25 Finance Questions You Were Afraid to Ask
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There are some financial questions everyone should probably know the answers to, but not everyone does. Basic financial education is lacking in the U.S., and many Americans don’t know answers to fundamental financial or banking-related questions. If you count yourself among those who could use some basic info, or at least a refresher course, it’s never too late to ask.
Click through to find out the basic finance terms you should know — and get answers to all your questions about them.
1. How Do Credit Cards Work?
Contrary to popular belief, a credit card is not a magic piece of plastic that pays for expenses like dining out. A credit card is actually a loan, one that can benefit you if you pick the right card and use it correctly. Every time you buy something with your card, you owe the bank that issued the card. If you don’t pay the full balance within the grace period, you’ll owe interest on that amount. Interest rates on credit cards often reach 20 percent or higher. At that rate, your debt can increase quickly if you carry a big balance — even if you don’t make any more purchases on the card.
To avoid getting into financial trouble, view your credit card as a convenient tool. Keep track of all of your charges and pay them off in full by the payment due date.
2. Am I Okay If I Just Make the Minimum Payment on My Credit Card?
Although you’re “okay” if you make the minimum payment on your credit card in the sense that you won’t be assessed any penalties, your financial future is not okay if you’re only paying the minimum. The average credit card rate in November 2017 for accounts assessed interest was 14.99 percent, according to the Federal Reserve. By only paying the minimum on your card, you’re extending the payoff date by years. This is such an important issue that card companies are now required to include minimum payment information on monthly statements.
3. What Are Credit Card Points and Miles? Are They Worth the Effort?
In the competitive world of credit cards, lenders are always looking at ways to entice borrowers to use their cards instead of those of their competitors. As a result, many offer generous rewards by offering points and miles on purchases. These rewards can be redeemed for everything from air travel and hotel stays to merchandise. For example, the Chase Sapphire Preferred card currently offers 50,000 bonus points if you open an account and spend $4,000 on the card in the first three months.
Whether or not these cards are worth it depends on your lifestyle and spending patterns. If you’ll never redeem the points or miles, you’re better off with different cards, since rewards cards often charge annual fees between $95 and $450 or even higher. Many rewards cards also carry high-interest rates, so if you don’t pay off your balance in full, you’re negating the benefit of your points and miles.
4. What Is the Difference Between an Account Number and a Routing Number?
Did you ever look at the bottom of a check and wonder if those numbers mean anything? As it turns out, they aren’t just random because you’ll need them for things like setting up a direct deposit. The first row of numbers at the bottom of your check is your bank’s routing number. The routing number is a nine-digit number that identifies the region where your account was opened. Each bank has its own routing number, which is also known as a routing transit number or an ABA routing number.
The next row of numbers at the bottom of your check, to the right of the routing number, is your account number. This number identifies the specific location of the funds backing up the check.
5. What Is the Difference Between a Wire Transfer and an ACH Transfer?
Wire transfers and ACH transfers are two ways to send money from your bank account to another account. Although the function of both is similar, the process is different. A wire transfer is conducted directly between banks and can be completed nearly instantaneously. An ACH transfer first goes to the Automated Clearing House, which acts as a middleman in the process. ACH transfers are processed in batches and can take a few days to complete. However, they are typically free or inexpensive, whereas wire transfers can cost $30 or more.
6. How Is My Credit Score Calculated?
Your credit score is a mathematical representation of your risk to lenders. The higher your credit score, the more likely lenders are to believe that you will pay them back. Thus, a high credit score typically results in lower interest rates on loans such as home mortgages and auto loans.
Your credit score is computed using the five following categories:
1. Payment history, 35 percent
2. Amounts owed, 30 percent
3. Length of credit history, 15 percent
4. New credit, 10 percent
5. Credit mix, 10 percent
Payment history, amounts owed and length of credit history are self-explanatory. They are also critically important, together comprising a full 80 percent of your credit score. Your new credit refers to the number of new accounts you have opened and/or applied for recently. Credit mix refers to the different types of loans you have, such as auto loans, personal loans, home mortgages and credit cards.
