Earlier today, after six months of squabbling and kicking the can down the road, Congress finally passed its final spending package that will fund the government for the current fiscal year and prevent a partial shutdown.
Roughly 70% to 80% of the government was headed toward a shutdown after midnight. The other 20% was already approved in a $460 billion spending package earlier this month.
Each fiscal year, Congress must approve 12 key appropriations to fund federal agencies. The 2023-24 fiscal year began on Oct. 1.
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The appropriations approved today include funding for Health and Human Services along with the departments of State, Justice, Defense, Commerce and Labor. About half of the package goes toward Homeland Security. The 1,000-page spending bill was introduced on Thursday. The House bypassed its rule that typically requires 72 hours between a bill’s introduction and voting to approve the package on Friday morning. The Senate approved it shortly after the midnight deadline passed.
Had Congress failed to approve the appropriations or pass a stopgap, part of the government would have shut down for more than a couple of hours. That would mean some federal workers would have been furloughed, while others would have had to continue working without pay. For example, the Internal Revenue Service (IRS) and the Transportation Security Administration (TSA) would still be technically functional, but many employees would be furloughed, which could result in service delays. But programs like Social Security, as well as Medicare and Medicaid, would continue uninterrupted.
How did we get here?
As a refresher, last year a fiercely divided Congress passed two continuing resolutions that extended funding for the 2023-24 fiscal year at 2022-23 levels so government operations wouldn’t be disturbed. But the continuing resolution in November split the appropriations (roughly 80% and 20%) and set two separate deadlines: Jan. 19 and Feb. 2.
The Jan. 19 deadline was for the departments of Transportation, Housing and Urban Development, Agriculture, and Energy. The Feb. 2 deadline was for the departments of State, Justice, Defense, Commerce, and Labor, as well as Health and Human Services.
Before that first Jan. 19 deadline hit, Congress passed a third continuing resolution that pushed back both deadlines: Jan. 19 to March 1, and Feb. 2 to March 8. Once again a shutdown was avoided, but not for long. On March 1, the deadlines were moved again: March 1 to March 8, and March 8 to March 22.
On March 8, Congress finally reached a partial agreement and sent six appropriation bills to President Biden to sign. Those appropriations fund about 20% of the government, including the departments of Transportation, Housing and Urban Development, and Agriculture, as well as military and veterans programs. The bundle also included spending for energy and water development and related agencies.
The government is now fully funded for the 2023-2024 fiscal year. But the breather will be short: In six months, in the thick of election season, the process to approve appropriations for the next fiscal year will start all over again.
(Photo by Chip Somodevilla/Getty Images News via Getty Images)
Dealing with debt can be an overwhelming experience. When you find yourself in a situation where you are unable to pay a debt, it’s important to understand the consequences of not paying a debt collector.
In this article, we’ll discuss the roles of collection agencies, the impact on your credit report, legal consequences, communication strategies, and ways to prevent debt collection issues.
Understanding Debt Collectors
Debt collectors are entities hired by creditors to collect debts owed by individuals or businesses. When you owe money to a creditor, such as on credit card debt or medical bills, and fail to make timely payments, the original creditor may sell or transfer the debt to a debt collection agency.
These agencies are responsible for collecting the unpaid debt and may employ various tactics, including phone calls and letters, to collect the outstanding balance.
The Debt Collection Process
Debt collection agencies follow a set process when collecting unpaid debts:
Initial contact: Collection agencies typically begin their collection efforts by sending a written notice, often called a demand letter, detailing the owed amount, the name of the original creditor, and instructions for repaying the debt.
Ongoing communication: If the initial notice is unsuccessful, the debt collector will continue to contact you via phone calls, emails, or additional letters to encourage you to repay the debt.
Reporting to credit bureaus: After a certain period of missed payments, usually around 180 days, the debt collector may report the unpaid debt to credit bureaus, which can negatively impact your credit score.
Potential legal action: If you still haven’t paid the debt, the debt collector may choose to file a lawsuit to recover the funds, which could lead to wage garnishment or seizure of assets if they obtain a judgment against you.
Legal Consequences of Not Paying a Debt Collector
1. Impact on Your Credit Report
When you don’t pay a debt collector, the collection account may be reported to the credit bureaus, which can have a negative impact on your credit score. A missed payment or default on your credit report can cause your score to drop significantly and remain on your credit history for up to seven years.
2. Lawsuits and Judgments
Debt collectors may resort to legal action in an attempt to collect an unpaid debt. Debt collection lawsuits can lead to judgments against you, which may result in wage garnishment, bank account levies, and asset seizures. It’s crucial to respond to a debt collector’s attorney or law firm if they initiate a lawsuit to avoid default judgments.
3. Statute of Limitations
The statute of limitations on debt is the time period during which a debt collector can sue you to collect a debt. This varies by state and the type of debt but typically ranges from three to six years. After this period, debt collectors can still attempt to collect the debt, but they lose the right to sue you for it.
4. Property Liens
In some cases, a debt collector may obtain a judgment against you and place a lien on your property. This means that if you sell the property, the debt must be paid from the proceeds before you receive any funds. Liens can also impact your ability to refinance or secure a home equity loan.
5. Seizure of Assets
Depending on the type of debt and the jurisdiction, a debt collector may have the legal right to seize your assets, such as your car or other personal property, to satisfy the debt after obtaining a court judgment.
6. Tax Consequences
If you negotiate a settlement with a debt collector for less than the full amount owed, the difference between the original debt and the settled amount may be considered taxable income by the Internal Revenue Service (IRS). You could receive a 1099-C form and be required to report this amount on your tax return.
7. Loss of professional licenses or certifications
In some cases, failure to pay certain types of debt may result in the suspension or revocation of professional licenses or certifications, impacting your ability to work in your chosen field.
Communication with Debt Collectors
The Fair Debt Collection Practices Act (FDCPA) is a federal law enacted to protect consumers from abusive debt collection practices. Under this act, debt collectors are prohibited from engaging in harassment, making false statements, and using unfair practices to collect debts.
If you believe your debt collection rights have been violated, you can report the violation to the Federal Trade Commission (FTC) and the Consumer Financial Protection Bureau (CFPB).
How to Respond to a Collections Notice
Receiving a collections notice can be stressful, but it’s important to act promptly and responsibly. Here’s a step-by-step guide on how to respond to a collections notice:
1. Don’t ignore the notice
Ignoring a collections notice can lead to further consequences, including damage to your credit report and potential legal action. It’s crucial to address the notice as soon as possible to avoid escalating the situation.
2. Verify the debt
Before taking any action, request debt validation from the debt collector to confirm the legitimacy of the debt. This collection agency should reply to you in a letter that includes the amount owed, the name of the original creditor, and any additional details about the debt. Ensure that the information is accurate and up-to-date.
3. Determine if the debt is within the statute of limitations
Research the statute of limitations for the type of debt in your state to determine if the debt collector can still legally sue you for the unpaid amount. If the statute of limitations has passed, inform the debt collector and dispute the debt with the credit bureaus.
4. Negotiate with the debt collector
If the debt is legitimate and within the statute of limitations, consider negotiating a payment plan or settlement with the debt collector. This may involve agreeing to pay a partial payment or making monthly installments until the debt is paid in full. Be sure to get any agreements in writing to protect yourself.
5. Dispute any inaccuracies
If you find any discrepancies in the debt validation letter or believe the debt is incorrect, dispute the information with the debt collector and the credit bureaus. Provide any relevant documentation to support your claim.
6. Seek professional advice
If you’re unsure about how to handle the collections notice or need assistance with debt management, consider consulting a credit counselor, financial advisor, or attorney. These professionals can provide guidance and help you deal with collections.
Preventing Debt Collection Issues
Dealing with debt collectors can be overwhelming, but taking proactive steps to prevent debt collection issues from arising in the first place is key to maintaining your financial well-being. Here are various strategies that can help you avoid the pitfalls of unpaid debts and ensure you stay on track with your financial goals.
Create a budget and manage expenses: Developing a budget and tracking your expenses can help you avoid accumulating debt and ensure you’re making timely payments to your creditors.
Prioritize debt repayment: Paying off high-interest debts, such as credit card debt, should be a priority to prevent the debt from growing and to protect your credit score.
Seek help from credit counseling agencies or financial advisors: If you’re struggling with debt, consider reaching out to a credit counseling agency or a financial advisor for guidance. These professionals can help you develop a debt repayment plan, negotiate with your creditors, and offer advice on managing your finances more effectively.
Understand the importance of timely bill payments: Making timely payments on your bills, including credit card debt and medical bills, is essential for maintaining a healthy credit score and preventing collection accounts from appearing on your credit report.
Build an emergency fund: Having an emergency fund can provide a financial cushion in times of unexpected expenses or income loss. This can help you avoid resorting to credit cards or loans, reducing the likelihood of falling into debt.
Monitor your credit reports: Regularly reviewing your credit reports allows you to spot any inaccuracies or signs of identity theft early on. You can also track your progress in improving your credit score and ensure that paid-off debts are accurately reflected.
Conclusion
Failing to pay a debt collector can lead to several negative consequences, including damage to your credit report, legal actions, and financial stress. It’s essential to understand the roles of debt collectors and collection agencies, as well as your rights under the FDCPA. If you find yourself dealing with unpaid debts, it’s crucial to communicate effectively with debt collectors and explore your options for repayment or dispute.
By prioritizing debt repayment, creating a budget, and seeking help from credit counseling agencies or financial advisors, you can work towards resolving your debt issues and maintaining good financial health. Remember, knowledge is power, and understanding the debt collection process and your rights will help you overcome these challenges more effectively.
If you find yourself in a bad financial situation, making an early withdrawal from your 401(k) may sound tempting. But early withdrawals from your 401(k) come with hefty fines and can put your retirement at risk. So, before you do this, you should be sure that it’s truly a financial necessity.
That being said, there are situations when it makes sense, and occasionally, you can find ways to get the fees waived. This article will review everything you need to know before making an early 401(k) withdrawal.
Early 401(k) Withdrawal Options
Wondering if you can tap into your 401(k) funds ahead of schedule? The ability to make an early withdrawal from your 401(k) hinges on several factors, including your employer’s policies, the specifics of your plan, and your current employment status. Here’s a straightforward guide to understanding your options.
Checking With Your Employer
Your first step should be to get in touch with your human resources department. Not every employer permits early withdrawals from their 401(k) plans, and those that do may have specific criteria and procedures you’ll need to follow. The ease of starting this process and the options available to you will depend on various factors, such as your age and the specific rules of your plan.
For Former Employees
If you’re no longer employed with the company that holds your original 401(k), reaching out to the plan’s administrator is your next move. The administrator can provide you with the necessary steps and documentation required to initiate an early withdrawal. They’ll guide you through the process, ensuring you understand any implications or penalties associated with accessing your funds prematurely.
For Current Employees
Still working for the company where you’ve built your 401(k)? There might be restrictions on your ability to make early withdrawals. But don’t lose hope; you might have the option to borrow against your 401(k) instead.
Taking a 401(k) loan can be a viable alternative, offering a way to access your funds without the penalties associated with early withdrawals. We’ll delve into the specifics of 401(k) loans and how they work later on, providing you with all the information you need to make an informed decision.
401(k) Early Withdrawal Penalties
When it comes to pulling money from your 401(k) before reaching the age of 59 ½, the Internal Revenue Service (IRS) doesn’t give you a free pass. Let’s break down what this really means for your wallet. You’re not just facing a flat fee; it’s a combination of penalties and taxes that can significantly reduce the amount you end up with.
