Idea$ 2014 - July: Preventing Identity Theft

In today's fast moving world where everything is electronic and information is shared over the internet more and more, there is a high likelihood that most people will suffer some form of identity theft in their lifetime.  Identity theft can range from an unauthorized party using your credit or debit card, using your social security number (SSN) to apply for credit, or even filing a fraudulent tax return under your name and SSN.  The obvious way to prevent identity theft is to keep personal information locked away in a safe and never let anyone else have access.  But, let's be honest, the majority of people are not willing to sacrifice the convenience of shopping online, paying for goods and services over the phone or through the mail, or e-filing tax returns in order to eliminate the risk of identity theft completely.  When you heard Target lost info on 100 million customers last year, did you vow never to shop at Target again just to find yourself there a month later?

The question is, in the "real world", how can a person guard themselves against identity theft?  Following are a few practical steps you can take to operate in our modern society while also protecting what's nearest and dearest - your identity.  

• Be mindful of how you transmit personal information.  Your personal information can include your SSN, bank account and credit card numbers, home address, and username/password information for email and financial websites.  Information like this should never be shared over a free, global email service like Yahoo! or Gmail because the message can be stolen.  If giving information over the phone, make sure you know who you're talking with and that they are a trusted source.  This also applies to people that still use fax machines, because you never know who will be picking up the document on the other end.  
• Research the security of your payments when online shopping.  Usually online retailers provide information on how online payments are handled.  For example, here is a link to how Amazon processes online transactions.  If you are shopping online with a retailer for the first time, research how they handle transactions and the security they use.  
• Save and shred.  If you still receive paper statements for your bank accounts or credit cards, save the statements in a safe, secure place (like a locked file cabinet).  If you're done with the document, get a small shredder for your home and shred the documents.  Ever see a guy digging through a trash can on your street?  Yeah, he's not looking for food - he's looking for your bank statement.  If you receive your statements in electronic format (PDF), save them somewhere secure on your computer i.e. not on your desktop in a folder called "Money Stuff".  
• Check your transactions weekly.  Before iPhone's and iPad's this would be a hassle.  But, if you have a bank account or a credit card, then chances are the provider now has an app you can download.  Then, every Sunday while you are watching golf on TV, scroll through your transactions and make sure there is nothing that looks funny.  You can also use a personal finance app like Mint which will accumulate all your accounts in one place for easy viewing and management.  
• Run your credit report.  You can run a credit report for free each year at a site like AnnualCreditReport.com.  The report won't give you a credit score, but it will show you everything on your credit report.  Look to make sure you recognize all the credit accounts on the report in case someone has opened up a credit card using your info that you don't know about.
• Use common sense.  Reputable businesses will not ask for personal information over email or ask for information they don't need.  Your plumber doesn't need your SSN and your Facebook friend doesn't need your credit card number for "verification purposes".  So if someone is asking for something from you that you are not comfortable sharing, question why they need the information.  

As mentioned above, with the advent of e-filing tax returns, criminals have found a new strategy of stealing money by filing fraudulent income tax returns.  The thief e-files a return using someone else's name and SSN and false tax information, generates a large refund, and then disappears with the money.  Then, when the real taxpayer files their actual return, it is rejected by the IRS because a return has already been filed for that SSN.  Big headache for the taxpayer.  The IRS has a website with resources for taxpayers that have been affected by identity theft.

 In closing, use common sense when sharing personal information and take steps to keep your information safe.  If you fall victim to identity theft, don't panic.  Fortunately, as identity theft crime has evolved so have the safeguards put in place by banks, online retailers and credit card companies.  In some cases, they know about the theft before you do.  Although this is not a fail-safe, at least you are not battling alone.  

Bitcoin

If you have been keeping up with new fads, you have probably noticed the growing popularity of the Bitcoin.  But, what exactly is a Bitcoin and how does it work?  

Bitcoin is a digital currency.  Bitcoin can be used to pay for goods or services (if the vendor accepts that type of payment).  But, there is no physical currency.  Bitcoin is completely electronic, and payments are made and received over the internet using computers, tablets and smartphones.

To get Bitcoin, you visit an exchange on the internet and buy them with real money (US dollars, Euros, etc.).  Then you can use your Bitcoin to pay for goods and services from vendors that accept Bitcoin.  You can also transfer your Bitcoin to another user.  For example, if you and your buddy split a cab and he pays for the ride, you can transfer him Bitcoin to reimburse him for your share.   