To keep your credit score high, make all your payments on time, keep accounts open, lower the amount of your outstanding debt, don’t apply for too many new loans and demonstrate a history of being able to pay off different types of loans.
7. What Is a Good Credit Score, and How Can It Help Me?
Typically, the higher your credit score, the lower the interest rates you can qualify for on everything from auto loans to credit cards. Although each lender is different in terms of how it analyzes a borrower’s personal credit, here’s how some analysts break down the credit score spectrum: excellent is 800-850, very good is 740-799, good is 670-739, fair is 580-669 and poor is below 580.
Find Out: How to Check Your Credit Score
8. How Can I Get a Job With a Bad Credit Score?
A bad credit score can hurt you in many ways, but you might be okay when it comes to finding a new job. An employer is not allowed to pull your credit report unless you give your permission — although not giving permission might end your application right there. The following cities and states have laws prohibiting employers from discriminating against current or prospective employees on the basis of credit information: Chicago, New York City, Philadelphia, Washington, D.C., California, Colorado, Connecticut, Delaware, Hawaii, Illinois, Maryland, Nevada, Oregon, Vermont and Washington.
Even in these jurisdictions, however, your credit can be used against you if you apply for certain types of jobs, such as law enforcement or financial services. In these cases, and in other states and cities, the best course of action is usually to be upfront about your financial situation before an employer or prospective employer sees your credit report.
9. What Is a Personal Loan?
Most personal loans are unsecured financial arrangements between you and a bank. For unsecured personal loans, you won’t have to put up any collateral. Thus, interest rates on personal loans are typically higher than they are on secured loans such as home or auto loans, where you do put up collateral, but there are ways to ensure you’re getting the best rate. On the plus side, you can usually use the proceeds of a personal loan for anything you want, although some banks will demand to pay your creditor directly if you are using the personal loan to pay off other debt.
10. How Do Car Loans Work?
Most Americans can’t afford to pay cash upfront to buy cars, so they apply for loans to finance them. When you take out a car loan, a bank will pay off the total cost of the car and then require installment payments from you. You should try to pay off this loan within three to five years to minimize the total cost of the loan since you’ll be charged interest along the way. Auto loan interest rates are typically fairly low, especially for borrowers with good credit, because your car acts as collateral for the loan. If you can’t make your payments, you’ll likely lose your car to repossession.
11. How Do Mortgages Work?
The basic idea behind a mortgage is simple: You borrow money from a bank, it pays the seller of the house and you agree to make regular payments to the bank to pay off the loan. Most mortgages are either 15 or 30 years in length, so it’s a significant financial commitment. The bulk of your mortgage payments at the outset will usually be in the form of interest.
There are many different types of mortgages, so you can pick one that suits your financial needs. The traditional mortgage is a 30-year loan with a fixed rate of interest, but you can also get adjustable-rate loans, where the interest rate you pay varies based on current market conditions.
Need to Know: How to Get the Best Mortgage Rate
12. What Is PMI?
Traditionally, homebuyers had to put up a down payment of at least 20 percent if they wanted to qualify for a home loan. PMI, or private mortgage insurance, was devised to sidestep this requirement. If you want to buy a home but can’t afford a 20 percent down payment, your mortgage lender will require you to buy PMI to help lower the risk that you don’t pay back your loan. PMI typically costs about $30 to $70 per month on every $100,000 you borrow, according to Zillow
Interested in PMI? 9 Things You Need to Know About It
13. What Do I Need to Buy a House?
If you’re buying a house with cash, all you’ll need to do is fill out a little paperwork and send over the money. For most Americans, however, buying a house involves taking out a mortgage loan. This can be a complicated process, as lenders will want to verify your ability to repay the loan. Here’s a list of items you’ll likely need to begin the process:
1. A pay stub from the last 30 days
2. W-2s from the last two years
3. Signed federal tax returns for the last two years
4. Documentation of any additional sources of income
5. Your two most recent bank statements
6. Documentation of the source of your down payment
7. Documentation of a recent name change, if applicable
8. Proof of your identity
9. Social Security number
10. Certificate of housing counseling or homebuyer education, if applicable
14. How Do I Make a Budget?
A budget is a way to track the money flowing into and out of your accounts. Without a budget, it can be hard to live within your means, since you won’t know where you’re spending all your money.
