I often hear “truths” about personal finance that just aren’t true. They are more like myths. Here are some:
Myth #1: The rich do not pay taxes. We have all heard this one. It seems that there are secret tax deductions that only the rich are aware of. They find out about them from their secret accountants, who are the only ones who have access to them. Perhaps these deductions are written up in a secret book called Protocols of the Elders of Accountants. If this myth is true, why don’t these special accountants ever advertise their services? Why doesn’t a Google search bring up these secrets?
The truth is that the rich pay a lot of taxes, possibly over 40% of their total income. So, the next time you hear this said, please ask to see a copy of the tax return and confirm for yourself that it is a myth.
Myth #2: Having a mortgage is a good way to save on taxes. It is true that the interest you pay on a mortgage is tax deductible, meaning that you get back some of it from the government. For example, if you pay $12,000 a year in interest, you might reduce your tax bite by $4,000. However, you are still paying $8,000 out of your own pocket. If you have no mortgage, you can save that $8,000. So a good goal should be to pay off your mortgage as quickly as possible. A paid-off house is the ultimate luxury.
This myth dates to the olden days, when all interest was tax deductible, including credit card interest. In 1987, under President Reagan, the tax laws changed, and credit card interest was no longer deductible. However, mortgage interest remained deductible. People therefore borrow against their house (a home equity loan) and use the money to pay off credit cards. Another reason is that the interest rate on mortgages is much lower than credit cards. Yes, home equity loans might save you in interest and taxes, but bear in mind that, while you can wiggle your way out of credit card debt (through bankruptcy and plain old negotiations), if you do not pay your mortgage, you are homeless. It sounds farfetched, but it is not. It is a very scary possibility. (That said, juggling retirement plan contributions vs. mortgage payoff strategies is complex. Get professional help.)
Myth #3: You should pull out money from your home’s equity and invest it. This piece of “wisdom” hold that, since mortgage rates are low and the stock market has been hot, it pays to borrow as much money as you can and invest it in stocks, where you will make more money then it costs you.
The truth: Here, too, if anything goes wrong, you are homeless. Investments go up and down, so people should only invest money they can afford to lose. Playing with your principal residence is way too dangerous. That said, I have seen people who have started successful businesses with money pulled from their houses, but this should not be followed as the general rule.
Myth #4: Renting your residence is an acceptable long-term plan. I have met people who rent expensive homes to accommodate their growing families. They justify it by saying they don’t have the funds for a down payment.
The truth is that, if you are going to live somewhere for more than a few years, buying is generally the way to go. Granted, not everyone can afford a house, especially at the beginning, but rent does not build equity and does not build wealth. The goal should be to save up for a down payment on a home, even a small one, after which the mortgage payments are often not that much more than rent, when you factor in the tax savings. That said, not every house is a great purchase. Choosing what to buy and at what price requires some wisdom, if not a downright sixth sense.
Myth #5: Leasing a car makes financial sense. Sorry, but there is no way this is true. Clearly, some people like to have a shiny new car every three years, but recognize that desire for what it is. Don’t believe me? Let’s crunch the numbers.
When you lease, you typically agree to use the car for three years and up to 36,000 miles. Here’s what’s really happening: You are buying the car with borrowed money. Your lease payment covers the interest on the loan. After three years, you sell it back to the dealer for the depreciated value (at least 33% less than its price when new). This amount has to be low enough that the dealer can sell it at auction without losing money and for used car dealers to acquire it at auction and then resell it for a profit. All this is covered with your lease payment. Furthermore, if you drive the car more than the 36,000 miles, you are charged extra, but if you drive it for fewer miles, you are not refunded any money. Almost invariably, you will drive less than 36,000 miles and are therefore paying for something you are not using. (Would you pay for a 36-pound case of chicken and agree to receive only 30 pounds?) Even if you are absolutely certain that you will drive 36,000 miles, the calculation still does not work.
Here’s an alternative: Buy an almost-new car from a local used car dealer. A quick look at some of their websites shows that I can buy a 2016 Toyota Camry with only 10K miles for $16,500. This car is essentially new. I can drive it for nine years and assume it will be very reliable. After nine years, I can probably sell it for $6,000. The true cost is therefore around $11,000.
