Ryan: How do we achieve financial independence? Getting filthy rich over a long career is the most traditional way, but there's another approach. Whether you call it, FI or FI that gets you there earlier, younger and hopefully happier. Brad Barrett, host of the ChooseFI podcast is here to tell us how in a lengthy main segment interview. On today's show, Sandy dishes on tax breaks for the middle class. And we debate the merits of buying insurance for your next big trip. That's all ahead on this episode of Your Money's Worth. Stick around.
- Episode Length: 00:33:27
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Ryan: Welcome to Your Money's Worth. I'm a Kiplinger staff writer Ryan Ermey joined as always by senior editor Sandy Block. I am back from a trip to Florida. Sandy, do I look any tanner?
Sandy: No, but you look refreshed.
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Ryan: Oh, thanks. I wore a lot of sunscreen . . .
Sandy: Good for you.
Ryan: So continuing on our promise theme, we said that we would be talking taxes all the way into April 15th and today we wanted to open up with something because you hear about tax breaks and generally we think that they're reserved for really wealthy folks. But in fact there are a litany of tax breaks aimed directly at the middle class.
Sandy: That's right. And some of them are really valuable. And the other important thing to note is that these tax breaks are available even if you don't itemize, people think that the big breaks are for itemizers, hardly anybody's going to itemize anymore. But that's not true. If you don't itemize, there are a ton of tax breaks that you can take and you certainly don't have to be rich to take them. In fact, in some cases the poorer you are, the bigger the tax breaks. So don't leave this money on the table.
Ryan: Talk to me.
Sandy: So the first one I want to mention is one that most people know, but it's always worth reminding is that you can cut your taxes by saving for retirement. Every money you put in your 401(k) is pretax. So that comes right off the top. And I do my own taxes and I always see that, if you aren't covered by a retirement plan at work or you make below a certain amount, and we'll put these thresholds in the show notes, you can deduct contributions to a traditional IRA. This is one of the few ways you can actually cut your 2018 taxes now if you make your contribution before April 15th it will reduce your 2018 taxes. So don't overlook that you can contribute up to 5500 and 2018 or 6,500 if you're 50 or older. So that's an important one. But the other one I want to talk about because it's really not used very much and it'd be very valuable for either people who are starting out or working part-time is the saver's credit.
Sandy: This is a credit, it's been around for a while. Hardly anybody uses it but if you're single and you have adjusted gross income in 2018 of 31,500 or less, or you're married and have 63,000 or less, you can make out really well with this credit, you can claim a credit with up to 50% of the amount that you contribute up to $2,000. So and the lower your income, the higher the credit. So here's what I think is really useful to consider here. You could create kind of a virtuous circle. Say you contribute even $500 to a retirement savings plan to be any kind of savings . . . 401(k), IRA, any of those, you get the tax credit, so you're going to get a bigger refund. So use that refund to invest in a retirement plan next year and you'll just keep it going. And I think as I said, this is often overlooked because the income levels are so low, but when you take into account the tax credit, the amount that you're going to put in is actually less. So I think this is something people need to think about.
Ryan: Now my very favorite tax credit when I was a younger man, now I'm still paying off my student loans and I know that you can take a deduction for paying off interest on student loans. But why I liked it so much before was that my parents helped me out for a couple of years and you can still take a deduction even if someone else is paying off your student loans./p>
Sandy: Right. The IRS doesn't care that somebody else paid off your student loans, you're still responsible for those loans. And that means you get the tax break. This tax break is worth up to $2,500 if you have interest of at least that much. And most people's student loans do, you don't have to itemize to claim it. There are income thresholds, but they're pretty high. I think most people who have student loans qualify for this deduction. It is a deduction and as you said, if mom and dad are making the payments, you can still claim the deduction. You might not want to tell them that, but they're your loans, your loans, your tax break. And the other one I wanted to mention while we're talking about college, because college is really in the news right now. All these rich people doing these really crazy things to get their kids into good schools sort of I think . . .
Ryan: Photoshopping people . . .
Sandy: Oh my gosh. Yes.
Ryan: . . . My favorite.
