money rules


1 CLOSE CREDIT ACCOUNTS

YOU NO LONGER USE

VERDICT: THUMBS DOWN !


Assuming your history with those accounts is good, cut up the cards, but keep the accounts open so you don’t hurt your credit score.


When lenders decide whether to extend credit, they look at how much of your available credit you’re already using—poetically called your utilization ratio. Let’s say you have five credit cards, each with a $10,000 limit, and your total balance is $6,000. That gives you a utilization ratio of 12%—not bad, in the eyes of lenders. But if you close four of those accounts, your ratio suddenly jumps to 60%—not good. “You haven’t borrowed an additional nickel, but on paper it looks as if you’re closer to being overextended,” says Craig Watts of Fair Isaac, the company that developed FJCO credit scores. Ideally, you should keep your

utilization ratio below 50 % says Maxme Sweet of the credit reporting cornpany Experian.


2 BUYING A CAR IS ALWAYS

 CHEAPER THAN LEASING.

 VERDICT: THUMBS DOWN!


It depends on your driving habits, the car you’re considering and what else you could do with the money.


One big benefit of leasing is that you can keep more money in your pocket. You don’t need a down payment, and your monthly note is lower—nearly half as much on some luxury models . Invest the difference, and you could come out ahead.


For a fee, you can get current lease data and software to check prices at sites like www.autoleasingsoftware.com and www.LeaseWizard.com. In general, if you buy a new vehicle as soon as your old one is paid off, leasing can save you money. Buying is a better deal if you tend to hang on to your car.


3 SET UP AN EMERGENCY FUND

  TO COVER 3 TO 6 MONTHS OF EXPENSES.

  VERDICT: THUMBS UP.


You might be able to get by with a smaller stash—say, two or three months of expenses—as long as you have a low-interest home equity line of credit. When calculating your expenses, don’t forget to include the deductible on your auto or homeowners insurance policy, whichever amount is higher. The idea is to keep enough cash on hand so that you don’t have to sell stocks or rack up credit card debt if you have an emergency—but not so much that you lose out on the higher returns you can earn on longer-term investments. Emergency money needs to be safe and accessible, which means keeping it in a bank money-market account or a money market fund with check-writing privileges (find the best rates at Bankrate.com or iMoneyNet.com).



4 A ROTH IRA IS ALWAYS BETTER

 THAN A TRADITIONAL IRA.

 VERDICT: THUMBS UP.


With its promise of tax-free withdrawals in retirement, the Roth IRA is almost always the better choice, assuming you meet the income qualifications. The opportunity to use a Roth is phased out as adjusted gross income rises—between $95,000 and $110,000 on a single return and between $150,000 and $160,000 on a joint return. If your income is too high and you’re not covered by a retirement plan at work, fund a traditional IRA and deduct your contribution.


If you’re covered by an employer-based plan and your income makes you ineligible for deducting your IRA contributions, consider taxable accounts that invest in stock mutual funds, say, or municipal bond funds. Tax rates on long-term capital gains are so low that taxable accounts generally trump a non-deductible IRA.


When you make withdrawals from a traditional IRA, your earnings will be considered ordinary income and may be taxed at a rate as high as 35 %. That compares to 15 % (or less) on long-term capital gains in a taxable account. This low rate may increase in 2009, so the difference between the two strategies may be smaller in the future. Unlike a traditional IRA, a taxable account doesn’t require minimum distributions, and your heirs won’t owe taxes on the growth when you die.


5 YOUR LIFE- INSURANCE COVERAGE SHOULD

  EQUAL 6 TIMES YOUR ANNUAL INCOME.

 VERDICT: THUMBS DOWN.



A better rule is 8 to 10 times your annual income, says Robert Bland, the chief executive officer of www.Insure.com. You’ll need the higher amount if you have young children and are also the sole breadwinner. If both you and your spouse work and you have saved enough to cover most of your kids’ college bills, the lower figure may be sufficient.


Add up your expenses, subtract sources of income available after your death—and buy enough life insurance to make up the difference. Use the “How much life insurance do I need?” calculator at Kiplinger.com/tools. Don’t overlook the value of a stay-at-home spouse. In the event of his or her death, your expenses for child care and other services could increase significantly.


6 DON’T BUY A HOUSE THAT COSTS MORE

 THAN 2.5 TIMES YOUR ANNUAL INCOME.

  VERDICT: THUMBS DOWN.


Good luck even finding such a house in many major cities. What really counts is your monthly payment. And that’s affected by your down payment and the terms of your loan. “If you’ve saved a substantial amount of money, benefitted from a windfall, or taken a lot of equity out of your previous house, you may be able to live with the payments on a more expensive house,” says certified financial planner Barbara Steinmetz of Burlingame, California.


Pete Bonnikson, senior vice president of mortgage operations for F-Loan, says a better rule of thumb is to make sure your monthly mortgage obligation—including principal, interest, taxes and hazard insurance—does not exceed 36 % of your monthly gross income.


7 MONTHLY PAYMENTS ON INSTALLMENT DEBT SHOULDN’T EXCEED 20% OF YOUR TAKE HOME PAY.

  VERDICT: THUMBS DOWN.


That’s too narrow a snapshot. After all, prospective lenders look at all of your current debt . That includes installment debt, such as car loans and credit card balances, plus your mortgage . A better rule is to figure that total monthly debt payments should not exceed 36 % to 40 % of your monthly income, says Bob Walters, chief economist for Quicken Loans.


8 DON’T BUY LONG-TERM CARE INSURANCE IF YOUR ANNUAL INCOME IS LESS THAN $30,000 OR YOU HAVE MORE THAN $1 MILLION IN ASSETS.

VERDICT: THUMBS DOWN.


This rule makes sense on the low end. The National Council on the Aging recommends that you have at least $25,000 to $35,000 in annual retirement income and $75,000 in assets (not counting your house and your car) before considering long-term care insurance. If your income and assets fall significantly, you might qualify for Medicaid if you needed nursing-home care. Still, if you can afford the premiums, long-term care insurance is preferable to relying on Medicaid.


Private insurance gives you significantly more choices. The $1-million cutoff on the upper end doesn’t make the grade, though. In theory, if you have that much in assets, you can afford long-term care. But many people would rather buy insurance: It alleviates the concern that caring for one spouse could deplete a couple’s assets. And it protects those assets for their heirs.


9 YOU CAN RETIRE COMFORTABLY

 ON A NEST EGG OF $1 MILLION.

 VERDICT: THUMBS DOWN.


A million bucks ain’t what it used to be. But it may be enough if you’ve paid off your mortgage, live in a low-cost area and have a comfortable pension.


“The $1 million will safely generate $40,000 the firs t year, and thereafter annual 3 % inflation increases,” says Stuart Ritter, a certified financial planner with T. Rowe Price. “So if you can live on that, plus your other income sources, then it’s enough. If you can’t, it isn’t.”


First, figure out how much money you’ll likely spend annually in retirement; then work backward to calculate how large a fund you’ll need. A T. Rowe Price retirement income calculator can give you alternatives to help your money last longer.

(www3.troweprice.com/ric/RIC).



Manage your money with our free financial tools at www.rd.com/money.



SOURCE:

KIPLINGER’S PERSONAL FINANCE MAGAZINE

                    January, 2005 (Pgs. 95-98)

By: The KIPLINGER WASHINGTON EDITORS, INC

                 1729 H St. N.W., Washington, DC 20006



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