I hope you didn't reduce your 401K or other retirement account contributions over the last four to six months as stock prices and markets tumbled. Even though the value of your current 401K or retirement plan probably fell over this time, in the long term the power of dollar cost averaging and recovering/rising markets would have ensured that your portfolio will be worth more than it would have been if you stopped your contributions when things got rocky. Here's a simple example that illustrates this concept

Joe had a 401K portfolio of $100,000. Assume each stock (or fund) unit was worth $1000 in September 2007. So he had 100 stock units. He used to buy 1 unit every month when he got paid, which cost him $1000. However with the fall in share prices, the unit price dropped to $50. So Joe's portfolio is now worth $50,000. Joe is not very happy but is a long term investor. So he keeps investing the same amount every month, but now gets 2 stock units for the same price. So by June 2008, 9 months later, he has 100 + 2x9= 118 units. With a recovering stock market (just like we are seeing now), the units are back to being worth $1000 again by year end. So Joe's 401K portfolio of 118 units are now worth $118,000. By the end of the next year (2009) with the economy growing again and optimism in the markets the units are now worth $1500. So Joe's 118 units are now worth $177,000. So in the medium term, even though the stock unit price fell, the investment turned out okay as the price recovered. But what if Joe had stopped investment when things got rocky and only started back again at the end of 2009?

If he stopped investing way back in Sep 07 when the stock market tumbled, he would only have the original 100 units and they would be worth $150,000 based on the final price in the example above. So, Joe's retirement portfolio is $18,000 worse off (less $9000 for the cost of the 18 units) by not keeping up his contributions. This example is very basic and is based on assumptions like the market recovering - which I would be very confident of given historical trends. Still you get the idea and power behind dollar cost averaging. You can get more bang for your buck when markets are down and magnify the gains when markets rise.

In conclusion

Unless other circumstances prevent you from maintaining your regular retirement account contributions, don't stop investing when things get rocky. To ensure a comfortable retirement aim to commit 10% to 15% of your salary in a 401K or other retirement account. Best of all your contributions will be tax free and most likely accompanied by a company match.

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The answer is No. According to the IRS website - "You will not owe tax on your payment when you file your 2008 federal income tax return. But you should keep a copy of the IRS letter you receive later this year listing the amount of your payment." That's a relief. I am still waiting for my check, but over the last few weeks the stimulus check has been a very hot topic with some stuff being said way off the mark. For accurate and verified information, go to the source - The IRS Economic Stimulus Payments Information Center - where you can get all the information and frequently asked questions on the stimulus you could ever need.

With that, and to find what else is the buzz, here are some of the recent blog carnivals and festivals my articles were featured in over the week. Great job by all the hosts.

Money under thirty hosted the Carnival of Personal Finance #152, which featued my article on starting to budget for $5 gas

Festival of Frugality #125 was hosted at the Quest For Four Pillars, and featured my article on frugal ways to keep your home safe. This was an editiors pick!

The 88th Festival of Stocks was hosted at the Stock Market Prognosticator, which included my article on Macau Play : Melco PBL (MPEL) - on the up and worth a gamble

The Money Hacks Carnival was hosted at Can I Get Rich on a Salary which had a greek gods theme and had my article on understanding Taxes and my Paycheck.

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Here are interviews with various people on what they plan to do with their stimulus checks. With the government hoping people will spend a majority of the $100 billion dollars, they may be concerned with some of the sample responses where a number of folks are just going to save the stimulus payment ($600 per person). What I found interesting was how the various folks responded in line with the the stereotype for their gender, race and background.
Video running time : 4 minutes

From a personal standpoint, I think the stimulus is going to have a limited effect and it will most likely benefit corporate America the most as people spend on services, merchandise or just repay debts. Realistically $600 is not going to save people in financial distress or dramatically change someones life. It is almost like the government has said we don't know how to effectively spend taxpayers money to save the economy so let them decide for themselves. So I ask you, what is the need for those high paid decision makers?