Sounds pretty neat right?  It's like going to the arcade and cashing in dollar bills for game tokens, except the tokens do not physically exist and they can be used all over the world.  But, there are a few other considerations that make the concept not so simple.  

First, Bitcoin has a market value, similar to an exchange rate.  As of the writing of this article, according to bitcoinexchangerate.org, 1 Bitcoin is valued at $653.42.  This value will fluctuate according to the demand for Bitcoin, similar to a stock in the S&P 500.  This creates an environment where some use Bitcoin to pay for goods and services, while others are holding them as an investment.  According to this chart from CoinDesk, the value of a Bitcoin has fluctuated between $67 and $640 in the last year.  

Second, the IRS has issued a notice and FAQ's regarding the tax treatment of Bitcoin.  In the notice, the IRS states that virtual currency is treated as property similar to other property in the hands of the taxpayer.  This means that the exchange of virtual currency for goods and services could result in a gain or loss to the buyer.  For example, if I use one Bitcoin I paid $600 for to buy a set of golf clubs for $700, the seller must report the receipt of the Bitcoin as a sale at fair market value on the day of receipt ($700).  Also, I must report a $100 gain on the exchange of the currency because I used an asset that cost me $600 to buy something worth $700.  Using virtual currency is also subject to the tax reporting rules i.e. 1099's.  If I pay a contractor $1,000 in the form of two Bitcoin, I must issue that contractor a 1099 at the end of the year since the value of the services were more than the $600 1099 reporting limit.  

In closing, I am a big fan of modern technology and moving into a "greener" world.  The use of virtual currency makes it easier for buyers and sellers to transact business across borders without the worry of currency translation.  However, users of virtual currency should make themselves familiar with the ins and outs of their transactions and any related tax consequences prior to buying or selling.  To find more information about Bitcoin, I found their website very helpful.  

Idea$ 2014 - June: Tax-efficient investments

Taxpayers are always looking for ways to accomplish the wealth trifecta - preserve principal, generate income, and minimize taxes.  Yet accomplishing this feat is very challenging due to a number of external factors.  In order to preserve principal, investors must often sacrifice higher returns for less risky investments, which reduces income.  Riskier investments have the potential to generate higher returns (income), but they also present the risk of loss of capital.  Furthermore, investments that generate income subject the investor to a higher tax rate.  As you can see, it's easy to find investments that meet 2 out of 3 of these criteria, but winning the trifecta is much more difficult.  Following are some alternatives for taxpayers looking for tax-efficient investments.  

Municipal bonds

Municipal bonds (muni's) are tax-efficient in that the income they generate is typically not taxable at the Federal level and, if planned correctly, at the state level.  Muni's are bond issues for municipalities such as cities, counties or school districts.  Muni's, like all bonds, are sold at a premium or a discount depending on the bond's yield at the time of sale.  

Interest on municipal bonds is always tax-exempt at the Federal level.  Each state is different, but in Arkansas, all interest earned on Arkansas municipal bonds is tax-exempt to Arkansas.  For example, an Arkansas taxpayer with municipal bond interest from school districts in Arkansas and Texas will only pay Arkansas tax on the interest from the Texas school districts.  

Beware that tax-exempt income is a preference item for the alternative minimum tax.  Investors considering substantial investments in tax-exempt bonds should consult their tax adviser to verify that the interest will not subject them to the AMT.  

Master limited partnerships

Master limited partnerships (MLPs) have gained popularity in recent years for their favorable tax treatment.  Investors enter into MLPs as a partner.  During the year, they receive distributions from the partnership that are not taxable.  Then, at the end of the year, the investor receives a Form K-1 reporting their share of income and losses.  

Although it is possible for the K-1 to report income to the partner, due to non-cash expense items the distributions typically exceed the amount of income on the K-1.  The downside to owning units in an MLP is that, upon sale, a portion of the gain (if any) is reported as ordinary income.  See additional information regarding investing in MLPs in a previous article regarding owning MLPs in a retirement account.  

Practical considerations

Tax-efficient investing is best suited for investors that desire to preserve principal in their investments and also do not have many deductions to offset their taxable income.  A young taxpayer with children at home, dependent care expenses and a mortgage can afford to generate more investment income because their effective tax rate will be lower as a result of their deductions.  However, a taxpayer with no children and few deductions will benefit more from tax-efficient investing.  