The 10% Penalty Explained
If you dip into your 401(k) early, the IRS imposes a 10% penalty on the amount you withdraw. This is their way of discouraging people from using their retirement savings prematurely. For example, if you withdraw $10,000, you owe $1,000 right off the bat to the IRS as a penalty.
Tackling the Tax Implications
But the financial impact doesn’t stop there. Since 401(k) contributions are made pre-tax, when you take money out, it’s considered taxable income. This means the amount you withdraw will be added to your total income for the year, potentially pushing you into a higher tax bracket.
To illustrate, let’s say you’re in the 22% tax bracket. On a $10,000 withdrawal, you’ll owe $2,200 in income taxes, in addition to the $1,000 penalty. So, from your $10,000, you’re down $3,200, leaving you with $6,800.
Real-World Example for Clarity
Imagine John, who decides to withdraw $10,000 from his 401(k) to cover an unexpected expense. John is in the 22% tax bracket. Here’s how his withdrawal breaks down:
10% early withdrawal penalty: $1,000
Income tax (22%): $2,200
Total deductions: $3,200
Amount John receives: $6,800
This example highlights the importance of considering the combined effect of penalties and taxes on early 401(k) withdrawals. It’s not just about the immediate need for cash but understanding the long-term impact on your retirement savings.
Tax Planning Strategies for Early 401(k) Withdrawals
Making an early withdrawal from your 401(k) can have significant tax implications. However, with careful planning, you can manage these impacts more effectively. Here are strategies to consider:
Spread Out Withdrawals
If possible, spreading out your withdrawals over several years can help manage your tax bracket. Large withdrawals can push you into a higher tax bracket, increasing your overall tax liability. By taking smaller amounts over time, you may stay within a lower tax bracket, reducing the amount of taxes owed.
State Tax Considerations
Remember that state taxes can also apply to 401(k) withdrawals. Tax rates and regulations vary by state, so it’s essential to understand the rules in your state and plan accordingly. Some states offer tax breaks or exemptions for retirement income, which could influence your withdrawal strategy.
Reinvesting Withdrawn Funds
If you must make an early withdrawal but don’t need the funds immediately for expenses, consider reinvesting them in a tax-advantaged account. This could be a Roth IRA, where withdrawals in retirement are tax-free, or a health savings account (HSA), if eligible. These moves can help mitigate the tax impact and potentially grow your investment tax-free.
Implementing these tax planning strategies can help you navigate the complexities of early 401(k) withdrawals, minimizing the tax bite and keeping your retirement goals on track. Consulting with a tax professional or financial advisor can provide personalized advice based on your individual situation and financial goals.
Hardship Withdrawal Eligibility and Requirements
When life throws you a financial curveball, tapping into your 401(k) through a hardship withdrawal might seem like a viable option. This choice allows you to access your retirement funds early without the standard 10% penalty, under specific conditions. Let’s explore what qualifies as a hardship withdrawal, the documentation you’ll need, and how to prove your need effectively.
Qualifying Conditions for Hardship Withdrawals
Hardship withdrawals are not given out for just any reason. The IRS defines specific scenarios where these withdrawals are permitted. These include:
Unreimbursed medical expenses: Significant out-of-pocket medical costs for you, your spouse, or dependents.
Home purchase: Down payment and closing costs for buying your primary residence.
Tuition and education fees: Tuition, related educational fees, and room and board expenses for the next 12 months of postsecondary education for you, your spouse, children, or dependents.
Prevention of eviction or foreclosure: Amounts necessary to prevent eviction from or foreclosure on your primary residence.
Funeral expenses: Costs related to the death of a family member.
Repair of damage to primary residence: Costs for repairs to your home that would qualify for the casualty deduction under IRS rules.
Documentation Requirements
To successfully apply for a hardship withdrawal, you’ll need to provide substantial proof that your situation matches one of the qualifying conditions. This might include:
Unreimbursed medical expenses: Bills and statements from healthcare providers, showing the costs not covered by insurance.
Home purchase: Mortgage documents or contracts that highlight the purchase of a primary residence.
Tuition and education fees: Invoices from the educational institution for tuition, along with documentation for related expenses.
Prevention of eviction or foreclosure: Notice of eviction or foreclosure proceedings against your primary residence.
Funeral expenses: Funeral home invoices or other documentation of related expenses.
Repair of damage to primary residence: Estimates or receipts for repairs necessary due to damage that qualifies for a casualty deduction.
The Process of Proving Hardship
Proving hardship is more than just submitting documents. You’ll need to:
Contact your plan administrator: Start by reaching out to your plan’s administrator. They can guide you through the specific requirements and process for your plan.
Gather your documentation: Collect all relevant documents that substantiate your claim. This may require obtaining records from various sources, so it’s wise to start this step as soon as possible.
Complete the application: Fill out the necessary application forms provided by your plan. Ensure all information is accurate and attach your supporting documentation.
Await approval: After submitting your application, there will be a review process. During this time, your plan administrator may request additional information or clarification.
While a hardship withdrawal can offer a lifeline during financial distress, it’s crucial to approach this option with a full understanding of the qualifications and process. Remember, these withdrawals can impact your retirement savings, so consider all alternatives before proceeding.
Should you consider a 401(k) loan instead?
Considering a 401(k) loan instead of an early withdrawal might be a strategic move under certain circumstances. Below, we will clarify the nuances of 401(k) loans, including repayment conditions, interest rates, and when it’s advantageous to choose this option over withdrawing funds directly.
The Basics of 401(k) Loans
A 401(k) loan allows you to borrow against the savings in your retirement accounts without incurring the penalties and taxes associated with an early withdrawal. It’s a feature many plans offer, providing a way to access your funds for immediate needs while still keeping your retirement goals on track.
Repayment Terms
Repayment terms for 401(k) loans vary by plan, but typically, you’re expected to repay the loan within five years. Payments are usually set up on a monthly basis and are deducted directly from your paycheck, making the repayment process straightforward and manageable.
Interest Rates
The interest rate on a 401(k) loan is often comparable to or slightly higher than current market rates, but significantly lower than the rates associated with credit card debt or personal loans. The interest you pay goes back into your 401(k) account, essentially paying yourself back with interest, which can make this option particularly appealing.
When to Consider a 401(k) Loan
Choosing a 401(k) loan over a direct withdrawal or other financial avenues can be wise in several scenarios:
Avoiding penalties and taxes: If you need access to funds but want to avoid the penalties and taxes associated with an early 401(k) withdrawal.
Debt consolidation: When looking to consolidate high-interest debt under a lower interest rate, thus saving money in the long term.
Major expenses: For significant expenses, such as home repairs or medical bills, where using a 401(k) loan can provide a financially responsible solution.
Before opting for a 401(k) loan, consider the impact on your retirement savings. While you’re repaying the loan, the borrowed amount is not invested, potentially missing out on market gains. Additionally, if you leave your job, the loan may become due in full much sooner than the original five-year term.
Substantially Equal Periodic Payments (SEPP): A Closer Look
When considering accessing your 401(k) or IRA funds before the typical retirement age without facing penalties, the Substantially Equal Periodic Payments (SEPP) program can be a lifeline. This strategy requires a commitment to taking consistent withdrawals for a significant period. Let’s dive deeper into how SEPP works, how to calculate your payments, and when this approach might be particularly beneficial or risky.
How to Calculate SEPP Payments
Calculating your SEPP involves choosing from one of three IRS-approved methods: the Required Minimum Distribution (RMD) method, the Fixed Amortization method, and the Fixed Annuitization method. Each method uses your current account balance and life expectancy factors to determine annual withdrawal amounts, but they vary in flexibility and payment amounts.
RMD method: This method recalculates your payment each year based on the current account balance and your life expectancy.
Fixed amortization method: This calculates a fixed annual payment based on your life expectancy and account balance at the start of the SEPP plan.
Fixed annuitization method: This uses an annuity factor to determine annual payments, resulting in fixed payments for the duration of the SEPP period.
Scenarios Where SEPP Might Be Advantageous
SEPP plans can be particularly useful in several situations:
Early retirement: If you plan to retire early and need a steady income stream, SEPP allows you to access your retirement funds without the 10% early withdrawal penalty.
Bridge income gap: For those who need to bridge an income gap until other retirement benefits kick in, such as Social Security or pensions.
Financial emergencies: In cases where there are substantial financial needs before reaching 59 ½, SEPP provides a structured way to access funds.
Potential Pitfalls and Considerations
While SEPP offers a way to access retirement funds early, there are important considerations to keep in mind:
Commitment: Once you start SEPP, you must continue the withdrawals for at least five years or until you reach age 59 ½, whichever is longer. Deviating from the schedule can result in retroactive penalties.
Market risk: Your account is still subject to market fluctuations, which can impact your balance and, potentially, your withdrawal amounts if you’re using the RMD method.
Locking in losses: If you withdraw money during market downturns, it can lock in losses, potentially jeopardizing the longevity of your retirement funds.
SEPP can be a strategic tool for managing retirement funds before reaching the traditional retirement age. However, it’s crucial to carefully assess your financial situation, consider the long-term implications of starting SEPP, and consult with a financial advisor to ensure this strategy aligns with your overall retirement planning goals.
Alternatives to Early 401(k) Withdrawals
Accessing your 401(k) early can come with significant financial repercussions, including penalties and taxes that diminish your retirement savings. Fortunately, there are several other strategies you can consider to meet your financial needs without tapping into your retirement funds prematurely. Let’s delve into some of these alternatives and how they might serve as viable solutions.
Borrow from Family or Friends
One of the most straightforward alternatives is to seek a loan from family or friends. This option can offer more flexible repayment terms and potentially lower (or no) interest rates. However, it’s essential to approach this solution with clear communication and, ideally, a formal agreement to avoid any misunderstandings or strain on your relationships.
Sell Personal Assets
Another strategy is to evaluate your personal assets for items that you can sell. This could range from high-value items like a second car or recreational vehicles to smaller, valuable assets such as electronics or collectibles. Selling assets can provide a quick influx of cash without the need to worry about interest rates or penalties.
Explore Government and Non-Profit Assistance
For those facing financial hardship, various government and non-profit programs offer financial assistance. These programs can provide support for a range of needs, including housing, utilities, food, and medical expenses. Researching and applying to these programs can offer a way to bridge your financial gap without compromising your retirement savings.
Consider Home Equity Loans and HELOCs
If you have equity in your home, tapping into it through a home equity loan or a home equity line of credit (HELOC) might be a strategic alternative to early 401(k) withdrawals. Both options can offer more favorable interest rates than a personal loan or credit cards, but with distinct differences in how you access and repay the funds.
Home Equity Loans
Home equity loans provide a lump sum at a fixed interest rate, making it an excellent choice for one-time, significant expenses. The predictable repayment schedule helps with budgeting but requires you to take out a precise amount from the start.
HELOCs
HELOCs, in contrast, offer a flexible credit line, similar to a credit card, but with lower interest rates. This option allows you to borrow as needed over a draw period, usually with variable interest rates. The flexibility is ideal for ongoing expenses, but it’s vital to manage this responsibly due to the fluctuating payments.
Personal Loans and Credit Options
Personal loans from banks or credit unions, as well as low-interest or 0% APR credit card offers, can also provide temporary relief. These options may come with higher interest rates than a HELOC but don’t require collateral. When choosing this route, it’s vital to compare offers and understand the terms to ensure they align with your financial recovery plan.