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When I moved here one of the financial mysteries for me were the taxes on my paycheck, what would be deducted and more importantly how much should I withhold to meet my tax obligations. I learnt the importance of understanding this the hard way with a hefty tax bill, due to not withholding enough taxes during the year. Luckily I had sufficient funds to pay the tax liability and there was no fine as this was the first year I owed taxes. If I owe taxes again next year, there will be a $300+ fine. With this in mind, I thought I would summarize my learning experiences around the taxes in ones paycheck and how they are calculated. I work in large Fortune 100 corporation, which outsources it paycheck process to a national payroll company, so I imagine it contains most of the common elements present in paychecks.

Here are the key items and related tax details that you should be aware of:

1.The paycheck should have all your correct personnel details listed near the top - especially your location and tax marital status (married or single). If incorrect, you need to contact your HR or Payroll department to fix these as soon as possible because they can affect your taxes. Per the tax tables at the end of this post tax rates and thresholds vary greatly by marital status.

2.The next section to look at is your Federal and State Exemptions (or Allowances). These are very important and suffice to say, could make the difference whether you pay taxes or get a refund at the end of the year. The exemptions you take will affect how much tax is withheld (deducted) from your paycheck to meet your annual expected tax liability. Generally the more exemptions you take the less tax is withheld during the year. The details behind this is separate post in itself, but the Internal Revenue Service (IRS) has detailed guide book and calculator to help you determine the appropriate number of allowances (or additional tax withholding) for your situation. It is long, but take the time to read it. When in doubt take zero exemptions.Talking to others I found that if you are renting or taking the standard deductions in your tax return, selecting no exemptions is the safest option. However this will vary for everyone based on their own individual situation.

3.The rest of your paycheck should contain your income details and various taxable and non-taxable deductions (like health insurance or 401K contributions you have elected to make). Remember your federal and state taxes are calculated on your Adjusted Gross Income. Next, look for a section that breaks down your withheld taxes and you should see the following four items :

- Fed Withholding - This is the amount of federal taxes you are having withheld. America has a PAYG (pay as you go) progressive taxation system where taxes are set aside or withheld from your paycheck during the year rather than having one massive tax bill at the end of the year. Think of this as the taxes you are paying in advance. You can choose to have less tax withheld in each paycheck by increasing the number of exemptions/allowances you select in step 2. Alternatively you can choose to have more tax withheld if you feel that the standard withholding is not sufficient. The IRS guide book referenced above can help with this as can the W4 form you use for submitting your exemption requests. See the tables at the end of the post for the 2008/9 tax tables to get a rough idea of what your annual tax liability will be. For example, on a $50,000 adjusted gross income your tax federal tax would be about $16,981 (25% single tax bracket) that works out to $653 per biweekly pay period. If this amount is not being withheld from your paycheck you could be liable for taxes at the end of the year.

- Fed MED/EE - is the Federal Medicare tax. This should be 1.45% of your gross salary.

- Fed OASDI/D - Federal Old Age Survivors Disability tax, which is also known as the Social Security tax. The idea is that this will be paid back to you as a pension when you retire. It is debatable whether this will be the case given government spending, but that is the subject of another post. The Social security tax rate for wages paid in 2008 is 6.2% of gross salary (to a limit of $102,000, after which it is fixed at $6,324). Your employer contributes a matching amount on your behalf.

- [State] Withholding - As with your federal withholding you withhold taxes for your state income tax liability. Each state has a different tax rate so withholding amounts will be different by location. Click here for a listing of state income tax rates.


Hopefully this article should help you get started on understanding your paycheck and taxes in it a little bit better. It is also a good guide to review your current paycheck. Take the time to ensure that the correct taxes are being withheld so that you don't have a large tax bill at the end of year. On the flip side, you also don't want too withhold too much and have a big refund in the subsequent year. This is because you are giving up money you rightfully should have and could have invested, as opposed to a free annual loan to the federal and state tax departments. Using last years returns and references in this article should help you determine the right of amount of taxes to withhold. If you have any feedback on the above or additional tips, do leave a comment.

