How Foreign Tax Credits Work for US Citizens

 

foreign tax credit, korea, germany, uk, switzerland

 

Last year I had the opportunity to work in South Korea helping to oversee the construction of my company’s new ship (pictured above).  It was a once in a lifetime opportunity, and one that I will not soon forget.

While living in South Korea (on a 4 week on 4 week off rotation) and working at the local shipyard, my company was paying income taxes on my behalf to the Korean government in addition to the US Federal  and Maine State income taxes that were already being withheld from my paycheck.  Normally, this double taxation would be a tremendous burden on US workers like me; however, thanks to the Foreign Tax Credit provision in the US Tax Code, taxes paid to foreign governments on behalf of US residents are eligible to be returned to them on a dollar for dollar basis in the form of a tax credit.

In cases like mine, US residents working in a foreign country come out ahead with foreign tax credits because they’re not actually paying the taxes (their companies are) yet they get to keep the money that is credited back to them.  But don’t spend that tax return before you get it, as I found out, you don’t actually get back all the money that your company paid on your behalf.

Foreign Tax Credit Example:

To keep this example simple, lets assume your gross income last year was $100,000 and your company paid 15% or $15,000 in foreign income taxes (on your behalf) to the country you worked in.

If your company hadn’t paid any foreign taxes on your behalf at all, you would be responsible for paying taxes on the $100,000 minus any deductions and personal exemptions you qualified for.

However, since your company paid taxes on your behalf, your gross income is actually “grossed up” to show you earned $115,000 (the $15,000 difference reflects the additional money your company paid on your behalf to the foreign country).  You are now responsible for paying taxes on $115,000 minus any deductions and personal exemptions you qualify for.  You will most likely qualify to get the $15,000 back in the form of a credit, but you’ll also have to pay federal and state taxes on $15,000 because it is effectively considered “income” per the IRS forms.

This means that all other things being equal, you’ll only come out ahead by $9,000 to $11,000 with a $15,000 foreign tax credit vs. your company not paying any foreign taxes on your behalf at all.

This post is provided to give you a general idea of how foreign taxes applied to my own unique case.  I recommend you do as I do and consult a licensed tax professional who is experienced in the area of foreign tax credits before actually filing your taxes.  Good luck!

So…You Want to Buy a Ski Condo

Last month my wife and I took our three kids on a family ski vacation to the Sugarloaf, USA ski resort in Maine to research ideas for some upcoming articles.  After exploring various lodging options we chose to rent a two bedroom “on mountain” condo in a family friendly condominium association that also had a “free” pool our kids could use.  To make a long story short, we had the time of our lives.  It wasn’t just the great skiing (which was amazing), but the whole atmosphere that surrounds the mountain, the outdoor activities,  and the friendliness of the people.

Naturally, my wife and I got thinking about how nice it would be to someday buy a condo unit of our own.  I wasn’t new to the idea, I’ve written articles on both the advantages and disadvantages of buying vacation properties, but now that we had developed an interest in a particular area, it was time to put my theories to the test.

As luck would have it, the exact unit we had rented for the week happened to be for sale with a list price of $179,000.  We weren’t in a position to make an offer, but it was interesting to compare the list price of the property to what we could rent the property for (we paid $1500 for the week).

After analyzing the numbers, we quickly realized that unless we used the unit nearly every weekend during the winter months (probably not going to happen with all of our kids extra-curricular activities), the numbers just weren’t in favor of us buying the property, here’s why:

Killer Maintenance Fees: The first thing that struck us was the monthly “maintenance” fee of $309 (as noted on the real estate listing) or $3709/yr.  For that price, I could rent the property for two weeks out of the winter and still have money left over for lift tickets without ever having to pay a single mortgage payment.

Heating Bills: The second thing that struck us was the monthly heating bill.  According to the listing sheet, the property we stayed in averages about $1700 a year in heating costs (between electric and propane). That’s another expense we don’t have as renters and translates into another week’s stay at the condo as renters without ever having to make a mortgage payment.

Interest: The third consideration was the interest we’d have to pay on the property if we bought it.  Assuming a 20% down payment, we’d be looking at over $7,000 a year in interest payments.  Again, there’s 4 more weeks we could have just rented the property and come out ahead.

Appreciation: Last but not least, we realized by looking at recent sales data for units within the condo association, the properties have seen very little (if any) appreciation over the last 6 years.  With such high costs of ownership vs. renting, it is unlikely that there will be any significant appreciation in the following years either.