In its most basic form, a budget is simply a list of your income and expenses. There are many different types of suggested budgets, but most follow a formula close to the so-called 50/30/20 rule. Under this budget, you should allocate 50 percent of your income to mandatory expenses such as rent and utilities. Twenty percent of your budget should go to savings. This leaves 30 percent for your “wants,” such as dining out and entertainment expenses.
No one type of budget works for everyone, so once you start with a simple budget you can tailor it to your specific needs. For example, if you own a home that’s entirely paid off, you won’t have an entry for mortgage or rent payments. You can tweak your budget to include increased savings in this instance, for example.
15. Should I Pay Someone to Do My Taxes?
Just like in most areas of the financial services industry, technology has changed tax filing forever. Whereas taxpayers used to have to either pay an accountant or undergo the time-consuming chore of filling out a tax return manually, a wide variety of tax filing software programs now simplify tax season for millions of Americans.
If you have a simple tax return, you can probably manage to do your taxes on your own or with the help of tax software. However, if your return is complicated, you probably want to consult a professional. Complicated tax returns include those filed by taxpayers who own businesses.
Most tax software companies let you try their programs for free, so you can take a look and see if you’re going to need additional help when it comes time to actually file your return.
16. Can I Claim My Boyfriend or Girlfriend on My Taxes?
In many relationships, a significant other can be a financial dependent in the truest sense of the word — you might be responsible for a significant amount of the cost of your partner’s food and lodging. Unfortunately, when it comes to the IRS and filing your taxes, you’re out of luck if you’re trying to claim your boyfriend or girlfriend as a dependent, even if you provide all of their financial support. According to IRS rules, a dependent must be a qualifying child or qualifying relative.
Save Money: 10 Tax Loopholes That Could Save You Thousands
17. What Is an IRS Audit?
An IRS audit is a detailed examination of your financial records by the Internal Revenue Service. There are three main types of IRS audits: the correspondence audit, the field audit and the office audit.
The correspondence audit is by far the most common. In this type of audit, you’ll get a letter from the IRS asking you to explain certain things on your return.
For a field audit, you’ll meet with an IRS official at your home, place of business or accountant’s office. For an office audit, you’ll be required to meet at the IRS office. These face-to-face interviews are typically more in-depth than correspondence audits.
No matter what type of audit you undergo, you’ll have to justify the entries on your tax return. If you can’t meet those requirements to the satisfaction of the IRS, you’ll likely have to pay additional taxes as well as penalties.
18. How Much Do I Need for Retirement?
Choosing a number for how much money you need in retirement is a personal exercise, as that number will vary wildly from person to person. However, many experts suggest that you’ll need between 70 percent and 90 percent of your pre-retirement income to live comfortably. As you approach your retirement date, you can make a more accurate budget that approximates your anticipated day-to-day expenses.
Once you’ve calculated your required retirement income, many experts recommend a 4 percent annual withdrawal rule to help you calculate the amount of funds you’ll need to save. For example, if you anticipate needing $50,000 per year to retire comfortably, this suggests you’ll need about $1.25 million in your nest egg, as $50,000 is 4 percent of $1.25 million. The larger the amount you can save, the more likely you can meet your retirement needs.
19. How Do I Pick Investments for My 401k?
If your company offers a 401k plan, you’ll typically be provided with a selection of mutual funds to choose from. You can approach the asset allocation in your 401k just like you would if you were investing on your own, except you’ll have to limit your choices to the funds available.
