Category: Everyday Finance

Why You Should Keep Personal and Business Finances Separate

If you are a business owner, it’s important to remember that your company is an independent entity; it’s free-standing from you and your personal finances.

As such, separating your personal and business finances can help ensure you treat your business like the independent entity it is while safeguarding your personal finances.

Why You should keep them separate

It may seem apparent, but there are several reasons to be proactive about separating business and personal finances.

The following breaks down some of the more important reasons why you should consider doing so yourself.

Tax Reasons: One of the major reasons to separate your personal and business finances is for tax purposes.

The ability to take advantage of tax deductions — including writing off business expenses — is a huge reason many business owners choose to split their personal and business finances.

Keeping accurate records of business expenses is vital when running a company, as the IRS is more likely to audit your business and deny deductions and businesses losses if you have no clear separation between business and personal expenses.

The IRS also puts the burden of proof on you to disclose your business expenses and income. Maintaining good records saves you from having to dig through a huge box of receipts to figure out which purchases were for business and which were for your personal expenses.

Personal Liability: Separating your personal and business finances is important for tax reasons, but perhaps equally important, is separating your personal finances for the sake of your personal security.

 If you don’t treat your personal and business finances separately, the law won’t either.

This is known as “piercing the corporate veil” which means the courts will hold a business’s owners, members, or shareholders personally liable for business debts or legal judgments.

Business Credit: Another important reason to detach your personal and business finances is to build business credit.

The ability to obtain working capital for your business is often vital to growing it but many times business owners find themselves signing personal guarantees for leases, loans, and lines of credit because the business doesn’t have established credit.

The goal should be to avoid personal guarantees as much as possible because it means you would be personally responsible for any debt incurred by the business in the event it defaults.

How To keep them separate

Determine How To Structure Your Business: Deciding the legal structure for your business the most important step you can take in separating your finances.

Whether you’re operating as a sole proprietor, corporation or an LLC, the legal structure of your business will basically dictate everything from your risk and liability, to how the IRS will retrieve your business taxes.

In order to make the best decision, take the time to discuss your options with an attorney, CPA, and financial planner.

Maintain Separate Accounts: The ability to distinguish between personal and business finances is critically important.

Open a bank account for your business which will help differentiate between personal and business expenses. It will also help your case if the IRS ever questions the legitimacy of your business.

You’ll also want to get a separate credit card for the business. This will help streamline business finances and helps the business build credit.

Make sure you treat your business checking account and business credit card like it’s someone else’s. You’ll be less likely to raid it in times of need — or for personal use — if you consider it like you’re the employee of the business.

Pay Yourself A Salary: Another tip for keeping personal and business finances separated is by paying yourself.

Write yourself a check each month from your business checking account. Transfer this to your personal checking account, and then behave as you would if you were working for someone else.

Paying yourself a salary can help isolate the line between business and personal profits, instead of haphazardly pulling money from the business.

Should I Use Qualified Charitable Distributions?

Beginning in 2018, there were significant changes to the allowable itemized deductions that could be taken on Schedule A and the standard deduction was increased substantially.

As a result, many taxpayers are no longer be able to itemize deductions which means they don’t receive a tax benefit for making charitable gifts.

However, there still remains a very appealing tax-planning option for folks who are age 70.5 and older called a Qualified Charitable Distribution (QCD).

What is a Qualified Charitable distribution?

A Qualified Charitable Distribution is a direct gift from an IRA (including traditional, rollover, inherited, SEP, and SIMPLE) to a qualified charity.

These distributions have the benefit of satisfying the annual Required Minimum Distribution (RMD) rules while also avoiding income taxes on the distribution — RMDs are taxed as ordinary income.

In fact, QCDs are not included in your adjusted gross income (AGI) at all. Depending on how much you give, this can lower the odds that you’ll be affected by various unfavorable AGI-based rules such as those that can cause more of your Social Security benefits to be taxed and Medicare premiums to increase.

Should i use one?

How do you know if making Qualified Charitable Distributions makes sense for you and your financial situation?

This flowchart will help you get the conversations started with your financial or tax advisor.

things to consider

If you think this strategy is a fit for you, there are some things you’ll want to consider before jumping in head first.

  1. Decide early in the year if you want to use a Qualified Charitable Distribution to satisfy your Required Minimum Distribution. The first dollars out of an IRA are considered to be the RMD. If you satisfy your RMD in February but want to do a QCD in November, that income can be excluded, but it won’t offset the income from the RMD taken earlier in the year.
  2. Each person can donate up to $100,000 annually using the QCD rule. If you’re married filing jointly, and each of you has an IRA, you can both QCD up to $100,000 per year. Keep in mind that that extra distribution can’t be carried over—i.e., used to meet the required minimum distributions for future years. This contrasts with other strategies, such as a donation of cash and appreciated securities, where a large donation can be made in one year and the tax benefits can be carried forward.
  3. Work with your IRA custodian to make sure the QCD is completed correctly. The funds will need to be made payable directly from your IRA to the charity, which means they can’t send you a personal check and you turn around and give it to charity.
  4. Make sure your tax preparer knows that you completed the QCD. Your IRA custodian will send you a 1099-R showing the amount withdrawn from your IRA but the QCD may not be clearly identified. If the QCD isn’t properly listed on your tax return, you won’t get the tax benefits of doing it.
  5. You can make QCDs to multiple charities, just keep meticulous records for your tax preparer.
  6. Verify that the organizations you are giving to qualify. The organization must be a 501(c)(c) and you can’t be receiving a benefit for giving (raffle, sporting event seats, etc.).