Of course, there are plenty of advantages of buying a ski condo, however, from a purely financial standpoint, I think we’re going to pass on this particular opportunity.

 

8 Reasons Renting a Vacation Home is Better than Buying

log-cabin

Vacation homes are great!  For many families and individuals, purchasing a vacation property is the realization of a lifelong dream. Few things are more rewarding than kicking back in your own personal slice of heaven with friends and family in an area you hold near and dear to your heart.

Unfortunately, most families are unable to afford the “lifestyle” associated with owning a second home.

Whether your dream is to own a lakeside cabin in Maine, or a ski house in Colorado, here are 8 reasons why renting a vacation property may be a better option for you. Continue reading

Target’s Free Credit Monitoring Program: Should You Sign Up?

target, security, breachWith a public perception that was once the envy of all discount retailers, Target Corporation is in serious damage control mode following the debit card and credit card security breach that has affected millions of customers. As part of its mea culpa, Target is offering one year of free credit monitoring through Experian’s “Protect My ID” service. The following benefits are included as part of Experian’s “Protect My ID” credit monitoring package:

Credit Report: You will get a free copy of your Experian® credit report.

Daily Credit Monitoring: You will receive alerts regarding key changes to your credit report, including new inquiries, newly opened accounts, delinquencies, or medical collections reported on your Experian®, Equifax® and TransUnion® credit reports for one year.

Identity Theft Resolution: If you have been a victim of identity theft, you will be assigned a dedicated, U.S.-based Experian® Identity Theft Resolution Agent who will walk you through the fraud resolution process from start to finish.

Identity Theft Insurance: If you have been a victim of identity theft, you will immediately be covered by a $1 Million insurance policy that can help you cover certain costs, including lost wages, private investigator fees, and unauthorized electronic fund transfers for one year.

ExtendCARE: You will get full access to personalized assistance from a highly-trained Fraud Resolution Agent even after the initial one year ProtectMyID™ membership expires.

If your information was compromised as part of the Target data breach, you can easily register through Target’s website to have a free Protect My ID activation code emailed to your inbox.

The question, of course, is if this “free” service is worth the hassle of signing up considering you need to provide your personal information including your Social Security Number (after all, isn’t this what got us all here in the first place)?

Although it is not an ideal situation for anyone involved (except maybe the criminals who stole your information), I believe the Experian credit monitoring service is a very worthwhile step to take if you are concerned about someone using your identity to commit fraud. Experian, as you may know, is one of the three major credit monitoring bureaus (the other two being TransUnion and Equifax) and is not part of Target; Experian, along with the other two credit bureaus is arguably best positioned to contain the fallout of this security breach.

The one caution I have for you is that Experian is also a “for profit” business and will attempt to sell you several additional products and services as “add-ons” to your free credit monitoring service (these add-ons include access to your credit scores, FICO/credit  score tips, credit score monitoring services, etc.). My advice is to simply pass on these offers and focus on the free services included in the “Protect My ID” package first.  The services already included in the Protect My ID product should be more than enough to control anyone from causing permanent damage to your credit file.

Should You Pre-buy Your Home Heating Oil this Winter: 2013-2014 Price Predictions

“Should I pre-buy my home heating oil this year”…

This is one of the most common questions I receive each year on my personal finance blog.  As many of my long time readers know, I’ve been very successful in predicting home heating oil prices over the last 5 or 6 years and readers keep coming back each fall to get my recommendations for the upcoming winter heating season. To help aid in this decision, I am once again offering my home heating oil price predictions for the fall of 2013 and winter of 2014.

Historically, pre-buying home heating oil via pre-paid or pre-purchase contracts, can be a great way to save money on heating oil costs during the cold winter heating season. However, if you’re not fully aware of the risks, you can also end up paying way too much money for heating oil as many consumers found out in 2008. In extreme cases, you can even lose your entire upfront payment as residents of Mid-Coast Maine found out when their local heating oil delivery company filed for bankruptcy.

Predicting home heating oil prices for the upcoming winter heating season has become one of the most popular series of articles each year on my personal finance blog Trees Full of Money.

While I provide this service for entertainment purposes, I am proud to say that I have developed an exceptional track record over the last 5 years in recommending the most beneficial payment option provided by most major heating oil delivery companies in the northern regions of the United States.