Supplementary information

Your paycheck will probably contain a lot of other information not mentioned here. So here are three good samples I found online with descriptions for all sections normally in a paycheck. Click the following links to view them: Example 1 and Example 2 and Example 3

US Tax Schedule 2008/2009 and Rates for Single Filing Status

10% on income between $0 and $8,025
15% on the income between $8,025 and $32,550; plus $802.50
25% on the income between $32,550 and $78,850; plus $4,481.25
28% on the income between $78,850 and $164,550; plus $16,056.25
33% on the income between $164,550 and $357,700; plus $40,052.25
35% on the income over $357,700; plus $103,791.75

US Tax Schedule and Rates 2008/2009 for Married Filing Jointly

10% on the income between $0 and $16,050
15% on the income between $16,050 and $65,100; plus $1,605.00
25% on the income between $65,100 and $131,450; plus $8,962.50
28% on the income between $131,450 and $200,300; plus $25,550.00
33% on the income between $200,300 and $357,700; plus $44,828.00
35% on the income over $357,700; plus $96,770.00

Definitions in your paycheck to know from a taxation perspective:

Gross Salary is the amount your employer pays you before any deductions, i.e., John gets paid $50/hour as an electrical engineer. His annual gross salary is $50/hour x 2,000 hours/year = $100,000/year.

W-2 Wages = Gross Salary less (contributions to employer retirement plan) less (contributions to employer health plan) less (contributions to some other employer plans)

Adjusted Gross Income (AGI) is Total Income (Gross Salary, bonuses and other income) less some specific allowed deductions (such as; alimony, home or student loan interest etc)

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I recently received an email from the IRS as shown in the screen shot below. Do you think it looks real? I did and for a minute I was about to do as it instructed - provide my social security and bank account details. Then I thought why would the IRS be asking me to do this if I had already provided it in my tax return. Luckily I took the time to check the real IRS website, and found that this "phishing" email is part of a far reaching identity theft scam to get your personal financial information.

Here is what the official IRS website has to say about it

An e-mail claiming to come from the IRS about the "2008 Economic Stimulus Refund" tells recipients to click on a link to fill out a form, apparently for direct deposit of the payment into their bank account. This appears to be an identity theft scheme to obtain recipients' personal and financial information so the scammers can clean out their victims' financial accounts. In reality, taxpayers do not have to fill out a separate form to get a stimulus payment or have it directly deposited; all they had to do was file a tax return and provide direct deposit information on the return.

I receive a number of scam and identity theft type emails every month but most of them are pretty obvious and automatically end up in my junk email. This one came directly to my inbox, looked quite genuine and the timing is also very good. It plays to the basic human emotion of greed and a way to get the stimulus money sooner for a lot of families eagerly awaiting these funds. Unfortunately, I think a number of people are going to get caught out by this hoax.

People whose identities have been stolen through scams like this can spend months or years — and their hard-earned money — cleaning up the mess thieves have made of their reputations and credit records. In the meantime, victims may lose job opportunities, may be refused loans, education, housing or cars, or even get arrested for crimes they didn't commit.

My rule is to always be wary of emails or phone calls that ask for personal and/or financial information. If in doubt check with the real provider. Never give out identifying information to sources you don't trust and check your credit history regularly.

Related Posts:

10 things to know about your Credit Score

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This is a guest post by Tony Parker, an experienced and succesful investor across various asset classes.

We all want to get out from under our massive mortgage debt. So what is the best way to pay off the mortgage quicker – and not significantly impact your ability to retire? The answer is a variation on the good old “Pay every two weeks instead of once a month” approach. Increasing the number or frequency of your payments, even marginally, can greatly reduce the amount of interest you pay and thereby, reduce the number of years you pay toward the mortgage – by about seven years, if done diligently.