Conclusion
When faced with financial needs, deciding whether to access your 401(k) early is a significant choice. It’s crucial to weigh the immediate benefits against the long-term impact on your retirement savings. As we’ve explored, alternatives like borrowing from family or friends, selling personal assets, or tapping into home equity through loans or HELOCs can provide the necessary funds without the drawbacks of early withdrawal penalties and taxes.
For those considering a 401(k) loan or Substantially Equal Periodic Payments (SEPP), these options offer ways to access your funds while minimizing the negative effects on your retirement account. However, each choice comes with its own set of considerations and potential impacts on your financial future.
Ultimately, the decision should align with your overall financial strategy and long-term goals. Consulting with a financial advisor can provide personalized advice, helping you to make an informed choice that balances your immediate needs with your retirement aspirations. Remember, the goal is to ensure financial stability now without compromising your future well-being.
Federal Reserve left its key short-term interest rate unchanged again Wednesday, hinted that rate hikes are likely over and forecast three cuts next year amid falling inflation and a cooling economy.
That’s more rate cuts than many economists expected.
The decision leaves the Fed’s benchmark short-term rate at a 22-year high of 5.25% to 5.5% following a flurry of rate increases aimed at subduing the nation’s sharpest inflation spike in four decades. The central bank has now held its key rate steady for three straight meetings since July.
That provides another reprieve for consumers who have faced higher borrowing costs for credit cards, adjustable-rate mortgages and other loans as a result of the Fed’s moves. Yet Americans, especially seniors, are finally reaping healthy bank savings yields after years of paltry returns.
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Will the Fed raise interest rates again?
The central bank didn’t rule out another rate increase as it downgraded its economic outlook for next year while lowering its inflation forecast. In a statement after a two-day meeting, it repeated that it would assess the economy and financial developments, among other factors, to determine “the extent of any additional (rate hikes) that may be appropriate to return inflation to 2% over time.”
Fed Chair Jerome Powell said at a news conference, noting the Fed’s key rate is “at or near its peak.”
while the Dow Jones Industrial Average closed at a record high after rising 1.4% following the Fed’s signals that it’s probably done lifting rates and is forecasting three cuts next year. The 10-year Treasury was down to about 4% from 4.21% on Tuesday.
Last month, Powell said high Treasury yields, if persistent, likely would constrain the economy and require fewer Fed rate increases,
In its statement Wednesday, however, the central bank didn’t acknowledge the recent decline in Treasury yields, suggesting yields are still relatively high and could spike again, crimping the economy.
“Tighter financial and credit conditions for households and businesses are likely to weigh on economic activity, hiring and inflation,” the Fed said, repeating the language of its previous statement.
Is inflation really slowing down?
The Fed’s middle-ground approach may have been cemented Tuesday by a mixed report on the consumer price index. The good news was that overall inflation barely budged in November amid falling gasoline prices, pushing down annual price gains to 3.1% from 3.2%, still well above the Fed’s 2% goal.
The Federal Reserve System is the U.S.’s central bank.
When does the Fed meet again?
The first Federal Reserve meeting of the new year will be from Jan. 30 through 31.
Federal reserve calendar
Jan. 30-31
March 19-20
April 30- May 1
June 11-12
July 30-31
Sept. 17-18
Nov. 6-7
Dec. 17-18
The U.S. economy was strong in the third quarter as consumers continued to spend despite high interest rates and inflation.
The value of all services and products generated in the U.S., or GDP, rose at a seasonally adjusted 4.9% for the year in the months spanning July to September, according to the Commerce Department. That was more than twice the 2.1% increase in the previous quarter and the most aggressive pace of growth since the end of 2021 when the economy surged back from a recession sparked by the pandemic.
a recession over the next year, down from the 61% odds forecast in May.
Barclays predicted a loss of roughly 375,000 jobs by the middle of next year. But consumer spending remains robust despite high inflation and interest rates that are making credit card use and consumer loans more expensive. And that may help stave off a recession, says Barclays economist Jonathan Millar.
What does FOMC stand for?
The FOMC is the Federal Open Market Committee, the voting body responsible for setting interest rates. The 12-member committee includes seven members of the Board of Governors and five of the 12 Reserve Bank presidents.
What causes inflation?
Inflation can have many roots. Typically, it’s caused by “a macroeconomic excess of spending over the economy’s relative ability to produce goods and services,” said Josh Bivens, the director of research at the Economic Policy Institute, a left-leaning think tank based in Washington D.C.
That means more people are wanting items and services than there is adequate supply, leading producers to raise prices.
“If everyone in the economy, tomorrow, decided they weren’t going to save any money from their paychecks, and they’re just going to spend every last dollar out of the blue, they would all run to the stores and try to buy things,” Bivens said. “But, producers haven’t produced enough to accommodate that big surge of across-the-board spending. So, you would see prices bid up.”
Inflation can also happen when there are too few producers, or there aren’t enough employees to provide the coveted products and services, Bivens said.
Finally, economies also have some “built-in inflation” to help keep inflation in check. In the U.S., that target is 2%, meaning businesses can raise prices 2% annually year and that shouldn’t overburden consumers. That’s also the typical cost of living raise offered by employers.
Inflation meaning
Inflation is the term for a “generalized rise in prices,” according to Josh Bivens, head of research at the Economic Policy Institute, a left-leaning think tank based in Washington D.C.
Everything from food to rent can become costlier due to inflation. But it is the overall impact that determines what the inflation rate actually is.
“Inflation, though, really is meant to only refer to all goods and services, together, rising in price by some common amount,” Bivens said. The Federal Reserve’s inflation goal is 2%, which means businesses can hike prices by 2% a year and that shouldn’t cause consumers financial distress. Cost of living increases to workers’ pay are also expected to meet that target to ensure consumers can adequately deal with the rising costs of goods and services.
What is CPI?
In November, the Consumer Price Index (CPI) ‒ a measure of the average shift in prices for different products and services ‒ was 3.1%, down slightly from the month before.
Annual inflation is down dramatically from the 9.1% in June 2022 that marked a 40-year high but remains above the 2% target the Fed sees as the level that signals the rate of price increases is under control.
Why is CPI important?
The Federal Reserve watches two key aspects of the economy, price stability and maximum employment, and those are the main factors it takes into account for its interest rate decisions. The CPI is a primary measure the Fed looks at to help determine if prices are “stable.’’
What is the difference between CPI and core CPI?
Core prices don’t count the volatile costs of food and energy items, giving a more accurate window into longer-term trends.
Are wages going up in 2024?
If you’re deemed a top performer at a company that is offering raises, you’ve got a pretty good chance of getting a pay boost next year.
About 3 out of four business leaders told ResumeBuilder.com they intended to give raises. But half of those company executives said only 50% or less of their staff members would see a pay hike, and 82% of the raises would hinge on performance. For those who do manage to get the salary boost, 79% of employers said the pay hikes would be greater than those given in recent years.
Are U.S. Treasury yields rising?
Not recently.
The 10-year Treasury yield was above 5% in November when the Fed kept rates steady for the second consecutive month the first time it had left the key rate unchanged two months in a row in almost two years.
That led to mortgage rates spiking to almost 8% and pushed up other borrowing costs for consumers and businesses. Stocks meanwhile sank close to a recent low, leading Fed Chair Jerome Powell to say such financial pressures could achieve the same cooling effect on the economy as additional rate hikes.
But in the following weeks, 10-year Treasury yields dipped to 4.2% and stocks rebounded. That might make the Fed resist rate cuts in case the economy heats up and causes the broader dip in prices “to stall at an uncomfortably elevated level,” Barclays says.
Barclays and Goldman Sachs forecast that rate cuts won’t happen until the spring, and that there will be only two, to a range of 4.75% to 5%, with more cuts implemented in the next two years.
When will inflation go back to normal?
It may take a little while.
Inflation’s decline likely “won’t show much progress in coming months,” Barclays wrote in a research note.
Overall price hikes have eased significantly since peaking at 9.1% in June 2022, a four-decade high. And in October, broader inflation as well as core prices experienced a dip, leading to a lower 10-year Treasury yield.
But core prices, which exclude the volatile costs of food and energy, will probably rise 0.3% each of the next three months, Goldman Sachs says. Used cars and furniture have been getting cheaper as the supply-chain shortages of the pandemic end. Meanwhile, health care, auto repairs, car insurance and rent continue to get more expensive, as employers pay higher wages to attract workers amid a labor shortage lingering from the global health crisis.
What is core inflation right now?
Core prices, which leave out the more volatile costs of food and energy, bumped up 0.3% in November, slightly more than the 0.2% uptick seen the previous month. That kept the yearly increase at 4%, the lowest rate since September 2021.
New inflation tax brackets
Inflation may also impact the amount of taxes you have to pay.
The Internal Revenue Service said in its annual inflation adjustments report that there will be a 5.4% bump in income thresholds to reach each new level in next year’s tax season.
In 2024, the lowest rate of 10% will apply to individuals with taxable income up to $11,600 and joint filers up to $23,200. The top rate of 37% will apply to individuals earning over $609,350, and married couples filing jointly who make at least $731,200 a year.
The IRS makes these adjustments annually, using a formula based on the consumer price index to account for inflation and stave off “bracket creep,” which happens when inflation shifts taxpayers into a higher bracket though they’re not seeing any real rise in pay or purchasing power.
The 2024/25 increase is less than last year’s 7% increase, but much more than recent years when inflation was below the current 3.1% inflation rate.
Will Social Security get a raise because of inflation?
Yes, but it will be a lot less than what recipients received in 2023.
The cost-of-living adjustment, or COLA, to Social Security benefits will be 3.2% next year. That’s roughly one-third of the 8.7% increase given in 2023, which marked a forty-year high.
The 2024 COLA hike is above the average 2.6% raise recipients have received over the past two decades, but seniors remain concerned about being able to pay their expenses as well as the increasing possibility Social Security benefits will be reduced in coming years, according to a retirement survey of 2,258 people by The Senior Citizens League, a nonprofit seniors group.
How does raising rates lower inflation?
The federal funds rate is what banks pay each other to borrow overnight. If that rate increases, banks usually pass along that extra cost, meaning it becomes more expensive for businesses and consumers to borrow as rates rise on credit cards, adjustable rate mortgages and other loans. That’s why the funds rate is the key mechanism used by the Federal Reserve to calm inflation.
Simply put, companies and consumers don’t borrow as much when loans cost them more, and that means an overheated economy can cool and inflation may dip.
Will credit card interest rates continue to rise this holiday season?
The Fed’s string of rate hikes, aimed at easing the highest inflation in four decades, are a big reason credit card interest rates have reached record highs just in time for the holiday season.
Some retail credit cards now charge more than 33% interest, topping a 30% threshold that stores and banks were previously able to bypass but seldom did – until now.
“They can charge that much,” said Chi Chi Wu, a senior attorney at the nonprofit National Consumer Law Center. “Credit cards can actually charge whatever they want. It’s a little-known fact.”
The domino effect of a high benchmark rate and soaring credit card interest could put many Americans in financial straits this holiday season.
Though some consumers are paring back to deal with high prices, rising debt and shrinking savings, the average shopper expects to spend $1,652 this year on holiday purchases, according to the consultancy Deloitte, more than was typically spent in the last three years.
A lot of the buying will be done with credit cards. In an October poll of 1,036 shoppers by CardRates.com, nearly 4 in 10 respondents said they intend to have holiday credit card debt in the new year.
The nation’s collective credit card debt was $1.08 trillion, at the end of September, a record high. And the average interest rate was 21%, the highest ever documented by the Federal Reserve.
Savings account impact of high rates
The upside to the Fed’s string of rate hikes has been that consumers were able to earn good interest on their savings for the first time in years. Even when the Fed leaves interest rates unchanged, savers can do well.