In last year’s heating oil price prediction analysis, I recommended NOT to prebuy your heating oil contract unless you could lock in a price of $3.35-$3.65 per gallon of heating oil.  In my particular area, the cash or spot delivery price of heating oil was actually less than what the per gallon “pre-buy” price was!

Last spring (2012), heating oil was hovering around $3.70-$3.80 yet my local heating oil delivery company wanted to charge me $3.89 per gallon for a pre-buy contract!  If I’m going to pre-buy my oil, AT THE MINIMUM, I expect a discount just for the simple fact that I’m paying the money upfront and there is no risk to the delivery company that I won’t pay as agreed (most home heating oil deliveries are made on credit where the homeowner in billed after the delivery is made.  Not to mention the oil company is earning interest on my money.

Before I provide this year’s recommendation on whether or not you should lock in today’s home heating oil prices, here is a quick review of some of the more common payment options offered by many local heating oil delivery companies.

The Spot Delivery or “Pay As You Go” Plan:

This plan means that you pay whatever the current cash price is for heating oil for the day it was delivered. This plan is excellent is you know for sure the price of oil will remain unchanged or even drop over the course of the heating season. Unfortunately, the price of oil has been so volatile over the last few years that making this prediction with any level of confidence is nearly impossible.

The “Budget” or Price Protection Plan:

This plan has been my favorite over the last few years. You sign a contract for the delivery company to deliver oil to your home for the entire heating season. The best part about most budget plans is they offer a “cap” or “price ceiling” on the price you pay per gallon, but unlike “pre-buying” contracts, if the price of a gallon of oil goes below the price per gallon you budget for you get the advantage of paying the lower price. As an added advantage, your payments are spread out evenly over a 10-12 month period so that you are not faced with gigantic heating bills during the coldest months of January and February.

The Pre-Buy or Pre-Pay Plan:

When you pre-buy or pre-pay your home heating oil, you pay for your home’s total estimated oil usage for the entire winter season upfront. The price you pay is usually competitive with the current spot delivery prices on the day you sign your contract. Pre-buy plans are excellent if you have the funds available, and expect the price of oil to rise over the winter season.

Should You Prebuy your home heating oil for the 2012-2013 winter heating season?

Although I’ve been fairly accurate in my predictions over the last few years, this year’s  prediction still comes with several cautions.

First, after observing what my father-in-law experienced three years ago when the oil delivery company he pre-paid filed for bankruptcy and he lost the balance in his account, I have come to appreciate the value of being able to “hang on to your money“. Before considering prepaying for my home heating oil, I would absolutely want to make sure that the company I was dealing with had a solid track record and was well grounded in the local community.

Second, like last year, the price of a gallon of oil is trading approximately in the middle of the range it has fluctuated in over the last few years which means that in a “perfect market” the price of oil has just about as good a chance of going up as it does of going down.

When oil prices are historically low (as they were in 2009), you can make a reasonable bet that pre-buying your heating oil (at a slight discount under current cash prices) will offer you the best price protection. However, when prices are historically high (as they were in 2008 at over $4.50 per gallon) I tend to shy away from pre-buying contracts as there is very little upside in price but plenty of room (historically) for the prices to go back down.

Like last year, with prices in the “middle” of the two extremes I have less confidence in making an accurate prediction of whether or not you should pre-buy your heating oil for the 2013/2014 heating season. As of today (10/9/12), my local heating oil company is charging $3.79/gallon for their pre-buy prices (current “spot rate” or “day rate” is only $3.59/gallon).  In addition to the $0.20/gallon premium to pre-buy your oil, my local oil delivery company is charging $0.25/gallon for “downside protection” to protect you if the price of oil actually does drop while you are still receiving your pre-bought deliveries.

In other words, I would end up paying $4.04/gallon to pre-buy my home heating oil vs. paying only $3.59/gallon to fill up my tank today.  The only way I would come out ahead pre-buying my heating oil (with downside protection factored in) would be if the “spot price” of heating oil rose above $4.04/gallon.  I just don’t see a reasonable situation where heating oil rises above $4.04/gallon during the upcoming heating season. 

Several years ago it made sense to pre-buy your home heating oil, however, oil delivery companies are capitalizing on consumer’s new perception that “it always makes sense to pre-buy heating oil” by actually charging more to pre-buy the oil vs. paying the daily delivery price when you need the oil.  This just doesn’t make sense.

