE MORE YOU MAKE THE MORE YOU SPEND

Remember your first paycheck from your first job, how it seemed like so much money and how everything seemed possible? Remember your first raise, how your expenses expanded to spend it, and you wondered how you ever managed to get by on that first paycheck? With every subsequent raise, you’ve probably increased your spending to use up every penny of it—even though you got by perfectly well before your most recent raise, the one before that, and the one before that.

THE THIRD LAW OF FINANCIAL FREEDOM (PART 2)

THE LESS  YOU THINK YOU MAKE THE LESS YOU WILL SPEND

No, no, no—this does not mean you should make less money; I hope you make as much money as you can! But there is a simple and remarkably effective way to make yourself spend less. You invest more. By putting more money into your retirement accounts, your take-home check will be less and you will quickly train yourself to spend at a lower level, just as you used to do when you were making less money. (If you still don’t see how you can spend less, reread Step 3, which will show you how to do so.)

If you do this now, if and when that day comes when you’re asked to attend an early retirement seminar, or when those rumors in your office about downsizing become reality, you’ll be ready. You’ll be the one with the $400,000 or more with which to face the future.

You may say, “But Suze, I can barely afford to pay my bills as it is. How do you expect me to live today and still put money away for my retirement?”

If you think you cannot make it today, while you’re working and have a paycheck coming in, how in the world do you think you’re going to make it in the future, when you will have essentially the same bills to pay but no paycheck coming in? The answer is that you won’t. But if you set it up now, even on a modest salary, you can put aside an impressive amount of money.

Some years ago a couple came to my office—early forties, nicely dressed, two children, annual salary of $35,000 (which would be closer to $70,000 in today’s dollars). The wife didn’t work outside her home, because the children were too small, although she planned to go back to work in a few years. They owned their own house and had fourteen years left on their mortgage. They paid their credit card bills in full every month. They already had a sizable nest egg, because the husband had been aggressively investing the maximum in his 401(k) plan at work. They had a few other investments that were doing nicely, earmarked to fund their children’s education. I remember asking them, “How is it possible that you can do all this on just $35,000 a year?” He

answered: “We only spend what we see. The company takes out the maximum for my 401(k), and I also have them send money directly to our credit union. The credit union sends money directly to a mutual fund to invest it. Our take-home money isn’t much, but at least we know we can spend it all and not have to worry. So it works.” I asked them why they had come to see me, and they said they wanted to make sure they were covering all their financial bases. With immense respect for the job they were doing, I sent them home and told them not to change a thing.

 

MAKING YOUR MIND YOUR FRIEND

 

Your mind is the most powerful tool you have, and in the same way my clients just mentioned did, you must make it believe that you make less than you do so that you will naturally spend less.

Your mind believes that if you bring home a monthly paycheck of

$3,000, then you have $3,000 to spend. And you’ll spend it, all of it. If you get a raise and start bringing home $4,000 a month, you’ll spend all of that, too, and wonder how on earth you managed on less. But if you start bringing home $3,500 a month, your mind will adjust to it, and you’ll naturally spend less. The way to do it is exactly the way my clients do: just put it away before you ever see it.

You won’t be depriving yourself. You’ll be paying yourself. You’ll be on your own payroll and soon be able to enjoy two of life’s great pleasures: counting your money as it grows and dreaming of how you’ll spend it when the time comes.

TIME AND YOUR 401 (K)

JUDY’S STORY

 

“I would happily save more for retirement,” Judy said, “but I can’t afford it

It was actually quite a few years ago when my mom died and left me what I thought was a nice inheritance. At the time, I had just a few credit card bills—not more than, say, $2,000. But I sure loved having more money in the bank. My partner and I had been living together then for about eighteen years, and we had always had a nice sharing relationship financially. But things seemed to change after I got that money. Before I knew it, I had spent more than half of it, on things I had never really given much thought to before. And Deb, well, she started to spend more, too. Before I knew it, our credit card bills were up to around $7,000. And that was before we bought our new apartment. But now I’m getting nervous about the future. I have a 401(k) plan at work, and I put in 6 percent, which is what the company matches. Deb doesn’t even have a retirement plan at work. I probably should put more money away for retirement, I know it makes sense, but I really can’t afford to, not with the mortgage and everything

Judy had it backward. In fact, she couldn’t afford not to put more money away for retirement. Having worked at the same corporation for twenty- seven years, she had missed out on thousands upon thousands of dollars she could have saved painlessly, effortlessly, and tax-deferred. By receiving a little less in each paycheck, she would have earned herself far, far more in the long term for her retirement, which would be upon her not too many years down the road.

THE FOURTH LAW OF FINANCIAL FREEDOM

IT'S NOT WHAT YOU MAKE - IT'S WHAT YOU GET TO KEEP

With Judy, as with the rest of us, it is not the amount of money earned that is important. It is how much of that she does not have to give to the

IRS, how much she really does get to keep.

Money that goes into a retirement fund is money you do not have to pay taxes on until you take it out. Or if you use a Roth IRA or Roth 401(k) to save for retirement, you invest dollars that have already been taxed and then in retirement all withdrawals will be tax-free. Depending on your income tax bracket, you might be able to keep up to 35 percent more of your money (the highest federal tax bracket through 2012). Because of the tax savings, contributing the maximum to your retirement account right now will not deprive you of as much current income as you might fear. And where it will make a vast difference is in what you’ll have to spend later.

Let’s say that I convinced Judy to raise her 401(k) contribution to

$500 a month or $6,000 a year, and let’s say that she is in the 35 percent federal tax bracket. By investing in the 401(k), she will have cut her monthly federal tax bill by $175. If she had not invested in the 401(k), that $500 would be taxed before she got the money, leaving her with just $325 to spend.

Your situation might be a little different, depending on what tax bracket you are in or whether the state you live in imposes an income tax, but the concept always holds true.

Finally I convinced her, and she promised to up her contribution to the maximum that very week, which she did. She called me a few days later: the very day she raised her contribution, her boss had called her into her office to give her a midyear raise. This was the first time in all these years she had been given a raise before the end of the year. She was stunned.

I wasn’t. This sort of occurrence, however you want to explain it, is not uncommon; I’ve seen it happen many times. I attribute it to the second law of financial freedom: Respect attracts money.

Judy had decided to respect herself, chosen to put the creed into action and take the steps to nurture her money. And by doing the right things with her money, she attracts more money.

 

EXERCISE

 

If you are covered at work by a 401(k), 403(b), or SIMPLE plan, I want you to go into your human resources office and up your contribution. You must contribute at least enough to qualify for the maximum matching employer contribution. That match is a free bonus you do not want to pass up. After you have achieved that, your focus should be on also funding a Roth IRA. Then, if you have the ability to save even more, you can increase your work-based contributions even higher. The absolute best move is if you can fully fund your work retirement plan as well as a Roth IRA. If you have not signed up for your retirement plan, please do so now. If you are self-employed or your place of employment doesn’t offer a 401(k) or similar plan, please read on and take  the actions that are right for you. Once you’ve done this, write down the date you took the action and begin to keep track, and see what happens in your financial life that never would have happened before. For Judy, it was a midyear raise. Soon you will see that there is a direct correlation between taking a step toward financial freedom yourself and watching your money take a step right back toward you.

 

IF YOU’RE AFRAID TODAY, YOU’LL BE MORE AFRAID IN THE FUTURE

 

You need not feel afraid about increasing your contributions. None of these changes is cast in stone, and you could always change back if you felt you had to. Among all the people I’ve had do this, by the way, not one single person has ever regretted it—or changed his or her contribution back to where it was. You cannot afford not to try this out. There will be a day, you know, when you won’t be able to bring in a paycheck, and you must prepare for that day now.

Companies are offering 401(k) plans because most of them do not offer pensions anymore. When many of our parents retired, things were different. Back then, many received a monthly paycheck from their longtime employers after retirement—that’s why retired people were called pensioners. Also, even a generation ago people were not living to ripe old ages, the way we are now, and retirement was a shorter-term eventuality. For most of us, the pension check is a relic of the past.

If you’re counting on Social Security to see you through retirement, count again. That is not the most secure bet you could make. When Social Security was first created, the average life expectancy was sixty-two. The architects of Social Security expected that very few Americans would live long enough to collect it. Surprise! Now that the average life expectancy extends well into the eighties, most of us will spend more years in retirement than we ever did working. This is placing a tremendous strain on the Social Security system, so much so that recently the government has changed the ages as to when you can collect your full Social Security benefit. Starting with people born in 1938, the normal Social Security eligibility age will rise by two months for each year, until it reaches sixty-six if you were born in 1943. It then stays at sixty-six for everyone born through the end of 1954. If you were born after the year 1954, then the age to receive full benefits starts to climb again by two months a year until it is finally capped at sixty-seven for those born in 1960 or later.

Not only does the change affect when you start collecting your full

benefit amount, but it also affects you if you decide to take your Social Security payment before your full benefit eligibility age. For instance, if your full benefit eligibility age is now sixty-six but you wanted to take your Social Security benefits at age sixty-two, your benefits will be 25 percent lower. People whose normal retirement age is now sixty-seven will see a 30 percent benefit reduction if they choose to take their Social Security at age sixty-two.

The way it used to work was you could get your full benefits at age sixty-five, but if you did take them at sixty-two you only had a 20 percent reduction. But now, not only do you have to wait longer to get your full benefit if you were born after 1938, but if you take your Social Security at sixty-two, you get less as well.

On the bright side, the yearly rate of increase in benefits for those who wait past their full eligibility age to start collecting Social Security will gradually rise, up to 8 percent for those born in 1943 or later. This incentive is not offered beyond age seventy, however.

The current eligibility age of 65 for Medicare, the nation’s health insurance program for the elderly, is not affected by the Social Security changes.

If all this is confusing, take a look at the chart above. The figures on the left refer to the year you were born and the figures in the second column refer to your actual full benefit age calculated by the SSA. The last three columns show you what will happen if you decide to start taking Social Security before reaching your full retirement age.

You can obtain an estimate of your Social Security benefits at the SSA website at http://www.ssa.gov.

So, as you can see, the government has the ability to make changes whenever they want; in my opinion, if you are counting solely on Social Security, you could be in danger. It is so very important to also save for retirement outside of your Social Security payroll deductions. For most of the people I have come in contact with, their saving grace is their 401(k) or other retirement plan. Almost certainly it will be for you, too.

 

RETIREMENT PLAN BASICS—HOW THEY WORK

The employer-sponsored plans known as 401(k) and 403(b) allow you to contribute a portion of your salary. A 401(k), which takes its exciting name from a section in the tax code, is an all-around plan that almost any employee of any company can enter into. A 403(b) plan is what you have if you work for a nonprofit organization, such as a hospital, university, or research organization. The 401(k) and 403(b) plans work in much the same way; if I refer to a 401(k) plan here, it will also apply to you if you have a 403(b) plan.

 

How Much Can I Put into My Plan?

The percentage and the amount you can contribute may vary from employer to employer; some employers limit the percentage of your salary you can contribute. Regardless of the percentage your company allows, the maximum dollar amount the government generally allows as of the year 2012 is $17,000 per year for 401(k) plans and 403(b) plans. That contribution limit is adjusted for inflation annually.

Individuals who are at least 50 years old by the end of the year can make an additional contribution to their plan. For 2012, the additional 401(k)/403(b) contribution limit is $5,500 and will be indexed for inflation in later years.

In addition, with a 401(k) the government has interesting regulations that affect how much you can contribute if you are making a lot,

$115,000 or more, in 2012. (This figure also changes for inflation.) When you earn this kind of money, the government considers you to be a “highly compensated employee,” and out of fairness to all employees it does not want the average percentage for those earning $115,000 or more and putting the maximum into the plan to be far greater than the average percentage of all other employees who are not as highly compensated. The term “highly compensated employee” means any employee who, during the current year, made at least $115,000, or your salary is in the top 20 percent at your firm. A plan where the more- highly-paid individuals contribute much more than the less well-paid is called “top-heavy.”

This means that if you are highly compensated in the government’s eyes, you might not even be able to contribute the full $17,000 to your 401(k). In fact, if employees at your company who are less well paid are not putting in anything at all, you may not be eligible to contribute anything whatsoever. Make sure your plan administrator has addressed this potential problem. Otherwise, if you are highly compensated and have put too much in your plan, they’ll have to give the money back to you, and it will be taxed as ordinary income.

 

How Do I Put Money into My Plan? What Happens to the Money?

The percentage that you decide to contribute, once okayed by the company, will be taken from your paycheck.

The company administering the plan then invests your money for you. You will usually have a choice of several investment vehicles, which might include mutual funds, bond funds, or individual equities such as the stock of your own company. Typically, the choices will offer a range of risks and returns. Some investments are highly predictable, such as bonds, which produce steady income at minimum risk. The stock market is more variable, and the most aggressive growth funds may swing up and down considerably in value, while they offer a higher return over time.

Usually you will be given extensive information about your investment options, and you can divide your contributions as you see fit among the different investments.

Plans today allow you to transfer money within the plan from one investment to another or to change how you want future contributions to be allocated among the investments. All it usually takes is a phone call. So if you have invested all your money in a stock fund, for instance, and the stock skyrockets and you sell your shares within the plan because you made 30 percent on your money, you will not owe a penny at that time in taxes. While the money sits in the plan you do not have to pay taxes on it.

 

Should I Invest All My 401(k) Money in My Company’s Stock?

It’s never wise to put all your eggs in one basket, particularly in stocks. The stock market has ups and downs, and individual companies may fall on hard times very quickly, due to management mistakes, changes in the economy, or sheer bad luck.

