Questions About Hail Damage, Inheritance, Startups, Cheapness and More!

What’s inside? Here are the questions answered in today’s reader mailbag, boiled down to summaries of five or fewer words. Click on the number to jump straight down to the question.
1. Hail damage question
2. Other views on “cheapness”
3. Withdrawing money from index funds
4. First steps toward investing
5. Starting out with 529 plans
6. Inherited cash
7. Inherited debts
8. Banking startup companies
9. Disability income and benefits
10. Navigating expenses after salary reduction
11. Buying life insurance for anyone?
12. 401(k) withdrawals while on disability

On this day when federal income taxes are due, I wanted to give a shout out to the Tax Filing Simplification Act of 2016, which I think is a sorely needed piece of legislation.

So, here’s the idea behind it. The IRS already has all of the data that we’re putting into our tax returns. They have copies of our W-2 forms and our 1099 forms already in hand. All that happens when we file our taxes is that they match the numbers we submit up with their database and then check for anomalies.

The proposal here essentially turns the tables. In February or March, most Americans would receive what amounts to an already-completed tax form from the IRS, with all of the work already done and standard deductions and typical tax credits already assumed based on the tax forms from the previous year. Most people would just sign the form and return it, while some people might send back a revised version with more deductions on it.

This would essentially eliminate most of the tax preparation industry, but it would save most Americans varying amounts of money, anywhere from $10 to thousands of dollars.

There is no rational reason why our tax filing process needs to be as complicated and fraught with confusion and challenges as it is. I’ve received dozens of tax questions from readers in the last month or two and virtually all of them would be solved instantaneously by this system.

Q1: Hail damage question

I recently got caught in a hailstorm driving to work. My 2013 Hyundai Accent, which I have no debt on, took a major pounding—cracked windshield, broken taillight, a tiny hole in the front bumper and dented hood and roof.

My insurance totaled the car and handed me a check. However, the car is still driveable. I took it to an auto shop and they said they could make the basic repairs for a reasonable amount, but repairing or replacing all of the parts would essentially be the same cost to me as buying a new car.

You’ve written before how you believe a good car should be able to reliably get you from point A to point B. A car’s appearance means nothing to me and I’m fine with driving this vehicle into the ground.

Should I get a new car or make only the necessary repairs, leaving my hood and roof dinged up, but with $2,000 more in my wallet? What are the pros and cons?
– Marcus

I’d keep driving it, but do it under the understanding that if something else happens to the car that damages the functionality, your insurance company won’t pay anything.

Most of the time, in a situation where your car has been “totalled” by the insurance company, they won’t insure it for anything more than liability insurance. Thus, if you render this car undriveable in the future, you won’t receive any compensation for it. You’ll just need to replace it out of pocket.

So, in your shoes, I’d stick with this car for now, but I’d start saving for the replacement for this car down the road.

Q2: Other views on “cheapness”

I live in Mexico and as you may have heard Mexicans have a close relationship with family (including parents and siblings) even after marriage. I like that, but I have this problem: my wife and I are not the kind of people that try to keep up with the Joneses. However; my brother has an expensive lifestyle and he thinks I am cheap because I do not spend the way he does. My wife and I have a good income but we like to save some money for the future. Can you give me an advice to stop caring about his opinion? I mean, sometimes I really don’t care but he is my brother and at some point I feel bad about what he thinks of me.
– Neal

You really need to stop worrying about what your brother thinks. Your brother is operating from a different set of values than you are. He values and cares about material things much more than you do.

There’s nothing wrong with that per se, but many people feel as though others who are not operating with the same set of values as them are actually insulting them in some subtle way, so they often feel the need to insult those who do not share their values. Not all people do this, but a lot of people do, and it’s often people who haven’t spent a lot of time thinking about their personal values and why they hold them and why other people might hold different values. Once you’ve done that, it becomes kind of silly to insult people who hold different values than you.

If you want to bring your brother around to your way of thinking, which I think is your underlying goal here, start sharing some personal finance articles with him. Look online for some articles that really sum up your view on things, summarizing how frugality is a tool for achieving personal finance success while still being fulfilling, and share them with him.