For the 2013-2014 heating season, I will only pre-buy if I can lock in at a price less than $3.39/gallon, and I will never pay for downside protection.  Buying downside protection insurance when you pre-buy home heating oil defeats the whole purpose of pre-buying your oil.  The delivery company is basically selling you “insurance” on your investment to pre-buy oil.  Its almost like buying GAP insurance on your vehicle when you bought the car with cash (GAP insurance pays the difference between what you owe on the car and what the car is worth should it be totaled in an accident).

An alternative method to protect yourself from rising heating oil prices.

As always, if you’re interested a more “advanced” method of hedging against the rising cost of home heating oil prices, check out my article on how to hedge against rising gasoline prices, except instead of buying gasoline ETF (electronically traded funds), you protect yourself by buying home heating oil ETFs (I like ticker symbol UHN).

Also, if you’re interested in learning about how offshore oil and gas wells are drilled, check out my article on an introduction to drilling offshore oil and gas wells.

Personal Finance and the Opportunity Cost of Capital

One of the interesting concepts I’ve learned in business school is the opportunity cost of capital and how it relates to investment decisions made by financial managers at public corporations.

In a nutshell, the opportunity cost of capital (expressed as a percentage) is the expected investment rate of return a company gives up for a certain amount of money invested in the financial markets when it instead decides to invest the money in the itself (development of a new product or service).

For example, let’s pretend that a pharmaceutical company has $1 billion sitting in their coffers. The company could return that money to shareholders in the form of dividends, they could invest that money in the financial markets (in stocks, bonds, treasuries, etc.), or they could reinvest that money in the company by perhaps researching, testing, and marketing a new drug.

Assuming the company decides not to pay a dividend to the shareholders (so the shareholders can reinvest the money themselves), financial managers within Pfizer must identify new projects that offer a higher rate of return than what they could get if they simply invested the money in the financial market (this being the opportunity cost of capital).

The trick with the opportunity cost of capital is making sure you compare the expected rate of return of a new investment project with the rate of return in the financial markets of an investment vehicle of similar risk (this is where a great deal of experience, guessing, and arguing comes into play among a corporation’s management, board of directors, and shareholders).

If it appears the company’s new invest project yields a higher expected return vs. investing company funds in the financial markets at a similar risk level, then it makes since to move ahead with the company’s new project.

On the other hand, if the expected rate of return on the proposed project is less than what the company could earn if it simply invested the money in the stock market, bonds, or treasuries, then it wouldn’t make sense to continue on with the proposed investment project.

How Does the Opportunity Cost of Capital Affect You and Your Personal Finances:

If you’ve been reading this blog for a while, you’re probably aware that I like to think a little differently when it comes to personal finance, investing, paying off debt, and saving. Considering the opportunity cost of capital as it relates to your everyday finances is another great example of this.

Let’s say you decide to purchase a new vehicle for $30,000. Not only is that $30,000 vehicle going to depreciate more than $15,000 in three years (most likely), you’ll also have missed out on the opportunity to have invested that money in the financial markets.

In three years, not only would you have lost $15,000 in the form of depreciation, you also would have lost out on the compounding interest you could have earned by investing that $30,000 in a highly rated bond corporate or government bond paying around 6% (as of this writing). This lost investment opportunity amounts to another $5,730 (30000 X 1.06^3 = $5,730).

Your opportunity cost of capital in this case would be the $5,730 you gave up by instead deciding to purchase the new car. I’m not saying you shouldn’t buy a new car (in fact I just bought one a few months ago), what I do think you should consider is how much that vehicle is really costing you in the long run.

I hope this gives you a little more food for thought the next time you consider making a big financial purchase.

Free Rental Property Investment Analysis Calculator (Excel Spreadsheet)

If you’re considering the purchase of a residential or commercial investment property but need help crunching the numbers to determine if the investment makes sense, my free Rental Property Investment Analysis Calculator (using Microsoft Excel) may be just the investment analysis tool you’re looking for!

As you may or may not know, rental properties generate value for their owners in three distinct ways: Cash Flow, Repaid Mortgage Principle, and Property Value Appreciation.  Here’s a closer look at each of these profit sources:

Cash Flow:

Cash flow is the rent money left over at the end of each month after the property’s mortgage, taxes, maintenance, insurance and property management costs are paid. Obviously, your goal is to have more rent money coming in each month than you’re paying out in expenses; this is known as having positive cash flow. If the rent collected each month does not fully cover the monthly expenses of owning the rental property, you have a negative cash flow. While positive cash flow is best, there are some instances when it may make sense to have a negative cash flow (especially for the first few years) on an investment property, but we’ll get to that a little later.