This doesn’t mean your company is a bad investment or that you shouldn’t express your loyalty by being a shareholder. But even great companies can see frightening declines in their stock. By all means, invest in your own firm, but spread your money around so that you’re protected if the unexpected happens. Diversification should be your watchword. I recommend you limit investments in one company to 10 percent or less of your assets.

 

When Do I Owe Taxes on a Retirement Plan?

The taxes on a traditional 401(k) will be deferred until you take your money out, at which time it will be taxed as ordinary income. But if you withdraw funds from a retirement account before the age of fifty-nine and a half, you will pay ordinary income tax as well as a 10 percent penalty. You will also pay a state tax and penalty, if applicable. With a SIMPLE, it works the same way after the first two years. But if you take out the money within the first two years you participate in the plan, an early withdrawal tax of 25 percent will apply.

However, there are exceptions.

 

Getting Around the 10 Percent Early Withdrawal Penalty

Very few people know about this, but it’s true.

If you’re fifty-five or older in the year of retirement from your company, you can withdraw whatever you like from what’s known as a qualified employer retirement account without any tax penalty whatsoever. You will pay tax on this money as if it were ordinary income. The tax will be withheld from your withdrawal off the top in the form of a 20 percent withholding tax. You’ll get a refund of this withholding tax if when you file your return you owe less than was withheld. If you owe

more, you’ll have to pay the balance.

This holds true only for employer-sponsored retirement plans such as the 401(k)and 403(b). If you take your money out of your 401(k) and put it (without you touching it) into, for example, an IRA rollover, this 20 percent withholding rule won’t apply to you.

 

What If I Leave My Present Employer?

When you leave your place of employment, many times you can leave your 401(k) right there and not have to take it out until much later. Other times you might want to withdraw your money, and some companies may encourage you highly to take it out when you leave, although if you have more than $5,000 in the plan, they can’t force you to do so. In any case, there might come a time when you need a place to which you can transfer the money.

You usually have two choices. If you’re merely changing jobs, you may be allowed to move it to the 401(k) plan at the new company. The other option is to arrange for a trustee-to-trustee transfer of the money from your current plan into an IRA rollover account which is often called a direct rollover. If you do this, you can continue to shelter all the money from taxes and invest it for your retirement. You can open an IRA rollover at a bank, a mutual fund company, an insurance company, or a brokerage firm. I prefer discount brokerages or low-cost mutual fund firms. IRA rollovers are governed by the same regulations as an IRA account (described later in this chapter).

 

Substantially Equal Periodic Payments to Avoid the 10 Percent Withdrawal Penalty

There is one other way to get money out of your retirement accounts and avoid that 10 percent penalty if you are not the permissible age or if your money is in an IRA or IRA rollover. You can do this by using a technique called substantially equal periodic payments (SEPP). Simply put, you have to take out a specific amount of money every single year until you are 59½ or for five years, whichever period is longer.

So if you are fifty-seven and you start to take money out of your IRA account under SEPP, you will have to do so until you are sixty-two. If you’re fifty-two when you start, you’ll have to continue withdrawing the money until you’re fifty-nine and a half—again the rule is whichever time period is longer.

The amount you can withdraw is calculated by one of three methods; the method you choose will determine the actual dollar amount you must take out yearly. This exact predetermined amount must be withdrawn every year for five years or when you reach fifty-nine and a half, whichever is longer. Very few people know about this loophole, IRS code 72(t)(2)(A)(IV), but it’s there if you need it. Make sure you consult with a financial adviser, accountant, or brokerage house who is familiar with this law.

 

When Do I Have to Start Making Withdrawals from My Retirement Plan?

The longer you can let it sit there, in most cases the better off you’ll be. But the government won’t let it sit there (tax-free!) forever. They want their taxes on your retirement money. According to a formula specified by the IRS, you have got to start taking money out of traditional retirement plans [except for Roth IRAs and Roth 401(k)s] by April 1 in the year after you turn seventy and a half. There is one big exception: If you are still working, your retirement money is in an employer-sponsored plan such as a 401(k), and you are seventy and a half or older, and you do not own more than 5 percent of the business, you do not have to make withdrawals until April 1  following  the calendar year in which you do retire.

 

What If I Don’t Have a Retirement Plan at Work?

Ask your boss to get you one. Take a poll and you will see that almost everyone you work with probably wants one, too. Choose the  best person to approach your boss to ask about establishing a 401(k) company plan or a SIMPLE for all of you. Offer to do the research yourself or with a colleague. Many excellent plans are offered by different mutual funds companies, all of whom will set up a plan for your company’s needs; Fidelity Investments (800-343-3548 or visit www.fidelity.com) and Vanguard Group (800-662-7447 or visit www.vanguard.com), for example, are two of the largest 401(k) money managers and wonderful places to start looking.

 

INDIVIDUAL RETIREMENT ACCOUNTS

 

If you are working for a company that still won’t offer you a retirement plan, your only other option is an IRA, or individual retirement account. You can make an IRA contribution of up to $5,000 for yourself, and if you’re married, you can also contribute $5,000 for your nonworking spouse. Individuals who are fifty or older as of the end of the year could contribute an additional $1,000 in 2012, for a maximum contribution of

$6,000. All IRA contribution limits are adjusted annually in line with inflation. In order to make a contribution, the combined income of both spouses has to be at least equal to the amount contributed to the IRA. You can also have a traditional IRA in addition to an employer’s retirement plan, but your contributions may not be tax-deductible.

There are three different kinds of IRAs that you can choose from: a traditional IRA, the spousal IRA, and the Roth IRA. Here are the new specifics.

 

The Traditional IRA

If your earning allows it, the traditional IRA gives you a current-year tax deduction. If you are eligible, you can contribute $5,000 to your IRA, and if you are in the 25 percent tax bracket, you will save $1,250 that year in income taxes ($5,000 × 25%). What is more, while the money is in the IRA, both your contributions and the IRA’s earnings grow tax- deferred, which means that the income taxes on any growth of the funds are deferred until you actually withdraw any of the money, at which time you will pay ordinary income tax on the amount withdrawn each year. With a traditional IRA, in most cases you cannot withdraw the money prior to age fifty-nine and a half without paying a 10 percent penalty on the amount withdrawn. (Exceptions to this are if you use SEPP, this page, or for the reasons listed below.) On the other end, if you do not need the money, it can sit there until you have to start making withdrawals by April 1 of the year after you turn seventy and a half. But remember, if after that date you have not taken out the required amount there is a 50 percent penalty on the amount that should have been withdrawn. The spousal IRA follows the same guidelines.

 

Who Can Withdraw Money Penalty-Free from a Traditional IRA?

There are two other circumstances in which you are permitted to make an early withdrawal without paying the penalty.

1.      If the money is used by a “first-time home buyer” to purchase a principal residence. The distribution may come from the buyer’s IRA or from an account belonging to the buyer’s spouse, or the child, grandchild, or ancestor of either the taxpayer or the taxpayer’s spouse. There is a lifetime limitation of $10,000 that can be treated as penalty- free “first-time home-buyer” distributions.

2.    Distributions for higher education expenses at an eligible education institution to the extent that such distributions do not exceed the qualified higher education expenses of the taxpayer, taxpayer’s spouse, or any child or grandchild of either the taxpayer or the taxpayer’s spouse for the taxable year.

 

Who Can Take Advantage of the Traditional IRA Deduction?

The traditional IRAs, including spousal IRAs, have rules regarding deductibility that are determined by whether the taxpayer is covered by a qualifying retirement plan at work and, if so, by what the taxpayer’s filing status and income are for the year. In 2012, the range was

$58,000-$68,000 for single taxpayers and $92,000-$112,000 for married filing jointly (MFJ). However, a spouse will not be considered covered by a retirement plan simply by virtue of the other spouse’s being covered. The spouse without a qualifying retirement plan will be able to make a fully deductible contribution to an IRA if the modified joint AGI does not exceed $173,000. Between $173,000 and $183,000, deductibility is phased out.

 

The Roth IRA

The Roth IRA differs, in that you do not get to take a current-year tax deduction in the year that you put the money in, or, for that matter, ever, but—here’s the lure—from the moment of deposit, no matter where you deposit it or what your return, your contribution grows tax- free. When you take your original contributions out, you will not pay any taxes or penalties whatsoever. That’s right, you can take your initial contributions out anytime, regardless of your age, without taxes or penalties (subject to a special rule on withdrawals of converted IRAs within five years of the conversion). And to get your hands on the earnings tax-free, the only rules are these: The money your contributions earn has to stay in the account for at least five years before you can withdraw it without taxes or penalties, and you have to be at least fifty- nine and a half years of age. The other ways to get your hands on the earnings penalty-free are if the owner has died or is disabled, or if the distribution is made for a qualified “first-home” purchase ($10,000 lifetime limitation is applicable) as long as the five year rule is met.

 

Who Can Take Advantage of the Roth IRA?

In 2012, up to $5,000 (or $6,000 if you are at least 50 years old) can be contributed by single taxpayers having less than $110,000 in modified adjusted gross income (MAGI). Married taxpayers filing jointly have full eligibility if they have a MAGI of $173,000 or less. Eligibility is lost at $125,000 MAGI for single taxpayers and $183,000 MAGI for MFJ. Taxpayers can have a combination of Roth IRA and traditional IRA accounts as long as the combined contributions don’t exceed the yearly maximum allowable for either type (which can be as much as $5,000 [or

$6,000 for those at least fifty], as of 2012).

A law that went into effect in 2010 now makes it possible for anyone

—regardless of how high their MAGI is—to invest in a Roth IRA. If your MAGI is greater than the limits above you first must make your contribution to a traditional IRA. Once you have done that you can then convert that traditional IRA to a Roth IRA. I recommend consulting with a tax adviser before you proceed with this strategy. It can indeed be a very smart move for you, but there are some rather confusing tax rules that come into play. That’s where a tax pro with experience in Roth conversions will be indispensable.

 

IRA Conversions and Qualifications

As of 2010, anyone—regardless of income—can convert to a Roth IRA. If you do this, what you need to know is that even though you may be under the age of fifty-nine and a half when you take the money out of your traditional IRA to convert to a Roth, the 10 percent penalty tax will not apply—but you will owe ordinary income tax on any money that you converted.

To Convert or Not to Convert, That Is the Question

Because the Roth IRA and the conversion feature continue to cause tremendous confusion, many websites and help departments at brokerage firms have been set up just to answer this question for you, given your particular circumstances—most of them in the hope that they will end up with your IRA money one way or the other. Try them out and do the calculations for yourself, using the sources available to you, and see if it makes sense for you in your particular situation to convert or not and then check your answers with a professional.

If you do decide to do a conversion, make sure that you can pay for the taxes out of your savings or your income, but not from the money in the IRA. Also, remember that no one ever said you have to convert all the money that is in your traditional IRA into a Roth; you may just want to convert a small amount so the tax bite is not so bad. Before you do anything, however, I would suggest getting a professional opinion—from someone who does not want to get your IRA money to invest, such as a CPA or an enrolled agent who does not take money under management.

 

Roth IRA and Roth Conversions

Q. If I open up a new Roth IRA and contribute $5,000 a year or convert my traditional IRA to a Roth IRA do I still have to wait till I am fifty-nine and a half to take the money out without penalty?

A. No. The rules that govern Roth IRAs and converted Roths are different than the rules that govern traditional IRAs.

In a contributory Roth IRA you can at any time you want, regardless of your age or time the money has been in the account, withdraw your original contributions without any taxes or penalties. So let’s say you are now thirty-nine years old and for the past three years you have put

$5,000 a year into your Roth IRA. You have put in a total $15,000 of original contributions. At any time you want, you can withdraw up to

$15,000 without penalties or taxes. Remember, you are only thirty-nine, not fifty-nine and a half, but that does not matter. The money has only been in there three years, but that, too, does not matter. Your yearly contributions can be withdrawn at any time, with no restrictions whatsoever and without taxes or penalties.

However, the  earnings  on  your  contributions  have  to  stay  in  the

account until you are at least fifty-nine and a half years old and the account is more than five years old. So let’s say that the $15,000 over those three years grew to $17,000. Yes, you could withdraw the $15,000 at any time, but the growth on that money or the $2,000 has got to stay in the Roth IRA till you are fifty-nine and a half and for at least five years before you can withdraw it without taxes or penalties.

 

Roth Conversions

When you convert money from a traditional IRA to a Roth IRA, the withdrawal privileges work like this. The money that you originally converted has got to stay in the Roth account for more than five tax years or until you are fifty-nine and a half, whichever comes first, before you can withdraw it without taxes or penalties. You do not, however, have to be fifty-nine and a half to withdraw the converted amount to avoid the 10 percent penalty, you just have to have met the five-year holding requirement. So let’s say that you are thirty-nine and you convert $50,000 from a traditional IRA to a Roth. That $50,000 has got to stay in the Roth IRA for at least five years. After that time, even though you are just forty-four, you can withdraw all $50,000 without any taxes or penalties. The earnings on that $50,000, however, cannot be withdrawn without penalties or taxes until you have attained the age of fifty-nine and a half.

 

Q. When does the five-year period begin for contributory Roth IRAs? This confuses me, since I am putting money in every year.

A. The time clock starts for all your contributions from the year of your first contribution. So let’s say in the year 2011, you deposit $5,000 into a Roth. The five-year time clock began—on January 1, 2011. Every contribution made from this point on will be backtimed to the year 2011.

Q. When I die, will my beneficiaries have to pay income taxes on the money that I leave them in a Roth IRA?

A. No. That is one of the beauties of this account. The money that you leave your beneficiaries via a Roth will be income tax-free when they take it out.