Can I Use A 529 To Repay Student Loans?

A question that often gets asked is if 529 accounts can be used to repay student loans. Technically the answer is yes, but there are major drawbacks in doing so.

You can use a 529 account to pay for tuition, fees, room and board, books, computers, and other “qualified” education expenses without tax implications or penalties.

However, student loan payments are not considered qualified expenses.

The earnings on non-qualified withdrawals are subject to federal income tax and may be subject to a 10% federal penalty tax, as well as state and local income taxes. Also, many states have a recapture or “clawback” provision that will make you pay back any tax breaks you received.

PRO TIP: If a non-qualified distribution occurs from a 529 account, the tax credit recapture is assessed to the owner of the account regardless of who actually contributed the funds and received the original credit (e.g., grandparents have been contributing to the account and claiming the credit but you own the account, you are liable for the recapture).

What if the rules change?

Earlier this year, the House Ways and Means Committee unanimously passed the Setting Every Community Up for Retirement Enhancement (SECURE) Act.

While not official yet, the legislation does propose expanding the benefits of 529 college savings plans, including adding principal and interest payments toward student loans as qualified education expenses — up to a lifetime limit of $10,000 per 529 plan beneficiary.

This would be a huge benefit for parents who have leftover money in their child’s 529 accounts after they have already graduated.

Families in this situation now only have two options:

  1. transfer the funds to other children or another family member to use for qualified education expenses, or
  2. accept the tax liability for non-qualified withdrawals.

Having the flexibility to use the 529 accounts for student loans payments would not only increase the 529’s utility for families in this unique situation but even independent, working adults who still have student loans.

Strategy for independent adults

If you’re an independent taxpayer (meaning you can’t be claimed as a dependent on anyone else’s tax return) you can deduct interest on student loans paid by you, or by your spouse if you file a joint return.

Like many tax breaks, the student loan interest deduction is designed to provide tax relief to Americans with low to moderate incomes.

The ability to take the deduction begins to phase out above a certain MAGI (modified adjusted gross income) level.

Phaseout thresholds for the 2019 tax year.

If your MAGI is under the threshold where the phase-out begins, you can deduct up to $2,500 in student loan interest or the actual amount of interest you paid, whichever is less.

PRO TIP: The deduction is capped at $2,500 in total interest per return, not per person, each year. In other words, if you’re single, you can deduct as much as $2,500 of student loan interest. However, if you’re married and file a joint return, you and your spouse can only deduct a total of $2,500, even if both spouses have student loan debt.

If you earn between $70,000 and $85,000 as a single filer or between $140,000 and $170,000 as a joint filer, you’ll qualify for a reduced amount of interest deduction less than $2,500. 

Unfortunately, your student loan interest isn’t deductible at all if your income is more than the ceiling where the phase-out ends. 

While the student loan interest deduction can be very valuable (if you even qualify for it) it’s possible that your state offers a tax incentive for contributing to a 529 plan that is more beneficial than the interest deduction. 34 states currently offer a state tax credit or deduction for contributions to a 529 plan.

Depending on the tax benefit your state is offering, it could make sense to fund a 529 account, earn the tax benefit, and then use the 529 account to pay your student loans.

PRO TIP: There are no age restrictions for 529 accounts which means anyone over the age of 18 can open a 529 and name themselves the beneficiary.

You can generally claim a state tax benefit no matter how long the money is held in your 529 plan. So instead of paying tuition straight from a bank account, you can funnel the money through a 529 plan in order to claim the tax benefit.

Hypothetical example

Let’s assume you’re an Indiana resident and your student loan payments equal $5,000 per year, $2,500 of which is interest.

Indiana taxpayers (resident or non-resident, married or individual) are eligible for a state income tax credit of 20% of contributions to a CollegeChoice 529 account, up to $1,000 credit per year.

You can either pay the $5,000 student loan payments out of pocket and claim the $2,500 interest deduction on your Federal return or use the 529 account strategy to claim a tax credit on your Indiana return.

PRO TIP: Tax code prohibits double-dipping when it comes to claiming multiple credits or deductions for the same expenses in a single year, so student loan interest payments made using a 529 account will not be eligible for the student loan deduction.

Very simplified, very hypothetical, use for illustrative purposes only.

Based on our example, using the 529 plan to funnel the student loan payments through saved an additional $450 in taxes. Not too shabby!

The potential tax savings would be even greater in a scenario where the person was above the income threshold for the interest deduction, as 529 plans don’t have income limits and even the highest earners can contribute and receive available tax benefits.