Any portfolio should take into consideration your investment objectives and risk tolerance. Because a 401k plan is a retirement account, you should view your investments there with a long-term perspective. If your company doesn’t offer financial advice, you can use online tools like the one offered by Betterment to help you select the most appropriate types of funds for you.
20. Can I Start Investing With a Small Amount of Money?
In the days when investing meant you could only go to a full-service financial professional, it was hard to begin investing with $1,000 or less. Times have changed. The proliferation of online brokers means stock investing is now as cheap as $4.95 per trade from firms like Fidelity — or even cheaper, as mobile-only broker Robinhood lets you trade stocks for free. Meanwhile, discount/online brokers like TD Ameritrade offer commission-free trading of numerous exchange-traded funds. There are also plenty of no-load mutual funds you can purchase from firms such as Vanguard. The bottom line is there is no longer an excuse for not saving and investing, even if you have limited funds.
21. What Are Long-Term vs. Short-Term Capital Gains, and Why Does It Matter?
When you sell a capital asset like a stock, the difference between your proceeds and the cost of your purchase is your capital gain (or loss). If you’ve held the asset for one year or less, that gain or loss is short-term. If you’ve owned the asset for longer than a year, your gain or loss is long-term.
This is an important distinction because short-term and long-term gains are taxed differently. A short-term gain is taxed at whatever your effective tax rate is. For example, if you’re in the 35 percent tax bracket, all your short-term gains are taxed at 35 percent. Long-term gains have a special tax rate that is typically 15 percent but that can drop to 0 percent in certain situations, such as if you’re a low-income taxpayer.
22. If Interest Rates Go Up, Do My Bond Payments Increase?
Bonds and interest rates have an inverse relationship. When interest rates go up, bond prices go down. Bonds are fixed-income investments, meaning the interest rate they pay to you is set and unchanging. If rates go higher, your bond value will go down but your interest payments will not rise.
There is one exception to this rule. If you own a bond mutual fund, your investment manager will constantly be buying new bonds for the fund. If rates are rising, the new bonds will be bought at the higher interest rates, meaning your income could go up as well.
Start Planning: How to Choose the Best Bonds for Your Financial Plan
23. Are CDs Insured by Banks?
Many investors understand that certificates of deposit are desirable since they’re among the safest investments available because they are insured. However, that insurance does not come from the issuing banks. Rather, the Federal Deposit Insurance Corporation, which was created in 1933 during the Great Depression, is the governmental agency that insures CDs. The FDIC also insures other deposit accounts, such as savings accounts, up to $250,000 per depositor, per bank, per account type.
24. Do I Need Life Insurance?
The short answer to this fundamental financial question is, “it depends.” Life insurance is designed to be a funding source in case of calamity. For example, if you’re the primary breadwinner and you have a large outstanding mortgage, you might consider getting life insurance so your surviving spouse and dependent children, if applicable, are not left with a large, unpayable debt in the event of your death. However, if you’re young and single, you might not need life insurance since you probably have little debt to pass on and no survivors to take care of.
25. Am I Responsible for My Spouse’s Debt?
If you live in one of the nine community property states, any debt that your spouse incurs is considered to be your debt as well. For the 41 common-law states, only the person whose name is attached to the account is considered responsible for the debt. However, if you have any joint accounts, you’re both liable for that debt, regardless of which state you live in. Additionally, any debt that a partner brings into a marriage that was accrued in his or her own name remains his or her own personal responsibility.
As of 2018, these are the nine community property states: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin.
Click through to read more about financial questions related to investments.
Editorial Note: This content is not provided or commissioned by the bank advertiser. Opinions expressed here are author’s alone, not those of the bank advertiser, and have not been reviewed, approved or otherwise endorsed by the bank advertiser. This site may be compensated through the bank advertiser Affiliate Program.
About the Author
John Csiszar
After earning a B.A. in English with a Specialization in Business from UCLA, John Csiszar worked in the financial services industry as a registered representative for 18 years. Along the way, Csiszar earned both Certified Financial Planner and Registered Investment Adviser designations, in addition to being licensed as a life agent, while working for both a major Wall Street wirehouse and for his own investment advisory firm. During his time as an advisor, Csiszar managed over $100 million in client assets while providing individualized investment plans for hundreds of clients.