Q. Do I have to start taking money out of a Roth IRA when I turn seventy and a half, like I do with my traditional IRA?

A. No. You can leave the money in there for as long as you want.

Q. Can I convert my 401(k) to a Roth IRA?

A. Yes.

Q. Can I have a 401(k) and a Roth IRA?

A. Yes. In fact, you can have almost any retirement plan and also have a Roth IRA if you meet the AGI income levels listed below.

Q. Does this mean I can have a traditional IRA and a Roth IRA?

A. Yes, as long as between the two IRAs you have not in one year contributed more than the $5,000 annual cap for IRAs (or $6,000 if you are fifty or older).

Q. Are there income limitations to who can have a Roth IRA?

A. Only if you want to contribute directly to a Roth IRA; anyone can contribute to a traditional IRA and then convert to a Roth. To make a direct investment in a Roth IRA, the maximum adjusted gross income limitations are as follows: for those filing an individual return, $125,000; for joint returns, $183,000.

Q. Is there an income limit to be able to convert a traditional IRA to a Roth IRA?

A. No.

Q. When do I owe the taxes on the money that I have converted into my Roth IRA from a traditional IRA?

A. You owe all the tax in the year of the conversion.

Q. What if I converted my traditional IRA to a Roth at the time the market was really high? Since then, the market has taken a tumble. I now owe a lot of taxes on an IRA that in reality is worth a lot less. Is there anything that I can do?

A. Yes. You have until October 15 of the year after the conversion to “recharacterize” the account back into a traditional IRA. You can then convert it back again to a Roth IRA as long as you wait until the later of

1)      the year after the year of the original conversion, or 2) more than thirty days after the date of the recharacterization. (Please note that I said the later of the two.) Just be sure that your income allows you to be eligible still to do a conversion at this later time. For instance, let’s say that you have a traditional IRA worth $100,000 and you converted it to a Roth. Six months later in the same year, the market has gone down

and now that $100,000 is only worth $78,000. Since you converted your traditional IRA when the value was worth $100,000, if you do not do anything, you will owe income taxes on $100,000. What you could do is recharacterize back to a traditional IRA, then reconvert back (30 days later or the next calendar year, whichever one is longer) to the Roth with hopefully a lower conversion value. This is something that you should always keep in mind. It could save you lots of money, but make sure you check with a tax professional before doing anything, since these laws can change.

 

IRA Guidelines

A few thoughts to keep in mind. Are you eligible for a company retirement plan like a 401(k) and do you also qualify to fund a Roth IRA? If so, it can be confusing as to whether you should fund your 401(k) plan or the Roth IRA first. It would be best to fund both to the maximum if you can. But if money is tight and it is an either/or situation, then this is what I would do. If you have a 401(k) plan where your employer matches your contribution, meaning that for every dollar you put into your retirement plan at work, they put money in for you as well to match in full or in part, I would first fund my retirement plan at work up to the point of the match. Now, if you don’t get a company match on your 401(k), I would make my first priority the Roth IRA before investing in the 401(k). If you have been investing in a nondeductible IRA, you, too, should definitely consider switching to a Roth IRA; for most people it makes the nontax-deductible IRA obsolete. If you are not covered by a company retirement plan, and can really use the tax write-off right now from a traditional IRA deposit, but you are a spender and not a saver and—realistically—will fritter away the tax savings from a traditional IRA instead of investing them each year, then you might want to lean more toward the Roth IRA as a savings against future taxes that you would have owed with a traditional IRA. In other words, pass up the current tax savings for the future big picture. If you are very young, just starting out in your career, and in a low tax bracket, by all means look into a Roth IRA, which can jump-start your retirement savings by a lot, even if you switch tactics later. Let’s say that from ages twenty-one to thirty you invested $5,000 a year into a Roth IRA

averaging an annual return of 6 percent every year and then you never deposited another cent into that account and just let it grow; at age sixty, you’d have more than $400,000 that you could access totally tax- free. Big difference, if you think that all it would have saved you in taxes in a traditional IRA (if you are in a 15 percent tax bracket) would be about $750 a year, or $7,500 over ten years. As you can see, it makes no sense to have to pay taxes on $400,000 later on in life (when you might be in a very high tax bracket) just to have saved $7,500 over ten years early in your career. By the way, if your tax bracket changes and you want the deduction of a regular IRA, you can make that change anytime you want. Rather than making a deposit into your Roth IRA that year, switch to a traditional IRA.

 

Benefits of Withdrawal of a Roth IRA vs. a Traditional IRA

With a traditional IRA, upon your death your spouse is the only one allowed to take over your account as if it were his or hers.  Thus surviving spouses (if withdrawals had not already started) can continue to use the tax deferral strategies until they really need to live off the money, or until age seventy and a half when withdrawals have to start. However, if you are currently not married, then your named beneficiary for these funds will have to start taking withdrawals that year and continue them over his or her entire life expectancy. But what usually happens is that the beneficiaries wipe the account clean over a short period of time. This often results in a significant tax bill for your beneficiaries. This can be avoided with a Roth IRA. In this case, your beneficiaries would also get the money tax-free. No doubt this will make you the most loved relative in the family.

 

Comparison of the Traditional IRA and the Roth IRA

Another possible advantage of the Roth IRA is that you do not have to start withdrawing money at age seventy and a half. With a traditional IRA, you have to start making withdrawals by April 1 of the year after you turn seventy and a half. Because of this, a Roth IRA could also help you tax-wise down the road. When you have to start taking money out of your traditional IRA—even if you don’t need it—these add to your tax bracket, which affects the bottom line all the way around. One  last factor is that if you really need help saving money, if you tend to sneak into your future piggy bank when you want money available to spend on today’s eventually useless treasures, gear yourself toward a traditional IRA where it is harder to get at the money without sustaining penalties before age fifty-nine and a half.

What’s the Difference between a 401(k) and an IRA?

Well, you can invest a lot more in a 401(k). In 2012, the general limit for an IRA contribution is $5,000, while the 401(k) limit is $17,000. And if you are at least fifty years old, your IRA limit for 2012 is $6,000 and your 401(k) contribution limit is $22,500. This is a big reason to push for a 401(k). Even with a SIMPLE (see this page) you can possibly put away $6,000 more a year than you can with an IRA.

 

Maximizing the Impact of a Roth or Traditional IRA

Most people wait to contribute to their IRA until they file their taxes in April of the year after—a mistake that adds up. For the tax year 2012, you have the right to put up to $5,000 in your IRA in January 2012 if you are under fifty years old. But most people will wait until April 2013 to do so. This is an incredible waste of money. If you possibly can, I urge you to put that money away at the beginning of the year rather than at the tax deadline.

If you invested your $5,000 in January 2012 and that money sat there averaging a 6 percent return, by the time April 15, 2013, came around, you would have an extra $393 in the account compared to if you waited until April 2013 to make your 2012 contribution.

If you don’t have $5,000 at the beginning of the year, and so can’t make the investment all at once, start putting $416 (or whatever you can) each month into your IRA. You will still come out ahead than if you had waited to do it in one lump sum on April 15.

 

RETIREMENT PLANS FOR THE SELF-EMPLOYED

 

If you’re self-employed and are not incorporated, you also have excellent options for funding your retirement. You can open up what is known as a SEP, a Keogh, or a SIMPLE. All three of these are great ways to plan ahead. In order to qualify for these three retirement accounts, your earnings must be reported on Form 1099-misc. or be earned as fees for services you’ve provided. (Company employees, on the other hand, are usually provided with W2s to report the money they’ve earned.)

If you have people working for you, after a certain period of time you’ll have to fund the SEP, Keogh, or SIMPLE plan for them as well.

 

Simplified Employee Pension Plan (SEP)

You can open a SEP, or simplified employee pension plan, and put away up to 25 percent of your income or $49,000—whichever is less—per year in payments for yourself. SEP-IRAs can be set up at banks, mutual funds companies, brokerage firms, discount brokerage firms—almost anywhere you’d like to invest (read Step 6 and decide). If you have employees who have worked for you for three out of the past five years, you will have to put money in their SEPs as well, to the tune of the lesser of 25 percent or $49,000. Please keep in mind that these figures change yearly, so check with a tax professional to find out the current limits. The above figures are for the year 2011.

Keogh

A Keogh plan (named after Senator Eugene Keogh, who came up with the idea) can also be used to fund a retirement for the self-employed. Keoghs are more complicated than SEPs but used to allow you to set aside more money than you could with a SEP. That is no longer true. The amounts are the same as with a SEP. You must also fund a Keogh for anyone who has worked for you for at least one year. And you must contribute the same percentage for those who work for you as you do for yourself.

Keoghs are divided into two types of plans. The first is known as a money purchase plan, and the second is known as a profit-sharing plan. With both, you can invest the money just about wherever you like. However, due to the new, more generous limitations for SEPs, there is currently no reason to set up either type of Keogh, since a SEP plan is easier to administer.

 

SIMPLE

SIMPLE, or Saving Incentive Plan for Employees, lets you put up to

$11,500 a year (for 2011) into a plan for yourself. The limit is $16,500 if you are over fifty years old. There is no percentage limitation for a SIMPLE, as there is for a SEP or Keogh. If you have any employees who have worked for you and have made at least $5,000 in compensation over the past two years and are projected to do so again, they, too, are eligible for a SIMPLE.

As a self-employed person with employees who are eligible, you are required to follow one of two contribution formulas for your employees: either the matching contribution formula or the 2 percent formula. Under the matching contribution formula, you must match dollar for dollar what the employee elects to put into it, from 1 percent up to 3 percent of their compensation. You get to decide. However, if  you choose the lower match, you cannot do that for more than two out of any five years. With the other formula—the 2 percent contribution formula—you simply decide that you are going to contribute 2 percent of the employees’ compensation.

Note that all contributions are considered vested the second they are made. This means that they belong to your employee even if he or she leaves your employ the very week after you made the match.

 

WHICH DO I WANT—SEP, KEOGH, OR SIMPLE?

 

One thing to know, particularly if paperwork makes you crazy, is that there’s more paperwork involved with a Keogh than with a SEP or a SIMPLE (for which the paperwork requirements are almost nil). With a Keogh, from the moment you have more than $100,000 in the account you have to file what’s called a 5500ez form at tax time. Not all that bad, but it’s still paperwork, and paperwork that’s not required with a SEP or a SIMPLE. If you don’t have employees, or if you do and you don’t mind contributing the same percentage of their income for them as you contribute of yours for yourself, the SEP is the way to go. If you have employees whom you do not want to contribute a lot of money for, or if your income is so low that you can put more away with a SIMPLE plan, then go with it. If you’re self-employed, you must take advantage of one of these options. Whichever way you go, you cannot lose

TIME CREATES MONEY

Employed, self-employed—it doesn’t matter. When it comes to money, time is probably the most important factor in the growth process. The more time you give to your money and the more time it has to grow are the two key ingredients to attracting and creating large sums. The amount you will have accumulated when retirement comes will determine what kind of lifestyle you will then be able to afford.

 

If you’re forty-five, and start putting $100 a month into an account that averages a 6 percent return, you’ll have $46,400 by age sixty-five.

If you start ten years earlier, at thirty-five, your $100 a month will have grown to $101,000 by age sixty-five.

If you can start saving $100 a month at age twenty-five, you will have $200,000 by age sixty-five.

 

Time accounts for the difference. By waiting twenty years, from age twenty-five to age forty-five, to start saving just $100 a month, you pass up more than $150,000.

 

MULTIPLYING YOUR MONEY

 

Time plays an essential role in building your future wealth, not only because the longer you contribute, the more you’ll have, but  also because with time, the contributions you have already made will do more work for you. This second feature that makes time so powerful is called compounding.

When you leave your money invested over time, the amounts of money that your contributions are generating on their own are the worker bees of your money hive.

For instance, let’s say you are investing $6,000 a year, and that $6,000 is earning 6 percent. Let’s assume that your investment will be able to average that 6 percent over the next twenty years, and that you continue to add $6,000 at the beginning of every year as well. There will come a point in time when the earnings on your account will add up, by themselves, to more than the $6,000 you are putting in every year. This is when those worker bees really start to make that money honey.

Take a look at the chart on the following page and see how many years it takes before you are earning as much in interest as you are putting in. Look a little farther down the road, and you’ll see that in just a few more years you could be earning two times more a year in interest than what you are contributing!

Why? Because of the magic of compounding. It is for this reason and this reason alone that you cannot afford to let one year pass without making a contribution into your retirement plan. When it comes to the

wonderful effects of compounding, you can never make up for lost time. This is why in the example just given, twenty years makes such a tremendous difference in what you will have in the end: more than $150,000 worth of difference

. This table illustrates the power of compounding at a 6 percent return; the higher the return, the better the results. In this case you have invested $120,000 over these twenty years. At 6 percent throughout, you have earned $114,000. You have earned, in other words, nearly as much as what you put in! Compounding is extraordinary, and the main ingredient of compounding is time. Give yourself that time.

Whatever your return, you can’t afford to miss out on the golden

opportunity that time allows. You work so hard for your money. Now let your money in return work hard for you.

 

CONSIDER THE FUTURE VALUE OF YOUR MONEY

 

Start training yourself to understand not just what your money is worth today, but what that same money will be worth in the future. Like a slide projected on a screen, your money becomes much larger over time. Consider the “big picture”—that compounded future value—when you are looking at the money you could save or spend today. Whenever I had a client come to my office who wanted to do something that day that would cost a lot of money, I always calculated what it would really cost by looking into the future. That’s the true cost of today’s desire.