Sandy: So yeah, I just can't get enough of this story. It's just so outrageous and I think it reinforces the idea that you have to be rich to get into a good school. And that's something we're going to be talking about for a long time. But the point I want to make is if you're not rich, you are eligible for some very generous tax breaks that can help offset the cost of college. And I think we've mentioned these before, but it's worth mentioning again, if you're doing your taxes and you have this child in school, in undergrad, you can claim the American Opportunity tax credit. It's available for up to $2,500 of tuition and related expenses. Again, that's a credit. So that's dollar for dollar reduction in your taxes. Do not leave this on the table. If you are in graduate school and you're doing something to continue your education, you might be eligible for the lifetime learning credit.
Sandy: This one is worth up to $2,000 of eligible expenses. Again, it's a credit. There are income thresholds but they're pretty high. So don't overlook these tax breaks that can help you pay the cost of college even if your child isn't on the crew team.
Ryan: Well, and the last one for the segment here is one that I always lament whenever I pay my taxes. I use H&R Block and they ask you all the questions to see if they could find more deductions or credits for you. And they would say, "Well do you have children?" And I always got to go, no, because they seem like a big tax break.
Sandy: They are a big tax break. I think a lot of people are aware that the child tax credit which you basically get if you have kids under 17, was greatly expanded this year. What people may not be aware of is that there is some really generous tax breaks for childcare and childcare has been in the news quite a bit lately. There have been, I've seen some estimates that people spend up to $18,000 a year on childcare, which is like sending your kid to college every year before he's six, right?
Sandy: So this is a huge expense for families. Don't overlook tax breaks for this. If you have children under age 13 you're eligible for a tax credit of up to $3,000 in child care expenses for one child and up to $6,000 if you have two or more. So again, that's a credit. There's income thresholds, but they're pretty manageable for most people. And it covers a lot of things, not just what you think of as traditional daycare, but even summer camp if your kids don't stay every night, the cost of a nanny, preschool. So again, this isn't going to pay your $18,000 preschool cost, but is certainly we'll make it a little more manageable.
Ryan: Yeah, I guess I'm probably coming out on top anyone?
Sandy: Yeah, I think so.
Ryan: Up Next, ChooseFI's Brad Barrett explains how you can get on the path to financial independence. Don't go anywhere.
Ryan: All right, and we're back. We're here with Brad Barrett cohost of the ChooseFI podcast, which helps people get more information about a movement that has gained some steam in recent years that the FI movement, financial independence, retire early. And we're going to learn all about that. So Brad, thanks so much for coming on.
Brad: I appreciate the invite. This should be fun.
Ryan: So Brad, what exactly is FI? What are its core tenants and why has it been gaining steam recently?
Brad: Yeah, well FI, it's a catchy acronym, right? I think people hear that and think, oh, that's somewhat interesting. And like you said, it's financial independence retire early. Though in fairness, we at ChooseFI don't focus on the retire early because I feel like it has negative connotations to a lot of people like, oh, is this just kids in their 20s and 30s looking to sit on the beach and sip umbrella drinks or something like that and to me it's the farthest thing from that. We're not the anti-job crowd at all. In fact, many of the people that I know that are in this movement are the most creative and hardworking people that I've met. They just don't want to be forced for decades to do something they don't want to do. Ultimately, it's how I look at it.
Brad: So we focus on FI, we focus on financial independence, and to me that's about gaining control over your life. So you asked about the core tenants. To me, it's controlling what you can control, expenses, the expense side of your equation, right? You have the income expenses, that's something you can control. And this is not about, it's not about deprivation, it's not about eating pasta and butter every night for the rest of your life. Certainly it's about controlling what you can control based on what you value. Whereas many people, there's this nebulous thing, right? When you get into the workforce, like, oh you're in your 20s, like you need five to $10 million to retire. Well, I don't know about you guys, but when I hear something like that, my mind just shuts off. That seems so implausible that why would I even bother?
Brad: Why shouldn't I just keep up with the Joneses and buy the expensive cars and the mansions? If there's no chance of me getting there, whereas we in the FI movement, we say control what you can control. So if you can get your expenses to whatever level, and again, it's not my place to say I don't care if you spend $40,000 a year or $200,000 a year, your fine number in essence is a function, a simple function of those yearly expenses. So generally speaking, it's 25 times your annual expenses get you to financial independence. It's kind of the inverse of what's known as the 4% rule or 4% rule of thumb. So that kind of is like a real quick overview of FI.
Sandy: So Brad, one question I have is how does cost of living affect your ability to save as much as you do? I believe you live in Richmond, but what if you live in a high cost place like Washington, D.C., New York or San Francisco?
