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 Post subject: Pleb's Journey to Financial Independence
PostPosted: Thu Jul 26, 2007 5:14 pm 

Joined: Sat Jun 09, 2007 5:44 am
Posts: 15
Hi, I'm pleb. Until a year ago, I was completely ignorant of money. My parents shielded me from it, and while I was at school my scholarship amounted to "we will take everything you have or accumulate, and give you the rest (plus some loans)". I graduated with a bachelor's and master's from a top-tier school in an employable field, but without a financial clue.

Next, I went on a personal finance binge, reading: Your Money or Your Life; Rich Dad, Poor Dad; The Millionaire Next Door; The Weathly Barber; A Random Walk Down Wallstreet; The Random Walk Guide to Investing; The Total Money Makeover; The Automatic Millionaire; The Only Investment Guide You'll Ever Need; Risk & Grow Rich; and some other books that were less memorable. The book with the biggest impression on me was definitely "Your Money or Your Life" and I've been more-or-less following its system since I finished reading it the first time a year ago.

My Financial Goals:
- pay off car loan and student loans (soon, within the month)
- buy real estate (1-3 years)
- become financially independent (10+ years?)

I'm very serious about pursuing financial independence as defined in Your Money or Your Life. Financial Independence happens when your investment income is more than your living expenses, and you can project this happening for the rest of your life. From this day forward, money stops impacting your actions. I can't wait.


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 Post subject: June 1st Wallchart
PostPosted: Thu Jul 26, 2007 5:16 pm 

Joined: Sat Jun 09, 2007 5:44 am
Posts: 15
Image

I track my finances and generate my wallcharts using Google Spreadsheets, which is basically like Excel, except it can be updated from any computer. I love it.

After tracking my expenses for the first three months, the biggest surprised to me is how much my car costs. I'm spending almost as much on it as my housing, and far more than any other category -- yet my car gives me much less utility than this. I'm not annoyed with this enough to sell my car, but I do wish I had chosen a used car instead.

The other thing that concerns me is that the government doesn't seem to be taking a high enough percentage of my income. I know from my tracking that they're taking around 13% for federal income tax, but my tax-bracket is going to be much higher than this. I don't actually mind them giving me a loan until tax-time next year (because I know I'll have enough in the bank to cover it), but I worry that there might be some sort of fee or penalty if it is too much. I suspect the problem is that this is my first full year of working and earning income, so they're uncalibrated.

Note: the spike in April income was due to my 2006 tax return, and the investment income line only has such a nice slope to it because the market was doing great in April and May.


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 Post subject: Re: June 1st Wallchart
PostPosted: Thu Jul 26, 2007 6:49 pm 
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Joined: Thu Apr 05, 2007 6:30 am
Posts: 336
Location: Houston, TX
pleb wrote:
The other thing that concerns me is that the government doesn't seem to be taking a high enough percentage of my income. I know from my tracking that they're taking around 13% for federal income tax, but my tax-bracket is going to be much higher than this. I don't actually mind them giving me a loan until tax-time next year (because I know I'll have enough in the bank to cover it), but I worry that there might be some sort of fee or penalty if it is too much. I suspect the problem is that this is my first full year of working and earning income, so they're uncalibrated.

Yes, you can get hit with penalties at tax time if your withholding is too low. Dig up a withholding calculator, such as the one at IRS.gov, and submit a revised W-4 to your HR department.

_________________
Read my 'fiscal fitness' financial disclosures here.


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 Post subject:
PostPosted: Fri Jul 27, 2007 3:43 pm 

Joined: Sun Jun 10, 2007 6:00 pm
Posts: 260
Location: Chicago, IL
Quote:
Underwithholding costs
If you haven't paid your taxes or paid too little during the year, the IRS will charge interest on the money it decides you should have sent in earlier. The interest is compounded daily and begins on the day the taxes were due and continues until the agency gets the money. The interest rate is variable, based on the federal short-term rate plus 3 percent, and is recalculated every three months.

In addition to the interest charged on unpaid taxes, the IRS can also hit you with a penalty. There is a late-payment charge of 0.5 percent of the tax owed for each month that your tax is unpaid after its due date. This penalty can increase up to 25 percent and can increase in 1 percent increments if you don't pay after getting several notices from the IRS.