Unfortunately, most account holders aren’t making the most of that potential opportunity.
Roughly one-fifth of Americans who have savings accounts don’t know how much interest they’re earning, according to a quarterly Paths to Prosperity study by Santander US, part of the global bank Santander. Among those who did know their account’s interest rate, most were earning less than 3%.
But consumers have time to make a change that could enable them to make more from their savings.
“We’re still a long way from (the Fed) beginning to cut rates,” said Greg McBride, chief financial analyst at financial services platform Bankrate. “This is great news for savers, who will continue to enjoy inflation-beating returns in the top-yielding, federally insured online savings accounts and certificates of deposit. For borrowers, interest rates staying higher for a longer period underscores the urgency to pay down and pay off costly credit card debt and home equity lines.”
The string of Fed rate hikes that began in March 2022 has made it costlier for consumers to borrow as interest rates on credit cards and other loans increased dramatically.
At the same time, inflation has made daily needs more expensive, pushing more Americans to lean on credit cards to get by. But lenders have become more reluctant to issue new cards, so in the midst of the holiday season, more shoppers are seeking higher credit limits, experts say.
In October, the application rate for higher limits rose to 17.8% from 11.2% in the same month the previous year, and from 12.0% in 2019, New York Fed data showed.
For some consumers, a higher limit on a card they already have is about their only option.
“After COVID, inflation and interest rates went out of control … people have less emergency funds for car repairs or buying presents,” said Brandon Robinson, president and founder of JBR Associates, which specializes in retirement strategies. “What they’re doing is using more credit card utilization – over 30% or well over 50% of their credit card allowance – and then can’t get approved for another card because their credit rating is down.”
Inflation is leading more Americans to work multiple jobs
The number of Americans working at least two jobs is at its highest peak since before the COVID-19 pandemic, according to federal data, an uptick that may reflect the financial pressure people are feeling amid high inflation.
Almost 8.4 million people had multiple jobs in October, the Labor Department said, a figure that represents 5.2% of the laborforce, the highest percentage since January 2020.
“Paying for necessities has become more of a challenge, and affording luxuries and discretionary items has become more difficult, if not impossible for some, particularly those at the lower ends of the income and wealth spectrums,” Mark Hamrick, senior economic analyst at Bankrate, told USA TODAY in an email.
People may also be moonlighting to sock away cash in case they’re laid off since job cuts typically peak at the start of a new year.
What is the Federal Reserve’s 2024 meeting schedule? Here is when the Fed will meet again.
What is the mortgage interest rate today?
Mortgage rates are falling, so is it time to buy?
It depends.
First of all, the Fed doesn’t directly set mortgage rates, but its actions have an impact. For instance, when the central bank was steadily boosting its key rate, the yield on the 10-year treasury bond went up as well. Because those bonds are a gauge for the interest applied to an average 30-year loan, mortgage rates increased.
But over the past six weeks, mortgage rates have been declining, averaging 7% for a 30-year fixed mortgage. That’s down from almost 7.8% at the end of October, according to data released by Freddie Mac on Dec. 7.
That may be giving some wannabe homeowners the confidence to start house hunting. For the week ending Dec. 1, mortgage applications rose 2.8% from the prior week, according to the Mortgage Bankers Association.
“However, in the big picture, mortgage rates remain pretty high,” says Danielle Hale, senior economist for Realtor.com. “The typical mortgage rate according to Freddie Mac data is roughly in line with what we saw in August and early to mid-September, which were then 20 plus year highs.”
So, many potential buyers may still need to sit on the sidelines, waiting for rates to drop further, says Sam Khater, chief economist for Freddie Mac. Hale and many other experts believe mortgage rates will dip next year.
Interest rate projection 2024
The Fed is expected to cut interest rates next year, though markets and economists disagree about how many rate cuts there will be.
Futures markets forecast there will be four or five rate cuts in 2024, amounting to a quarter of a percentage point each. The cuts, they predict, should start by spring, and ultimately drop interest rates as low as 4% to 4.25%.
But core prices, which leave out the volatile costs of food and energy and are the metric followed more closely by the Fed, ticked up 0.3% in November, higher than the 0.2% increase the month before. That might make the Fed more hesitant to nip rates in the immediate future.
Goldman Sachs and Barclays expect there to be only two rate decreases in 2024. And Fed Chair Jerome Powell has cautioned in recent public remarks that it was “premature” to talk about rate cuts.
November inflation report
Inflation dipped slightly last month, with falling gas prices mitigating the impact of rising rents.
Consumer prices overall increased 3.1% from a year earlier, slightly below the 3.2% rise in October, according to the Labor Department’s consumer price index. That slower pace moves the inflation rate nearer to the level, reached in June, that was the lowest in over two years. Month over month, prices increased a slight 0.1%.
Core prices, however, which leave out the more erratic costs of food and energy and which are more closely monitored by the Fed, increased 0.3% in November after rising 0.2% the previous month. That means core inflation’s yearly increase remained at 4%, though it’s the lowest level since September 2021.
Inside: Are you confused about the differences in types of income? This guide will help you understand earned income, passive income, and investment income, and their importance in achieving financial stability. Learn about the different tax implications for each type of income.
Understanding the differences in income types is a vital component of your financial literacy.
Earned, passive, and investment income all play a distinct role in your financial portfolio and tax liabilities.
These types of income are important to grow your wealth.
We will quickly answer the difference, provide examples, and understand the tax implications.
This post may contain affiliate links, which helps us to continue providing relevant content and we receive a small commission at no cost to you. As an Amazon Associate, I earn from qualifying purchases. Please read the full disclosure here.
What Is Earned Income?
Earned income is the money you actively work for. You trade your time for money.
This comes in the form of salaries and wages, where you receive a fixed amount of compensation for your role or job. It can also occur as hourly wages in part-time or contractual jobs.
Other forms include tips received in the service industry, bonuses for achieving specific goals, and self-employment income for freelancers, consultants, and small business owners. Any income that directly results from your personal efforts and active participation falls under earned income.
Typically, this is the most common form of income for most people.
Real Life Examples of Earned Income
A supermarket cashier receives an hourly wage.
A financial analyst is being paid for salary.
A freelance graphic designer receiving payment for a recently completed project.
A waitress at a restaurant receives a tip from a satisfied customer.
A real estate agent receives a commission on the sale of a house.
A sales manager at a car dealership receives a bonus for meeting sales targets.
A renowned author receiving an honorarium for delivering a keynote speech at a literature festival.
A hairstylist at a salon receives income from the haircuts and styling services provided.
A fitness coach generating income through personal training sessions.
Any side hustle income is typically earned income.
How Is Active Income Taxed?
Active income, also known as earned income, is subject to income tax at various rates as determined by the IRS’s current tax brackets. Seven tax brackets, ranging from 10% to 37%, are set for individual taxpayers. 1
The tax treatment is wholly dependent on where an individual’s income falls within these brackets. Your employer typically deducts this tax directly from your paycheck, reducing net take-home pay. It’s advisable to understand the tax implications of your earnings to avoid any surprises at tax time.
Use this tax calculator to know your taxes due.
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Role of Passive Income
Passive income refers to money earned that is not directly linked to active efforts or time spent, often described as income one can earn while sleeping, vacationing, or indulging in hobbies.
This kind of income usually demands some sort of initial investment, which could be financial, a substantial time commitment, ingenuity, or a mixture of all. For many, they invested 10k to get started. Examples include writing a book, creating a course, investing in real estate, or running an affiliate marketing program.
Despite the upfront work often required, passive income potentially provides a steady additional revenue stream and financial independence, making it an attractive prospect for many.
Common Forms of Passive Income
Dividends and interest income: Profits made from investments in stocks or bonds often involve receiving dividends or interest.
Rental income: This is earned from renting out property you own, like houses or apartments as a real estate rental.
Royalties: Income from allowing others to use your intellectual or creative properties, such as copyrighted books, music compositions, or patented inventions.
Capital gains: Profits from buying assets like stocks or property for a certain amount and selling them at a higher value.
Product or Course Sales: A small business owner receiving income from a product or sales that they created once and can resell.
Remember, there is still a level of effort involved in managing these streams, even though they are considered passive.
How Is Passive Income Taxed?
The tax liability of passive income can vary based on how the income is generated. 2
In general, how passive income is taxed depends on how the income is earned. The key note is you are not trading your time for money.
Some forms of passive income are subject to self-employment taxes, while others may be taxed at your regular income tax rate. For instance, net rental income, a form of passive income, may attract unique taxation rules.
However, the applicable tax rules can be complex. Therefore, it’s highly recommended to seek advice from a licensed tax professional when managing taxes for passive income.
Insights into Investment Income
Investment income is a distinct financial category mainly composed of profits resulting from various investments. This pathway consists of the strategic acquisition of assets with a prime focus on their long-term appreciation or regular income, potentially in the form of dividends or interest.
Unlike earned income which often demands a substantial time investment, and unlike passive income which may need initial setup, investment income principally necessitates strategic decision-making and periodic performance reviews.
The common form is learning how to invest in the stock market or real estate.
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Examples of Investment Income And Strategies
Dividends: Income received from owning shares of a company. A long-term investment strategy generally works best here.
Bond Interest: Income paid from bonds for lending money to entities. Risk-averse investors often lean towards bonds for steady income.
Capital Gains: Profits from selling investments at a higher price than their purchase. This needs a strategic understanding of market patterns.
Real Estate Investment Trusts (REITs): Income from investing in property-related assets. This strategy may provide steady cash flow with potential growth.
P2P Lending: Returns from lending money through online platforms. The ability to scale and diversify this investment depends on your risk tolerance.
Interest on savings accounts – Money earned on the balance held in your savings account.
All require a strategic approach, balancing risk and rewards, to drive income growth effectively.
Please note, that the successful generation of investment income often requires careful financial decision-making and strategic asset allocation.
Impact of Tax on Investment Income
Taxes on investment income include interest, dividends, and capital gains. However, the rate is usually lower than that for earned income.
Investment income is often taxed at a lower rate than earned income, however, the exact tax rates can depend on an individual’s tax bracket and the holding period of the investment.
In certain circumstances, Investment income can be subject to capital gains taxes, which apply if you sell a stock or other investment at a profit.
For some high-income individuals, Investment income may be subjected to the Net Investment Income Tax (NIIT). The NIIT is an additional 3.8% tax on certain investment income, such as interest, dividends, and capital gains.
Capital gains from the sale of assets (like real estate or a business) are often taxed at a lower rate compared to ordinary income.
Therefore, it’s important to consider these tax implications when shaping your investment strategies. Proper tax planning can help mitigate the impact of taxes on your investment income.
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Major Differences Between Active (Earned) and Passive Income
The primary differences between active (earned) income and passive income revolve around how they are earned and managed.
Active (earned) income requires active, day-to-day involvement in work. For example, a full-time job where you’re on the clock. It’s often less scalable due to time and energy constraints. Earned income is also more prone to risks like job loss or health issues that prevent work. Furthermore, in most regions, earned income tends to fall in higher tax brackets.
Conversely, passive income demands initial setup and some regular review but not daily oversight. Examples include earning royalties from a book you wrote or income from renting properties. This is more scalable because you aren’t exchanging time for money in the same way.
Advantages of Diversifying Your Income Sources
#1 – Achieving Financial Goals with Flexibility
Diversifying your income source adds flexibility to your personal finance strategy, helping you achieve your financial goals effectively. An income diversified across active, passive, and investment income can cushion against financial downturns whilst providing multiple avenues for wealth generation.