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There are some financial questions everyone should probably know the answers to, but not everyone does. Basic financial education is lacking in the U.S., and many Americans don’t know answers to fundamental financial or banking-related questions. If you count yourself among those who could use some basic info, or at least a refresher course, it’s never too late to ask.
Click through to find out the basic finance terms you should know — and get answers to all your questions about them.
1. How Do Credit Cards Work?
Contrary to popular belief, a credit card is not a magic piece of plastic that pays for expenses like dining out. A credit card is actually a loan, one that can benefit you if you pick the right card and use it correctly. Every time you buy something with your card, you owe the bank that issued the card. If you don’t pay the full balance within the grace period, you’ll owe interest on that amount. Interest rates on credit cards often reach 20 percent or higher. At that rate, your debt can increase quickly if you carry a big balance — even if you don’t make any more purchases on the card.
To avoid getting into financial trouble, view your credit card as a convenient tool. Keep track of all of your charges and pay them off in full by the payment due date.
2. Am I Okay If I Just Make the Minimum Payment on My Credit Card?
Although you’re “okay” if you make the minimum payment on your credit card in the sense that you won’t be assessed any penalties, your financial future is not okay if you’re only paying the minimum. The average credit card rate in November 2017 for accounts assessed interest was 14.99 percent, according to the Federal Reserve. By only paying the minimum on your card, you’re extending the payoff date by years. This is such an important issue that card companies are now required to include minimum payment information on monthly statements.
3. What Are Credit Card Points and Miles? Are They Worth the Effort?
In the competitive world of credit cards, lenders are always looking at ways to entice borrowers to use their cards instead of those of their competitors. As a result, many offer generous rewards by offering points and miles on purchases. These rewards can be redeemed for everything from air travel and hotel stays to merchandise. For example, the Chase Sapphire Preferred card currently offers 50,000 bonus points if you open an account and spend $4,000 on the card in the first three months.
Whether or not these cards are worth it depends on your lifestyle and spending patterns. If you’ll never redeem the points or miles, you’re better off with different cards, since rewards cards often charge annual fees between $95 and $450 or even higher. Many rewards cards also carry high-interest rates, so if you don’t pay off your balance in full, you’re negating the benefit of your points and miles.
4. What Is the Difference Between an Account Number and a Routing Number?
Did you ever look at the bottom of a check and wonder if those numbers mean anything? As it turns out, they aren’t just random because you’ll need them for things like setting up a direct deposit. The first row of numbers at the bottom of your check is your bank’s routing number. The routing number is a nine-digit number that identifies the region where your account was opened. Each bank has its own routing number, which is also known as a routing transit number or an ABA routing number.
The next row of numbers at the bottom of your check, to the right of the routing number, is your account number. This number identifies the specific location of the funds backing up the check.
5. What Is the Difference Between a Wire Transfer and an ACH Transfer?
Wire transfers and ACH transfers are two ways to send money from your bank account to another account. Although the function of both is similar, the process is different. A wire transfer is conducted directly between banks and can be completed nearly instantaneously. An ACH transfer first goes to the Automated Clearing House, which acts as a middleman in the process. ACH transfers are processed in batches and can take a few days to complete. However, they are typically free or inexpensive, whereas wire transfers can cost $30 or more.
6. How Is My Credit Score Calculated?
Your credit score is a mathematical representation of your risk to lenders. The higher your credit score, the more likely lenders are to believe that you will pay them back. Thus, a high credit score typically results in lower interest rates on loans such as home mortgages and auto loans.
Your credit score is computed using the five following categories:
1. Payment history, 35 percent
2. Amounts owed, 30 percent
3. Length of credit history, 15 percent
4. New credit, 10 percent
5. Credit mix, 10 percent
Payment history, amounts owed and length of credit history are self-explanatory. They are also critically important, together comprising a full 80 percent of your credit score. Your new credit refers to the number of new accounts you have opened and/or applied for recently. Credit mix refers to the different types of loans you have, such as auto loans, personal loans, home mortgages and credit cards.