Mortgage Principle Repayment:

If you’ve mortgaged a rental property and you’re using the rent money to pay the monthly mortgage payments, you are also reaping the benefits of having someone else pay down your mortgage.

Property Value Appreciation:

The third way investors make money with rental properties is through the property’s appreciation in value. In “real terms” the increase in a rental property’s value can be affected by inflation. If inflation is 3% per year and your rental property appreciates in value at only 2% per year, you’re rental property is actually decreasing in value in terms of “today’s dollars”.

Understanding these values and how to calculate them can be very difficult for beginner or aspiring real estate investors. Making this process even more difficult are the many variables that come into play that can affect some if not all of the ways you can make money with rental properties.

Variables that Affect the Profit of Rental Properties:

Purchase Price:

The biggest factor affecting the potential profit of a rental property is the purchase price of the property. All other things being equal, the more you pay for a rental property, the less your profits will be.

Down Payment:

Believe it or not, the less money you put down on a rental property, the higher your return on investment will be. This is because your return on investment is measured by how much money you actually personally invest into the property. If you put $25,000 down on a rental property and pay the mortgage off with rent money paid by the property’s tenant(s), the $25,000 is considered your investment. The total profit earned on the property from cash flow, mortgage principle repayment and the property value appreciation all result from your initial $25,000 investment that helped you secure a mortgage on the property.

Mortgage Interest Rates:

Mortgage interest rates will affect the profitability of rental properties. The higher the interest rate, the higher your monthly mortgage payments will be. Higher interest rates will also affect how much of the mortgage’s principle is repaid each month.

Mortgage Length:

Deciding how long to mortgage rental property can be a very hard decision; however, it is possible to determine the optimum number of years to finance a rental property to maximize the return on your investment (your down payment). The longer you mortgage the rental property, the higher your monthly cash flow will be (lower monthly expenses). On the other hand, the principle is paid down more slowly on the property. Using my rental property analysis tool, you’ll be able to find the “sweet spot” between these two variables to determine how long your mortgage should be on your rental property.

Property Value Appreciation:

Most properties will appreciate in value over the long term. Historically, homes in the United States have appreciated in value by about 4% per year (staying slightly ahead of inflation). The higher the annual appreciate rate (which you can only estimate), the more profit you will make on the rental property since you’ll be able to sell it (or charge more rent) than you could when you first bought the property.

Property Tax Rate:

The higher your annual property tax rate, the lower your monthly cash flow will be.

Maintenance Expense:

Another cash flow killer is maintenance expense. Many real estate investors count on spending 1% of the property’s market value each year in maintenance costs. For a $120,000 rental property, they’ll budgeting $1200 per year ($100/month) on maintenance costs.

Monthly Rent:

The more rent you can earn off a property, the higher your monthly cash flow will be.

Occupancy Rate:

You won’t be able to rent the property out 100% of the time. Once a tenant moves out, it takes time to ready the property and find a new tenant. There are also instances when a tenant is unable (or unwilling) to pay rent. Some real estate investors I’ve talked with say their occupancy rate is around 90-93% on average.

Property Management:

If you’re relatively new to rental properties or you live far away from the rental property that you own, you may considering using a property manager to deal with the tenants and handle any issues that may arise. If this is the case, you can expect to pay a fee of 5% to 10% of the monthly rent for this service. This fee will hurt your monthly cash flow.

Annual Insurance Premiums:

Depending on which part of the country you live in, you may pay anywhere between .3% and 3% of the rental property’s market value in rental insurance each year. Dividing this out over a 12 month period will allow you to determine the affect property insurance has on your monthly cash flow.

Inflation Rate:

Inflation can take a bite out of your cash flow as well as the rate at which your property appreciates in value when looked at in “real terms” or “today’s dollars”. As we discussed above, a home can appreciate by 4% each year, but if inflation is 2% the real value of the home’s appreciation is much less.

As you can see, any one of the above variables could adversely affect the profitability of a rental property. To help me analyze a particular rental property I’ve put together an easy to use Excel Spreadsheet that takes each of these variables into consideration and tracks their effect.

This rental property investment calculator is an experiment and I make no guarantee of its accuracy, but for me it is a valuable investment analysis tool. When I see a prospective rental property for sale, I can just plug the numbers into my investment property program and I will get a pretty good idea if the property is a good investment or not.