Brad: Yeah, I mean I think, I think FI is certainly achievable for anyone. I mean obviously I'm not going to say it's not harder for someone living there. Clearly your expenses are more so therefore again, based on that simple function, it's going to be more difficult to get to that net worth number. But I think it's the focus on savings that kind of changes the game mentally I would say, so I think anybody, the larger question is FI available for people who have low incomes, right? Not even high income people living in expensive places, but people with low incomes. And what I would say to that is, yeah, maybe it's going to be more difficult, just like it would be more difficult for someone living in San Francisco or New York.
Brad: But isn't your life so much better when you have money saved up? Right? So think about that person who is living paycheck to paycheck no matter what amount of income they have and if they have one to $10,000 in the bank, every little calamity, right? Like a flat tire is not an existential crisis, right? For so many of us, that is sadly because people are mired in debt, they have no savings rate, they have no space there. And that is just such a stressful way to go through life. So I think the fundamental tenants of FI are clickable to anybody, obviously based on your circumstances, it's going to take you a certain amount of time to get there. But I think it's the path. Like to me guys, this is not zero one, it's not FI and FI and those are the only two things that matter. This is a spectrum and every step along the way, you save more money, you get more power and autonomy in your life. That's a good thing. And it helps you just live a happier life ultimately.
Ryan: So what are some saving strategies? The common ways that people can tighten their belt without having to resort to eating ramen every night or eating rice and beans every night.
Brad: Yeah. Ultimately you guys this does come down to personal value. So we like to say in our podcast, we are not here to dictate anything to you. There are no dictates from on high that you have to do X, Y, and Z to be a card carrying member of the FI community. It just, it doesn't work that way, but you have to figure out what you value. So for my wife and I, cars are something that we don't value at all, we appreciate them for their function, but we're not into expensive cars. So we each drive a 2003 I drive a Civic, she drives a Toyota Highlander and we have not had car payments in 10 plus years. So just making that one choice as opposed to buying a new car every couple of years or leasing a car even worse, right? That one decision for each of us has saved us potentially probably about $100,000 I would say compounded and over many decades that's going to be hundreds of thousands of dollars from that one decision. So that's an obvious one.
Brad: I think food is another simple one. My wife and I, Laura loves to cook. This is one of her things. It's a passion in her life and she loves to try out new meals and experiment and she meal plans very intelligently. So we like to stick and for people in big cities, this might sound crazy, but we like to stick to $2 per person, per meal for dinner as kind of like our guiding light. And while that might sound like deprivation to many people, it is not at all. I mean, especially when you meal plan and you buy in bulk and Laura will do, let's take two hours and fry up, I don't know, 10 pounds of chicken cutlets and I'm giving you an anecdote, but it's the little things that are the big things. So, and then she'll freeze them into separate portions and we'll have, I don't know, 10 different dinners or 20 different dinners, whatever it may be frozen and you just have it, you save time also, right?
Brad: This is a life strategy to just make everything better. So I think clearly food and cars are easy ones. And of cell phones, I use a company called Republic Wireless that I pay about $16 a month for data. And again, it's what you value. So you can't have everything, you can't live your current life if you have a 0% savings rate and not change anything, expect everything to be roses and unicorns, right? Like the world doesn't work that way. You have to make decisions. So for me, I'm on Wifi 95% of the time. So I use less than a gigabyte of data on my phone and therefore I'm able to use Republic Wireless and it cost me 16 to $20 a month. So that's a huge savings when both Laura and I do that. And you compound that over years and decades. That's a huge amount. So I mean it's the little things, right? It's FI cutting the cord, it's cutting down in subscriptions, all these kinds of things. But they really do add up when you're looking for them in your life.
Ryan: So you mentioned compounding, which is something that we're keenly interested in here because the other half of the coin when it comes to financial independence is investing, right? So you're saving but then you have to put that money to work. So what are the investing principles the FI community sort of adhere to?
Brad: Yeah, in very general terms we believe again in controlling what you can control. And that to me is expenses on your investments. So I think most people in the FI community believe in low cost index funds. And just pumping the money in there and seeing that compound over decades and I mean I'm a CPA, my wife's a CPA. We could theoretically do research on individual stocks and that would be all well and good, but I don't have any genuine belief that I can outperform the market over 30 to 50 years and I mean even just reading something like Warren Buffet, which he put in his 2013 letters to the shareholders, right? He talked about the advice to his trustee, which he said put 10% of the cash in short term government bonds and 90% in a very low cost S&P 500 index fund.