Idea$ 2014 - February: Retirement accounts

During the month of January, it seemed as if everyday I went to the mailbox or checked my email, there was some kind of document related to my finances waiting for me.  On Monday I got a 1099 from my bank for interest earned during the year.  On Tuesday American Express sent me my "Annual Summary" which shows how much money I spent during the year and in what categories (which can be a great tool to use when making a Budget).  Then on Wednesday, I got my W-2, Thursday brought my 1098 mortgage statement, and on Friday I got a Form 5498 showing contributions to my Roth IRA.  The irony is, the 5498 also discloses the fair market value of the account at the end of the year, to which I responded "hmm, I figured it would be more than that....I wonder what I still own in there?"  

Between packing up holiday decorations and getting together tax information, retirement accounts don't carry as much priority this time of year.  But, this is a great time to go over your retirement accounts and analyze contribution amounts and investment allocations.  

Investment allocations

The investment allocation of your retirement portfolio is simply how you have your portfolio diversified between different types of investments.  There is a wide array of investment options out there, including common stocks and exchange traded funds (ETFs), to mutual funds and bonds.  There are even different allocations within some of these families.  For example, a mutual fund can own large-cap growth stocks or small-cap international stocks.  Determining how to allocate your retirement portfolio between these different types of investments is usually tied to your age.  A 30-year-old worker will want to have their portfolio allocated more to higher-risk investments like growth and international stocks, whereas a 60-year-old worker will want to have more of their portfolio invested in less risky assets such as dividend stocks or bonds.  This is true for two reasons: 1) as an older worker nears retirement, their risk of loss of principal is greater because they will be withdrawing the funds in the near future, and 2) an older worker does not have as much time to make up for losses in a broad market decline as compared to a younger worker.  A simple Google search will produce a number of links to investment allocation calculators where you can input your age, how long until you retire, and the amount you expect to contribute, and the calculator will suggest an investment allocation for you.  One of my favorites is from CNN Money, and can be found here.

Contributions

Another aspect of a retirement account to consider is how much to contribute.  The common response to this is 10% of gross wages, but that figure is debatable given certain circumstances.  First, a young worker might not be able to contribute 10% because they have other liabilities such as student or car loans that must be serviced.  A young worker just starting out, living on their own and providing for themselves might also not have the cash flow to put away 10%.  In this case the worker should put away something that they are comfortable with.  On the other hand, take an older worker (55) that makes a very high wage, let's say $250,000/year.  The 2014 contribution limits to a 401(k) are $17,500, and workers over the age of 50 can defer an additional $5,500 as catch-up contributions.  In this case, if the older worker put away 10%, they would exceed the allowable amount of contributions.  One other consideration is the employer match.  If your employer matches all contributions made by the employee up to 3% of their income, then it is beneficial for the worker to defer at least 3%.  This way, the worker will be saving something, and will be getting full benefit from their employer.  The match is in effect free money and should not be passed up.    

Company stock

I live in Little Rock, and we have a handful of publicly traded companies located here, one of which is Windstream Communications.  Dividend investors love Windstream because, even with a stock price below $10, they pay a $1 per share annual dividend.  This is a pretty good return, especially on common stock.  But every once in a while I will hear a friend of mine that works at Windstream say "I dumped all of my 401(k) into Windstream stock...can't beat that dividend!"  Although this mindset seems smart, ("I work there, it's a great company, and it's a great dividend) it is a very risky move.  Several employees at Enron did the same thing, and ended up with no retirement savings after the company went belly-up.  I'm in no way suggesting that Windstream will have a similar fate, but the lesson is investing all of your retirement account in one asset, including company stock, is very risky.  The key to having a retirement account that grows and can weather the ups and downs of the market is diversification, and investing all of your contributions in one asset prevents even the smallest form of diversification.  

In conclusion, take some time this month to look over your retirement account statement.  Calculate how much you have invested in each asset class, and if there is too much or too little consider rebalancing the account.  Because the assets are in a retirement account, you won't be taxed on any gains or losses generated transferring funds between investments.  During this process, consider how much you have invested in stock of the company where you work, and take some off the table if it seems too high.  Also look at your contributions and see if they are too high or too low.  If you find yourself having excess funds each month, it might be wise to up your contributions, but if you are struggling to make ends meet or have other obligations it's okay to lower the contributions, as long as you don't sacrifice your company's matching provision in the process.  

Idea$ 2014

Each month during 2014, the Ruggnotes will dedicate one article to a financial topic. These topics are are designed to give readers resources to address various parts of their finances.

Posts are now published for the following months:

January - Budgeting

February - Retirement accounts

March - Taxes

April - Spring cleaning

May - Wills, Trusts and the Zombie Apocalypse

June - Tax efficient investments

Check back in July for the next topic in the Idea$ 2014 series.