Entering the Rental Property Variables into the Program:

click image to enlarge

The first section of the rental property investment program is where you enter in all the variables that affect the profitability of the rental property. Note: The “Amount Financed” value is calculated automatically for you:

Analysis Results Section:

Once you’ve entered and reviewed all the relevant data into the spreadsheet, you can look at the “Analysis Results” section to get a sense of the profitability of the investment property. Below is a screen shot of what the results will be based on the sample data entered in the section above:

click image to enlarge

Let’s take a look at each of these values as I try to explain my methodology on how to calculate each one.

Total cash flow during the full term of mortgage’s repayment (or the length of time you plan to own the property): This value, $20,867.55, is the estimated total of all the monthly cash flow you will have over the term of the mortgage (or time you expect to own the home). It is calculated by adding the balances of each month’s rent-expenses. Even if the first few years are negative, as they are in this example, you still may end up with a positive overall cash flow because you’ll be able to charge more rent (theoretically) as the property increases in value.

Total cash flow during the full term of mortgage’s repayment (or the length of time you plan to own the property) in “Today’s Dollars”: This value, $17,488.58, is the estimated total of all the monthly cash flow you will have over the term of the mortgage (or time you expect to own the home). It is calculated by adding the balances of each month’s rent-expenses. This time, however, the monthly cash flows are “discounted” based on the rate of inflation you entered in the fields above. You can also see the comparison between the monthly cash flows and the “adjusted” monthly cash flows in the “Raw Data” section of the spreadsheet.

Monthly rent cash flow in “today’s dollars” after mortgage is paid off: After the mortgage is paid off (or if you pay cash for the property) your monthly cash flow will be much higher. The value of this monthly payment is displayed here and assumes the rent you can charge for the property increases at the same rate the property’s market value does.

Principle repaid during term of mortgage repayment in “Today’s Dollars” (will be zero if you paid cash for the property): This amount is equal to the amount you plan on mortgaging for the property. This is the amount of principle on the property that will be “paid off” by the renters.

Once the mortgage is paid off, this is the value of receiving your monthly rent payments in “Today’s Dollars” (assuming a conservatively invested perpetuity): One of the great things about owning a rental property is that after the mortgage is paid off you still have the monthly rent income coming in forever (providing you keep up on the property’s maintenance). The financial term for this sort of payment is called a “perpetuity”. You can calculate the present or current value of a perpetuity (the $825 monthly cash flow mentioned above), by dividing the value by a “conservative” interest rate. In other words pick an interest rate that you could be almost guaranteed to earn in the open market (I used 4% as a value in this spreadsheet). This value is “how much money” you would need to invest at 4% to earn $825 per month? Answer: $247,500. This value may not matter to some real estate investors, but it is an interesting value to me.

Increase in rental property’s market value in “Today’s Dollars” during the mortgage term (or during the time you expect to own the property): If the investment property appreciates in value at the same rate of inflation, this value will remain “$0” because there will be no change in the “real” value of the property. However, if you enter a different inflation rate and property value appreciation rate the difference will be calculate here.

Compound Annual Growth Rate (Return on Investment) of your initial investment (down payment) during the time you plan to own or mortgage the home using the “geometric average” formula including the effect of inflation: This value (7.84% in our example) is the average return earned on your initial investment (which is considered to be your down payment). In other words, this is the effective rate that your investment would grow annually in order to achieve the “total profit” calculated in the next cell below.

Total profit during the mortgage repayment period (or during the time you expect to own the property) in “Today’s Dollars”: In the values above, the program has calculated the “profits” of the investment over the three main sources of value rental property investor receive (cash flow, principle repayment, and property appreciation). The value in this box is simply the sum of these three individual profit sources of owning a rental property. In our example, the total estimated profit of purchasing the property using a 15 year mortgage is $155,023.39 in today’s dollars.

Raw Data:

The “raw data” calculated by my experimental rental property analysis program also reveals some interesting data that is of interest to the beginning or aspiring investor. Here is a screen shot of the raw data section of the Excel Sheet:

click image to enlarge

Month by Month Cash Flow Analysis: Perhaps the most useful information found in the “raw data” files is a breakdown of the rental property’s monthly cash flows. As you can see in our example, the first few months start off cash flow negative (the property owner has to pay extra out-of-pocket cash to cover expenses). However, because of the appreciation in property value and rent, the cash flow for our example rental property turns positive by the 38th month (not shown in this screen shot).