Brad: I suggest Vanguards and I think that's a lot of what we do, which is put this money in low cost index funds and don't try to beat the market. If we can just match the market, then we're going to be ultra, ultra wealthy when you're saving significant amounts, right? Like we're saving 30%, 50%, 70% of our income in the FI community. This is not the standard advice of oh, save five or 10% of your income. So we definitely believe in that. I mean obviously there are other strategies, many people focus on real estate and single family rentals and there are many, many strategies. But I would say the fundamental strategy is low cost index . . .
Sandy: One of the criticisms we got after we wrote about the FI community in our November issue was that this is nothing new that people have been doing it for years. They just didn't have an acronym for it. The other more pressing criticism we got was that this is a bull market phenomenon that once the market stops rewarding people 8% 10% or more on their investments, that the enthusiasm for this whole movement will fade away.
Brad: It's a great question and I'm not sure that I agree with the premise of it because it's not about just, okay, we got lucky, right? If it was okay, we saved some money and bought a house and it happened to wildly appreciate it and we got lucky. I don't know if that's replicable. Right? Whereas if you're saving 50% of your income over years and decades, there's no way to fail financially. There's almost, I can't foresee a scenario where that happens. So this is not about just getting lucky and then riding off into the sunset and not worrying again. I mean, these are people who have focused their lives on saving and being intentional.
Brad: It just it seems odd to me that the people would imagine that, we would just stick our heads in the sand and say, "Oh, look at us, we're retired." Right? So I certainly understand it, but I think the fundamental point that's being missed is this is about savings and it's about living a life of intentionality. Not about, "Hey, let's go retire on a beach somewhere in Thailand and sip umbrella drinks again." Right? So I think if people understood that fundamentally about the FI movement, it would maybe lessen those type of questions.
Sandy: One of the other questions we have about the whole FI movement is what do you do about healthcare? A lot of people who were involved in this work for themselves, they like the fact that they don't have to work for the man, but health insurance is increasingly expensive and it's a cost that's much harder to control than say food or car payments. So what do you advise people who are interested in this whole way of life to do about making sure that they have enough health insurance to cover them in an emergency?
Brad: Sandy, I wish I had a great answer. And this is something that's come up many, many times in the FI community. There's no magic answer. I mean if you live in the US we have to deal with the system as it is. And I think being realistic is just the important part. So you have your yearly expenses and you factor into that amount what healthcare is going to cost. Right? I mean again, I wish there was some magic, but there's not. So you know you can buy health insurance on the exchange, on the ACA and it's going to cost you an amount. And unfortunately for many people it's hugely significant. But you build that into your numbers. So again, it's not that magic thinking of, "Oh, these are my expenses today, but then when I retire, they're not going to go up."
Brad: Right? In some cases they'll go up, some, some will go down, right? Gas costs will probably go down. Commuting costs, those kinds of things. But healthcare is going to go up. So are there ways that some people are going to qualify for subsidies. Whether in the FI community or not, there are alternate options of health sharing ministries, which gets a little bit odd because they're not traditional insurance. But I know many people consider those just because the monthly premiums are so dramatically smaller. So just like anything in life, you have to go in with eyes wide open and determine what type of risk you're willing to take. I mean, for me, we were on a liberty health share for a number of years, but actually in just recently in 2019 we moved to a traditional health insurance plan because to me, even though the premiums are significant, that just wasn't a risk I was willing to take any more. So it's going to be personal preference obviously. But like I said, I just build those numbers into my annual expenses and I move forward.
Ryan: All right, well we got to let you go here soon. But before we did, I did want to get a sense from you as to which are your favorite tools, financial tools that people can use to track and manage their savings and investments?
Sandy: I bought it before just twice. I bought it when about 10 years ago. We did a family trip to Hawaii. It was a big package deal, plane tickets, rental car, condo. And my father's sister was not well and we wanted to have the ability to reschedule if she fell ill. And then a few years later my mother and I went on a cruise and my mother had had health problems, so I wanted to have the ability to cancel that trip. And I think the time that travel insurance might make sense is when you're spending a lot of money and a lot of it is nonrefundable, but that usually doesn't apply to short hops across the country. Maybe you might have to pay a change fee or you're just out a couple of 100 bucks.