An unexpected job loss, for example, maybe less devastating when you have additional income streams to bank on, such as rental income or dividends, providing you with the flexibility to navigate financial bumps. It also allows you to explore unique investment opportunities without undue stress.
Consequently, a multi-faceted income model can be a stepping stone towards financial freedom.
#2 – Stable Financial Standing with Multiple Income Streams
Having multiple income streams provides a buffer that can significantly enhance your financial stability. “You’ll catch more fish with multiple lines in the water,” says Greg McBride, chief financial analyst at Bankrate. 4
If one income source dwindles or disappears, other income streams continue to provide essential financial flow. This duplication shields you from the full brunt of economic or occupational changes, ensuring you maintain your standard of living while working towards your financial goals. Thus, a diverse income portfolio lays a foundation of financial resilience and prosperity.
#3 – Tax Benefits and Deductions: Navigating the Complexities
Income diversification presents an opportunity to mitigate taxes through various benefits and deductions. Depending on your jurisdiction, you may be eligible for specific tax breaks or deductions on passive or investment income. For instance, certain expenses related to generating rental income may be deductible, or long-term capital gains might be taxed at a lower rate.
It’s also noteworthy that certain types of income like qualified dividends or long-term capital gains can offer potential tax advantages over regular income. While tax laws can be complex, a basic understanding of these concepts could be beneficial to reduce your tax obligations.
That said, always consider seeking the help of a tax professional to navigate these intricacies, especially with an S corporation or with a schedule C.
FAQ About Different Types of Income
Earned income and passive income are two distinctly sourced income channels. Earned income is money received as a direct result of work performed or services provided. This includes wages, salaries, tips, and self-employment income.
Passive income, on the other hand, is money earned without active, daily participation. Although it may require initial efforts to set up, its subsequent generation entails minimal direct input. The key difference between the two lies in the level and timing of involvement required to generate them. Passive income gives you more time freedom.
Portfolio income and passive income are often misunderstood as the same. However, the Internal Revenue Service (IRS) distinctly categorizes them. 3
While passive income generally refers to earnings gained without active involvement, portfolio income specifically relates to income derived from investments such as interest, dividends, or capital gains. Although both involve some lack of active participation, their origins, and tax implications are different.
No, investment income and earned income are not the same. The key difference lies in the source: one is actively earned by working, while the other is accrued through investing or letting money work for you.
The variance also manifests in their respective tax treatment by the IRS.
Earned income refers to wages, salaries, bonuses, and other income earned by providing a service or actively participating in a job or business.
On the other hand, investment income is generated from things like dividends, interest, and capital gains from the sale of financial assets such as stocks or bonds.
Diversification is the Key to Types of Income
Choosing the right income channel—earned, passive, or investment income—depends heavily on your financial goals, resources, risk tolerance, and time commitment.
Earned income may provide stable, regular income, but requires active participation.
Passive income, while enticing with its offer of money while you sleep, requires initial effort and savvy management.
Investment income may promise attractive returns, yet it can involve significant risk and demand financial acumen.
Diversifying your income streams could provide economic stability, flexibility, and potential tax benefits.
One wise woman, Teri Ijeoma, once stated, “It is better to make more money than you know what to do with rather than worry about how the taxes work.”
Remember, there’s no one-size-fits-all answer to financial prosperity, but understanding the nuances of various income types is a step in the right direction toward financial literacy and independence.
Now, let’s move to how to become financially independent.
Source
Internal Revenue Service. “IRS provides tax inflation adjustments for tax year 2024.” https://www.irs.gov/newsroom/irs-provides-tax-inflation-adjustments-for-tax-year-2024. Accessed November 20, 2023.
Internal Revenue Service. “Passive Activity and At-Risk Rules.” https://www.irs.gov/pub/irs-pdf/p925.pdf. Accessed November 20, 2023.
Internal Revenue Service. “Publication 550 (2022), Investment Income and Expenses.” https://www.irs.gov/publications/p550. Accessed November 20, 2023.
Bankrate. “23 passive income ideas to help you make money in 2023.” https://www.bankrate.com/investing/passive-income-ideas/. Accessed November 20, 2023.
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The Internal Revenue Service (IRS) generally requires that you report a forgiven or canceled debt as income for tax purposes. But forgiven student loan debt is different.
The American Rescue Plan (ARP) Act specifies that student loan debt discharged between 2021 and 2025, and incurred for postsecondary education expenses, will not be counted as income, and therefore does not incur a federal tax liability.
This includes federal Direct Loans, Family Federal Education Loans (FFEL), Perkins Loans, and federal consolidation loans. Additionally, non-federal loans such as state education loans, institutional loans direct from colleges and universities, and even private student loans also qualify.
However, some states have indicated that they still count canceled student loans as taxable income. Read on for more information about which discharged student debt is taxable and by whom.
Different Student Loan Forgiveness Programs
Federal student debt can be canceled via an income-driven repayment plan (IDR) or forgiveness programs.
While President Joe Biden’s plan to offer federal debt cancellation of up to $20,000 to those with qualifying income failed — struck down by the U.S. Supreme Court — other forms of student loan forgiveness have been strengthened.
In October 2023, the White House announced at least $127 billion in student loan relief for nearly 3.6 million Americans:
• $5.2 billion in additional debt relief for 53,000 borrowers under Public Service Loan Forgiveness programs.
• Nearly $2.8 billion in new debt relief for nearly 51,000 borrowers through fixes to income-driven repayment. These are borrowers who made 20 years or more of payments but never got the relief they were entitled to.
• $1.2 billion for nearly 22,000 borrowers who have a total or permanent disability who have been identified and approved for discharge through a data match with the Social Security Administration.
Recommended: Guide to Student Loan Forgiveness
Whose Student Loan Cancellation Is Not Federally Taxed?
As stated earlier, under the provisions of the ARP Act, any student debt (private or federal) for post-secondary education that was or is forgiven in the years of 2021 through 2025 will not be federally taxed. This means that the borrowers just listed above were not required to report their discharged loan amount as earned income, and therefore taxable.
Outside of the special five-year window of tax exemption provided by the ARP Act, participants in the Public Service Federal Loan program who receive forgiveness also don’t have to worry about paying taxes on the canceled amount. The program explicitly states that earned forgiveness through PSLF is not considered taxable income.
Recommended: A Look Into the Public Service Loan Forgiveness Program
Whose Student Loan Cancellation Is Federally Taxed?
Borrowers who receive loan cancellation after participating fully in an income-driven loan repayment plan can generally expect to pay taxes. Again, those whose debt was discharged in 2021 and 2022, or will be discharged in 2023, 2024, or 2025, will not need to pay federal taxes on their forgiven loans.
Forgiven amounts that are taxable are treated as earned income during the fiscal year it was received. Your lender might issue tax Form 1099-C to denote your debt cancellation. 💡 Quick Tip: Enjoy no hidden fees and special member benefits when you refinance student loans with SoFi.
Which States Have Said They Will Tax Forgiven Student Loans?
Typically, states follow the tax policy of the federal government. But some states have announced that their residents must include their forgiven or canceled student loan amount on their state tax returns.
As of October 2023, the states that say forgiven loans are taxable are Mississippi, North Carolina, Indiana, Wisconsin, and possibly Arkansas, depending on an upcoming vote in its legislature. More states could decide to do so.
It’s important to consult a qualified tax accountant or someone knowledgeable about forgiveness of student loans in your state to confirm the latest information of how much you owe.
Preparing to Pay Discharged Student Loan Taxes
If you’re anticipating a tax liability after receiving loan forgiveness, there are a few steps you can take today to get ready.
Step 1: Estimate Your Bill
The first step when bracing for a student loan forgiveness tax bill is calculating how much you might owe come tax season. This factor can be influenced by factors including the type of forgiveness you are receiving and the forgiven amount.
To avoid sticker shock, you can use a student loan forgiveness tax calculator, like the Loan Simulator on StudentAid.gov. It lets you see how much of your student loan debt might be forgiven, based on your projected earnings.
Step 2: Choose the Right Plan
Enrolling your federal student loans into an IDR plan can help you keep your monthly payments to a manageable amount while you’re awaiting loan forgiveness. All of these repayment plans calculate your monthly payment based on your income and family size.
The newest IDR program is the Saving on a Valuable Education (SAVE) plan, which offers unique benefits that will lower payments for many borrowers, to as low as 5% of disposable income in 2024 for those who qualify.
Recommended: The SAVE Plan: What Student Loan Borrowers Need to Know
Step 3: Prioritize Saving
If you’re expecting loan forgiveness after 2025, it might be advantageous to allocate extra cash flow toward a dedicated tax savings fund. Incrementally setting money aside over multiple years can ease the burden of a sudden lump sum tax bill down the line.
Paying Taxes on Canceled Student Loan
If you can’t afford to cover an increased tax bill, contact the IRS to discuss your options. Inquire about payment plans that can help you pay smaller tax payments over a longer period of time. However, be aware that fees and interest will likely accrue. 💡 Quick Tip: Refinancing could be a great choice for working graduates who have higher-interest graduate PLUS loans, Direct Unsubsidized Loans, and/or private loans.
The Takeaway
Thanks to a special law passed by Congress in 2021, post-secondary education loans forgiven from 2021 through 2025 will not count as earned income and will not be federally taxed. That said, state taxes may be due, depending on where the borrower lives.
Looking to lower your monthly student loan payment? Refinancing may be one way to do it — by extending your loan term, getting a lower interest rate than what you currently have, or both. (Please note that refinancing federal loans makes them ineligible for federal forgiveness and protections. Also, lengthening your loan term may mean paying more in interest over the life of the loan.) SoFi student loan refinancing offers flexible terms that fit your budget.
With SoFi, refinancing is fast, easy, and all online. We offer competitive fixed and variable rates.
FAQ
Is loan repayment considered taxable income?
If your employer offers loan repayment assistance benefits, they would typically be considered taxable income. However under the Cares Act, loan forgiveness payments — and employer assistance loan payments up to $5,250 — made each year from 2021 through 2025 are tax-free.
Will refinancing my student loans help me avoid taxes?
Student loan refinancing simply involves reworking one or more existing student loans into a new private loan with more favorable terms. It’s a repayment strategy that does not incur a tax liability.
Photo credit: iStock/fizkes
SoFi Student Loan Refinance If you are a federal student loan borrower, you should consider all of your repayment opportunities including the opportunity to refinance your student loan debt at a lower APR or to extend your term to achieve a lower monthly payment. Please note that once you refinance federal student loans you will no longer be eligible for current or future flexible payment options available to federal loan borrowers, including but not limited to income-based repayment plans or extended repayment plans.
SoFi Loan Products SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.
Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
Non affiliation: SoFi isn’t affiliated with any of the companies highlighted in this article.
Non affiliation: SoFi isn’t affiliated with any of the companies highlighted in this article.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
About one in seven Americans has unclaimed funds lurking somewhere. In fact, there’s an estimated $70 billion in unclaimed assets in the United States. Typically, the amounts people receive when retrieving this money can be small (say, $20) or, in rare cases, it can be a significant amount of six figures or higher.
States typically manage these funds, which can come from forgotten bank accounts, pensions, insurance benefits, wages, savings bonds, and other sources.
If you’re wondering whether there’s any money out there that belongs to you, read on. This guide will walk you through where unclaimed money may be hiding and how to claim it.
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How to Find Unclaimed Money 5 Ways
Money usually remains unclaimed because owners have no idea it exists. That’s why it may be worth searching for unclaimed funds in your name just in case. So how do you go about it? Unfortunately, there’s no single place you can look for all potential unclaimed cash. It may take some work, but here are some steps you can take to help make sure you’re claiming everything that’s yours.