I once had a client come in and say, “Suze, I want to take a year off work, and $20,000 out of my savings, to go live in Europe for a year.” No problem, I said, as long as she could understand what that meant for her future. That $20,000, if left invested at a 6 percent annual return, would, in twenty years’ time, when she turned sixty-five, be worth

$64,000. Did she feel comfortable spending $64,000 to take a year off, not to mention the money she’d lose by giving up a year’s salary? “But Suze,” she said, “in twenty years $64,000 won’t even be $64,000, because of inflation.” But using a 3 percent inflation adjuster, in twenty years that $64,000 would still be worth $36,000. The trip would cost her

$36,000.

It is so important to see what things are really costing you, and the way to see this is to see money over time. It is when you start looking at money like this—finding out how what you do today affects your future before making your decisions, which must be based on reality and not just on hope—that you will really begin to understand money. Desire the trip, understand what it will really cost, decide whether you can afford it, and if you can, then take it by all means. Or scale it back, if that makes more sense. Or wait a year. If not this year, then the right actions with your money will still get you to Italy next year or when the time comes.

And when you’re doing the right things with your money, when you’re being respectful, the right time will always come

DOLLAR COST AVERAGING

One thing that your mind will try to tell you is that when you invest money, whether in your retirement account or on your own, you have to keep it safe and sound, that you can’t afford to take risks with it. Wrong. The truth is that you really can’t afford not to take risks. You have to invest this money for growth, especially if you are under the age of fifty. The younger you are, the more aggressive you can be.

As long as you have at least ten years during which you won’t have to touch this money, invest the majority of it for growth.

Put your money in whatever stock or equity mutual funds your 401(k) offers. If you are in a SIMPLE, IRA, SEP, or Keogh, and just want to keep your life as easy as possible, look into good no-load index and managed growth mutual funds (this page) as well as exchange-traded funds (ETFs). Your investment mix can also include a small percentage in international growth funds if your company offers it. Over the years, stocks or equities have outperformed every other investment out there— so again, the younger you are, the more aggressive you can be.

When you start approaching retirement, and know that you will soon be living off this money, it’s time to consider easing up on your more aggressive investing. Even so, it’s always best—and perfectly safe and sound—to have a nice mix of funds and keep your money diversified.

 

BUT I DON’T WANT TO LOSE MY MONEY

 

Of course you don’t, nor does anyone want you to. When you begin paying yourself every month, as you do with a retirement plan, not only do you get more long-term bang for your buck, you also take some of the risk out of investing this money. So you don’t have to be afraid. When you put the exact same amount of money month in, month out, into the same investment vehicle, you are taking advantage of the investment strategy known as dollar cost averaging. It puts time, your money, and the market all on your side at once. (We’ll talk about this more later.)

I believe this with all my heart, but regardless of what I say or what anyone says, you should invest only if you want to. The reason I say only if you want to is that even though investing for growth may be the right thing for you to do economically, it’s not the right thing to do if it keeps you up at night worrying or makes you afraid all the time. As you’ll see in the next chapter, you must always trust your own gut feelings about money. If you can’t live with risk, you must invest where you feel safe investing. Perhaps your new truth will make you feel stronger about taking risks. Maybe reading throughout the rest of this book will make you feel differently about risks and your fears about money. But respect yourself first, and however you choose to invest, take care to understand how things work—or you might end up doing what Michael did.

 

MICHAEL’S STORY

 

With time on your side, you win when the market is up—but you also win when it goes down.

My company has a 401(k), but I never joined it. I knew that it would be a good way to build up retirement money, but I never knew which investments to put my money in, plus I was afraid to make the wrong choices. I’m more a cash kind of guy. But now I’m starting to make more, and I’m thinking of getting married to my girlfriend. I’ve been feeling more like a grown-up, I guess, and I was really thinking it was time to invest.

Since it was the beginning of the year, I thought why not start the year off right, and I signed up, and started to contribute the maximum I could, which they told me was $750 a month based on what I made. I put all the money into this one aggressive growth mutual fund that seemed as though it had done really well over the years. The first month, fine, and the second. But then the market dropped, and the fund tumbled way down. I couldn’t believe it. By the time I had added my third payment, my $2,250 was only worth about $1,950—I had already lost money. I was somehow seeing my fear come to life. But I decided to stick with it. Two months later, after I put in another $750 for each of those months, I should have had $3,750, more if it was actually earning money, but when I looked at my statement I only had $3,343. I was still losing money. This was when I couldn’t take it anymore, so I went back to the human resources department to withdraw from making any more contributions to the 401(k). I mean, there’s no point in losing money. I thought at least I could wait till the market started to go up and maybe then I would rejoin.

Michael’s trouble was that he understood only the concept that when you buy something you want it to go up, better known as “buy low, sell high.” He didn’t understand that what you want to do with dollar cost averaging—which is what you’re doing with a 401(k)—is to buy low and lower and lower and then sell high. Michael had actually chosen a great fund to invest in, and since he had many years left until he retired, he should actually have been thrilled when it took a tumble. But no one told him that.

 

BUY LOW AND LOWER AND LOWER AND THEN SELL HIGH

 

With dollar cost averaging, you are taking the money you’re investing and averaging the cost of the shares you’re buying over time. Since you are investing every month, wouldn’t you rather buy into your funds when the market is low, so you don’t have to pay so much for your shares? Of course you would. When what you are buying goes down rather than up, that means you’re paying less and are able to buy more. I always think of it as a mutual fund sale—getting what I want for less than others had to pay just a few months earlier. Michael got upset because the shares he bought went down in price over a few months. Had he stayed in for the long run, however, he would have made everything back plus more when his mutual fund started to climb again.

 

BE ON ALERT WHEN THE MARKET GOES DOWN

 

When I say you should be happy if your fund starts to go down as you’re

 buying it, I mean be happy if all the funds that are similar to yours are also going down. You want to make sure that your 401(k) plan, and any other mutual funds you hold, are with a good portfolio manager (this page), one who is able to do as well as or better than other comparable managers. If your fund is going down and the others are all going up, then you do need to take action; check with your human resources department. If the market starts to go down, just keep an eye on your funds to make sure they’re not going down more than other similar funds. If your portfolio manager can keep your money from going down as much as the others in a down market, think what she’ll be able to do when the market goes back up!

 

DOLLAR COST AVERAGING: BETTER THAN INVESTING ALL AT ONCE

 

Michael’s plan was to invest $9,000 a year. What if he had invested the entire amount in January, when the market happened to be at its highest? He would have paid top dollar for that mutual fund. Let’s see how this would have played itself out. If the mutual fund he wanted to buy was at $15 a share, Michael could have bought 600 shares for his

$9,000. But now let’s see what would have happened if he had just stayed in the 401(k) and continued to put his $750 a month in this mutual fund over time, rather than all at once

The price of the mutual fund at the end of the year was $10 a share, which means that Michael’s $9,000 investment would now be worth

$7,753 (775.27 × 10), for a loss of $1,247. That’s a 13.9 percent loss on paper.

But if you look at what happened to the shares, they dropped 33 percent in value from 15 down to 10. So here is a fund that went down 33 percent from the start. This is what Michael’s loss would have been on paper if he had invested all at once. With dollar cost averaging, however, his loss was only 13.9 percent. Let’s look at the actual dollars and cents of it. If he had invested the entire $9,000 in January, when shares were $15, he would have only 600 shares, not the 775.27 he would have had with dollar cost averaging. His fund on paper would be worth $6,000, not the $7,753 it could have been worth. Dollar cost averaging can really cut your risk. Michael lost money, but he didn’t lose his shirt.

 

YEAR AFTER YEAR, IT GETS BETTER

 

Michael is investing here for the long term, not just for a year, and this

fund is not going to stay down forever. Let’s take dollar cost averaging through another year.

Let’s say the market starts to rally, as it always does sooner or later, and he keeps putting in the $750 every month. Since the market is going up, by the end of the year he has been able to buy 685 shares, fewer than the year before; the fund ends up the year at $15 a share.

In total, he has put in $18,000 over the two years, in a fund that started at $15 and ended at $15 but was considerably down in between. He now owns a total of 1,450 shares, 765 from the first year and 685 from the second. But since the market was down so much of the time, what’s the best you think Michael can hope for—that he broke even? He did better than that. At $15 a share his total shares are worth $21,750, which is a 21.7 percent gain on his money over the two years of market fluctuation. Not bad, huh? If you’re not going to be cashing out for years to come, the more shares you accumulate the better. When the market does skyrocket, you will have made very good money.

This is not to say that if you buy stock that starts to go up, you should be sad—but here is a no-lose case, because you win in the end with a downslide as well. With dollar cost averaging you don’t lose as much as you could have if you had invested in one lump sum just before the market goes down. If the market goes straight up from the time you started, you won’t make as much, either. In my opinion, this is a really safe way to take risks—the best of both worlds.

 

TAKE THE LONG VIEW

 

Michael also wasn’t trusting the principle that time creates money. At forty, Michael had twenty-five years for the money to grow before he would turn sixty-five, well more than the ten it generally takes to watch your money really grow. I am always thrilled for myself and others when the market goes down and we have money available to buy more shares. The best investment advice I could give Michael was to go back into the 401(k) and take that $750 he wants to put into it every month. But this time he should diversify the money among two or three other good funds in the plan, be patient, and wait for time to touch his money.

This kind  of  investing  is  being  respectful  to  what  you  have  and

 respectful to what you want to have. It is not going out on a financial limb or taking a gamble with everything you have.

But you also have to watch over those things that whittle away at the money you want to create. You must also be respectful to the money you don’t have

Your money is governed by how you treat it; it’s that simple. It thrives when you are being responsible, respectful, and doing honorable things with it. For many of us, debt is too big a part of our overall money picture not to give it the respect that it is due. How we treat our debt and the people who are a part of that debt plays a major role in our path to financial freedom.

 

HAVE THE CREDIT CARD COMPANIES SEDUCED YOU?

 

Credit card companies are very smart and seductive, and they know exactly what to do to get you deeper and deeper into trouble. Have you ever noticed, for example, if you’re one of the many among us who are susceptible to credit card debt, that you find that as your balance keeps creeping up and up, your “available credit” total keeps going down and down? Before the financial crisis, what typically happened was right before you used up your total credit limit, all of a sudden, without even asking for it, you get a letter in the mail, saying that because you’re such a great customer, they’re raising your credit limit by $2,000. What a great company! With financial “friends” like this, who needs enemies? Before you even know it, you had used up that extra $2,000 limit, and were in more debt than ever before. Not to worry.

YOUR CREDIT HABITS CAN COST YOU A LOT MORE THAN YOU MIGHT THINK

 

You also need to realize that how you handle your credit cards and all your debt will have a large impact on so many parts of your financial life. That’s because every credit and debt move you make is tracked and then used to compute a FICO credit score for you. Trust me, if you somehow don’t know about your FICO score, that doesn’t mean you don’t have one.

Your FICO credit score is used by mortgage and auto lenders to determine what interest rate to offer you on a loan; it is also used to determine the interest rate on your credit card. A version of your FICO score is often used by insurance companies when they set your premium rate. It also can come into play when you try to rent a home; landlords will check your FICO score to see if you are reliable. And cell phone companies might require a deposit if your FICO score is too low. The bottom line is that a good FICO score is a financial boon for you, while a low FICO score is going to cost you money, and maybe even more.

If you don’t know your FICO score, I want you to find out right now. While the truth is that many companies offer to tell you your credit score—some of them for free—there is only one company that offers the gold standard of credit scores: FICO. The FICO score is the only one you should care about, in my opinion. That’s because the vast majority of mortgage lenders, auto lenders, and other financial types use the FICO score when sizing you up. So what good does it do to get a “free” credit score that businesses don’t use? More important, if you are applying for a mortgage and the lender is going to use your FICO score to set your interest rate, don’t you think it makes sense for you to know your FICO score in advance so you can do everything possible to make sure it is super high?

As of  2011  you  could  obtain  a  FICO  credit  score  for  free  at

www.myfico.com. You actually have three FICO scores (more on this in a minute), but unless you are buying a home, it is fine to just get one of your scores.

Your FICO score will range between 300 and 850. If your score lands in the 300–620 range, you have some serious financial problems. Basically no lender or company will want to do business with you without charging you some mighty hefty fees and interest rates.

Above 620, the FICO computers sort you into one of six basic ranges

Congratulations if your score falls into the 760–850 range. You are in the highest FICO range and that typically means you will be offered the best terms on loans and other financial products. For example, in mid 2011, here is the interest rate on a thirty-year mortgage you might qualify for based on your FICO score. And in the right column is the monthly mortgage payment you would owe on a $200,000 mortgage

Now you see what I mean when I say your FICO score can cost you a lot of money. If your score is between 620–639, your monthly mortgage payment on a $200,000 loan will be nearly $200 higher than if you land in the top FICO range of 760+.

 

THE FACTORS THAT MATTER TO FICO

 

Your   FICO   score    is   the    result    of   how    you    rate    on   five    broad measurements of your financial personality. Here’s the breakdown:

The biggest factor is your tendency to pay your bills on time. You don’t have to pay the entire bill; all that matters is that you at least send in on time the minimum payment due each month on your credit card bill and other debt payments. In the eyes of FICO and the financial world, your ability to make your payments on time is an indication that you are a responsible person who would make a good credit risk. One important note: paying on time means the money arrives on the due date, not that you put it in the mail on the due date.

Your debt-to-credit limit ratio is the next most important factor in determining your FICO score. Your debt is the combined balances on all your various credit cards: the sum of what you owe. Your credit limit is the combined total of the maximum amount each credit card company is willing to let you charge. (Included along with that calculation is whether you carry balances on other accounts, and how much debt you have left on loans such as a mortgage or car loan, compared to the original amount borrowed.) The lower your ratio, the better.