Property Value Appreciation: You can also see the estimated monthly increase in the property’s value.

Increase in Rent: Because we’ve fixed the estimated monthly rent you can charge for the property, you can also the average monthly increases you’ll be able to charge for rent. The rent won’t actually increase each month as shown in our example because you’ll probably fix the rent in 12 month lease increments. For the purposes of our calculations, the effect of the increasing the rent monthly does not affect our overall calculations.

Let me know what you think!

This rental program investment program is far from perfect, but it is a good starting point for me as I consider investing in rental properties. As always, please be sure to consult a qualified investment professional before acting on any of the results calculated in this spreadsheet since I cannot guarantee their accuracy or validity.

If you have any ideas for improvements or see any mistakes that need to be corrected please email me or leave a message in the comment section below!

Good Luck!

P.S. I was inspired to write this article and create the Excel spreadsheet after reading posts on real estate investing by J Money, Lazy Man, 2Million, FMF and Flexo.  They really got me thinking about the benefits of investment properties and hopefully this rental property investment program will help them too!

USAA’s Term Life Insurance Application Process

On the advice of our USAA personal finance adviser, my wife and I decided to purchase private term life insurance outside of what we already had through my employer.

Note: USAA provides FREE personal financial advice for all members and it is an extremely valuable service if you have questions about investing, college savings, insurance, retirement, etc.).

After filling out an online application for term life insurance through USAA, we received a call from a USAA representative who asked a few additional questions about our respective applications and then transferred us to a third party medical company who asked us medical related questions such as whether or not we were smokers, previous medical conditions, current medications, etc.

Next, we had to arrange for a quick home visit from a nurse to measure our height and weight, take our blood pressure, and collect urine and blood samples that would be sent back to a lab for further analysis.

That was it! All told we each had about an hour invested in the entire application process including filling out paperwork, scheduling the at-home visit and enduring the actual physical examination.

Don’t let the burden of applying for term life insurance hold you back from protecting you and/or your family’s financial well being in the event something happens to you!

Do College Graduates Really Earn More Money Over Their Lifetime

Once again a popular website has published a story about how much more money college graduates earn over their lifetimes than workers with only a high school diploma.

“The difference between a bachelor’s degree and a high school diploma is at least seven figures over a lifetime”, says Christina Couch from Bankrate.com in her article “The Million Dollar Difference of a College Degree“.

Using data from a Georgetown University study, Couch cited several examples where college graduates did “earn” substantially more than their non college educated counterparts. In fact, of the 5 distinct job categories that were profiled in the article, all of them earned at least 1.3 million more in lifetime salary.

Unfortunately, the article fails to consider the opportunity cost of the actual college education expense itself. Instead of paying $75,000 over four years for tuition, room and board, what if you decided not to go to college and went straight into the work force (as this article suggests is possible).

What would that $75,000 grow to over your working lifetime (starting at 18 years old and retiring at 65 = 47 working years) if you instead invested it in a mutual fund earning a realistic 7% return on investment.

A quick entry into Excel reveals this investment would grow to $1,803,428! In other words, you’d actually make $500,000 more over your lifetime by not going to college assuming you can gain employment in the jobs profiled without a college degree as Couch’s article does.

Things are not always as cut and dry as they seem!

When Do Roth IRA’s Make Sense over Traditional 401K and Traditional IRA Plans

As I mentioned in yesterday’s article comparing the tax advantages between 401K and Roth IRA plans, I’ve decided that it is better for me to max out my 401k first before starting to invest in a Roth IRA. The deciding factor for me is that I expect to be in a lower income tax “bracket” in retirement than I am now.

Money that I put in a Roth IRA today would be taxed at my current tax rate of 28%. No matter how optimistic my retirement saving’s projections are, I don’t expect to have the same income in retirement as I do now and “theoretically” any income I do have should be subjected to a lower tax rate.

So when does it make sense to fund a ROTH IRA?

Higher Tax Rate in Retirement: Obviously, if you feel you’ll be in a higher tax bracket when you retire, its better to pay taxes now with a Roth IRA or Roth 401K than it would be to pay higher taxes later through a tax deferred retirement plan like a 401K or 403B program.

Save More: Because the limits are the same for a Roth IRA and a Traditional IRA, you can effectively save a higher percentage of your current annual income for retirement each year because $5,000 in a Roth is worth much more than $5,000 in a Traditional IRA (remember you still have to pay taxes on funds in a Traditional IRA).