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1. Searching State Databases
A good first step may be to hunt for unclaimed funds at the state level. Each state has an office that oversees unclaimed property, typically housed in the state treasurer’s, controller’s, or comptroller’s office. You can link to your state by visiting the website unclaimed.org, which is run by the National Association of Unclaimed Property Administrators.
Don’t forget to search your name in the database of each state where you have lived, not just the one where you live now. Make sure that you are searching the official state site (it should have .gov in the URL) to avoid scams. If you are married and changed your name, you may want to consider searching under your maiden name too.
You can continue your search by checking MissingMoney.com, which offers a multi-state database endorsed by the National Association of Unclaimed Property Administrators.
All of these searches are free to complete. If someone asks you for money to complete a search, that’s a red flag. There’s no reason to pay to access money that’s yours, unless there is a small processing fee.
If you happen to find unclaimed property, each state has its own process for proving that you’re the true owner and getting your hands on the cash. Many states allow you to file a claim electronically.
Usually you need to provide some kind of official documents to prove that you’re the person named as the owner. Luckily, there is typically no time limit for claiming the money. If the owner has died, you can often claim funds from a deceased relative. You can typically file a claim if you’re an heir, trustee, or executor of the estate.
2. Looking for Unpaid Wages and Pensions
Here’s another possibility in terms of how to find unclaimed funds: Hunt for back pay. If your employer owes you back wages, you can search the Department of Labor’s database. Start by inputting the name of the employer. You typically have to move quickly in this case, since the agency only keeps unpaid wages for three years.
You can also look for pensions from a former employer. Pension funds may be unclaimed if a company closed its doors or ended a particular pension plan. You can look for funds through the website of the Pension Benefit Guaranty Corporation, which is a government agency.
3. Checking for Unclaimed Tax Refunds
If you think you may have failed to receive a tax refund at some point, you can track that down through the Internal Revenue Service’s website. Keep in mind that you will need to know the exact refund amount in order to conduct the search.
4. Searching for Insurance Funds
Many insurance companies transfer unclaimed funds to states, but a couple of federal government agencies maintain their own unclaimed funds databases. The U.S. Department of Veterans Affairs holds onto unclaimed VA life insurance funds for most policyholders and, if they’re deceased, their beneficiaries.
People who had mortgages insured by the Federal Housing Administration can check for potential unclaimed refunds on the website of the U.S. Department of Housing and Urban Development.
5. Finding Savings Bonds
Another potential place to find unclaimed funds could be in forgotten or lost savings bonds. To check whether you have a bond that has reached maturity, check the government’s website Treasury Hunt. You’ll be prompted to enter your Social Security number and your state.
The site also offers advice on finding lost, destroyed, or stolen savings bonds.
• FDIC and Closed Banks You may also want to see if you have any money that is in a lost bank account or one that was held at a now-closed bank. It’s a very rare occurrence, but bank failures do occasionally happen. If you believe you had funds in one that you never received, you can contact the FDIC Claims Depositor Services at 888-206-4662, option 2.
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Being Aware of Scams
Where there’s free money, there are bound to be con artists trying to take advantage of it. Some companies may offer to help you find unclaimed funds and recover the money for a percentage of the amount owed you. Be cautious: These can be scams. Paying these fees is pointless, since you can search for unclaimed property and reclaim it for free (or perhaps for a small processing fee to the state).
The IRS recently warned of another kind of unclaimed money scam, in which a letter arrives, claiming to be from the government, alerting you to a refund you have not yet accessed. This fraudulent communication then says that your banking details are needed to receive the money. If you send that sensitive information, you could end up losing money and having your accounts compromised.
Using Your Unclaimed Money
If you happen to be one of the lucky people who finds cash waiting for them, what should you do with it? You may be tempted to blow the surprise windfall on those new shoes you’ve been eyeing or on a dream vacation.
But depending on the sum you receive and your financial situation, there may be smarter ways to put the unexpected money to use. Consider these possibilities.
Paying Off Debt
If you have high-interest debt, many people suggest putting much of your extra cash toward knocking it out. That’s because interest rates can cause a balance to balloon significantly over time, meaning the longer you wait to pay off your high-interest debt, the more you’ll likely pay overall.
Credit cards and payday loans tend to have high interest rates, but you may also want to check the rate you’re paying on your student loans, car loan, personal loan, or mortgage. One method for potentially paying off your debt faster is to tackle your highest-interest debt first, while staying on top of minimum payments for your other liabilities.
Building An Emergency Fund
Once you’re on top of your debt or at least the highest-interest liabilities, it may be a good idea to establish or pump up an emergency fund.
Financial experts suggest having enough saved to cover three to six months’ worth of living expenses.
It may be a good idea to keep this money in a safe place, like a high-interest savings account, for unexpected emergencies such as car repairs, medical bills, or a layoff. Having an emergency fund may help you avoid getting into high-interest debt in the future since you have that cash cushion to see you through challenging times.
Saving for a Goal
Once you have a basic emergency fund, you may want to start setting aside money to get closer to a big financial goal. Maybe you want to have a wedding, travel, start a business, or buy a home.
Saving in advance means you may need to take out less in loans or pay less in credit card charges. Or you might be able to avoid them altogether, keeping more of your money in your pocket.
Investing for the Future
Another option is to invest your money in an individual retirement account, college savings plan, brokerage account, or another financial vehicle.
Investing your money for the long-term could allow you to take advantage of the power of compounding returns and potentially increase your chances of reaping solid growth over time. It can be tempting to spend your lucky find on short-term fun, but investing may set you up for financial freedom in the future.
Recommended: Weird Ways to Make Money
The Takeaway
How do you find unclaimed funds? Typically, it involves searching on websites to see what pops up. These are usually specific to the kind of money that is sitting unclaimed, whether that means going searching for tax refunds, the contents of closed bank accounts, back wages, or insurance payments.
Whether it’s deciding what to do with reclaimed cash, if you’re owed any, or figuring out how to afford a big goal, life poses plenty of personal finance challenges. Finding the right financial partner can be an important step in making your money work harder for you.
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FAQ
What is the best website to find unclaimed money?
Using a website to find unclaimed money will depend somewhat on the source of the unclaimed funds, such as whether it’s from an insurance claim, a forgotten safety deposit box, or other source. One good place to start can be unclaimed.org, which is run by the National Association of Unclaimed Property Administrators.
What happens if money is unclaimed?
When money is unclaimed, it often goes through a dormancy period (perhaps five years), after which the state takes control of the funds.
How do you claim unclaimed money from the IRS?
If you were expecting a federal tax refund and didn’t receive it, visit the IRS’ Where’s My Refund page and/or call their helpline at 800-829-1040. For state taxes, contact your local Department of Revenue by checking this website.
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How much wealth could you have by maxing out retirement accounts? We show you the numbers.
Everywhere you look, experts are telling you to contribute to your retirement accounts. Whether it’s advice from newspapers, blogs, financial planners, or friends, any advice that is worth taking must include planning for retirement. Why? Because it’s that important!
Over time, setting aside a small portion of your monthly income can mean the difference between living a comfortable retirement and not being able to retire at all. But how much should you put away?
One of the most common rules of thumb is to stick 10% of your income into a retirement account. If you have a work-sponsored plan, like a 401(k), you should always invest enough to at least meet your company match. But again, these numbers are a bare minimum for retirement savings. Why not save more if you can?
While the advice to save for your retirement is certainly sound, few people actually consider what saving more could mean for their future. Why stop at saving 10%? Why not save 15-20%? Heck, what would happen if you got really aggressive? How rich could you be if you actually maxed out your retirement accounts each year? Let’s take a look.
2024 IRS Contribution Limits for 401(k) Plans and IRAs
Every few years, the Internal Revenue Service adjusts the total amount of money that you are allowed to place into your retirement accounts. Contribution limits are going up in 2024, increasing to $23,000 for 401(k) and other workplace retirement plans and $7,000 for IRA and Roth IRA accounts. In addition, the IRS allows taxpayers who are 50 and older to make “catch-up” contributions. In 2024, these allow an additional $7,500 contribution for 401(k) plans and $1,000 for IRAs. We can expect these limits to increase in the future, although it is not certain when that will happen.
Our Assumptions
That being said, we need to make a few assumptions in order to calculate the amount of wealth we can build by maxing out our retirement plans. To begin, we’ll assume that we’re going to be making regular contributions only, so we will not be adding additional money for “catch-up” contributions.
Additionally, we’ll make all of our calculations based on the current contribution limits — $23,000 for 401(k) plans and $7,000 for IRAs. Again, if history repeats itself, those limits will be increased in the future. (We won’t account for that here, though.) Furthermore, we’ll assume that our investments will compound on an annual basis. And, finally, we’ll assume a very conservative growth rate of 5%.
Maxing Out Your 401(k)
Using a free compound interest calculator, let’s take a look at 401(k) plans. First, let’s assume that you are currently saving $4,000 a year in your plan and have been doing so since you were 25 years old. Based on our current set of assumptions, you would end up with just over $500,000 in your retirement account at age 65. Not bad, right?
And had you started saving this much at age 20, you would end up with $670,740 by the time 65 rolled around. Better yet, if you can stick it out for just 5 more years, you’ll end up with $879,261 over a 50-year time period. As you can see, compound interest plays a huge role, especially over the last few years.
Related: The Power of Compound Interest
But, what if you get really aggressive? What if you take a page out of the extreme early retirement book, cut your spending to the bone, and max out your 401(k) account? Here’s what you’ll save:
After 10 Years – $303,756
After 20 Years – $798,542
After 30 Years – $1,604,498
After 40 Years – $2,917,314
After 50 Years – $5,055,754
Amazing, right? By maxing out your 401(k), you could save about $300,000 more in 20 years than you would have saved in 40 with just a $4,000 a month contribution. You’ll have over $5 million more over a 50-year period.
Maxing Out Your IRA
Of course, maxing out a 401(k) plan can seem totally out of reach for most individuals. It’s much more feasible for someone to max out their IRA plan at $7,000 per year. If you did that, here’s an estimate of what you’d end up with:
After 10 Years – $92,447
After 20 Years – $243,034
After 30 Years – $488,325
After 40 Years – $887,878
After 50 Years – $1,538,707
Again, you’ll notice the compound interest coming in strong toward the end. Your savings almost doubled over just the last 10 years. So, the longer you can hang in there, the better off your finances will be.
Maxing Out Both Your 401(k) and IRA Plans
Now, let’s imagine that you have done extremely well for yourself and are able to max out both your 401(k) plan and your IRA. How much wealth can you build then?
After 10 Years – $396,203
After 20 Years – $1,041,577
After 30 Years – $2,092,823
After 40 Years – $3,805,192
After 50 Years – $6,594,461
Obviously, this type of money should provide you with a wonderfully comfortable retirement.
The Takeaway
Remember, these numbers are all for individual investors. Married couples can combine their retirement savings to increase their wealth-building power. So, while saving $23,000 a year by yourself may not be within reach, it could be achievable as a household.
Rather than deflate or discourage you, hopefully, these numbers will motivate you to save as much as you can for as long as you can do it. The power of compounding interest is real, and you can make it work to your advantage. The more you are able to save, the better off you’ll be in retirement.
More so than anything else, these numbers should be a reminder that putting money away for retirement is a long-term proposition. The earlier you start saving, the more success you’ll have. You have to play the long game with your focus firmly set on the future. If you ride the ups and downs of the market, save until it hurts, and remember to be patient, you could end up being extremely wealthy in the end.