For instance, you might simply tell him that you don’t want to live on the paycheck-to-paycheck treadmill any more, that you’re willing to give up some things for personal freedom, and this is the path that you’re following. This approach isn’t a guarantee of the results you want from your relationship with your brother, but it’s a pleasant way to show him your perspective without conflict.

Q3: Withdrawing money from index funds

What’s the process (and penalties) for removing money from index funds? Similarly, when you are to the point of removing money from your index funds to live on when you’re financially independent, what does that look like?
– Tammy

If you have money in a typical index fund that’s not in a retirement account or anything else – such as money invested directly through Vanguard in a taxable account – withdrawing money is pretty painless. In fact, it’s a lot like withdrawing money from a savings account. You just go to their website and indicate how much money you want to withdraw and Vanguard will “sell” enough shares from that index fund to free up the amount of cash you want and then transfer it to your checking account. You can do it with just a few clicks.

The only penalty you need to worry about in this situation is the income taxes. Usually, selling investments from an ordinary taxable account triggers capital gains tax, which you’ll have to pay at the end of the year. Let’s say you originally invested $10,000 and then the investment grew to $25,000. When you sell that investment, you’ll be taxed on that $15,000 that you gained while it was invested. Long term capital gains are taxed at 15%, so you’d have to pay $2,250 in taxes on those gains.

When you’re financially independent, you can tell Vanguard to sell off a certain dollar amount of your index fund investment each month and transfer it to your checking account. They’ll send you a form at the end of the year that will help you with taxes, but a good approach is to save 15% of what you withdraw for taxes. So, let’s say you need $4,000 a month to live on. You’d want to withdraw an extra amount – I’d withdraw 15% more than $4,000, or $4,600 a month – and then save the extra for taxes – in this case, $600 a month.

Tammy has a follow-up question.

Q4: First steps toward investing

We were going to get started with about $10k from a CD that just matured. We also have $30k in a money market savings account that earns basically nothing. It’s our “we both lose our jobs” emergency fund, which we plan to never tap. But should we need to tap it, we’d like it to be relatively liquid. Would you put that into an index fund, as well?
– Tammy

I would generally not put money in the stock market unless I had a specific goal for that money and that goal was more than a decade down the road or that investment will be slowly withdrawn over a very long period that’s ideally significantly more than a decade (like retirement or some other form of long-term support).

If you don’t have a goal, or your goal is shorter term, I would put your money into that very savings account or money market account that you decry.

There are several advantages to such an account that you’re overlooking. First, savings accounts are FDIC insured, which means you can’t lose money on balances lower than $250,000. They’re also really flexible – you can get cash out with incredible ease. They do earn a return, though it’s a small one, so you’re basically guaranteed to move in a positive direction, albeit slowly.

Putting that money in the stock market means that, based on past performance, you’ll earn a higher average annual return. However, that annual return is an average – there are one, three, and five year periods in the stock market where the overall return is negative, which means that you’ve lost money on your investment. It’s actually quite possible that your investment is worth less in five years than it is right now. That risk really only balances itself out over the long term, at least according to historical data.

Basically, investing in stocks comes with significant risk, one that you can mitigate but only over a lot of years. If you’re not going to be in stocks for a lot of years, it doesn’t make sense to take on that risk.

Q5: Starting out with 529 plans

I’ve been wanting to open up 529s for my children for a few years now and just do not know how to sort through all the information to make the best decision for my family. My husband and I make over 200K gross, adjusted I think was around 150. We are not maxed out on our 401K/403b accounts around 10% each. I want to open up 529s for our children and want something direct sold, low cost, and does decent. They are 1.5 and 5 years of age. We live in Hawaii and there is no one (with savings for college) to help me comb through it all to help. Hawaii does not have any tax breaks for joining the state’s 529. However, I was also reading about tax-efficient investing. What should I do? Where do I start? We have a huge mortgage (and a second mortgage on our rental that is being covered by the rent) and after our bills and budgeted spending, we manage to still save about 2100/month, 200 dollars of which are budgeted for college education savings. We’re still trying to build an emergency fund of 6 months, which for us is about 37K. We want to have a little bit more because we have a rental and if my husband’s parents are unable to pay their share of the mortgage (1400) then we need to be able to cover that as well. Housing is expensive in Hawaii. I am still trying to pay off my student loans, which is still at 60K. I currently pay my standard 465/month plus an additional 600/month to it at this time (the 600 is budgeted as bill pay, not savings).
– Nina

The advantage of a 529 is that any money gained in the 529 account is free from federal taxes if used for educational purposes. Some states do offer additional benefits for residents of those states where the money contributed to the 529 is an additional break on state income taxes, but not all states offer that and the benefit is usually much smaller than the educational use tax break you’ll get later on. I think a 529 is still useful for you.