It seems they fine you pretty heavily. There is some sort of waiver process if you made an honest mistake but I doubt they'll let that go more than once. You probably want to get that straightened out asap.


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 Post subject:
PostPosted: Fri Jul 27, 2007 9:40 pm 

Joined: Sat Apr 07, 2007 2:03 am
Posts: 872
Location: Taishan, Guangdong, China
There are safe harbor provisions for underwithholding. They are the smaller of:

1) 100% withholding of the previous year's tax
2) 90% withholding of this year's tax

Since this is your first year working, you will obviously meet #1. Hence you will not have to pay penalty or interest.

And you may be overestimating your tax bill. First 6.5K income not taxable due to standard deduction + personal exemption. You'll get some more deductions based on the student loan interest your paying. And if you are contributing to 401K/IRA, that's more money not taxable. After you've exceeded these deductions do you start paying tax. From eyeballing your pie chart, it looks like you are making 85K a year. And it seems like you are saving+investing 3/mo. If you have immediate access to your 401K, putting half of your savings to the 401K will make the tax picture look like so:

6.5K = no tax, standard deduction
2K = no tax, student loan interest
15.5K = no tax, 401K contribution
8K * 10% = 800
24K * 15% = 3600
29K * 25% = 7250
Total Tax = 11650 or 13.7% of 85K salary

If you are not eligible for your 401K and can only contribute 4K to an IRA, that'll bump the percentage to about 17%.


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 Post subject:
PostPosted: Sat Jul 28, 2007 5:48 am 

Joined: Sat Jun 09, 2007 5:44 am
Posts: 15
Thank you for the information about withholdings tinyhands, Baker, and MossySF. It's nice to know that this is penalty is definitely something to keep in mind, but not something that will affect me this year.

The optimizer in me wonders if I can abuse safe harbor #1. Last year I probably paid about $6k in taxes for the portion of the year I worked. Imagine if this year I set up my withholdings to pay $6.1k, and next year $6.2k, and the next $6.3k... Assuming I pay about $13k in taxes at the end of the year (15% of $86k, thanks again Mossy), I'd have about $7k of the government's money to invest every year. If I put that in a 5% savings account for half the year, it'd be a free $175.

I guess when I think about it though, $175/year is not worth the possibility of incurring the wrath of the government in case they have special rules about abusing the safe harbors too blatantly or consistently.


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 Post subject:
PostPosted: Sat Jul 28, 2007 9:20 am 

Joined: Sat Apr 07, 2007 2:03 am
Posts: 872
Location: Taishan, Guangdong, China
pleb wrote:
The optimizer in me wonders if I can abuse safe harbor #1. Last year I probably paid about $6k in taxes for the portion of the year I worked. Imagine if this year I set up my withholdings to pay $6.1k, and next year $6.2k, and the next $6.3k... Assuming I pay about $13k in taxes at the end of the year (15% of $86k, thanks again Mossy), I'd have about $7k of the government's money to invest every year. If I put that in a 5% savings account for half the year, it'd be a free $175.


You can only abuse it if you get paid different amounts every year. Last year you paid $6K. This year you pay $13K. So the next year, your withholding must be either $13K or 90% of $13K+raise %.

Now if you want to tell your boss to pay you $76K one year, $96K the next year and alternate between the two constantly, yes you would be able to get a nice tax-free loan to skim interest from every other year.


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 Post subject: August 1st Wallchart
PostPosted: Thu Aug 02, 2007 4:13 pm 

Joined: Sat Jun 09, 2007 5:44 am
Posts: 15
Image

I'm debt free! I paid off my student loans and car this month. I will likely never have non-mortgage debt again.

I wasn't sure how to track the $14k for my car and $11k for my loans on my wallchart. If I put them as expenses, they would dwarf the other expenses for the year. I decided just not to record them.

The negative slope on investment income kinda sucks. It'd be nice if the stock market would do better. I'm not even thinking about pulling out or investing less, though, which is good evidence that I've internalized the long term investor mentality.

