How Could New FICO Scoring Affect You?

A new scoring model from Fair Isaac Corp., the company behind the FICO score, is set to be implemented later this year by Equifax and other major credit bureaus. The popular score is commonly used by lenders to determine your eligibility and interest rate for certain loans. Read on to find out if it could affect you.

Consumers in Debt

The new model, FICO 10, will start incorporating consumers’ debt levels into its tabulation, which could cause a decrease in score for some overextended consumers, particularly those who have both personal loans and rising debt. This change is speculated to create greater divide to scores in the 600s. If your score is in the 600s and you’re making payments on time and hacking away at debt, your score could increase. On the other hand, if you’re struggling to pay off debt and missing payments, your score could go down.

Combat Credit Card Spending

FICO 10 will give more consideration to how consumers have changed their payment history in the previous two years, benefitting individuals who are making progress in paying off debt and judging more harshly those who show increasing financial strain. Currently, credit card utilization, which is the percent of your available credit lines you’re using, accounts for 30% of your score, but it could become even more important in FICO 10. The goal is to keep your utilization as low as possible, so be sure to pay balances in full each month or at least keep the balances low. One option to paying off credit card debt is to consolidate it by taking out a personal loan, but this only works if you use that loan to pay off debt while refraining from piling new debt on your credit cards.

Create a Monthly Budget

Because delinquent payments will carry greater weight in the new model, it’s crucial to pay bills on time, so if missing payments is a habit or even an occasional slip-up, you’ll want to be more mindful of this. The best way to keep up with payments is to create a monthly budget. This will not only help with keeping payments at the forefront of your mind (and on your calendar), but you’ll have a better overall picture of your finances and whether or not you’re overspending. Also consider enrolling in autopay, with your loan or credit card payments automatically taken from your bank account at the same time each month.

Though banks and lenders decide which credit model they’ll use, Fair Isaac claims that FICO is used in 90% of all lending decisions, so take the next few months to make changes that will start cutting away at high interest rate debt and provide better overall financial wellness.

Essential Year-End Tax Tips

As the clock winds down to the end of the year, there are a few last-minute money moves to make in order to lower your tax bill.

Maximize Your 401(k) and HSA Contributions

While tax deductible contributions can be made to traditional and Roth IRA accounts until April 15 of 2020, the deadline for 401(k)s and HSA accounts is December 31 of this year. You can contribute up to $19,000 to a 401(k), 403(b), most 457 plans, and federal Thrift Savings Plans (plus $6,000 in catch-up contributions for those who are 50 or older). As for HSA accounts, the maximum contribution for 2019 is $3,500 for individuals and $7,000 for family coverage. And if you’re 55 or older you can contribute an additional $1,000.

Start Thinking About Retirement Contributions for 2020

Retirement contributions to 401(k)s have increased for 2020. Individuals can contribute $19,500 next year, and those 50 or older can contribute an additional $6,500. If you prefer to spread out your contributions evenly throughout the year, you’ll need to adjust your monthly contribution amounts by January.

Take Advantage of Your Flexible Spending Account

Funds in a flexible spending account revert back to the employer if not spent within the calendar year. Some companies might provide a grace period extending into the new year, but others end reimbursements on December 31.

Prevent Taxes on an RMD with Charitable Donations

After seniors reach age 70 ½ they must take a required minimum distribution each year from their retirement accounts (an exception to this rule is a Roth IRA account). Seniors who aren’t dependent on this money for living expenses should consider having it sent directly from the retirement account to a charity as a qualified charitable distribution, effectively preventing the money from becoming taxable income.

Consider a Roth Conversion

Because withdrawals from traditional IRAs are taxed in retirement while distributions from Roth IRAs are tax-free, you might think about converting some funds from a traditional IRA to a Roth IRA. Just be sure this move doesn’t tip you into the next tax bracket. You’ll need to pay taxes on the initial conversion, but the money will then grow tax-free in the Roth IRA.

Take Stock of Losses

Sell any losses in stocks for a deduction of up to $3,000, but be aware that purchasing the same or a substantially similar stock within 30 days of the sale would violate the wash-sale rule. If that happens your capital loss would be deferred until you sell the new shares.

Meet with a Tax Advisor

If you’re unsure whether or not you’re ending the year in a favorable tax bracket, check in with an advisor who can identify actionable steps to reduce taxable income through retirement contributions or itemized deductions.

Holiday Spending: Make a Financial Plan and Avoid Going into Debt

With fall in full swing, it’s the perfect time to start drafting a financial game plan for the holidays in order to avoid overspending, plunging into debt, and piling stress on top of an already stressful season. Here’s how you can hatch a holiday plan for this year and start saving for next year.

Create a Holiday Budget

You’ll first need a solid understanding of your financial situation. How much do you have in savings, and how much of that can be allocated to holiday spending? Or maybe you don’t have enough in savings, or you don’t want to dip into savings, preferring to rely on your discretionary income after monthly bills have been paid? Once you have a full picture, create a budget that works with your current financial circumstances.

It also helps to be mindful of optional spending over the next couple of months. For example, cut back on dining out and retail therapy. You could even cancel some monthly subscription services until after the holidays.

Next, using your budget as a guide, make a list of the items that you’d like to get for everyone on your list along with a set price point for each item. This might take a little research, but having a specific gift in mind and knowing the average market price will help to avoid making impulse purchases. This will also help to cut through the noise of holiday ads and promotions and hone in on sales and discounts for only the items on your list.