401K is Maxed: If you’ve already maxed out your 401K or similar retirement account (403B, etc.), Roth IRA’s are usually the “next best option”.

Investement Option Flexibility: If you don’t like the investment options in your current 401K and you want more flexibility, opening a Roth IRA (or Traditional IRA) will give you access to a virtually unlimited number of investment options.

Everyone’s financial situation is different. The ideas and opinions about ROTH IRAs and 401Ks above relate to my own specific financial situation and are intended to give you a broader perspective of what may (or may not) be best for your specific financial situation. If you have any doubts about whether a ROTH IRA or 401K is better for you (after you invest the minimum in your company’s 401K program to get their match) be sure to speak with a professional financial advisor (I’m just some dude with a blog).

Should You Max Out Your 401K before Investing in a Roth IRA

I read a great article comparing 401ks and IRAs  at Cash Money Life the other day and I wanted to expand on one of its key elements:

Roth IRAs are non-deductible, which means you use post-tax money to fund your account. However, the distributions made during retirement age are tax exempt, which is the main reason people invest in a Roth IRA.

Are average investors really doing the right thing by investing in ROTH IRAs?

If your company matches your 401k contributions up to a certain percentage of your salary it makes sense to invest at least enough to get the full company match. The question is, should you contribute more to your 401K (above the matching percentage) or should you open a ROTH IRA and fully fund it before resuming contributions to your 401K?

If you listen to personal finance guru’s like Dave Ramsey and Suze Orman, they repeatedly tell you to invest enough to get your company’s 401k match, then max out a Roth IRA and only then (if there is any money left over) invest any additional money you can in your company’s 401K up to the maximum annual contribution limit (currently $17,000).

The theory is the money in the Roth IRA will grow “tax free” and you won’t have to pay taxes on it when you withdraw the money in retirement. The caveat is that you pay taxes on the money before you put it in the ROTH IRA.

On the flip side, money you put into a traditional 401K account is not taxed before it goes in the account and you receive the benefit of a lower tax bill now (instead of later in retirement). This drawback here, or course, is that you WILL pay taxes on 401K proceeds when you withdraw the money in retirement.

And so begs the inevitable question:

Is it better to Pay Taxes Now through a Roth IRA or Pay Taxes Later through a Traditional 401K Plan?

The truth is, if your tax rate remains the same now as it does in your retirement years, the “real” value of your retirement savings is EXACTLY the same.

Example: Lets say you have an extra $10,000 per year above what you’re putting in your 401K to get the company match. You plan on retiring in 30 years and you want to know if you should invest your money in a ROTH IRA or a Traditional 401K. Which option will save you the most money on taxes over time?

ROTH IRA Scenario:
You invest $10,000 per year in a ROTH IRA for 30 years assuming an average annual return of 8%, and a tax rate of 25%. Because of the 25% tax rate, you would actually only be contributing $7,500 per year (after tax dollars) into the ROTH IRA. After 30 years your retirement account would grow to $849,624.08.

Traditional 401K:
You invest $10,000 per year in a traditional 401K for 30 years assuming the same average annual return of 8% and a tax rate of 25%. Your account grows faster because you are contributing the full $10,000 each year (before tax) into the traditional 401K, the difference is you’ll be responsible for paying taxes on the money when you withdraw it. After 30 years your 401K retirement account would grow to $1,132,832.11.

All other things being equal, 25% tax on $1,132,832.11 leaves us with$849,624.08, the exact same amount you’d have if you invested the money in a ROTH IRA.

What Will Your Tax Rate Be in Retirement?

As you can see from our case study example, our decision to invest in a Roth IRA vs. a Traditional 401K really comes down to what you think your tax rate will be in retirement.

If you think your tax rate will be lower in retirement (like I do), it makes sense to invest your money before taxes are taken out in a retirement account like a Traditional 401K or Traditional IRA.

If you think your tax rate will be higher in retirement, it makes sense to invest your money in a ROTH IRA or “Roth 401K” if your company sponsors one.

The way I see it, if I’m making more money in retirement than I am working (putting me in a higher tax bracket), I’ve done some serious over-saving for retirement. That would mean in the few years leading up to retirement I could actually retire and make just as much money. That just doesn’t seem practical to me, especially considering my living expenses should be considerably lower in retirement (mortgage paid off, kids off on their own, etc.).