Now that I don't have a $330 / month car payment or $80 / month student loan payment, I'd like to try to get my monthly living expenses down below $1,666/month, or $20k/year.


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 Post subject: Year in Review
PostPosted: Thu Aug 02, 2007 4:18 pm 

Joined: Sat Jun 09, 2007 5:44 am
Posts: 15
I've been working for exactly one year now. In that time, I paid off my debt of $28k ($17k car loan, $11k student loans). I also saved $23k ($18.7k in retirement accounts, $4.3k in cash).

In total I increased my net worth $51k, from about -$28k to $23k. I averaged $4.25k/month of net worth increase. $51k represents 59% of my salary for the year. I didn't actually save that high a percentage of my salary though, because some of that $51k earned was from investment income.

My average living expenses for the time that I tracked was $1.96k/month or $23.5k/year.

If I continue to save $51k/year and can get X above inflation, I could throw off an amount of investment income equal to $23.5k/year living expenses in about:

1% above inflation: thirty-eight years
2% above inflation: nineteen years
3% above inflation: twelve years
4% above inflation: nine years
5% above inflation: seven years
6% above inflation: six years
7% above inflation: five years


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 Post subject:
PostPosted: Thu Aug 02, 2007 6:32 pm 

Joined: Wed Apr 04, 2007 9:50 pm
Posts: 752
Location: Vancouver, Canada
What do you do for a living?

_________________
Andrea Coutu
Consultant Journal
www.consultantjournal.com


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 Post subject:
PostPosted: Thu Aug 02, 2007 7:10 pm 

Joined: Sun Jun 10, 2007 6:00 pm
Posts: 260
Location: Chicago, IL
I make about the same as you but I am not saving anywhere near what you have been able too. IThere is absolutley no way I could get living expenses below $1666. Well maybe if I moved my family into my moms house but I doubt the wife would go for that.

Great job. I wish I could free up that much money.


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 Post subject:
PostPosted: Fri Aug 03, 2007 4:04 pm 

Joined: Sat Jun 09, 2007 5:44 am
Posts: 15
consultantjournal wrote:
What do you do for a living?


I'm a software engineer.

Baker wrote:
Great job. I wish I could free up that much money.


Thanks. I'm single and live with two other people. Except for an unnecessarily nice car, I basically still live like a college student.


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 Post subject:
PostPosted: Fri Aug 03, 2007 4:16 pm 

Joined: Sun Jun 10, 2007 6:00 pm
Posts: 260
Location: Chicago, IL
Are you including retirement funds into you investment return time-frame to reach your cost of living? I couldn' tell but it looked like it. If so you may want to re-calculate your times without that money since you wouldn't really have access to those funds.


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 Post subject:
PostPosted: Sat Aug 04, 2007 2:15 pm 

Joined: Sat Jun 09, 2007 5:44 am
Posts: 15
Baker wrote:
Are you including retirement funds into you investment return time-frame to reach your cost of living? I couldn' tell but it looked like it.


Yes, definitely. Otherwise my projections would be forever. Check this out:

Quote:
IRS regulation 72(t) allows an individual to withdraw "substantially equal periodic payments made for the life expectancy of the individual or the joint lives of the individual and the designated beneficiary." If an individual follows one of the three ways to calculate the "substantially equal payments," they will avoid the 10% early withdrawal tax completely.

The only stipulation for taking early withdrawals is that they must continue until the individual reaches 59.5 years old, or for a period of five years, whichever is longer


Obviously this is a bad move for most people, but if I'm sure that I have enough to retire this way at, say, 40, I see no reason not to go this route.

By the way, the big problem with my projections is that they assume my cost of living stays the same, whereas I'm likely to eventually get married and have kid and have my expenses skyrocket.


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 Post subject:
PostPosted: Sat Aug 04, 2007 2:33 pm 

Joined: Sun Jun 10, 2007 6:00 pm
Posts: 260
Location: Chicago, IL
that and you are calculating based on having stable returns. there is no way to predict where the interest rate will be or wether the stock market will be in an up cycle or down 20%

I was just looking at the IRS site regarding "substantially equal payments" its a little more involved than just skimming interest off the account every year.


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