While this strategy is purely hypothetical right now, I do think it has merit if the SECURE Act becomes law.

I will definitely be keeping my eye on the progress of the bill!

What Are The Different Types of Life Insurance?

There are two basic types of life insurance, term and permanent. 

Depending on your age, health, and overall financial goals you need to weigh the benefits of both before deciding which type of insurance to purchase.  You may only need one type or you may need both.

Understanding what each has to offer is key in making a sound decision.

Term Life Insurance

  • Term insurance only pays a benefit as a result of death within the term period.  The term period usually ranges from one to thirty years.
  • There are two types of term insurance, level term and decreasing term.
  • Level term means that the death benefit will remain the same throughout the existence of the policy.
  • Some level term policies may contain an increasing benefit rider, which increases the death benefit each year over the course of your term.  You will, however, agree to pay slightly higher premiums each year as well.
  • Decreasing term means that the death benefit is steadily reduced, usually in one-year increments, throughout the existence of the policy.
  • Term conversion options are included in many term life insurance policies which allow you to convert to a permanent form of insurance, like whole life.
  • The years in which you can convert — and the products you can convert to — will vary depending on the specific policy and carrier.

Permanent Life Insurance

  • Permanent life insurance does not expire, hence the name. It will pay a death benefit no matter when you die.  It does not limit you to a term period.
  • There are four types of permanent life insurance: traditional whole life, universal, variable, and variable universal.
  • In a traditional whole life policy, the death benefit and premium stay “level” throughout the life of the policy.  This means that a higher than needed premium is paid in the early years to offset the cost of benefits in the later years.  Basically, the “overpayments” are invested to cover the death benefits of older policyholders.  Companies are legally bound to adhere to the limitations of these “overpayments.”  Once they reach a certain amount, the money becomes available to the policyholder if they choose not to maintain the policy until death.  Essentially, it is like having a savings account.
  • A universal policy has its own key characteristics.  You may be able to increase your death benefit if you pass a medical exam.  The cash value account or “savings account” earn interest at a money market rate.  Once you have enough money in your cash value account you may be able to adjust your premium payments.
  • A variable policy allows you to invest your death protection and cash value in stocks, bonds, and mutual funds.  You have the opportunity to grow your policy quickly.  You also, however, assume more risk and may end up with a decreased benefit or cash value.
  • The variable universal policy combines the principles available in both universal and variable policies.  You can adjust premiums and death benefits like you can with universal, but you can also invest aggressively with the potential for greater rewards as with variable.

Educating yourself and understanding the life insurance options that are available is the first step.  Next, you will need to examine your own family structure and financial goals to determine which policy will be best for you and your loved ones.

A financial advisor can help you determine which life insurance is right for you.

5 Investing Mistakes That New Investors Make

With a little knowledge, or some help from a financial advisor, many of the investment mistakes new investors make can be largely avoided.

But most people aren’t aware of the psychological barriers inhibiting their ability to invest successfully in the first place until it’s too late.

Here are the five investing mistakes that most new investors make and how to avoid them.

Relying on Investment Advice from Friends & Family

Your friends and family may have the very best of intentions, but that doesn’t make them qualified to give you advice for investing your wealth.

What’s worse is because we trust our friends and family so much, we are more susceptible to blindly following what they have to say. Which can open us up to misinformation and sometimes downright bad investment advice.

Only a trained, financial professional can analyze your particular financial situation and provide objective advice that’s based on research, facts, and prevailing wisdom.

Trying to Do it On Your Own

Education and active participation in your investment strategy is positive, especially when combined with the financial expertise of a trained financial advisor.

For some people, the DIY method works, but only because they typically treat it as a second profession.  Trying to do it on your own when you’re not sure what you’re doing can lead to costly consequences.

Instead, consider hiring a financial advisor.

Financial advisors not only advise you on how to invest, but how much and when. They’ll make investment recommendations based on your total financial picture, ensuring that you invest where it makes the most sense for you and your personal situation.

Ignoring Risk or Not Understanding Risk

Nothing in life is certain, especially investing.

Every investment comes with risk, some more so than others. A financial advisor will make you aware of the level of risk associated with investments and minimize your exposure to risk as best they can.

Diversification is one such way that a financial advisor minimizes your risk by spreading investments across asset classes so that your eggs aren’t all in one basket.

Not Arming Yourself with Financial Education

Even if you do end up hiring a financial advisor to help you manage your investments, it’s still good to have a general understanding of what type of investments are out there.

Increasing your financial literacy will only help you ask the right questions.

Not Understanding Your Money Personality

One of the first things a financial advisor or even a robo advisor will ask you is how you feel about risk. Your tolerance for risk is a major determining factor in how our investment portfolios are constructed. 

Risk tolerance is determined by a few factors, such as how close you are to retirement and what you are trying to accomplish with your wealth.

Your money personality is how you feel about money, what causes you the most anxiety, and what will cause greater financial security for you.

Knowing your money personality will help a financial advisor to build an investment strategy that most closely aligns with your needs and according to your psychological comfort zone.