I think your overall savings plan seems reasonable and the $200 per month for college savings is reasonable, too. Your question is, obviously, what should you be doing with it.

In your shoes, I’d start looking at lists of the best 529 plans for non-residents. I generally agree with FinAid.org’s listing of these plans. They suggest that the best 529 plans for non-residents are, in no particular order:

All of the TIAA-CREF plans except Kentucky (which is not open to non-residents): Idaho, Mississippi, Oklahoma, Tennessee, Vermont, California, Connecticut, Georgia, Michigan, Minnesota, Missouri, New York.
Pennsylvania
Iowa
Hawaii
Illinois
Utah
Nebraska
College Savings Bank

I live in Iowa, so I use the Iowa plan and get the additional tax benefit. I am very happy with Iowa’s plan.

I’d look at the plans on that list and choose one that works well for you.

Q6: Inherited cash

The money from a money market was given to daughter upon death of the owner. Is this full amount taxable?
– Sandra

If your daughter simply inherited cash from an estate for which the estate taxes have already been paid (that’s their responsibility, not yours), the inheritance is yours without federal taxes and without taxes in most states, either. Only a few states have inheritance taxes and they’re almost all limited to very large inheritances.

From TurboTax’s reference on this: “The eight states that impose an inheritance tax include Indiana, Iowa, Kentucky, Maryland, Nebraska, New Jersey, Pennsylvania and Tennessee.” If you live in those states, you’ll want to look into the specifics.

My guess is that this is a small amount, so it’s very likely that you won’t owe any taxes at all!

Q7: Inherited debts

Can you tell me if I can go after bad debts from an apartment building that I purchased?
– Charlotte

If I’m understanding you correctly, you acquired an apartment building that previously had renters that did not pay their rent to the previous owners.

In that case, unless those debts were also sold to you, you have no grounds to go after those debts. Those debts are owed to the previous owner of the apartment building, as the debts were incurred due to an arrangement between that owner and the renter. That has nothing to do with the building itself.

So, unless you purchased the debts, too, you can’t go after those bad debts.

Q8: Banking startup companies

Could you please give your views on saving startups in the US, specifically Qapital Inc.?
– Quentin

First of all, there are a lot of savings startups in the United States. Qapital is one. SmartyPig is another. I could list many of them.

They tend to operate in a similar fashion. Many of them are focused on having great user experiences, with some going for a full-featured approach while others are going minimalist. Most are associated with a larger bank in some fashion, allowing that larger bank to handle the actual accounts and banking regulations. They’re required to use banking industry level security, so they’re each as secure as any other bank. Many of them offer different “perks,” such as the ability to get withdrawals in the form of gift cards with a small bonus attached to the value of the card.

I don’t really have a strong feeling about them one way or another. They mostly just offer user tweaks that enable people to manage their accounts in a way that’s appealing to them.

Q9: Disability income and benefits

I’m a disabled veteran and I’m trying to file my taxes. I haven’t seen any forms come in the mail and this is the first time I will be filing with getting a disibility income. I’m trying to figure out what form (W-2, 1099) I need and where can I get it?
– Eric

Disability income is not considered earned income. In the words of TurboTax: “Worker’s comp and service-connected veteran’s disability payments aren’t taxable and don’t need to be reported on your return.”

In other words, you don’t have to pay taxes on it and you don’t even need to report it. You shouldn’t have any tax forms related to it.

Breathe easy, my friend!