How long you have had a traceable credit history accounts for about 15 percent of your FICO score. That’s one reason I do not recommend ever canceling a credit card that you no longer use. Another reason is that when you cancel, you wipe out the available credit limit for that card, and that will cause your overall debt-to-available-credit ratio to rise. It is smarter to simply stick an unused card in your desk drawer, or if you think you will be tempted to use the card, then simply take a pair of scissors and cut it up. You can’t use the card, but your history is not wiped out.

The remaining 20 percent of your score comes down to how many new credit card accounts you are applying for and the mix of debt you have. To help your FICO score, you don’t want to open a lot of new cards at once. As for the “mix” issue, lenders like to see how you handle different types of debt. So if you have a credit card, a retail credit card (such as a department store), as well as an installment loan like a car loan, you have a broad mix of debt.

If your FICO score is below 760, paying attention to any of these five factors can improve your score. You can learn more about boosting your FICO score at www.myfico.com.

 

KNOW WHAT’S IN YOUR CREDIT REPORT

 

So where does FICO get all the information about you that it uses to compute your FICO score? There are three major credit bureaus that track and keep records of all sorts of your financial transactions. Based on the information that each of the three credit bureaus supply to FICO, you are then assigned three FICO scores.

The three credit bureaus are Equifax, Experian, and TransUnion.

You need to make sure that the information in each of your three credit reports is correct. You would be amazed how many reports contain incorrect information, from misspelled names and addresses to old accounts that you closed down years ago but that are still showing up on your report as active. There’s also a huge problem with identity theft; when someone steals enough of your private data—typically a Social Security number and name is enough—to open accounts in your name (that then show up on your credit report), or simply gets access to your credit card number and makes unauthorized charges on your account. Any wrong information is going to pull down your FICO score, so that’s why you need to make sure your credit reports are clean and up-to-date.

You can now receive one free credit report from each of the credit

bureaus every year. Be very careful how you go about getting your free report. Plenty of businesses pretend to offer it for free, but then sneakily get you to pay for other services. You should never ever have to share your credit card information to get your credit report. Simply go to

www.annualcreditreport.com to get your report.

I recommend getting one report every four months. For example, you might start with Equifax and then four months later get your Experian report, and four months after that your TransUnion report. By using this system, you have created your own ongoing checking system. For free. I think that’s a lot smarter than paying money to any of the credit bureaus for one of their “monitoring” services.

If you do uncover a basic problem such as an incorrect address, you need to contact just that credit bureau; it is then required to forward your corrected information to the two other bureaus.

You can contact the bureaus at:

 

Equifax www.equifax.com	800-685-1111
Experian www.experian.com	888-397-3742
TransUnion www.transunion.com	800-888-4213

But that said, getting problems corrected can be a big hassle. If you need to challenge information in your report—such as a loan you paid off that is showing up as delinquent—you will need to file a dispute with the credit bureau. It then has thirty days to check into your claim and get back to you. With any luck, you will get the matter resolved quickly, but I won’t lie; it can take a lot of time and perseverance to prove your case to the credit bureaus.

And when identity theft is involved, it can be a truly difficult experience to straighten out your record. Here’s your plan of attack for identity theft:

When you suspect identity theft is involved, contact one credit bureau and request a fraud alert be placed on your account. That credit bureau is required to send the alert to the two other bureaus. You can contact the fraud divisions at Equifax (800-525-6285); Experian (888-397-3742); and TransUnion (800-680-7289). This alert will require all creditors (card companies, department stores, etc.) to contact you directly before granting any new credit. It will also inform anyone taking a look at your credit report (such as a mortgage lender) that there may be a fraud problem here that could help explain a low score. The standard fraud alert lasts for ninety days.

You will also want to contact your local police department and ask to file a criminal complaint. Some police departments don’t like doing this because these are such hard cases to crack. But just be politely persistent that you need the report; it is going to help you clean up your record. Next, you need to fill out the Federal Trade Commission’s Fraud Affidavit form and submit it to all creditors where you have an identity theft           dispute.      You     can                  get                   the            form        at www.consumer.gov/idtheft/pdf/affidavit.pdf. Having both the police report and the fraud affidavit will help you deal with the credit bureaus and the company whose charges you are disputing. Both will have a formal “dispute” report/process for you to complete.

 

BREAKING THE CREDIT CARD HABIT

 

Credit cards can be as addictive and destructive as hard drugs, with the same ability to create a false sense of euphoria, give you a quick fix by satisfying temporary desires. Drugs are different in one respect, though. In most cases you have to seek out the drug dealer. Credit card companies seek you out. The more you use the cards, the more new cards, with enticing offers and promises, will come your way. In fact, all you have to do now is answer the phone. Credit card companies have taken to the phone lines to call you directly to see if they can get you addicted to what they have to offer.

DEBIT CARDS BETTER THAN CREDIT CARDS

One of the best ways for you to steer clear of the temptations and high cost of credit cards is to use a debit card instead. There are two basic types of debit cards. You can have a debit card linked to your checking account or you can have a prepaid debit card. The key aspect of both

types of cards is that your spending is basically limited to the amount of money you have in your checking account (assuming you turn down overdraft protection, which you should), or the amount of money you load onto a prepaid debit card. That is, there is really no way you can be tempted into spending more than you have and then be faced with a big

balance you can’t pay back at a ridiculously high interest rate.

Debit cards, especially prepaid debit cards, have become very popular in the past few years, and I expect they will become even more widespread in the future. As with all financial products, there is a wide range of cards to choose from, and if you’re not careful you can end up paying very high fees. You need to make sure a prepaid card is a good deal. Key elements to keep an eye out for:

Is there an activation fee? Is there a monthly fee?

Is there a charge very time you swipe the card?

Is there a charge when you use an ATM more than once a month? Is there a charge to pay your bills online?

Is there a charge to check your balance?

Is there a charge to load money onto your prepaid card? Is there a charge to cancel your prepaid card?

In 2011, among prepaid debit cards that levied an ongoing monthly fee, that charge could be as high as $9.95 a month. Some cards with a lower monthly charge hit users with fees for various services, such as bill pay or using an ATM. In 2011, there were some prepaid debit cards that if you weren’t careful could end up costing you $50 a month. That is just crazy if you ask me.

One drawback of debit cards is that as of 2011 the three major credit bureaus do not track your payment history on a debit card. As I explained on this page, the information that the three major credit bureaus (Equifax, Experian, and TransUnion) collect is the basis for computing your FICO credit score. So as crazy as it is, debit card users are penalized because their payment history does not help them build a strong credit report. At my website, I have information for a low-fee prepaid debit card, The Approved Card, which is the first card that will share your debit card transactions with one of the major credit bureaus,

TransUnion. You can learn more at suzeorman.com and theapprovedcard.com.

 

ARE YOU IN CREDIT CARD TROUBLE?

 

If you can’t pay off your credit card debts right now, today, then you’re in credit card trouble, which can erode a solid financial foundation faster than anything. It’s true that if you’re in credit card trouble, you got yourself there, but it’s also true that the credit card companies worked as hard as they could to help you along. I’ve seen this happen so many times and I’ve seen the damage debt can cause. If you are in credit card trouble, you have to get out of it—and stay out by learning to avoid credit cards like the plague.

 

WHAT DEBT FEELS LIKE

 

Debt feels like the heaviest burden of life. It weighs down your spirits, keeps your mind occupied with your burden, and makes you feel bound

—because you are bound.

There are two kinds of debt, personal and institutional. Personal debt is money you owe to a family member, friend, or any other human being. Institutional debt is money you owe to a credit card company, a business, a school, the IRS, a bank, and so on. When debts start taking on a life of their own, and start growing faster than you can pay them, the weight of the debt drains everything—the money you’re saving for your future, your capacity to save and invest more, your ability to pay the debt as it keeps growing. My friends who are bankruptcy lawyers say that if your credit card debt is equal to your annual salary, you will never be able to get out of debt. You are in essence bankrupt.

 

FACING THE TRUTH ABOUT DEBT

 

When people start facing the truth about their finances, they’ll often say, “Well, I owe my brother $5,000, but what I’m really worried about is that I owe $8,000 on my credit card bills.” But I’ve seen money destroy

personal relationships so many times, and I know what loaning money to, or borrowing money from, someone you care about can do to both of you. Remember: People first, then money. Personal debt is every bit as important as institutional debt, and I would much rather have a credit card company, with all its resources, tracking me down than watch as my best friend grew more and more resentful the longer I waited to pay her back the money she lent me in good faith and that is long overdue to her.

It’s this simple: Whether it’s personal or institutional debt or both, you must face your debt head-on. Otherwise the disrespect starts to take root in your soul. Even if you have permission from the person who loaned you money to take your time, it will still weigh heavily on your heart every time you think about it (which will be often) and fail to take action. It will be harder and harder to face people to whom you owe money in person. Remember: Disrespect repels money. Not paying your debts is a serious form of disrespect that makes it almost impossible to find new ways to create new money to pay off old debts. Not paying debts will not make them go away; instead, it will make your money vanish, and possibly your friendships, too.

 

THE RICH CAN GET POORER

 

This was a shocker to me, but the more people I started to see after I opened my practice, the more the numbers spoke for themselves. Most of the people who had major credit card debt were people you would consider affluent. It seemed as if the more money they made, the more disrespect they had for their money.

My associate, Janet, did an informal survey in our area, and out of the sixty people we talked to, all leaders in the community, all of them carried credit card debt. How much debt? Only eleven had debt below

$1,000. All the rest had debt ranging from $6,000 to $45,000. When we started asking around among these people if they thought others like them carried debt as well, they all guessed wrong. They would say, “Absolutely not.”

All these people made great money and were highly regarded in the community. Credit card debt is rarely created out of true need. It fills up,

even if just for a moment, something else that is missing. If you hide it from others, as these people did, and believe you’re alone in your debt, you create a secret as burdensome as the debt itself.

 

THAT SECRET CREDIT CARD

 

Another scenario that plays itself out often is when one spouse or partner has to admit to the other that he or she is hiding debt, usually credit card debt, from the other. That secret Visa card with the growing balance. The department store bill on which you keep paying the minimum balance due, but that never seems to go down. The big check you wrote against your Optima card and haven’t been able to pay off. Cash advances here, cash advances there. You just sort of don’t tell your partner for a while, and then it’s too late to tell.

This terrible secret is a burden to you, if you’re carrying it, and it’s an unfair burden on your partner, who, if you share expenses together, is unconsciously also carrying the debt. Debts can’t be kept secret forever. I’ve had blowups in my office. More than once I’ve heard, “Oh, so that’s the secret. I thought maybe you were having an affair.” Responses to the news vary. Some couples decide to deal with it together, some feel that the person who created the debt has to deal with it. But even if there’s a blowup, the result of letting that secret out is always a relationship that’s truer and more honest.

Please tell your partner if you’re hiding debt. Your integrity and self-

respect are more important than whether your partner gets mad at you. Get help if you need it. You’re not alone. Nonprofit credit counseling bureaus have been set up all over the country to help in cases just like yours; call one if you feel you need one. You can get out of debt. So many others have, and you can, too—and once you do, you’ll create so much more money, without being drained by your debt and your secrets

THE FIFTH LAW OF FINANCIALFREEDOM - YOU AND YOUR MONEY MUST KEEP GOOD COMPANY

In life we are very much influenced by the company we keep. If you have surrounded yourself with people who are healthy, eat well, exercise, and are well balanced, chances are good that you yourself live a vigorous and healthy life. If you surround yourself with people who drink, smoke, take drugs, and so on, I would venture to guess that your vitality level is not so high.

It works the same way with your money; the only way to keep it vital and make it grow is to keep it in a healthy environment. Credit card companies are never good company to keep, unless you’ve chosen one wisely, use it sparingly, for convenience, and pay it off in full every month, with only the rarest exceptions. Being respectful of your money also means being respectful of those to whom you owe money, and being respectful to yourself also means getting out of debt—as fast and efficiently as possible.

 

HOW CREDIT COMPANIES WORK

 

 

CARYN’S STORY

 

Caryn tried everything to get out of debt. But the credit card companies kept winning.

Every time I start to make a dent on my credit cards, something happens, and boom, I’m right back charged to the max. It’s hard to move $15,000 of debt. For a while I was putting the odd $100 into a savings account and just paying off the minimum, but then I noticed that sometimes my finance charges were bigger than the amount I was putting away. So that was losing money. Before I save any more, I just want to get rid of this debt. It hasn’t helped that my back is bad again, making it hard to work. Since I couldn’t work, I decided to figure out everything there is to know about credit cards, all the fine print, and at least get the best deal I could. I had about five different cards, all with different interest rates, and I got obsessed—with

getting a better rate, a bigger grace period, with all the new offers. I figured that some have to be better than others, right?

But it is hard to tell what’s the best deal. They charge every which way. One card sent me a bill saying, hey, you can skip this month’s payment. I thought they were doing me a big favor, but no. They charged interest on the money I should have paid. When the bill came the next month, it had grown by two finance charges. If I had known, I would have paid the money the first month. One time I thought I found a really good deal—5.9 percent. Turned out it was 5.9 percent on the balances I had transferred, but much higher on cash advances and new purchases. I would have been better off staying with the company that charged me 9.9 percent on everything. Then there was that so-called grace period. I learned the hard way there, too. I thought that no matter what I bought I would have twenty-five days to pay it off before I was charged interest on it. I was out with a friend and she wanted to buy an anniversary gift for her parents—we were at an art fair and she saw this wonderful sculpture she wanted to buy for them. She didn’t have her credit card with her, so I said I’d use mine and she could write me a check and I’d just pay the bill when it came. Done. When I got the bill, I couldn’t believe it. They began charging me interest on that sculpture the day we bought it. But they had told me there was a grace period.