Don’t Lose Sight of Additional Holiday Spending

Keep in mind that gifts aren’t the only expense that will cut into your budget. Plan to be frugal with holiday meal shopping, including extra treats and baked goods. Don’t purchase something simply for the sake of tradition and try instead to tailor your holiday meal planning around the actual likes of the people who will be attending your get-togethers. This cuts back on both food waste and money waste. Other often overlooked expenses include gift wrap, holiday cards, mailing costs, and travel expenses.

Make a Plan for Next Year

To make a plan for next holiday season, start by tracking your spending during this holiday season to get a blueprint for average expenses. Then, decide on which strategies you’ll employ for next year’s savings. Here are a few suggestions:

  • Open a holiday savings account. These are typically offered by credit unions, and they are often locked so you can’t access them until the holiday season.
  • Set aside a portion of every paycheck specifically for holiday spending. You can even set up automatic transfers into a separate savings account, building the habit of saving in a “set it and forget it” way.
  • Try the popular 52-week savings challenge. Start by saving $1 the first week of December, then $2 the next week, $3 the following week, and so on. By next holiday season you’ll have nearly $1,400 saved.

With a little foresight and preparation, holiday expenses don’t need to add stress to the festivities of the season.

How to Avoid Paying Capital Gains Tax When You Sell Your Home

Before 1997, once a homeowner reached the age of 55, they had the one-time option of excluding up to $125,000 of gain on the sale of their primary residence. Today any homeowner, regardless of age, has the option to exclude up to $250,000 of gain ($500,000 for married couples filing jointly) on the sale of a home.

What Is Capital Gains Tax?

When you sell property for more than you originally paid, it’s called a capital gain. You need to report your gain to the IRS, which will then tax the gain. Home sales can be excluded from this tax as long as the seller meets the criteria.

Who Qualifies for Capital Gains Tax Exemption?

In order to qualify a seller must meet the minimum IRS criteria:

  • You’ve owned the home for at least two years.
  • You’ve lived in the home as your primary residence for at least two years.
  • You haven’t exempted the gains on another home sale in the last two years.

How to Calculate Gains and Losses

By keeping records of the original purchase price, closing costs, and improvements put into the home (you’ll need to present records and receipts when submitting your taxes), you can avoid being taxed on a significant amount of the profit you make when selling your property.

If, for example, you buy your home for $150,000 and put $20,000 into qualifying upgrades, your cost basis would be $170,000. If you sell the home ten years later for $300,000, the ‘gain’ on your house would be $130,000 (sale price – cost basis), which would have no tax implications because you’d have met the required criteria.

What If You Have More than $250k ($500k for married couples) of Gains?

You’ll be taxed for the amount of gains above $250,000 or $500,000 for married couples filing jointly. To help reduce this amount, keep detailed records of any improvements you put into the home as some improvements can be added to your cost basis, and will thus lessen the amount that needs to be reported.

How to Stop the Paycheck to Paycheck Cycle

According to a 2017 study from Career Builder, nearly 78% percent of people live paycheck to paycheck, with little to no money left over after financial obligations are paid. This means that nearly 8 out of 10 workers may not be able to handle even a $500 emergency. Here’s how to break the paycheck-to-paycheck cycle.

Build a Budget

Yes, this tired old budget thing is rearing its head again, but every financial plan needs to start here. You simply must know where your money is going. Start by creating a simple spreadsheet in Google Docs, which can be shared if you have dual contributors to your household income. If you’re ready for something a bit more sophisticated, Mint.com is a great online tool for budgeting. It will even send you notices and alerts, creating a more personal budgeting experience.

In order to know where your money is going, you need to also track your spending. Document every single purchase for two to four weeks. You’ll be surprised at how seemingly insignificant purchases can quickly add up. Typically, this exercise helps consumers to be more mindful of how they’re spending.

Establish and Emergency Fund

If you approach saving by promising to set aside whatever’s leftover after your financial obligations are paid, you’ll never make a dent in creating an emergency fund, let alone heftier savings goals. Funds intended for saving should come before any other spending. Aim to initially save the equivalent of one month’s paycheck.

Quick fix: put saving on autopilot. If your company offers a 401(k) plan, make sure you’re participating in it. You can also set up an automatic transfer on paydays to have some money automatically transferred from your checking account into a savings account.

Pay Down Debt

Nothing perpetuates the paycheck-to-paycheck cycle like having debt looming over your head. Control and monitor your spending by discontinuing the use of credit cards until you’ve paid them off. To streamline this process, you can consolidate your debt by transferring all your credit onto one card. While you’re focused on paying off debt, avoid taking out any kind of loan. If you can chip away at your debt while simultaneously building up an emergency fund, you can use that fund to pay for any unexpected expenses that may crop up instead of relying on credit cards.

Examine Your Lifestyle

Sometimes fixing the paycheck-to-paycheck cycle is as simple as taking a hard look at your lifestyle and making adjustments where necessary. Is your monthly car payment too high? Does your monthly mortgage payment exceed 28% of your monthly gross income? Are you paying for subscriptions or memberships you don’t use? You get the idea. Examine your monthly costs and find ways to scale back.

Stop Treating Raises and Bonuses as Fun Money

If you’re stuck in the paycheck-to-paycheck cycle, upticks in earnings such as raises, bonuses, and tax returns should be stashed away in savings, not spent on wants and splurges. Likewise, you shouldn’t rely on bonuses as part of your budget. These earnings should be used to increase your emergency savings or retirement funds.

If you have questions or would like to talk about how the information in this article may impact you personally, please reach out to me at jmiller@mkrcpas.com and we’ll schedule a time to talk.