It's Not Fun, but It Has to be Done Benjamin Franklin wrote a 1789 letter that states, “But in this world nothing can be said to be certain, except death and taxes.” Even at the United States’ early beginnings, federal taxes were a necessary evil to fund various public projects and administrative costs. Today, federal taxes serve much of the same purpose. While virtually no one likes to prepare and file their taxes, it is a necessity if you want to avoid fines and further hassle. It is no secret that preparing and filing your taxes is notoriously complicated. Many people lament that it should not be so difficult to pay the government. However, some of the complications allow people to save money if they discover specific tax benefits. Knowing how to file your own taxes may be a good option if your tax situation is relatively straightforward, or if you are willing to learn the process. Why Do You Need to File Your Taxes Every Year? The short answer is that federal law requires that most individuals file taxes annually. Income taxes are assessed every year based on your income earned during that period. You then pay a percentage of that income to the government, less any deductions, adjustments, or credits that you qualify to receive. If you do not file (and pay) your taxes, then you may be assessed penalties and interest. The Internal Revenue Service (IRS) can even go as far as garnishing your wages and repossessing your property if you do not file and pay as required. The Benefits of Filing Your Own Taxes If you are one of the 43% of Americans that are doing your own taxes, you are certainly not alone. Roughly 53 million people prepared and filed their own taxes in 2018. There are many benefits to filing your own taxes, including: Saving money: Hiring a tax professional is expensive, and many people can prepare and file their returns on their own, completely free of charge. Control: Some people like knowing the exact information that is included in their return and being able to control the data, and for some, knowing precisely how the numbers work out, is comforting. Gain helpful information: When you prepare your taxes, you can see what items saved you money this year or which issues you should address so you can save money next year. While filing your own taxes is complicated, it can be beneficial under the right circumstances. There are several programs online that walk you through the process to help ensure you are taking advantage of all of your available deductions and credits. The Drawbacks of Filing Your Own Taxes In addition to the benefits, there are also some disadvantages to filing your own taxes. These include: Time and effort: Preparing and filing your taxes takes time and work You have to sift through financial information and deal with concepts that you may not understand well. The process can be frustrating and take a considerable amount of time. Error risk: If you do not completely understand how your taxes work, you run the risk of making a mistake because of misconceptions. If that happens, it could lead to underpayment and audits down the road. Questions: Even if you use a tax preparation software, you may still have questions that will remain unanswered unless you do significant research or reach out to a tax professional. For some people, the risk of having a substantial error that triggers the IRS’s attention is enough to scare them away from preparing their own taxes. Preparing for Filing Your Taxes When you begin work on your taxes, you should have information gathered throughout the year. Some of the most common items that you will need include: Social Security numbers for you, your spouse, and any dependents Information about wages, such as W2s or 1099s Investment income information Documents that represent any other source of income Information regarding adjustments to income, such as student loan interest paid, IRA contributions, and health savings account contributions, just to name a few Information regarding potential credits, including, for example, child care expenses, education expenses, or retirement savings contributions Data about any tax payments that you may have made throughout the year Keeping good records will help make tax preparation easier at the beginning of the year. [youmaylike] The Basics About What You Can Claim When Filing You must pay income taxes on all your income earned throughout the year. However, that income is reduced by a few things. The further you can reduce your taxable income, the less you tax you will pay. There are three general categories of tax reduction methods: Standard or Itemized Deductions Everyone can claim either the standard or itemized deductions. Standard deductions are a set amount that is based on your filing status. Itemized deductions are based on actual expenses that you incurred throughout the year. You can choose to use the higher deduction. The higher the deduction, the less tax you will have to pay on your income because your income decreases on paper. Itemized deductions include things like medical expenses, state and local tax payments, and home mortgage interest deductions. Itemized deductions will only decrease your income by a certain percentage, or up to a specific point. Adjustments Some adjustments to your income may also be available. These include things like paying student loan interest or alimony. Adjustments are more valuable compared to deductions because they decrease your income dollar for dollar. Credits A credit decreases your taxable income as well. Some credits are refundable while others are not. For example, you get a child tax credit simply for having children that qualify for that credit, but that credit will not be paid out to you if you do not have any tax obligations. On the other hand, the Earned Income Credit, which is available for low-income filers, will be refunded to you even if you do not owe any taxes. There are a wide variety of deductions and credits available. Take a look at the federal forms and related schedules to determine whether you might qualify for any of these. How to File Your Own Taxes If You Live Overseas If you earned income in the United States as a U.S. citizen or resident alien, you likely need to pay taxes on that income. This is true even if you live overseas. You can still choose to e-file or mail your tax return to the IRS once you have it prepared, just as if you physically lived in the United States. In some cases, you will be taxed on the income that you earned throughout the world. However, you may be able to deduct a portion or all of the revenue that was not made in the United States in some circumstances. Filing Online The IRS offers an online filing option that is free for individuals that have an adjusted gross income below a specific threshold. Generally, your income must be below $66,000 to qualify for this service. You can also file online by using a commercial tax preparation software. Examples of this type of software include: H&R Block TurboTax TaxCut TaxSlayer There are many programs available that will file your taxes for you, often for a fee. Knowing how to file your own taxes can be a great way to save money, but it can be tricky as well. If you want to file your taxes yourself, be sure to read the form instructions thoroughly and get familiar with various tax saving opportunities before you begin preparing your return.