When I called them up they said no grace period for me because I

carry a balance. Only if I paid off the card every month could I have the grace period. Also, no grace period on cash advances; I found that out the hard way, too. Cash advances cost the highest interest rate, plus a fee on top of that—about 5 percent of the amount I withdrew just for withdrawing it. I hadn’t even thought of that. So I went back and checked. Already this year I had paid $220 in fees for cash advances.

I guess it’s all there, in small type, but who can figure it out? How do you get out of credit card debt?

There’s nothing like credit card debt to paralyze us. The sad part is that most of us don’t have a clue how the cards we have really work. When you were reading Caryn’s story, did you already know as much as she had found out about how the cards work? Probably not. The only thing most of us pay attention to is the interest rate they are charging us, and even then some of us don’t take any action. Even though we know there are credit cards at lesser rates, we just don’t want to deal with it. Grace periods,  average  daily  balances,  the  forms  we  might   have  to   fill out … most people would rather keep paying 18 percent or more just so they don’t have to deal with it.

Throwing away hundreds of dollars in unnecessary interest payments every year is truly being disrespectful of your money. Caryn was so close to getting the formula right that I told her simply to keep obsessing about it—and acting on what she learned. She has, and little by little she is erasing her debt. She has also become something of a crusader and is starting a business creating a newsletter to keep people up-to-date on all the rates and scams: all she wishes she had known about before.

 

WHEN YOU SHOULD SWITCH CARDS

 

If you have a good credit history, credit cards will make it very easy for you to switch to the card they’re offering. Caryn had discovered that you can switch your balance to an account with a lower (much lower) interest rate with a few phone calls and five minutes of paperwork.

And continued vigilance.

Too-good-to-be-true offers are usually just that: too good to be true. Open and read every credit card offer you receive in the mail. Ask and answer for yourself all the questions that follow. It may be that you have to roll over your debt two or three times a year to get the best deals. That’s a few calls and fifteen minutes of paperwork a year, and it might save you literally hundreds of dollars. When can you stop being so vigilant? When your debt is gone and you’ve taken the steps to guarantee it won’t go back up again.

 

WHAT YOU MUST KNOW ABOUT YOUR CREDIT CARDS

 

If you spend just a few minutes working on your debt as hard as you work on your job, you’ll at least create intelligent debt—debt at the lowest possible cost. You’ll also become aware of what you really owe,freeing up the paralysis you feel dealing with it. And with your knowledge, you’ll be facing your debt from a position of power, instead of one of weakness. The credit card companies are expecting you to behave a certain way—to be ignorant of the real costs of your debt and too lazy to change it. They want your money. You have got to want your money more than they do, or they’ll get it.

If you currently have a credit card or are considering a new card, here is what you need to know.

 

What Is the Minimum Percentage That Is Required to Be Paid Every Month?

The answer to this will vary from 1.5 percent of your balance to up to 4 percent. Here, for once, you want the figure to be higher, rather than lower, because the lower your required payment, as the credit card companies well know, the longer it will take you to pay off the debt.

In fact, it is essential that you pay more than the minimum each month. (We’ll talk about why later in this chapter.) But the higher the minimum is, the better.

 

What Is the Cash Advance Fee Charge, and What Interest Rate Applies to Cash Advances?

This is where these companies can get you big-time. Even if your introductory rate is zero percent, if you take out a cash advance, regardless of whether or not you owe a balance, many companies charge a fee of as much as 4 percent of the amount of each cash advance. And there is no grace period with the cash advance; you start paying interest immediately. By the way, even if you have a zero percent interest rate, you are going to get hit with a different rate on the cash advance. It typically is more than 20 percent. Some cards will charge you less for cash advances or tell you to use the convenience checks they supply, but you have to ask, because many companies charge those exorbitantly high interest rates even when you use their convenience checks. “Convenient” for them.

 

Is There an Annual Fee?

The best cards will not charge a fee, or just a small charge of less than

$20.

 

Then there are the essential questions: What is the current interest rate? How long will this rate last? What does the interest rate go up to after the introductory period?

Again, you need to scrutinize all offers carefully—sometimes the rates for balance transfers and cash advances are higher. And their introductory rate may jump by 20 percentage points or more after a few months. Obviously you want the card with the lowest introductory rate, and the longer the low rate lasts, the better. In any case, you don’t want a card whose normal rate is above 10 percent.

Take a look at the table that follows and you will see how much more you will pay and how much longer you will pay with higher interest rates. If you have an $8,000 credit card balance and are paying a monthly minimum of $320:

GETTING CONTROL OF YOUR DEBT

First thing: Put all your credit cards away in a drawer so you will not be tempted to frequently use the cards. If you know you won’t be able to control your spending, then cutting up your cards may be the best move for you. But ideally what I want you to do is keep your cards but not use them more than once a month for a small purchase. If you don’t use the credit card at all, the card company may cancel your account (not the debt you already owe; they will just cut off future purchases). That can have a negative impact on your FICO credit score. When an account is closed down your overall available credit limit will drop, and as I explained earlier, your debt-to-overall credit limit is a major factor in your credit score. So that’s why it is best to keep an account open. But be honest with yourself here. If you know you will be unable to curb your overspending, then you need to consider cutting up the cards completely. If the card issuer ends up canceling your card, that’s the price you will have to pay for gaining control over your overspending.

 

TAKING STOCK

 

Now is the time to sit down with your debt, study your statements, face what you owe, and see what they’re charging you to owe it.

Make a list of all the money you owe in descending order, starting with the highest interest charges first. List as well the phone number of everyone you owe money to. Please include personal debt. Debt is debt, and just because most personal debt doesn’t inspire the fear of most corporate debt, on the scale of self-respect it weighs in pound for pound. List the amount you owe, the interest rate, and the minimum monthly payment. For example

If you’re late with any of these payments, personal or institutional, call them up now and tell them why. All the entities to whom you owe money already know that you don’t have the money to pay the bill or you would have, so don’t be embarrassed. With your new truth from

Step 3 in hand, pick up the phone and call. You’re in debt, that’s all. You’re not a failure or a bad person. If someone is rude to you, be very kind and gentle in return. Explain your situation. It might be that you’re late but will have the money in two weeks. Or it might be that you can only send them $25. In any case, call them before they call you.

If you’re not late with your payments, call up the high-interest credit card companies anyway, tell them you’re considering switching to a better value card, and see if they’ll match a lower rate. You can negotiate with them, and often they will reduce your interest rate right on the spot. If they won’t make good on your request, try to move the balance to a card that meets the criteria just discussed. If what they will agree to is not as good a deal as you can get elsewhere, you’re out of there.

Offers keep changing from company to company, so keep up-to-date on the best offers by checking a current issue of Smart Money magazine (http://www.smartmoney.com)        or                                                                 Kiplinger’s                          magazine (http://www.kiplinger.com). You can also check via the Internet site www.creditcards.com.

If you have a blemish on your credit record, try to clean that up before you start switching companies. Credit card companies don’t like it even if you’ve been just one payment late, and for that reason alone a better company could turn you down.

 

DIGGING YOURSELF OUT OF CREDIT CARD DEBT

 

If you’re in big credit card trouble, don’t panic. But you can get out of it, a step—or a month—at a time. I have found that most people are not aware of how very important it is to pay more than the minimum. Let’s say you owe an average balance of $1,100 on a card that charges 18 percent interest. If you pay the minimum 4 percent every month, and you never charge another thing, it will take you about seven and a half years to pay off your debt. It will have cost you $576 in interest.

Same situation, but if instead you had paid $10 more than the minimum each month, you would have cut the payment period down to two years and your interest payments would be just $218. That is a savings of $358. Ten dollars a month is only thirty-five cents a day.

Remember, with many cards, the more you owe the longer it will take you. I have seen cases where just paying the minimum every month would mean that the debt would take forty years to pay off, to say nothing of the thousands and thousands in interest it would cost you.

Let’s assume that you owe $4,000 and see what a difference a few bucks will make at different interest rates. Once I showed my clients this chart, they began to see what a difference a little more money each month can really make

A STEP-BY-STEP PLAN

 

These are the steps that many people, including quite a number of my former clients, have taken to get out of debt. You can do it, too.

1.        Figure out the absolute largest amount you can afford to pay monthly toward your credit cards. Let’s say that amount is $600 a month. You may think this is a lot, but when you carry a lot of debt on at least several different cards, this is probably not much less than what all your payments add up to.

2.    Review the list of creditors you owe money to and total the cost of the minimum monthly payments, plus $10, for each of them. If the minimum payment on one card is $150, write down $160, and so on; then take the total of those figures.

3.   Subtract this total from the number you wrote down in step 1. Let’s say the minimum payment plus $10 for all of your credit cards is $400. You’ve decided that in fact you can pay $600 a month toward eradicating the debt. Subtract the $400 you must pay from the $600 you can pay, and this leaves you with $200 extra to pay on your credit cards.

4.     Now take the “extra” $200 and put it monthly toward the credit card that is charging the highest interest rate. When that card is paid off, put it in a safe place where you won’t frequently use it, or cut it up. But don’t cancel the account; it will hurt your FICO score to close out the account.

5.     Now you start all over. Stick with $600 a month (unless you can raise it!) as your debt-paying allocation. Total all the minimum payments of your remaining cards, adding on $10 to each card. Let’s say that this figure is now $300 a month. Subtract this from the $600 you have allocated a month, leaving $300. Pay that $300 to the card that is now charging you the highest interest rate.

 

WATCHING YOUR DEBT GO DOWN

 

This whole process may take months or it may take years, but with each payment you will be closer to becoming debt free, at which time you’ll be free to pay yourself more and more. Look at the statements each time carefully, keep transferring accounts for the best interest rate deals as

necessary, and take pleasure and pride each time the amount due is smaller. With each payment you are that much closer to financial freedom.

 

BORROWING FROM YOUR 401(K)

 

You may be able to borrow from yourself to pay off your credit cards through your 401(k) plan at work. Many employers will let you borrow up to 50 percent of the money you have in your plan, up to $50,000, to buy a house or pay off bills or for other situations that qualify. Be careful in doing this, however; the supposed upside is that when you borrow money from a 401(k), you have five years to pay back the money (rather than the forty years it could take you by paying the minimum on some credit cards). In addition, the interest you pay goes right back to yourself

—that’s right. It’s your money, you’ve borrowed it from yourself, and you’re paying it back directly into your account; all the payments plus interest go to you. Usually you will pay yourself about 2 percent above the prime rate, which is the basic interest rate set by the government.

But the realistic downside is this: when you borrow money from your 401(k), you are losing out on the growth potential of the money. So it’s a decision to be made cautiously and wisely.

Another consideration is that if you take out a loan on your 401(k), you are in essence paying back money that you have never paid taxes on with money you have paid taxes on, and then, when you go to take the money out sometime in the future, you will have to pay taxes on it again. That really makes no sense. So you really have to think about this carefully before you take out a loan from a 401(k). Not only are you losing growth on this money, but you are subjecting yourself to double taxation.

Another prospective downside is that if you happen to leave the job or get fired, the money you borrowed is due in one lump sum at that time. If you can’t pay it back, you’ll pay taxes on the money as if it were ordinary income; if you’re under the age of fifty-five, you may also have to pay a 10 percent penalty on the amount you haven’t paid back. If you are thinking of taking out a loan, and there is a possibility you may leave your current employer, you might want to reconsider your

situation before you take out the loan; make sure you understand what you would have to do if you were to leave your job.

 

HOME EQUITY LOANS TO PAY OFF CREDIT CARDS

 

Another alternative, if you’re really in credit card trouble, is to take out a home equity loan to pay off your debt. A home equity loan can have its advantages. The loan may be at a lower interest rate than your credit card, and often that interest is tax-deductible, so you’ll have converted a high-interest, non-tax-deductible debt to one that has lower interest and is probably tax-deductible.

The amount of money that you can take out of your home with this kind of loan is based on a percentage of the equity that you have in your home. Equity is the difference between what your house is worth and how much you owe on your mortgage. In other words, if your house is worth $200,000 and you have a mortgage of $150,000, it means that you have about $50,000 equity in your home.

Can you then take out a $50,000 home equity loan? Probably not. Most banks will let you borrow a total of only 80 percent of the value of your house, including all current mortgages. If your house is worth

$200,000, 80 percent of its value is $160,000. Subtract the $150,000 you owe on the first mortgage, and this gives you the amount you can get on a home equity loan if you qualify: in this case, $10,000.

 

EQUITY LINE OF CREDIT

 

Another option is an equity line of credit, which enables you to borrow money as you need it against your house. Rather than a fixed interest rate, an equity line of credit usually has a rate that varies according to what interest rates are doing. Also, the payback period is not set—so be sure you’re very disciplined if you consider this alternative. With this type of loan you do not have to pay back principal each month if you don’t want to. You can just pay the interest if it better meets your needs. A home equity loan, on the other hand, works pretty much like a regular mortgage. You can get a fixed interest rate and pay back the loan over a

fixed period of time, usually from five to fifteen years.

 

WHICH IS BETTER: BORROWING FROM MY 401(K) OR A HOME EQUITY LOAN?

 

Before we compare the numbers, think about whether you are disciplined or not—it may have been lack of discipline in most cases that got you into all this debt to begin with. With a 401(k) loan you don’t have a choice. You have to pay back the loan in five years. Home equity loans, on the other hand, can go on for up to fifteen years. So you have to make sure that you don’t let the loan drag on for fifteen years, that you stick to a maximum payback period of five years, just as you would with a 401(k) loan. If you will agree with yourself to do this, and if the interest rate is favorable compared to your credit card’s interest rate, I would say in general that a home equity loan would be better.