Compare this to Toyota’s current online leasing offer: You lease a new Camry for $169 a month plus $2,900 due at signing. That works out to $250 a month. This does not include tax, title, dealer fees, insurance, and disposition fees, which are extra. In Maryland, the cost is even higher, due to the fact that sales tax is levied on the entire value of the new car even though you are only acquiring 36 months worth of it. The cost of leasing that car can easily exceed $30,000 over nine years. You can see that the lease cost is well over double the $11,000 cost of buying, even if you factor in possible repair bills.
Those who do not drive much might consider a five-year-old car with low mileage. That way, you benefit greatly from the depreciated value of the car. At one of the frum-owned used car websites, I saw a 2012 Hyundai Accent with 46,000 miles selling for $6,900. This is a good deal for a set of wheels with which to zip around town and commute to work.
Myth # 6: Buying a timeshare saves on vacations. Timeshares, where you buy the right to occupy a vacation home for a specified number of days per year, are worse than car leases. First of all, their cost is outrageously high. Then the annual maintenance fee is typically more than what you would pay to rent the place. You are also greatly limited in where you can go on vacation, even if the company claims dozens of locations; and finally, your preferred location may not be available when you want to go.
Many timeshare owners have concluded that they are a lesson in frustration and a drain on their finances, and often spent thousands of dollars just to get rid of them. A quick check of eBay shows that, in the last three months alone, there are listings for over 1,100 timeshares whose price never exceeded one dollar! Most of those never sold even at that price! I see people accepting these offers of a “free” vacation in exchange for sittin through a super-high pressure sales presentation that lasts for hours. I think one’s vacation time is too valuable to be wasted on such torture. I would absolutely avoid this “bargain.”
What to do instead? Across our great country, untold thousands of hotels, motels, and cabins of every stripe exist at modest cost. Since most frum people do not stay for Shabbos, a one-week vacation is often four or five nights. That can be booked for a cost of $200 to $600, depending on the luxury level. No need for anything more complex or expensive.
Myth #7: Roth IRAs are the obvious choice. This one is a little complicated. Money put into a Roth IRA is not tax deductible when you contribute to it, but it is not taxable when you take it out. A regular IRA is tax deductible, but then you pay taxes on the entire value when it is withdrawn. Deciding which one is better is complicated but certainly requires comparing your current tax bracket to your expected tax bracket upon retirement. Get professional help.
Myth #8: Any college degree is better than none. I have seen people get a quickie degree, planning to think about what to do with it afterwards. Remember one thing: once you earn one degree, you are ineligible to receive Pell grants for any subsequent degree. Yes folks, you have disqualified yourself from receiving financial aid from Uncle Sam for the rest of your life. This alone should make you ponder your move.
Perhaps you think you are ineligible for aid due to your parents’ good financial situation. Bear in mind that if you get married or turn 24, you no longer have to include your parents’ income on your financial aid application. That might make you eligible for aid.
Myth #9: Tax deductions give you 100% payback. A question I get from time to time is “If I give charity of $100 will I save $100 on my taxes?” If this person really believes this, why are they only giving $100? Why not much more? In fact, if it is true, all charities would be very well funded. Obviously, it is false. When you give charity, you save an amount corresponding to your marginal tax bracket. Typically, you will save 23 to 35% of your charitable contribution – but that is only if you itemize. If you do not itemize, your donation is worthless as a tax deduction!
Myth #10: If you need cash, take it from your retirement account. Some people look at their retirement accounts as a savings account, which they use as spending money. There are consequences to such an attitude. First, if you withdraw money, it is taxable. If you are under 59, you will also pay a 10% penalty! But more, as your income goes up, you might lose various tax credits and other goodies. You might even lose your health insurance assistance! That could be a big ouch! And of course, you will have less money for your retirement.
We all face many financial decisions in life. In fact, financial acumen is a constant part of living. That is why it is so important to get the facts straight. Doing so will avoid much headache and regret.
Eli Pollock CPA can be reached at firstname.lastname@example.org.