To keep your credit score high, make all your payments on time, keep accounts open, lower the amount of your outstanding debt, don’t apply for too many new loans and demonstrate a history of being able to pay off different types of loans.
7. What Is a Good Credit Score, and How Can It Help Me?
Typically, the higher your credit score, the lower the interest rates you can qualify for on everything from auto loans to credit cards. Although each lender is different in terms of how it analyzes a borrower’s personal credit, here’s how some analysts break down the credit score spectrum: excellent is 800-850, very good is 740-799, good is 670-739, fair is 580-669 and poor is below 580.
Find Out: How to Check Your Credit Score
8. How Can I Get a Job With a Bad Credit Score?
A bad credit score can hurt you in many ways, but you might be okay when it comes to finding a new job. An employer is not allowed to pull your credit report unless you give your permission — although not giving permission might end your application right there. The following cities and states have laws prohibiting employers from discriminating against current or prospective employees on the basis of credit information: Chicago, New York City, Philadelphia, Washington, D.C., California, Colorado, Connecticut, Delaware, Hawaii, Illinois, Maryland, Nevada, Oregon, Vermont and Washington.
Even in these jurisdictions, however, your credit can be used against you if you apply for certain types of jobs, such as law enforcement or financial services. In these cases, and in other states and cities, the best course of action is usually to be upfront about your financial situation before an employer or prospective employer sees your credit report.
9. What Is a Personal Loan?
Most personal loans are unsecured financial arrangements between you and a bank. For unsecured personal loans, you won’t have to put up any collateral. Thus, interest rates on personal loans are typically higher than they are on secured loans such as home or auto loans, where you do put up collateral, but there are ways to ensure you’re getting the best rate. On the plus side, you can usually use the proceeds of a personal loan for anything you want, although some banks will demand to pay your creditor directly if you are using the personal loan to pay off other debt.
10. How Do Car Loans Work?
Most Americans can’t afford to pay cash upfront to buy cars, so they apply for loans to finance them. When you take out a car loan, a bank will pay off the total cost of the car and then require installment payments from you. You should try to pay off this loan within three to five years to minimize the total cost of the loan since you’ll be charged interest along the way. Auto loan interest rates are typically fairly low, especially for borrowers with good credit, because your car acts as collateral for the loan. If you can’t make your payments, you’ll likely lose your car to repossession.
11. How Do Mortgages Work?
The basic idea behind a mortgage is simple: You borrow money from a bank, it pays the seller of the house and you agree to make regular payments to the bank to pay off the loan. Most mortgages are either 15 or 30 years in length, so it’s a significant financial commitment. The bulk of your mortgage payments at the outset will usually be in the form of interest.
There are many different types of mortgages, so you can pick one that suits your financial needs. The traditional mortgage is a 30-year loan with a fixed rate of interest, but you can also get adjustable-rate loans, where the interest rate you pay varies based on current market conditions.
Need to Know: How to Get the Best Mortgage Rate
12. What Is PMI?
Traditionally, homebuyers had to put up a down payment of at least 20 percent if they wanted to qualify for a home loan. PMI, or private mortgage insurance, was devised to sidestep this requirement. If you want to buy a home but can’t afford a 20 percent down payment, your mortgage lender will require you to buy PMI to help lower the risk that you don’t pay back your loan. PMI typically costs about $30 to $70 per month on every $100,000 you borrow, according to Zillow
Interested in PMI? 9 Things You Need to Know About It
13. What Do I Need to Buy a House?
If you’re buying a house with cash, all you’ll need to do is fill out a little paperwork and send over the money. For most Americans, however, buying a house involves taking out a mortgage loan. This can be a complicated process, as lenders will want to verify your ability to repay the loan. Here’s a list of items you’ll likely need to begin the process:
1. A pay stub from the last 30 days
2. W-2s from the last two years
3. Signed federal tax returns for the last two years
4. Documentation of any additional sources of income
5. Your two most recent bank statements
6. Documentation of the source of your down payment
7. Documentation of a recent name change, if applicable
8. Proof of your identity
9. Social Security number
10. Certificate of housing counseling or homebuyer education, if applicable
14. How Do I Make a Budget?
A budget is a way to track the money flowing into and out of your accounts. Without a budget, it can be hard to live within your means, since you won’t know where you’re spending all your money.