Now let’s look at the economics.

 

401(K) LOAN FEES VS. HOME EQUITY LOAN FEES

 

With a 401(k) loan, fees are variable: some employers will charge you for taking out the loan and some won’t. Some make you pay a fee of up to $100 just to fill out the paperwork, and some charge a yearly fee while the loan is outstanding. The same is true of home equity loans: some can be gotten for no fees except for an appraisal on your home ($200–$350), and some will charge you fees up front to get the loan or do the paperwork, which can add another $100 or $200 to the bill. But if you look carefully, you should be able to find a home equity loan that can be gotten for no fees, no points, and a very small appraisal fee, if any.

With both kinds of loans, the application process is usually fairly easy. You may have to fill out a form, or you may be able to do it over the phone. However, loans from either source take time to process, so if you’re desperate, ask your employer or lender how long each loan will take to process and when you will have the money in hand.

 

Who Decides What Investment My 401(k) Will Come From?

If you take out a 401(k) loan, it will depend on your company’s policy who decides which investments get sold. Some let you decide; others decide for you. Ask about how this works in your company. If you do have a choice, and if you have some of your money in a bond fund within your 401(k) plan, take your loan from that fund. Your equity funds will still have their full potential for growth, and since a bond fund is mainly giving you income anyway, it makes the most sense to take it from there.

 

USING YOUR 401(K) OR HOME EQUITY TO PAY OFF CREDIT CARD DEBT

 

I don’t think either move makes sense. Borrowing from your 401(k) isn’t nearly the great deal all your colleagues rave about. I already told you about the problems with 401(k) loans. My issue with home equity loans and home equity lines of credit is that they are what is known as secured debt. That is, you are putting your home up as collateral. Your credit card debt, however, is unsecured. There is no collateral you put up. So to take out an HEL or HELOC—that puts your house at risk if you fall on tough times and miss too many payments—isn’t a smart move when dealing with unsecured credit card debt.

 

CONSUMER CREDIT COUNSELING SERVICE

 

Okay, if you are struggling with credit card debt, and I am telling you that tapping your 401(k) or borrowing against your home isn’t the right move, what is?

First, call up your credit card issuers and see if they will lower your rate, or work out a payment plan with you. When you are at your wit’s end, you might want to check out a nonprofit organization that has been set up to help educate you on your money and at the same time, set up a payment plan with you so that all of your cards will be paid off within five years at most.

My favorite of them all is a group known as National Foundation for Credit Counseling (NFCC). To find the office nearest you, please call 1- 800-388-2227 or visit www.NFCC.org.

This is how they work: You hand over all your credit cards to them, and for about fifteen to thirty dollars a month, you will pay them one check and then they will pay your creditors for you. Most likely they will be able to get you a lower interest rate on your cards than what you are currently paying. They can do that because they have deals with many of the credit card companies themselves, so that they are able to negotiate a better interest rate with your current cards than you are able to. In fact, it is the credit card companies that help to fund most of these kinds of companies, for they believe that it is better to get some of their money back rather than none at all. Many people take advantage of organizations such as the NFCC, but they do have their drawbacks as well.

Below is an interview with Caryn Dickman, who is the woman in our

story here and who has worked for the NFCC. Please read it carefully; it will help you answer many of the questions that you may have about NFCC.

 

CD: Can you talk to us a little about what a debt management program is?

NFCC: A debt management program is when we negotiate with the creditors to reduce the interest rates or to eliminate them altogether. A lot of creditors, because they’re going through NFCC, will go ahead and completely eliminate the interest rates. This is really great. In other words, if I, as Joe Consumer, were to call the creditors and say “Let me work out a payment arrangement”—sometimes what they’ll do is say, “Okay, fine, we can do that and we’ll lower your payment, but your account is going to continue to age.” So you’re constantly going to be behind. Most of the time when going through NFCC, you don’t have a problem because we negotiate that by saying we don’t want any of this in arrears, we don’t want the person to be continually showing as behind. I want them brought up-to-date as of today. When we sign the contract, I want the interest rates either eliminated or reduced and this

is what we do. Sometimes we have to get nasty with creditors.

CD: Then does the client pay NFCC every month or can they continue to pay themselves?

NFCC: Well, what happens is they give us the money; they’re not

actually paying us, they’re actually giving us the money and we put it in a trust account. And it sits in the trust account until Thursday of every week. We make payments on Friday mornings.

CD: In that respect, when you get a credit report it would say that the accounts are being paid by NFCC?

NFCC: A credit report will never show us because we don’t report to the credit report agencies. Everything we do is confidential. It is between us and the client.

CD: What about the company that’s owed money?

NFCC: Right. Now what the creditors will do sometimes is that they will put a line in the credit report saying paid through a NFCC. The reason why it’s a good thing when this happens is because we really don’t want the client to accumulate any more debt. And sometimes what will happen is, because somebody’s habits haven’t changed and their skills haven’t developed yet, they will go and try to get more credit. In that case, having this line on their credit report is good because they know not to give them any more credit until it’s paid off.

CD: And when it’s all completed, then if they do want to reapply for credit, can they get it? These are the kinds of things that keep people from wanting to use your servces; they’re afraid that they won’t be able to ever get credit again.

NFCC: If they choose to reapply, that’s not a problem. We have a pool of creditors that we work with that actually want to give credit back to our clients.

CD: My question is what is the point at which you advise people to go bankrupt?

NFCC: There is a point and quite frankly, sometimes—we never say you have to go bankrupt. What we do say is you may want to contact a lawyer; that is one of your options. Another one is that you can fight your way out of this situation and we can also show you how to do that.

Basically what happens is if somebody can’t meet the basic living expenses, forget about the debts. If they can’t pay the rent and they can’t afford food and they can’t manage their fixed expenses, then that’s when we say to them you’re going to have to look into some other way of taking care of this, because there’s not enough money here to make it even with our recommendations. We try to explore all options like having people move in with their families. Maybe that’s not even an

option. Maybe there’s just no other way. That’s when we’ll say it’s time to go ahead and see a lawyer.

Sometimes, however, I have had clients say that’s absolutely not acceptable. And I say, fine, let’s figure out another way of doing this. Let’s figure out how I can help you and what I can do. There are tons and tons of jobs available right now. Are you willing to work two jobs? Are you willing to go and get some training so that you can get a better paying job? We have this huge referral book and our counselors are really well trained—some of them have been doing this for years, so they know what’s available.

CD: Is the training free?

NFCC: Sometimes it’s free; it depends on the situation. If somebody, for example, is on welfare right now, we know we can go through the county and help them get the training for free. If they’ve been downsized, there is usually a way we can figure out how to get it for free or at a very low cost.

CD: Another question I wanted to ask is how is coming to NFCC different from collection agencies?

NFCC: Collection agencies work for the creditor. We’re working for the client. That’s the biggest difference. And basically what we do is we’re not trying to get the creditor’s money back. That’s not our purpose. Our purpose is to help you by giving you the tools that you need in order to gain control so that you can sleep at night, so that eventually you can start saving money, so that you can get out of debt, so that you can have an emergency fund, so that you don’t have to constantly be worrying about this same problem over and over again. A collection agency’s primary purpose is to get money back; they don’t care how it’s done.

CD: Who pays them?

NFCC: They get paid by the creditor. What happens is most organizations have their own internal collection agency. And basically the way they work is that they’re paid a salary, for example, $24,000. Then, of course, they get commissions on top of that $24,000. So they get paid by collecting money from you. The more they collect, obviously, the more money they make.

CD: Okay, so when you go to a creditor and you say you have a client who wants to pay it off, just get rid of all the interest, why would they choose to let that happen as opposed to letting their own collection

people go after them?

NFCC: Well, because a lot of times what happens is their own collection people have tried and failed. That’s usually what happens. Basically, there are a couple of reasons why. One is that our program has been more successful than their collection departments. The reason why it’s generally been more successful is because we’re on the clients’ side. Also the creditor would rather get some money back than none at all. Many people come here distraught; they’re at that point where they’re on the verge of bankruptcy. Also, we do get money from the creditors. About 75 percent of our funding does come from creditor contributions. But please remember they are contributions. We’re not getting paid. It’s also cheaper for them to use a nonprofit organization because it’s tax deductible and it’s voluntary. They have to pay their employees; that’s not an option.

A question I hear fairly often is “Is this going to go on my credit

report?” And basically the answer is it’s up to your creditor. Usually it’s that line that says paying through NFCC. Is that negative? Some people look at it as negative and some people think of it as something positive because you’re doing something about it and taking control.

CD: Another question you must get a lot is “When I walk in here are you going to rip up all my credit cards?”

NFCC: When you walk in here, no. If you choose to go on the debt management program, then what we will ask you to do is cut up all your credit cards.

CD: Every single one of them?

NFCC: Every single one of them. However, if you have your own business or if you have an emergency or there may be an exception, sometimes we let you keep one.

CD: What is the average amount of time that people stay on the program?

NFCC: Basically, we don’t like people to be on the program for more than five years. We want to get them out of debt in five years. That’s our goal. The average length of time is three and a half years with  an average debt load of $22,000.

CD: I keep coming back to this question. How long does the fact that someone has been using NFCC stay on their credit report?

NFCC: Generally, things stay on your credit report for seven years.

Now what we have done is with those creditors that work with us, they are usually really great about just going ahead and taking it off and showing it as a zero balance and that’s it.

CD: How often do you have “repeat offenders”?

NFCC: The rate is not high. Unfortunately, we don’t have solid numbers. What I really find is the number one reason why people have so much debt is because they don’t have the skills or they didn’t implement them. So, in other words, they’re not tracking where their money is going. They don’t have a spending plan. And they don’t have their goals. It’s like they’re driving around and they’ve got no map and they have no idea where they’re going. You need to do all this planning and preparation.

 

BANKRUPTCY REALITY

 

Be very careful if you think that you can escape your money problems by filing for bankruptcy. It is not easy to qualify to file for protection under Chapter 7. Instead, the likelihood is that you will be required to enter credit counseling, and if you still can’t work out a repayment plan with your creditors, you will be required to file Chapter 13, in which your debts will not be forgiven; the court will set a payback plan for you.

 

AFTER THE DEBT

 

Once out of debt, you’ll find the pleasure of not creating debt far exceeds the momentary thrill of buying something on credit that you really don’t need, can’t afford, and won’t really care about much beyond the time you get it home. What is more, all the money you’ve been pouring into interest charges can now go instead toward creating wealth, investing in yourself and your future.

FOUND  MONEY

If you saw a quarter on the street, would you stoop to pick it up? Of course you would—we all would. Would you throw a dollar on the street for someone else to pick up? I doubt it. Yet without even knowing it, you may be throwing away hundreds or thousands of dollars in found money for you and your future just by the way you’re dealing with  your financial life.

Most people try to set up their lives for convenience, to make things easy. But easy can be costly. Respecting yourself and your money means wanting to put every penny you can to work for you. Respect attracts money, remember? You might have “found money” right now, a few hundred dollars a year here, a few hundred there, or more. Wouldn’t you like to find it? You can if you are just willing to look. If you’re willing to rearrange the pieces of your financial life just a little, you’ll be able to see the solution to the puzzle—and find the money.

 

YOU MUST LET YOUR MONEY EARN THE HIGHEST WAGES POSSIBLE

 

 

ROB’S STORY

 

“I suppose I could be making more money on my money,” said Rob. “I guess I’m just too lazy to figure out how.”

I do work in landscape design and make pretty good money at it. Last year I made about $60,000. I’m getting better at the building side of it—making walls, building arbors—so this year I should do even better, maybe $70,000 or $75,000. But the money I earn is seasonal. Maybe in February, someone will come and ask me to design something, so that’s when it starts. I’m busy all through the summer and into the fall. By Thanksgiving I’m usually through, then a few months of downtime. The thing is, all my money comes in all during the season for me to live on all year. I pay taxes, I put some into a SEP-IRA, but the rest is just in my checking account. This way, I can always see exactly what I have. I’ve got about $10,000 in there now,

and just got my first call about next season, so I’ll have enough. I know that $10,000 should be earning more than 2 percent interest, but I haven’t taken the time to figure out how.

You and your money must keep good company, remember? If there is a company, bank, brokerage firm, credit union, mutual fund company, or anywhere else that’s offering you a higher interest rate or lower fees than where you are currently keeping your checking or savings account, it is your duty to yourself to transfer your money into a higher-paying account. You put time and energy into finding the lowest rates for your credit cards, right? That same kind of energy needs to go into finding the highest rates for your cash. Going through Rob’s checking account statements for one year showed me that for four months during that year he had $45,000, give or take, in his checking account. Talk about throwing dollars on the street! During those four months alone, had he kept the bulk of his money in a money market account earning, say, 2 percent, his money would have earned $225. Over the course of the year he was losing much more.

Rob’s case is unusual, in that his money is seasonal, but not unique— I’ve had plenty of clients who receive bonus money, sizable tax refunds, and big checks and simply deposit them into their checking accounts, or savings accounts where the interest isn’t all that much better, then just leave it all there until it dwindles away. I also have had clients who keep a lot of money in their savings accounts so that they’ll have  free checking at the same bank, when they could be making much more if they moved their savings to a money market fund. By saving the checking fees, they are giving up much more that their money could be earning for them elsewhere. And I have had clients who keep huge balances in checking accounts, just “so they can see their money at a glance.”

I tell them what I told Rob, you can see your money just as well in a

money market account or a bank certificate of deposit that pays more than your checking account.

 HOW TO SAVE SMART

It is very important to keep some of your money absolutely safe and sound. This is money you want to be able to tap quickly in the case of an emergency. I believe the best way to be respectful to yourself is to aim to have at least eight months of living expenses set aside in a safe emergency savings fund.