Ryan: So here's why I generally don't buy it. One is I just got over the sort of euphoria of booking a new trip and I'm just getting over also spending probably more money than I should as which is always the case. And then I get the psychology of having, oh I need to pay for another thing when I don't anticipate anything going wrong, which obviously that's what insurance is for. But there are a couple of other reasons too. One being that your credit card may be able to cover a lot of the things that trip insurance covers. So, and I don't even have like a fancy card. I looked this up before the segment. I use the Citi® Double Cash Card which is one that we like. It's a no annual fee and it's 2% cash back on everything, but it's by no means some like super fancy status.
Sandy: . . . Yeah.
Ryan: No, and it's not like a travel status thing. I don't get into lounges with it, which is really a shortcoming but they'll cover up to $1,500 per trip if it's canceled or interrupted for reasons such as sickness, injury or severe weather up to $5,000 a year. And so then I sort of think about, well, all right, when would I actually want to buy trip insurance? And I think all right, well maybe if I was flying to the Caribbean during hurricane season and I look on the news and I see that the town I'm going to the roofs are being torn off by the next hurricane. But the problem is you have to buy trip insurance usually well in advance. Otherwise once a storm is named, they're not going to sell you trip insurance anyway.
Sandy: That's right. And I think that's even if you are in a situation like I was in where you're spending a lot of money and you want to buy travel insurance, you really have to dig down and find out what it doesn't cover. As Ryan said, it won't cover a named hurricane because they don't want everybody buying insurance just because of hurricane has come up. Even illness, which is a common reason people buy travel insurance, they want to be able to get in out if they get sick. If you have a preexisting condition, it may not cover it. They do sell travel insurance that will cover anything, but it costs about 40% more than traveling insurance with restrictions. So if you're going to pay the money, I think Ryan makes a really good point first, makes sure you don't already have some coverage. And second, make sure that it will cover you if you file a claim.
Ryan: But I do see the scenarios where you bought it. I do see the wisdom in that. Right? So you were traveling with someone who didn't have a preexisting condition, but you were worried that something might come up, which makes some sense to me. So if you are shopping around for it and know for some people it's just a matter of peace of mind and they're willing to something maybe you're going on a trip where you have a ton of prepaid resort package stuff planned and if something gets canceled that's all going away and you're not going to be able to get refunded. So how should people go about shopping for this? I can't imagine it's just springing for the one that pops up when the airline asks about it.
Sandy: No, it's not, those are probably the most restrictive and the worst value for your dollar. If you really decide you need travel insurance for the reasons that we've described, go to a third party and we can put some links in our show notes, but some of the examples are insuremytrip.com and squaremouth.com they sell, this is what they do. They sell trip insurance and you'll get a better deal, going for the popup is rarely a good idea.
Ryan: Right. What I will say about the airlines is check what their policies are. Because sometimes by the time ... Your definition of a delay and the airlines definition of a delay and your insurers definition of delay may all be very different. So when you're comparing policies, you should also see what your airline says they will provide in the case of a delay or cancellation. Maybe you can get vouchers for meals and hotel stays through your airline. You may be able to get credits toward future flights in some instances. And once you take that stuff, your insurance doesn't kick in anymore anyway.
Sandy: Right. Oftentimes you can negotiate with the airline, with the hotel if you have some emergency you can go to them. And I think I've read that Southwest, which has a lot of the Boeing planes is letting people change flights. They don't need travel insurance to do that.
Ryan: So that's sort of the bottom line here, folks. As always, shop around, make sure to get your money's worth, make sure you shop around and go on these sort of a third party sites. Don't just buy whatever the airlines are selling you and really sort of be cognizant of the kind of trip you're taking, the kind of risks you're taking when you're taking this trip and what you might be covered for through your credit card, through the airline and what those gaps might be because insurance might be able to fill them.
Ryan: That's it for this episode of Your Money's Worth, for show notes and more great Kiplinger content on the topics we discussed on today's show is at kiplinger.com/links/podcasts you can stay connected with us on Twitter, Facebook or by emailing us at podcast@kiplinger.com and if you liked the show, please remember to rate, review and subscribe to Your Money's Worth wherever you get your podcasts. Thanks for listening.
Links and resources mentioned in this episode
- 10 Tax Breaks for the Middle Class
- ChooseFi.com
- ChooseFi Podcast
- FIRE Savers Race to Retirement
- Disaster-Proof Your Vacation With Trip Insurance