However, making payments every two weeks may not be ideal for a number of people due to personal or work related circumstances. So, I have an approach that will alleviate this pressure AND still achieve the same benefits as making bi-weekly payments. Just do the following: Make two additional payments (principal and interest, not taxes, insurance, or other escrow stuff) anytime throughout the year and you achieve the same objectives as above – within a year or so. This approach is based on simple math and is flexible and free. You can make the extra payments when it is most accommodating – bonus time, tax return time, etc. – rather than being “under the gun” every two weeks to pay your mortgage; I hate that kind of pressure.

The best part about this process is the benefit you gain in the long term. Those two extra mortgage payments per year could be applied to retirement savings, but I don’t the trade-off is worth it. Some may disagree with me on this, but I would rather own my home, outright, at age 65 and sacrifice a few extra bucks meant for my 401K and/or IRA. Here some more reasons why:

1. You always need a place to live and having your own gives that peace of mind - unless you like socializing with individuals in shelters.

2. Unfortunately, unless you are really wealthy, you are at the mercy of the prevailing economic environment. Therefore, if you happen to start retirement in the middle of a recession, chances are your portfolio will be significantly lower than the guy who started withdrawing five years earlier. If historical trends hold, chances are your house will maintain more of its value during a recession than your stocks and bonds. The housing market may currently be depressed, but most people are not losing 50% of their homes value as is happening with a number of out blue-chip stocks currently (Bear Stearns anyone?)

3. It is far easier to pull equity out of your house than in the recent past. Specifically, although costly, reserve mortgages are a gem, especially if you have no children (or don’t like your children!) and therefore don’t feel a need to leave assets behind after you go to the big sandbox in the sky (deep underground, for some of you!).

4. The Maestro, Greenspan, believes we are entering a long-term high inflation environment. If true – and I think he is right – then inflation will have much more impact on liquid assets (stocks/bonds/funds) than hard assets (real estate). In fact, although you are paying more for your day-to-day consumables, your house will likely appreciate at the same rate of inflation, thereby benefiting your net worth - if not your day-to-day pocketbook.


Conclusion: Pay off that mortgage before you hit 65, even if it means less retirement savings.

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Here is a great article covering what a 401K is and why it is a great investment. It is a good refresher article!

As more Americans shoulder the responsibility of funding their own retirement, many rely increasingly on their 401(k) retirement plans to provide the means to meet their investment goals. That's because 401(k) plans offer a variety of attractive features that make investing for the future easy and potentially profitable.

Below we've listed a number of key points regarding 401(k) plans. Be sure to talk to your employer or plan administrator about the specific features and rules of your plan.

What Is a 401(k)?

A 401(k) plan is an employee-funded savings plan for retirement. It takes its name from the section of the Internal Revenue Code that created these plans, which are also known as "qualified defined contribution" retirement plans -- "qualified" because they meet the tax law requirements for favorable tax treatment (described below) and "defined contribution" because contributions are defined under the terms of the plan, while benefits will vary depending on plan balances and investment returns.

Tax Treatment

The 401(k) plan allows you to contribute up to $15,500 of your salary in 2007 to a special account set up by your company. Future contribution limits will be adjusted for inflation. Keep in mind that individual plans may have lower limits on the amount you can contribute. In addition, individuals age 50 and older who participate in a 401(k) plan can take advantage of "catch-up" contributions of an additional $5,000 in 2007.

Commencing in 2006, 401(k) plans now come in two varieties: traditional and new Roth-style plans. A traditional 401(k) plan allows you to defer taxes on the portion of your salary contributed to the plan until the funds are withdrawn in retirement, at which point contributions and earnings are taxed as ordinary income. In addition, because the amount of your pretax contribution is deducted directly from your paycheck, your taxable income is reduced, which in turn lowers your tax burden.

The tax treatment of a Roth 401(k) plan is different. Under a Roth plan, contributions are made in after-tax dollars, so there is no immediate tax benefit. However, plan balances grow tax-free; you pay no taxes on qualified distributions.Both traditional and Roth plans require that distributions be qualified. In general, this means they must be taken after age 59 (or age 55 if you are separating from the employer whose plan will be making the distributions), although there are certain exceptions for hardship withdrawals, as defined by the IRS. If a distribution is not qualified, a 10% IRS penalty will apply in addition to ordinary income taxes on all pretax contributions and earnings.