 STICK WITH FEDERALLY INSURED BANKS AND CREDIT UNIONS

The safest place for your money is a bank or credit union account that is federally insured. If your money is at a bank, you want to make sure it is a member of the Federal Deposit Insurance Corp. program (FDIC). One quick way to confirm that a bank is federally insured is to check its website homepage or the door of a branch location; you will see an icon that says “Member FDIC.” You can also check online at the FDIC’s deposit insurance website: http://www.fdic.gov/deposit/. If you use a credit union, your job is to verify that your credit union participates in the insurance program run by the National Credit Union Administration (NCUA). If you see “NCUA” on the website or front door of your credit union, that tells you members’ savings accounts are in fact federally insured. You can learn more about NCUA insurance at www.ncua.gov/NCUAsafe.aspx.

The insurance coverage for both banks and credit unions is virtually

identical. In the event anything were to happen to your bank or credit union, the government agency (FDIC or NCUA) steps in and promises to make sure that you do not lose a penny in your savings up to certain limits. Here is what you need to know about how deposit insurance works.

You have $250,000 in coverage per bank or credit union. If you have less than $250,000 in savings accounts at any single bank, you have nothing to worry about. You are fully insured. That $250,000 coverage amount was made permanent in 2010. At my website, suzeorman.com, I have information on how you can have higher coverage if you own different types of savings accounts.

The limit is per bank, not per bank branch. Be careful. If you

have $250,000 in the ACME bank’s branch on Main Street and another

$250,000 in savings that you deposited at another ACME branch across town, you will not be fully covered. The $250,000 is per bank or credit union, across all its branches.

Not everything sold at a bank or credit union is covered by insurance. Only deposits are covered by the insurance programs. That includes your basic checking and savings accounts, certificates of deposit (CDs), and money market deposit accounts (MMDAs.) But mutual funds sold by a bank or credit union are not insured. This is very important to understand: if you invest in a mutual fund through your bank and that fund loses money, you are not covered by the insurance programs. This is also true of a type of savings account offered through mutual fund companies, called money market mutual funds (MMMFs). I discuss MMMFs in more detail below, but please be aware that there are these two very similar looking savings accounts, but only one, a bank MMDA, provides you with insurance.

SAFETY COMES BEFORE INTEREST

The financial crisis that began in 2008 has caused the interest rate on safe savings accounts to plummet to near zero. In late 2011, a one-year CD typically had a yield of less than 1 percent. And the Federal Reserve, which controls short-term rates, has signaled it intends to keep rates very low through mid 2013. As frustrating as it is to see your money sitting in accounts that earn so little (or nothing), remember what this

money is for. Safety. Emergencies. You want to know that at a moment’s notice you could access the money and know it will all be there. Sure, there are other investments that may pay you a higher interest rate—for example, I happen to think stocks that pay dividends are a great investment. But saving is not the same as investing. Keep your savings safe in a federally insured bank account. That’s how you protect yourself and your family. Now, that said, I want you to scour your bank or credit union offerings to find an account that pays you something, especially if you have a very large sum at the bank. For example, if you have

$150,000 in a non-interest-bearing savings account, you’re earning nothing. Shifting that into an account that earns a little something, even just 0.25 percent, would earn you $375. Earning something is better than earning nothing. And once interest rates begin to rise (though it looks like that may not happen until at least late 2013), you will see the rates on these savings accounts rise as well.

 

MONEY MARKET MUTUAL FUNDS - NOT WORTH THE COST

As I explained earlier, money market mutual funds are not the same as money market deposit accounts. Money market funds are typically the cash accounts available through the fund company or discount brokerage where you have your money invested. MMMFs are not eligible for federal deposit insurance. The reality is that they have historically been extremely safe. They invest in the same types of short-term securities as a money market account at your bank or credit union. But in the event a money market fund runs into any trouble, there’s no insurance program that will make sure shareholders get every penny back. One rare event occurred in 2008 during the financial crisis: a money market mutual fund that had a big investment in a short-term security of Lehman Bros. got into trouble when Lehman Bros. went out

of business. The impact for investors in that money market fund was a loss of 3 percent. While no one wants to lose 3 percent on any investment that is super safe, it is important to realize that in the depths of such a crisis, the impact on this money market fund was pretty minor. Still, if you want to make sure your savings are 100 percent safe and sound, I recommend you stick with a money market deposit account at a federally insured bank or credit union.

Money market mutual funds are also handicapped by the fees they charge to shareholders. The fee is typically very small; it might be just

0.20 percent a year. But when rates are very low, you can’t really afford to give even that much away. Consider that in 2007 before the financial crisis, the average money market mutual fund paid about 4.5 percent interest. Paying 0.20 percent or so for the convenience of having a cash account with your investment portfolio wasn’t a big deal when you were earning so much. But in late 2011, the average money market fund pays about zero interest. I don’t think it makes a lot of sense to pay anything in a fee when you’re not earning anything.

If you have money in a money market mutual fund, think through whether you might be better off, at least during a period of low interest rates, shifting some into a federally insured account at a bank or credit union. And if peace of mind is a priority, then you definitely want to focus on a bank or credit union MMDA.

 

FOUND MONEY - OTHER SOURCES

There are lots of other ways we leave quarters on the sidewalk. Here are ways to pick up that found money.

 

PAY TAXES QUARTERLY RATHER THAN MONTHLY

 

If you are self-employed or retired and getting a pension check, did you

know you don’t have to have taxes taken out of your checks each and every month? The interest that this tax money could earn could be about

$100 or $200 a year, which invested yearly over forty years at 8 percent

could net between $25,906 and $51,811.

If you can, pay your taxes by using an estimated tax payment schedule, which means that four times a year (April 15, June 15, September 15, January 15) you need to send in an installment payment of the taxes that you will owe. Here, too, you have a choice. In these four installments you need to send in either 90 percent of this year’s projected tax or 110 percent of the tax you paid in the previous year.

Let’s say last year you owed $8,000 in taxes, but this year you took a large sum of money from your retirement plan and, as a result, you will owe about $18,000 in taxes. Your choice is to send in 110 percent of last year’s taxes, which totaled $8,000, over those four installments at

$2,200 each, or pay 90 percent of what you expect this year’s  tax liability to be—in this case 90 percent of $18,000 = $16,200.

Who wants to part with money, particularly to the IRS, before they have to? You would pay the $8,800 (110 percent of $8,000), in four installments of $2,200 each, and keep the remaining $7,400 you owe in a money market or interest-bearing account of some kind. Instead of letting the IRS earn interest on your money, you’re doing it. And it can add up to a nice sum.

 

PAY OFF YOUR THIRTY-YEAR MORTGAGE IN FIFTEEN YEARS

 

Let’s say that you buy a house with a thirty-year mortgage of $200,000 at 6 percent. You will be scheduled to make 360 payments of $1,199.10, paying a total of $431,676 by the time your house is paid for. That interest can sure add up, to the tune of $231,676, over time. However, if you pay off this thirty-year mortgage in fifteen years, you will pay far less in interest. Your payments would be higher, $1,687.71 a month rather than $1,199.10, but since you would be paying them for only half the time, you would have shelled out a total of $303,788 to own your house free and clear, or about $128,000 less than if you did it over a thirty-year period of time. That’s quite a savings.

If this is something you’re thinking about doing, please make sure you

consult a financial professional. There are other factors to consider—the present tax deduction on the interest from a primary-residence mortgage; what the $489 difference in monthly payments would add up to if you invested it well instead (and whether you would be disciplined enough to do it). This is an emotional decision, too, as well as a financial one: if you bought a house with a thirty-year mortgage at age forty, how would you feel knowing that those monthly payments would cease when you were fifty-five? Or when you were seventy?

Several other options are available to you as well. Sending in one extra mortgage payment per year, for example, and specifying that it be used against the principal will start to reduce a thirty-year mortgage. If you do this, it will reduce a thirty-year mortgage to just under twenty- five years and a fifteen-year to about thirteen years, depending on your interest rate. Beware, however, of banks that offer to do this service for you (deduct from your account bimonthly) and charge a onetime $300 fee. You can accomplish the same goal by simply sending in an extra payment.

 

DON’T APPLY FOR A THIRTY-YEAR MORTGAGE WHEN YOU INTEND TO PAY IT OFF IN FIFTEEN YEARS

 

Did you know the interest on a thirty-year mortgage is usually higher than the interest on a fifteen-year mortgage? The 6 percent you’re paying for your thirty-year mortgage in the previous example would most likely have been only 5.5 percent, or 0.50 percentage points less, if you had applied for a fifteen-year mortgage to begin with.

You need to give thought to this before you apply for your mortgage. If you are planning to pay it off in fifteen years, why would you apply for a thirty-year mortgage in the first place, the way so many people do? For a safety net, right? You figure that if money gets tight, you can always go back to paying it off with less expensive monthly payments over a longer period of time.

Your safety net, based on the difference between a 5.5 percent, fifteen- year mortgage and a 6 percent, thirty-year mortgage will cost you an additional $103,000 in interest payments.

DON’T HAVE THE MORTGAGE COMPANY WITHHOLD YOUR PROPERTY TAXES AND INSURANCE PAYMENTS— PAY THEM YOURSELF WHEN THEY COME DUE

Wasn’t it nice when you signed up for your mortgage and the lender said, “Why don’t we just go ahead and add your property taxes and insurance to the bill every month, and we’ll pay it all for you?” Sure it was nice. For them.

Property taxes and insurance both come due twice a year, but by saving yourself the hassle of writing four simple checks a year, you’re paying them every single month—and losing out on the interest the money could be earning. It is not farfetched to think you could have earned $240 a year on the interest from your insurance and property taxes. Let’s say you did. Over forty years (which is about how  long people really pay mortgages, by buying a house, selling it, buying another house, and starting the mortgage process all over again) at 8 percent, you could be paying your bank $62,173 in lost interest and earnings just to be your personal secretary and write those four checks for you. Over thirty years you could have lost out on $20,187; over fifteen years, $6,517. And if you’re carrying two mortgages, your savings will more than double.

 

DON’T PAY CREDIT CARD FEES WHEN YOU DO NOT HAVE TO

 

Some credit cards do not charge annual fees, but those that do levy an average fee of $43. If you are paying $43 a year, you are essentially wasting $5,693 over the next thirty years. That’s how much your $43 a year would grow to assuming an 8 percent average annual return. Over fifty years, you are throwing away $28,662. To me that’s found money.

 

DON’T PAY FULL-SERVICE COMMISSIONS WHEN YOU CAN GET WHAT YOU WANT FOR LESS

 

Often I encounter people who tell their brokers exactly what to buy or sell, yet they are still paying full-service commissions on their trades. When I ask them why they don’t switch to a discount broker, the answer is usually: “Well, we’re settled where we are, so why change?” Or, “Well,

he’s a great guy.” (Or, “He’s done so well for us,” which is curious, since they’re the ones making all the decisions!) Even if you’re forty-five right now, if you save just $300 a year on commissions and invest the money at 6 percent over the next forty years, that adds up to $49,000. Will you still be making investments in forty years? If you’re alive, you will. Are you sure you like your broker that much?

 

NEVER BUY A LOADED MUTUAL FUND WHEN YOU COULD BUY A NO-LOAD FUND

 

Let’s say all you ever invest is $5,000 a year in an IRA, and you put that money in a loaded mutual fund with a 5 percent commission. (The difference between loaded and no-load funds is explained in Step 6.) Five percent of $5,000 a year is $250. If you start your IRA at the age of twenty-five, by the time you turn sixty-five that $250 that you did not need to spend every year invested at 6 percent a year would have added up to more than $40,000. It seems to me that the one who will eventually be loaded is that broker who is selling everyone these funds.

 

DON’T GET A TAX REFUND AT THE END OF THE TAX YEAR

 

Would you lend me, every year for the next thirty years, a few thousand bucks interest-free?

Well then, why would you make that loan interest-free every year to the IRS?

This drives me crazy. Every year at tax time I used to get a few new clients who were all excited because they had just gotten their refund back from the IRS. Well, they could have begun investing it months before and, on a $4,000 refund, could have already earned a good bit of interest. The IRS takes your money, but know that it doesn’t give any back with interest—these refunds have been earning interest for the IRS, not for you. Make sure you send them your fair share of taxes when they’re due, but not a penny more. No refund is what you want. Let your money work for you instead.

 

ON BECOMING RESPECTFUL

When someone says to me, “Oh, I don’t know, I guess I just don’t really care about money,” I always say, “But if you don’t care more about your money than anyone else, who is caring about it on your behalf?” When someone else says, “Well, I just don’t think about money,” I say the same thing: “But if you don’t think about your own money, who will? You must think and care about your money until you’ve taken the necessary steps to know that you have done everything you can to show respect for your money, which is a way to show respect for yourself.” Then your money will think and care about you in return.

That’s what this step has been about: respect.

With this step, the path to financial freedom is coming into view. You’re almost there, you’re on course. Now you can clear out the debt that’s cluttered up your present and weighs you down in fear. The future looks clearer, too, now, doesn’t it? Now you can see that you can create enough for tomorrow once you’ve acted today. You have to count every penny to make every penny count. When you have done that, you can begin to create money, more and more money.

Respect for your money and respect for yourself are linked. Building one builds the other. With the next step, you will learn how much you already know deep inside you. We all have a wisdom within us that will tell us, if we listen, how to act, with our money and with every other aspect of our lives. To get in touch with that voice from the core of our being is not only a step toward financial freedom. It’s also a step toward spiritual serenity. That they go hand in hand is not as curious as it may seem at first glance. When you can create money, you are suddenly free to live a life rich in all kinds of ways

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