Greg Johnson is a writer and entrepreneur who leveraged his online business to quit his 9-5 job, spend more time with his family, and travel the world. As a money nerd, he focuses most of his writing on topics that relate to budgeting, frugality, and investing. With his wife Holly, Greg co-owns two websites: Club Thrifty [http://clubthrifty.com] and Travel Blue Book [http://travelbluebook.com]. Find him on Pinterest and Twitter @ClubThrifty.
Inside: Do you want to claim your partner as a dependent on your taxes? This guide will explain the rules of claiming dependents whether girlfriend or boyfriend and help you take the necessary steps to do so.
Navigating the waters of tax credits can be tricky, especially when it involves claiming an unmarried partner as a dependent.
The Internal Revenue Service (IRS) does permit the declaration of a non-relative adult as a dependent, provided certain conditions are met.
And that is where it gets tricky for the tax novice.
That is where we are going to reference the IRS guidance, so you can determine whether or not you qualify for this deduction.
By pointing you in the right direction, you can understand the specific tests and requirements to avoid any tax-related complications.
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Understanding dependency in the context of taxes
The word “dependent” might remind you of a newborn baby or an elderly family member. But in tax terms, the meaning broadens.
In the IRS terms, a “dependent is a person, other than the taxpayer or spouse, who entitles the taxpayer to claim a dependency exemption.” 1
This might be a child, an adult family member, a significant other, or even a close friend. This term “qualifying relative” is crucial in IRS parlance for its implications on your tax dues.
Typically, any person can qualify as a dependent if more than half of their financial support, including living and medical expenses, is taken care of. Also, it’s an opportunity to boost one’s tax return by up to $500 with the Other Dependent Tax Credit.
What qualifies a person as a dependent?
The IRS bases dependents on two categories: “Qualifying children” and “Qualifying relatives.”2 You might think of a qualifying child as your son or daughter. Expanding the scope, a qualifying relative can be a sibling, a parent, or even a significant other.
The essence lies in their financial reliance on you and the nature of your relationship. They ought to:
Be related to you via blood, marriage, or adoption;
You provide over 50% of their financial support including housing, food, medical care, and other expenses
They are U.S. citizen.
The income of the possible dependent.
These nuanced rules might sound overwhelming, but IRS guidance and tax experts like TurboTax can help lighten the load.
Now, let’s address this sticking point: Can you actually claim your partner as a dependent? The following section unravels the mystique.
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Can I Claim My Partner as a Dependent?
You can claim your partner as a dependent on your tax return, provided they meet certain criteria explained by the IRS, including passing the non-qualifying child test, the citizen or resident test, the joint return test, the income test, and the dependent taxpayer test.
I know this is where it gets difficult to follow for the average person.
So, we are here, to break this terminology down into layman’s terms, as such you can then make the best decision for your tax situation.
If you are still confused, then consult with an online tax software like TurboTax or a tax professional for guidance on your personal taxes.
Basic requirements for claiming your partner as a dependent
This essentially means that your partner should be financially dependent on you, where you bear more than half of their living expenses.
In essence, claiming your partner as a dependent revolves around these fundamentals: 2
Residency: Your partner must have been living with you for the full tax year.
Income limit: Your partner’s gross income should not exceed $4,700 for the year 2023.
Support Requirement: You are the main pillar for your partner’s financial needs by covering over half of their total expenses.
Anyone Else Claiming Them: None else should claim your partner as their dependent.
Unmarried. Your partner must be unmarried legally.
All fulfillment of these criteria moves you a step closer to enjoying some tax relief.
Confirm with an accountant or tax expert as exceptions can exist, such as temporary absences due to illness, education, business, and others.
Common scenarios where you can claim your partner as a dependent
Claiming a partner as a dependent isn’t as fancy as it sounds, but it’s plausible. Here are common scenarios enabling you to do so:
Co-habiting Before Marriage: You and your partner share a home, and you pay more than half of your partner’s living costs. However, your living situation cannot violate local laws, as in some states, “cohabitation” by unmarried people is against the law.
Unemployed Partner: Your partner’s tie with working life is severed (e.g., due to health issues or being laid off), and you bear most of the living expenses.
Supporting Student Partner: Your partner pursues their education, and you shoulder the majority of their expenses.
Take this interactive IRS quiz to determine whom I may claim as a dependent.
How much will I get if I claim my girlfriend as a dependent?
Now the pivotal question: what’s the advantage in dollars and cents?
In essence, claiming your partner as a dependent will slash your taxable income by $500 with the Other Dependent Tax Credit. 3
If you already qualify for Head of Household status with another dependent, then it is possible your deduction may be more. 4
Remember, there’s no one-size-fits-all answer. When tax complexities strike, consult an expert!
Is it better to claim my girlfriend as a dependent?
Honestly, like most tax questions, the answer is: it depends.
If you’re covering your partner’s majority expenses and they’re fulfilling all IRS criteria, then claiming them can bring solid tax savings.
Yet, bear in mind:
If your partner earns substantial income (greater than $4,700), they might lose personal benefits by becoming your dependent.
By claiming your partner, their Social Security or medical benefits may take a hit.
So, assess your partner’s income, benefit entitlements, and your tax situation. Then, tread wisely.
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Important Rules to Keep in Mind When Claiming Your Partner
When filing taxes, it’s crucial to understand that both parties are responsible for the accuracy of each other’s tax reporting and liability.
It’s worth noting that tax advantages and disadvantages exist in the scenario of being married and filing jointly, such as potential reductions in your tax bracket and sharing of business losses. So, it may be something to consider.
Can I claim my girlfriend as a dependent if she has no income?
In a nutshell, yes! If your girlfriend had no income in the tax year, you might claim her as a dependent. Given you provide over half of her total support and she lived with you all year, you’re golden.
For 2023, your partner’s gross income should not exceed $4,700.
However, keep in mind that in cases where public assistance or Social Security benefits are her primary financial sources, claiming her could negatively impact those benefits.
Learn the answer to do you have to file taxes if you have no income.
Remember: tax waters are often murky. When in doubt, lean on a tax professional’s shoulder!
Support factors
Answering the support question plays a hefty role in determining who qualifies as a dependent.
You shouldn’t just share the living cost; you should pay more than half of it. Remember, it includes an array of expenses, like food, clothing, education, or medical expenses.
The implication of your partner being claimed by someone else
Here’s a key rule: if someone else is claiming your partner as a dependent, you’re out of the game. The IRS rules say a person can be claimed as a dependent by only one taxpayer in a single tax year.
This could happen if your partner perhaps lives part of the year with someone else like a parent.
Another possibility is if your partner is legally married still, then they would have to file a married, filing separately return.
So, if your partner qualifies as someone else’s dependent, even if they don’t claim them, you can’t claim your partner.
Frequent Situations Where You Can’t Claim Your Partner as a Dependent
Considerations for Non-resident or Non-citizen partners
If your partner isn’t a U.S. citizen, resident, or national, the dependent claiming game changes. Notably, nonresident aliens cannot be claimed as dependents.
However, if your partner is a resident of Canada or Mexico or a U.S. national, you may claim them. But they should be living with you full-time. 2
This rule extends to partners awaiting changes in their residency or citizenship status. In such cases, you must wait until their status changes before claiming them.
When your partner earns more than the stipulated income threshold
When your partner’s income level sails past the IRS limit ($4,700 in 2023), claiming them as a dependent slips off the table. 2
Any part-time job, seasonal work, or income source counts, even those seemingly negligible. As soon as they cross this threshold, regardless of how heavily they rely on you or where they reside, they can’t qualify as your dependent.
Make sure to stay updated on IRS rules. They adjust the income limit for inflation annually, which changes this income ceiling. Keep an eye peeled for those IRS updates!
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How to Officially Claim Your Partner on Your Taxes
To officially claim your partner as a dependent on your tax return, you will do this when you file your taxes.
Thankfully, this is made easier with online software companies like TurboTax or H&R Block.
The same is true when you are trying to figure out how to file taxes without a W2.
Necessary steps to claim your partner on your taxes
You will first identify them as “other qualifying dependent” or “other qualifying relative”.
Gather the facts first: Confirm your partner’s income, residency, and who has been supporting them for more than half the year.
Document expenses: Keep track of all relevant bills and receipts to demonstrate your majority support.
Use tax software or a professional: Follow prompts about dependents in tax software like TurboTax. They could guide you through the process and specifics.
Complete relevant Tax Forms: Prepare the necessary forms such as Form 1040 and Schedule H and have proof of residency, financial support, gross income information, and certification of your domestic partnership to support your claim.
File your return: Don’t forget to include your partner’s details and tick the correct boxes.
Remember, the devil is in the details. So carefully evaluate your situation to avoid missteps, and consult with a tax professional when in doubt.
Pitfalls to avoid while filing tax returns
While preparing to file your tax returns, beware of these common pitfalls:
Incorrect income calculation: Ensure you tally your partner’s gross income accurately. Reminder: it should not eclipse $4,700 in 2023.
Overlooked Living Qualification: Your partner must have resided with you the entire year. Temporary absences (illness, education) can be exceptions.
Ignoring Other Claimants: If someone else is poised to claim your partner as a dependent – even if they don’t – you can’t claim them.
Emergency Funds Consideration: If your partner taps into their savings for a large expense, this could speak against you providing most of their support.
Forgotten Documents: Maintain a record of bills, receipts, and other expense documents.
The IRS overlooks no mistakes, so take care and stay informed. When in doubt, professional tax help is a button away.
Frequently Asked Questions (FAQ)
Intriguing question! Here’s the short answer: Your partner’s marital status may indeed affect your ability to claim them as a dependent.
For instance, if your partner is married and files a joint tax return with their spouse, you can’t claim them as a dependent.
Remember, tax rules are lock-key specific, and bending them can lead to penalties. Always seek advice from a tax professional.
While you might be able to claim your partner as a dependent, laying claim on their children as dependents is unlikely. IRS rules are clear: you can claim a dependent only if they’re your child or relative.
Since your partner’s children don’t fulfill this requirement, you can’t claim them unless they can be considered your qualifying relative AND you provide more than half of their support.
As always, it’s best to run this by a tax professional for clarity on your unique situation. All we tax-seers can do is guide; the decision falls on your shoulders.
Here’s the hard truth: if your partner didn’t live with you all year, you couldn’t claim them as a dependent. IRS rules are stringent about this: your partner must have the same home as you for the entire year. That is 365 days, no less.
However, IRS grants a green light to temporary separations due to special circumstances like illness, education, military service, or even a holiday. The key lies in their intent to return and, of course, their follow-through.
Stay wise and stay informed, and consult with a tax analyst to seal your decision with assurance.
Get Online Help
Navigating tax rules and regulations doesn’t need to be overwhelming. With the advent of online help, understanding whether you can claim your partner as a dependent becomes considerably more manageable. Here are a few benefits of seeking online help:
Convenience: With online help, you can access the information you need anywhere, anytime. No need to schedule appointments or deal with traffic to get to a tax office. You can get the updates and instructions right from the comfort of your own home.
Accessibility: Some great examples of accessible platforms are TurboTax, e-File, and H&R Block which provide 24/7 support and resources. They offer a wealth of information and experts at your fingertips.
Expertise: Apart from the convenience, these websites employ tax experts who deliver professional analysis and guidance tailored to your specific needs. Specifically, you can use TurboTax Live Full Service for someone to do your taxes from start to finish. Or you can ask questions with TurboTax Live Assisted.