If your plan permits, you can make contributions in excess of the 2007 limit of $15,500 ($20,500 if over age 50), as long as your total contribution is not more than 100% of your pretax salary, or $44,000, whichever is less. That means if your salary is $100,000, you can contribute up to $44,000 total to your 401(k) plan during that year. In the case of a traditional 401(k), however, only the first $15,500 ($20,500 if over 50) of your contributions can be made pretax in 2007; contributions over and above that amount must be made after taxes and do not reduce your salary for tax purposes.

Matching Contributions

Besides its favorable tax treatment, one of the biggest advantages of a 401(k) plan is that employers may match part or all of the contributions you make to your plan. Typically, an employer will match a portion of your contributions, for example, 50% of your first 6%. Under a Roth plan, matching contributions are maintained in a separate tax-deferred account, which, like a traditional 401(k) plan, is taxable when withdrawn.

Employer contributions may require a "vesting" period before you have full claim to the money and investment earnings. But keep in mind that if your company matches your contributions, it's like getting extra money on top of your salary.

The Advantage of Tax Deferral

As you evaluate the potential benefits of a 401(k) plan, consider the advantage of tax deferral. When a hypothetical $100 monthly investment is made for 30 years in a traditional 401(k) plan, vs. a fully taxable investment account. The chart assumes an annual 8% average rate of return compounded monthly and a 25% tax rate. For simplicity, it assumes the taxable account earns interest income only, which is taxed at the end of each calendar year.

The result? The chart shows that even if the entire amount in the 401(k) plan was withdrawn after 30 years and taxed, there would still be more money left than in the taxable account. Bear in mind that withdrawals from a 401(k) plan before age 59 may be subject to penalty taxes. This example is hypothetical and not indicative of future performance in your retirement plan.

Tax-Deferred Compounding

The benefit of compounding reveals itself in a tax-advantaged account such as a 401(k) plan. As the accompanying chart shows, if your $100 monthly contribution accumulates tax-deferred over 30 years, you could grow your retirement nest egg to $150,030. That's a difference of almost $50,000 just because you didn't have to pay taxes up front! Of course, you'll have to pay taxes on earnings and deductible contributions to a traditional 401(k) when you withdraw the money. But that will likely be when you are retired and may be in a lower tax bracket.

Choosing Investments

Generally, 401(k) plans provide you with several options in which to invest your contributions. Such options may include stocks for growth, bonds for income, or money market investments for protection of principal. This flexibility allows you to spread out your contributions, or diversify, among different types of investments, which can help keep your retirement portfolio from being overly susceptible to different events that could affect the markets.

Changing Jobs

When you change jobs or retire, you generally have four different options for what to do with your plan balance. You can keep the plan in your former employer's plan, if permitted; you can transfer balances to your new employer's plan; you can roll over the balance into an IRA; or you can take a cash distribution. The first three options generally entail no immediate tax consequences; however, taking a cash distribution will usually trigger 20% withholding, a 10% IRS penalty tax, and ordinary income tax on pretax contributions and earnings.
When deciding on which of the first three options to choose, you should consider available investment options and ease of access. Often, rolling over to an IRA provides the greatest flexibility and control, while affording a wide choice of investment alternatives.

Borrowing from Your Retirement Plan

One potential advantage of many 401(k) plans is that you can borrow as much as 50% of your vested account balance, up to $50,000. In most cases, if you systematically pay back the loan with interest within five years, no penalties are assessed.

If you leave the company, however, you may have to pay back the loan in full immediately, depending on your plan's rules. In addition, loans not repaid to the plan within the stated period are considered withdrawals and will be taxed and penalized accordingly.

Get Advice

A 401(k) plan can become the cornerstone of your personal retirement savings program, providing the foundation for your future financial security. Consult with your plan administrator or financial adviser to help you determine how your employer's 401(k) plan could help make your financial future more secure.

(Source From Businessweek.com/Standard & Poor's Financial Communications)

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