In its most basic form, a budget is simply a list of your income and expenses. There are many different types of suggested budgets, but most follow a formula close to the so-called 50/30/20 rule. Under this budget, you should allocate 50 percent of your income to mandatory expenses such as rent and utilities. Twenty percent of your budget should go to savings. This leaves 30 percent for your “wants,” such as dining out and entertainment expenses.
No one type of budget works for everyone, so once you start with a simple budget you can tailor it to your specific needs. For example, if you own a home that’s entirely paid off, you won’t have an entry for mortgage or rent payments. You can tweak your budget to include increased savings in this instance, for example.
15. Should I Pay Someone to Do My Taxes?
Just like in most areas of the financial services industry, technology has changed tax filing forever. Whereas taxpayers used to have to either pay an accountant or undergo the time-consuming chore of filling out a tax return manually, a wide variety of tax filing software programs now simplify tax season for millions of Americans.
If you have a simple tax return, you can probably manage to do your taxes on your own or with the help of tax software. However, if your return is complicated, you probably want to consult a professional. Complicated tax returns include those filed by taxpayers who own businesses.
Most tax software companies let you try their programs for free, so you can take a look and see if you’re going to need additional help when it comes time to actually file your return.
16. Can I Claim My Boyfriend or Girlfriend on My Taxes?
In many relationships, a significant other can be a financial dependent in the truest sense of the word — you might be responsible for a significant amount of the cost of your partner’s food and lodging. Unfortunately, when it comes to the IRS and filing your taxes, you’re out of luck if you’re trying to claim your boyfriend or girlfriend as a dependent, even if you provide all of their financial support. According to IRS rules, a dependent must be a qualifying child or qualifying relative.
Save Money: 10 Tax Loopholes That Could Save You Thousands
17. What Is an IRS Audit?
An IRS audit is a detailed examination of your financial records by the Internal Revenue Service. There are three main types of IRS audits: the correspondence audit, the field audit and the office audit.
The correspondence audit is by far the most common. In this type of audit, you’ll get a letter from the IRS asking you to explain certain things on your return.
For a field audit, you’ll meet with an IRS official at your home, place of business or accountant’s office. For an office audit, you’ll be required to meet at the IRS office. These face-to-face interviews are typically more in-depth than correspondence audits.
No matter what type of audit you undergo, you’ll have to justify the entries on your tax return. If you can’t meet those requirements to the satisfaction of the IRS, you’ll likely have to pay additional taxes as well as penalties.
18. How Much Do I Need for Retirement?
Choosing a number for how much money you need in retirement is a personal exercise, as that number will vary wildly from person to person. However, many experts suggest that you’ll need between 70 percent and 90 percent of your pre-retirement income to live comfortably. As you approach your retirement date, you can make a more accurate budget that approximates your anticipated day-to-day expenses.
Once you’ve calculated your required retirement income, many experts recommend a 4 percent annual withdrawal rule to help you calculate the amount of funds you’ll need to save. For example, if you anticipate needing $50,000 per year to retire comfortably, this suggests you’ll need about $1.25 million in your nest egg, as $50,000 is 4 percent of $1.25 million. The larger the amount you can save, the more likely you can meet your retirement needs.
19. How Do I Pick Investments for My 401k?
If your company offers a 401k plan, you’ll typically be provided with a selection of mutual funds to choose from. You can approach the asset allocation in your 401k just like you would if you were investing on your own, except you’ll have to limit your choices to the funds available.