Q10: Navigating expenses after salary reduction

I am a single parent, with one child at home in college and three others mostly out on their own. I lost my husband two years ago. The house was in his name and it has been sold by heirs. My mother left her children some money when she passed away. With that I bought a home at the age of 56 and my daughter and I live here. I am a journalist who made about $42,000 a year until recently when new owners raised insurance greatly. Now I make about $36,000. I barely had room to make my mortgage payment, even though it was low, about $450, and I sometimes had to use remaining inheritance money, which is in an inherited IRA. It was difficult imagining doing this until I was in my 80s. I decided to pay off the remaining mortgage last year. I hadn’t figured adequate taxes and the tax bill for 2015 greatly reduced my inherited IRA. It was a shock, I’ve got to say. I do have aother IRA. Now I guess I’m having “payer’s remorse.” But I truly was unable to make my monthly house payments, while still helping two children with some of their expenses. It’s done, but any hand-holding you can give would be most appreciated. thanks you so much.
– Nadine

So, right now, you have a fully paid for home. You make $36,000 a year. However, you now have less saved for retirement than you originally expected. You have four children, three of which are independent and another which is close to it (as soon as she finishes college). You’re getting fairly close to retirement age and are concerned you now won’t have enough to retire according to your previous plans. That’s my understanding of your situation.

Given that situation, the first thing I’d do is take a look at my Social Security benefits statement. What do those benefits look like? How much will you be receiving annually at various ages, and how close is that to the amount you’ll need to live on?

The ground you’ll have to make up in retirement is the difference between your Social Security income and how much you think you’ll need each year, so the next real step is to figure out what you’ll need each year. Start by looking at your own annual spending right now, minus what you spend on your daughter who will be independent by then. Will that spending go down when you retire? It’ll likely go down somewhat, as you won’t need to commute for work or buy work clothes (I’m not sure what your wardrobe requires) or incur any other work-related expenses (like eating out).

Likely, there’s still going to be a gap between what you need and what Social Security can provide you. Figure out that annual amount and multiply it by 25. That’s roughly what you need to have saved between all of your retirement accounts to have enough money to cover what you think you need in retirement. Hopefully, it’s close.

If you find you have a lot of ground to make up, you have several options. Obviously, you need to save as much as humanly possible for retirement starting right now. You may also need to consider working a bit later than you planned, especially so that you can kick in your Social Security benefits at the last possible year to get the largest benefit that you can (making your gap smaller). You may also want to consider things like downsizing your home and moving to somewhere smaller when your last child leaves the nest, as the extra money from the sale will stay in your pocket.

I don’t think you’re in a bad situation, especially not compared to many other people your age.

Q11: Buying life insurance for anyone?

When buying life insurance, can one buy a policy for another person if they are not related as family or employee, if Purchaser is also beneficiary?
– Sarah

The only way you can buy a life insurance policy for someone else is when you have what is called “insurable interest” in that person’s welfare, meaning that you would be adversely impacted financially if that person were to die.

In cases of immediate family and of employees, this is easy to prove, but outside of that, you’re going to have to show the insurance company clear evidence of insurable interest to be able to get that policy. Insuring someone without their consent or without insurable interest is considered insurance fraud.

In general, it’s difficult to buy policies for people besides yourself, your spouse, your children, your parents, or your employees because proving that you have “insurable interest” in such a person becomes very tricky.

Q12: 401(k) withdrawals while on disability

I am a 100% service connected disabled veteran. I am on disability retirement from the state of NC as well, I have a 401k from my my County, as a Detention Offier. Can I withdraw/cash out my 401k without tax penalty? I also get social security, disability, retirement. I am 57 years old.
– Taylor

Your disability income is tax free. Your 401(k) income is not tax free, but in the description you gave, it would be your only taxable income, so the amount of taxes you would pay on it would be very low. In fact, for small annual withrawals, you’d pay zero taxes on it.

Since I don’t know the full specifics of your situation, my honest recommendation is to visit with a tax preparer to figure out the details. This situation can probably be handled out of season, however.

Good luck!

Got any questions? The best way to ask is to follow me on Facebook and ask questions directly there. I’ll attempt to answer them in a future mailbag (which, by way of full disclosure, may also get re-posted on other websites that pick up my blog). However, I do receive many, many questions per week, so I may not necessarily be able to answer yours.

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