Reverse Mortgage Definition
Many folks run into an issue when they retire. They end up with a paid-off house with some retirement savings, and not many other financial assets. Sure, they’re eligible for Social Security and other retirement benefits, but that’s often not enough. This doesn’t translate into a whole lot of income.
The most common solution to this problem is to downsize to a smaller house, a move that frees up capital that can be put to work in stocks, bonds, CDs, or various other income-producing investments. And since you can sell your home without paying taxes on the proceeds, every dollar gained can be invested in your future.
But there are a few problems with that method. First, moving is a pain. Most people try to avoid it at all costs. It can also be expensive if you hire people to help you do it. Putting the cash into stocks isn’t guaranteed either. As we’ve seen over the last few months, stocks sometimes crash. Retirees might be better served to put their money in safer investments, but interest rates are incredibly low right now.
Some retirees are using a different way to extract income by utilizing reverse mortgages. Let’s take a closer look at this method and the reverse mortgage definition, and see if it might work for you.
What Exactly Is a Reverse Mortgage?
A reverse mortgage by definition works exactly how the name implies. If you pay money every month to the bank for a regular mortgage, you’ll receive money every month on a reverse mortgage. You can also opt for a one-time sum.
Before you start getting too excited, we should verify some details. A reverse mortgage isn’t free money. All that cash needs to be paid back at some point, which happens when the property is sold. The balance of the loan goes up every month depending on how much cash you get, and a borrower is charged interest each month on the cumulative balance.
A regular mortgage sees interest charges drop steadily as the loan is paid off. The opposite happens with a reverse mortgage. The amount of interest paid keeps going up as the balance owing goes up. When you’re investing, that’s a powerful thing. But it works against you when borrowing.
This compounding effect is why reverse mortgages are only offered to retirees with paid-off homes. The lender must ensure the amount paid back to the borrower won’t exceed the value of the house. Reverse mortgage lenders do this by capping the loan-to-value ratio at approximately 50% of the value of the house. So, if you have a $500,000 house, the maximum reverse mortgage balance you’ll qualify for is $250,000.
The loan is generally Federal Housing Agency insured and it’s a non-recourse loan. This means if you take out a reverse mortgage and the value of your home tanks, the bank can only sell the house to recoup its losses.
Who Should Take a Reverse Mortgage?
As I previously mentioned, the product simply isn’t offered to younger people. You must be 62 or older to get a reverse mortgage. The loan must also be secured against your principal residence; investment or vacation properties do not apply.
A reverse mortgage is well-suited for people who don’t have a lot of investment knowledge. Borrowing against your house is a lot simpler than trying to manage an investment portfolio, although the latter can always be outsourced to a fund manager or financial advisor.
A reverse mortgage can be a smart part of a retirement strategy. One way to do it might be to exhaust your savings when you first retire, leaving the reverse mortgage as an option in your 70s or 80s. This minimizes interest charges, ensuring more cash in your pocket when it comes time to sell.
Pros and Cons of a Reverse Mortgage
Reverse mortgages are gaining popularity with retirees because they’re easy. Unlike other methods of extracting home equity, getting a reverse mortgage is a simple process. You’re just borrowing against property you already own versus getting a brand-new house.
Another plus for a reverse mortgage is you’re able to productively use your home equity. After years of paying off your home, it finally returns the favor and starts paying you.
The biggest con is the amount of interest charged, of course. Reverse mortgage rates are often 2 to 3% higher than conventional mortgage rates. That can really add up over time, especially if you end up staying in your home for a couple of decades – or longer.
Say you take $500 per month from your home and get charged 5% annually for the privilege. You consistently get paid that much for 15 years and then go to sell your home. You’ll be stuck paying back nearly $136,000 to the bank.
Many retirees want to leave an inheritance for their kids or grandkids. A reverse mortgage will impact their ability to do so. This is something you can recognize and plan around, but it must still be considered when looking at your total financial picture.
Another disadvantage is you may run out of allowed home equity before you’re ready to leave your home. In this situation, the bank is in control of your retirement, not you.
How to Apply
Before applying for a reverse mortgage, you must first own your house. Exceptions apply for folks who have almost paid off their home, provided part of the reverse mortgage is used to pay off the existing loan.
You’ll also have to speak to an approved councilor before being allowed to apply. This person will guide you through the process and explain how everything works.
The next step is to apply for the loan. Note that this isn’t as easy as going down to your local bank branch. Reverse mortgage lenders tend to specialize in their unique loan. Certain mortgage brokers will be permitted to do reverse mortgages as well.
After this, the steps are the same as applying for most any loan. You’ll need to submit paperwork, verify certain financial information and so on.
Reverse Mortgage Definition: The Bottom Line
Like any financial product, reverse mortgages have pros and cons.
Ultimately, it’s up to you whether you decide to get one.
This special category of mortgage lending has experienced steady growth over the last decade or so as more Americans see the benefits. Many folks will happily pay interest if it means not selling their home.
But just remember one thing: compound interest is wonderful when you’re investing. It’s not very nice when it’s working against you. Reverse mortgage balances have a habit of ballooning much higher than the homeowner ever imagined.