Any portfolio should take into consideration your investment objectives and risk tolerance. Because a 401k plan is a retirement account, you should view your investments there with a long-term perspective. If your company doesn’t offer financial advice, you can use online tools like the one offered by Betterment to help you select the most appropriate types of funds for you.
20. Can I Start Investing With a Small Amount of Money?
In the days when investing meant you could only go to a full-service financial professional, it was hard to begin investing with $1,000 or less. Times have changed. The proliferation of online brokers means stock investing is now as cheap as $4.95 per trade from firms like Fidelity — or even cheaper, as mobile-only broker Robinhood lets you trade stocks for free. Meanwhile, discount/online brokers like TD Ameritrade offer commission-free trading of numerous exchange-traded funds. There are also plenty of no-load mutual funds you can purchase from firms such as Vanguard. The bottom line is there is no longer an excuse for not saving and investing, even if you have limited funds.
21. What Are Long-Term vs. Short-Term Capital Gains, and Why Does It Matter?
When you sell a capital asset like a stock, the difference between your proceeds and the cost of your purchase is your capital gain (or loss). If you’ve held the asset for one year or less, that gain or loss is short-term. If you’ve owned the asset for longer than a year, your gain or loss is long-term.
This is an important distinction because short-term and long-term gains are taxed differently. A short-term gain is taxed at whatever your effective tax rate is. For example, if you’re in the 35 percent tax bracket, all your short-term gains are taxed at 35 percent. Long-term gains have a special tax rate that is typically 15 percent but that can drop to 0 percent in certain situations, such as if you’re a low-income taxpayer.
22. If Interest Rates Go Up, Do My Bond Payments Increase?
Bonds and interest rates have an inverse relationship. When interest rates go up, bond prices go down. Bonds are fixed-income investments, meaning the interest rate they pay to you is set and unchanging. If rates go higher, your bond value will go down but your interest payments will not rise.
There is one exception to this rule. If you own a bond mutual fund, your investment manager will constantly be buying new bonds for the fund. If rates are rising, the new bonds will be bought at the higher interest rates, meaning your income could go up as well.
Start Planning: How to Choose the Best Bonds for Your Financial Plan
23. Are CDs Insured by Banks?
Many investors understand that certificates of deposit are desirable since they’re among the safest investments available because they are insured. However, that insurance does not come from the issuing banks. Rather, the Federal Deposit Insurance Corporation, which was created in 1933 during the Great Depression, is the governmental agency that insures CDs. The FDIC also insures other deposit accounts, such as savings accounts, up to $250,000 per depositor, per bank, per account type.
24. Do I Need Life Insurance?
The short answer to this fundamental financial question is, “it depends.” Life insurance is designed to be a funding source in case of calamity. For example, if you’re the primary breadwinner and you have a large outstanding mortgage, you might consider getting life insurance so your surviving spouse and dependent children, if applicable, are not left with a large, unpayable debt in the event of your death. However, if you’re young and single, you might not need life insurance since you probably have little debt to pass on and no survivors to take care of.
25. Am I Responsible for My Spouse’s Debt?
If you live in one of the nine community property states, any debt that your spouse incurs is considered to be your debt as well. For the 41 common-law states, only the person whose name is attached to the account is considered responsible for the debt. However, if you have any joint accounts, you’re both liable for that debt, regardless of which state you live in. Additionally, any debt that a partner brings into a marriage that was accrued in his or her own name remains his or her own personal responsibility.
As of 2018, these are the nine community property states: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin.
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About the Author
John Csiszar
After earning a B.A. in English with a Specialization in Business from UCLA, John Csiszar worked in the financial services industry as a registered representative for 18 years. Along the way, Csiszar earned both Certified Financial Planner and Registered Investment Adviser designations, in addition to being licensed as a life agent, while working for both a major Wall Street wirehouse and for his own investment advisory firm. During his time as an advisor, Csiszar managed over $100 million in client assets while providing individualized investment plans for hundreds of clients.