File your own taxes with confidence using TurboTax. This can greatly simplify the process and minimize potential missteps.
Now, Can I Claim my Unmarried Partner as a Dependent is Up to You
As they say, “Ignorance of the law is no excuse”. The same holds true for tax rules.
Falsely claiming a dependent can lead to severe penalties, not just a dinging of your wallet. You’d be sailing the choppy waters of tax evasion, which can bring on hefty fines or even dark days behind bars.
In blatant cases, the IRS could impose a Civil Fraud Penalty. That means a penalty amounting to 75% of the unpaid tax amount resulting from fraud. 5
In short, play by the rules! Accurate and clear tax filing may seem tedious, yet it will steer clear of any legal trouble. Remember, it’s always safer to ask if you are unsure!
Now, are you wondering why do I owe taxes this year?
Source
Internal Revenue Service. “Tax Tutorial.” https://apps.irs.gov/app/understandingTaxes/hows/tax_tutorials/mod04/tt_mod04_glossary.jsp?backPage=tt_mod04_01.jsp#dependent. Accessed October 23, 2023.
Internal Revenue Service. “About Publication 501, Dependents, Standard Deduction, and Filing Information.” https://www.irs.gov/forms-pubs/about-publication-501. Accessed October 23, 2023.
Internal Revenue Service. “About Publication 501, Dependents, Standard DeductionUnderstanding the Credit for Other Dependents.” https://www.irs.gov/newsroom/understanding-the-credit-for-other-dependents. Accessed October 23, 2023.
Intuit TurboTax. “Guide to Filing Taxes as Head of Household.” https://turbotax.intuit.com/tax-tips/family/guide-to-filing-taxes-as-head-of-household/L4Nx6DYu9. Accessed October 23, 2023.
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Did the post resonate with you?
More importantly, did I answer the questions you have about this topic? Let me know in the comments if I can help in some other way!
Your comments are not just welcomed; they’re an integral part of our community. Let’s continue the conversation and explore how these ideas align with your journey towards Money Bliss.
Inside: Are you considering opening multiple Roth IRA accounts? You need to know if you can have multiple Roth IRAs. Here is what you need to know before making the decision.
While managing multiple Roth IRAs can create confusion, especially with tracking contributions across different custodians and potentially violating the five-year rule, I have found a method to use them to my benefit.
By having multiple Roth IRAs, I am able to diversify my investments as each Roth IRA account has a specific purpose.
However, you must know the rules about having multiple IRAs.
For the average investor, having multiple Roth IRAs may seem like a potential strategy to diversify your investments and attain financial independence, but it often leads to more confusion than benefit. Therefore, simplifying your finances by having a single Roth IRA might be a more feasible approach to reaching financial independence.
However, readers at Money Bliss know there is always a reason if I am strategic about why I do something.
So, let’s go through everything you need to know about having multiple Roth IRAs and if it is worth it for you.
What is a Roth IRA?
A Roth IRA stands as a type of retirement account with distinct tax benefits. The Internal Revenue Service (IRS) manages specific rules on who can open a Roth IRA, along with the contribution limits and withdrawal policies. 1
When your contributions in this retirement account and their interest earnings grow, they do so tax-free. 2
“Roth IRAs give you the flexibility to increase retirement savings tax-free. Thus, helping you to reach financial independence quicker.”
Kristy @ Money Bliss
Can You Have Multiple Roth IRAs?
Absolutely! You can certainly have more than one Roth IRA.
Different from some other types of retirement accounts, no restrictions apply to how many Roth IRAs you can manage.
From the IRS perspective, regardless of how many different IRA custodians you choose to utilize, your contributions are treated as one Roth IRA. You must still follow the guidelines on contribution amounts on your Roth IRA and traditional IRA. 3
This could potentially lead to tracking or contribution errors, or even unintentional violations of the Roth IRA’s 5-year rule, which can result in penalties. Furthermore, managing multiple accounts can also lead to an accidental overweighting of one investment strategy due to faulty fund allocation.
Why would a person want more than one Roth IRAs?
Several reasons could motivate an individual to manage multiple Roth IRAs:
Saving for various objectives. Investors might manage different IRAs for distinct purposes—one for retirement income, another as a cushion for emergencies.
Diversification of investment portfolio. Multiple Roth IRAs facilitate varied levels of risk adoption across different types of investments.
Raising insurance protection. With multiple Roth IRAs spread across separate institutions, each account can avail of $250,000 FDIC insurance protection. 4
Simplifying inheritance. Dealing with inheritance matters gets easier upon having distinct Roth IRAs, as assets can be split and handed down according to wishes.
Personally, I choose to have multiple Roth IRAs because I actively trade options contracts in one while the other is for long-term holdings.
Is it smart to have multiple Roth IRAs?
This is a highly personal decision as it depends on individuals and their unique circumstances.
Multiple Roth IRAs can offer remarkable benefits. However, keep in mind that more accounts may mean more fees and added complexity when managing your retirement savings.
You must consider your financial goals, risk tolerance, and time horizon is crucial before opting for multiple IRAs.
Many people end up with multiple IRAs when they decide to rollover a 401k from a previous employer.
Benefits of Opening Multiple Roth IRAs
You will have to decide if these benefits of multiple Roth IRAs are worth it for you:
Diversified investments. By having multiple accounts, it allows you to vary your investment strategy by account.
Conversion Flexibility. Managing the tax implications of converting traditional IRAs or employer-linked retirement accounts to Roth IRAs gets easier.
Varying Savings Objectives. Different Roth IRAs can be maintained for different purposes such as retirement income, house maintenance or rainy day funds.
Elevated Insurance Protection. If one Roth IRA is reaching the FDIC insurance limit, a second account with a different institution ensures additional protection.4
Drawbacks of multiple Roth IRA accounts
While having multiple Roth IRAs has broader benefits, it comes with some shortcomings:
Complex Management. Managing several Roth IRAs requires frequent monitoring and coordination.
Increased fees. Many IRA accounts come with fees. Even low fees across multiple accounts can add up.
Unequal Investment Allocation. Spreading investments across multiple IRAs makes monitoring performance difficult.
More Paperwork. More accounts mean more paperwork, which could be time-consuming.
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Unfolding the Complexities of Multiple Roth IRAs
With multiple Roth IRAs, complexities unfold around the management and tracking of these accounts. The investments need to be monitored on a regular basis to maintain strategic alignment with retirement goals.
It’s necessary to regularly check for fees and investment performance.
Balancing the portfolio of multiple IRAs plays a vital role, as the percentage of each investment differs between accounts. This could make it challenging to form a streamlined portfolio until you have sufficient experience.
Nevertheless, this is an easier question to answer than is now a good time to buy stocks.
Understanding the rules with multiple Roth IRAs
Understanding the regulations with multiple Roth Individual Retirement Accounts (IRAs) is essential when planning for a stable retirement.
With a comprehensive overview of the laws governing multiple Roth IRAs, one can strategically leverage these tax-advantaged accounts for optimal retirement savings.
No more confusion or lack of knowledge on how many Roth IRAs they can legally own, this section provides clarifications on these essential rules.
Does having multiple Roth IRAs mean you can contribute more total money each year?
The short answer is no.
Regardless of how many Roth IRAs you have, your total annual contributions combining all accounts can’t surpass the IRS-placed limits.
For 2023, the limit stands at $6,500 if you’re under 50 or $7,500 if you’re 50 or older. 3
In 2024, the limit stands at $7000 if you’re under 50 or $8000 if you’re 50 or older. 3
Can I contribute to a Roth IRA and a Traditional IRA?
Yes, you can contribute to both a Roth IRA and a Traditional IRA.
However, the total contribution to all your IRAs cannot exceed the annual limits set by the IRS. 3
For instance, in 2023, the total contribution limit is $6,500 for individuals under 50, and $7,500 for those who are 50 or older.
You don’t want to be taxed on excess IRA contributions.
Tips for managing multiple IRAs
Managing multiple IRAs comes with its own set of challenges. But, with the right approach, you can reap substantial benefits:
Organize Your Investments. Keep your IRAs clearly labeled for distinct goals—a critical step.
List Your Beneficiaries Properly: You must list your beneficiaries on each Roth IRA account.
Consolidate Accounts. If you find managing many accounts overwhelming, think about consolidating them at one institution.
Regular Review. Evaluate your portfolio time and again to see if adjustments are needed.
Monitor Fees. Fee accumulation can hollow out your retirement savings. Keep a close watch on them.
Use Software to Help You. My personal favorite is Quicken Classic
For many people, they learn how to invest 10k the first time using their Roth accounts.
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FAQs About Having Multiple Roth IRAs
For 2023, the total combined contribution limit for all of your Roth IRAs stands at $6,500, or if you are 50 or older, it is $7,500 thanks to an extra ‘catch-up’ contribution.
This limit applies to the total contribution made across all of your Roth IRAs and traditional IRAs.3
The IRS does not impose a limit on the number of IRAs an individual can own. You are free to open as many IRAs—Roth or traditional—as you want to suit your retirement savings strategy.
Remember, however, that total annual contributions across all your IRAs must stay within the defined limit. [Quote from IRS documentation stating there’s no limit on the number of IRAs]
No, unfortunately, you can’t.
The yearly limit of $7,000 (or $8,000, if you’re 50 or older) applies to the total amount you contribute across all of your Roth and traditional IRAs, not each individual account for 2024. 3
Yes, you can. The IRS doesn’t set a cap on the number of Roth IRA conversions you can execute.
So, you can certainly convert multiple traditional IRAs into just one Roth IRA.
Take note that you’re likely to owe income tax on the entire amount converted in the conversion year.
Learn more about converting a traditional IRA to a Roth IRA because this decision will affect your taxes.
From my experience, there are times when it is wise to convert and I did. Then, there were others that converting the account did not make financial sense. So, make sure you figure out the best-case scenario for you.
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Now, How Many Roth IRAs Can I Open?
In conclusion, it is not only possible but also potentially advantageous to hold multiple Roth IRA accounts.
By diversifying your retirement savings across various Roth IRAs, you can expose your money to different asset classes and investment opportunities not all available in one account.
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Nevertheless, the decision to open multiple Roth IRAs must be driven by your personal financial circumstances, retirement objectives, risk tolerance, and expected time horizon. If the decision aligns with your financial blueprint and retirement strategy, opening multiple Roth IRAs today could be a smart move.
Given the unique tax advantages Roth IRAs offer – tax-free withdrawals during retirement – this could ensure a financially secure and tax-efficient retirement.
Honestly, I think choosing the right brokerage is harder for most people.
As always, consider seeking guidance from a trusted financial advisor to help navigate these decisions and ensure your retirement planning is optimally structured for your financial needs and goals.
Remember, the key to successful retirement planning lies in understanding all associated rules, benefits, and potential drawbacks.
Sources
Internal Revenue Service. “Types of Retirement Plans.” https://www.irs.gov/retirement-plans/plan-sponsor/types-of-retirement-plans. Accessed October 10, 2023.
Internal Revenue Service. “Roth IRAs.” https://www.irs.gov/retirement-plans/roth-iras. Accessed October 10, 2023.
Internal Revenue Service. “Retirement Topics – IRA Contribution Limits.” https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-ira-contribution-limits. Accessed October 10, 2023.
FDIC. “Your Insured Deposits.” https://www.fdic.gov/resources/deposit-insurance/brochures/insured-deposits/. Accessed October 10, 2023.
Internal Revenue Service. “Retirement Topics – IRA Contribution Limits.” https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-ira-contribution-limits. Accessed October 10, 2023.
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