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75 Personal Finance Rules of Thumb

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A “rule of thumb” is a mental shortcut. It’s a heuristic. It’s not always true, but it’s usually true. It saves you time and brainpower. Rather than re-inventing the wheel for every money problem you face, personal finance rules of thumb let you apply wisdom from the past to reach quick solutions.

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I’m going to do my best Buzzfeed impression today and give you a list of 75 personal finance rules of thumb. Some are efficient packets of advice while others are mathematical shortcuts to save brain space. Either way, I bet you’ll learn a thing or two—quickly—from this list.

The Basics

These basic personal finance rules of thumb apply to everybody. They’re simple and universal.

1. The Order of Operations (since this is one of the bedrocks of personal finance, I wrote a PDF explaining all the details. Since you’re a reader here, it’s free.)

2. Insurance protects wealth. It doesn’t build wealth.

3. Cash is good for current expenses and emergencies, but nothing more. Holding too much cash means you’re losing long-term value.

4. Time is money. Wealth is a measure of how much time your money can buy.

5. Set specific financial goals. Specific numbers, specific dates. Don’t put off for tomorrow what you can do today.

6. Keep an eye on your credit score. Check-in at least once a year.

7. Converting wages to salary: $1/per hour = $2000 per year.

8. Don’t mess with City Hall. Don’t cheat on your taxes.

9. You can afford anything. You can’t afford everything.

10. Money saved is money earned. When you look at your bottom line, saving a dollar has the equivalent effect as earning a dollar. Saving and earning are equally important.

Budgeting

I love budgeting, but not everyone is as zealous as me. Still, if you’re looking to budget (or even if you’re not), I think these budgeting rules of thumb are worth following.

11. You need a budget. The key to getting your financial life under control is making a budget and sticking to it. That is the first step for every financial decision.

12. The 50-30-20 rule of budgeting. After taxes, 50% of your money should cover needs, 30% should cover wants, and 20% should repay debts or invest.

13. Use “sinking funds” to save for rainy days. You know it’ll rain eventually.

14. Don’t mix savings and checking. One saves, the other spends.

15. Children cost about $10,000 per kid, per year. Family planning = financial planning.

16. Spend less than you earn. You might say, “Duh!” But if you’re not measuring your spending (e.g. with a budget), are you sure you meet this rule?

Investing & Retirement

Basic investing, in my opinion, is a ‘must know’ for future financial success. The following rules of thumb will help you dip your toe in those waters.

17. Don’t handpick stocks. Choose index funds instead. Very simple, very effective.

18. People who invest full-time are smarter than you. You can’t beat them.

19. The Rule of 72 (it’s doctor-approved). An investment annual growth rate multiplied by its doubling time equals (roughly) 72. A 4% investment will double in 18 years (4*18 = 72). A 12% investment will double in 6 years (12*6 = 72).

20. “Don’t do something, just sit there.” -Jack Bogle, on how bad it is to worry about your investments and act on those emotions.

21. Get the employer match. If your employer has a retirement program (e.g. 401k, pension), make sure you get all the free money you can.

22. Balance pre-tax and post-tax investments. It’s hard to know what tax rates will be like when you retire, so balancing between pre-tax and post-tax investing now will also keep your tax bill balanced later.

23. Keep costs low. Investing fees and expense ratios can eat up your profits. So keep those fees as low as possible.

24. Don’t touch your retirement money. It can be tempting to dip into long-term savings for an important current need. But fight that urge. You’ll thank yourself later.

25. Rebalancing should be part of your investing plan. Portfolios that start diversified can become concentrated some one asset does well and others do poorly. Rebalancing helps you rest your diversification and low er your risk.

26. The 4% Rule for retirement. Save enough money for retirement so that your first year of expenses equals 4% (or less) of your total nest egg.

27. Save for your retirement first, your kids’ college second. Retirees don’t get scholarships.

28. $1 invested in stocks today = $10 in 30 years.

29. Inflation is about 3% per year. If you want to be conservative, use 3.5% in your money math.

30. Stocks earn 7% per year, after adjusting for inflation.

31. Own your age in bonds. Or, own 120 minus your age in bonds. The heuristic used to be that a 30-year old should have a portfolio that’s 30% bonds, 40-year old 40% bonds, etc. More recently, the “120 minus your age” rule has become more prevalent. 30-year old should own 10% bonds, 40-year old 20% bonds, etc.

32. Don’t invest in the unknown. Or as Warren Buffett suggests, “Invest in what you know.”

Home & Auto

For many of you, home and car ownership contribute to your everyday finances. The following personal finance rules of thumb will be especially helpful for you.

33. Your house’s sticker price should be less than 3x your family’s combined income. Being “house poor”—or having too expensive of a house compared to your income—is one of the most common financial pitfalls. Avoid it if you can.

34. Broken appliance? Replace it if 1) the appliance is 8+ years old or 2) the repair would cost more than half of a new appliance.

35. Used car or new car? The cost difference isn’t what it used to be. The choice is even.

36. A car’s total lifetime cost is about 3x its sticker price. Choose wisely!

37. 20-4-10 rule of buying a vehicle. Put 20% of the vehicle down in cash, with a loan of 4 years or less, with a monthly payment that is less than 10% of your monthly income.

38. Re-financing a mortgage makes sense once interest rates drop by 1% (or more) from your current rate.

39. Don’t pre-pay your mortgage (unless your other bases are fully covered). Mortgages interest is deductible, and current interest rates are low. While pre-paying your mortgage saves you that little bit of interest, there’s likely a better use for you extra cash.

40. Set aside 1% of your home’s value each year for future maintenance and repairs.

41. The average car costs about 50 cents per mile over the course of its life.

42. Paying interest on a depreciating asset (e.g. a car) is losing twice.

43. Your main home isn’t an investment. You shouldn’t plan on both living in your house forever and selling it for profit. The logic doesn’t work.

44. Pay cash for cars, if you can. Paying interest on a car is a losing move.

45. If you’re buying a fixer-upper, consider the 70% rule to sort out worthy properties.

46. If you’re buying a rental property, the 1% rule easily evaluates if you’ll get a positive cash flow.

Spending & Debt

Do you spend money? (“What kind of question is that?”) Then these personal finance rules of thumb will apply to you.

47. Pay off your credit card every month.

48. In debt? Use psychology to help yourself. Consider the debt snowball or debt avalanche.

49. When making a purchase, consider cost-per-use.

50. Make your spending tangible with a ‘cash diet.’

51. Never pay full price. Shop around and do your research to get the best deals. You can earn cash back when you shop online, score a discount with a coupon code, or a voucher for free shipping.

52. Buying experiences makes you happier than buying things.

53. Shop by yourself. Peer pressure increases spending.

54. Shop with a list, and stick to it. Stores are designed to pull you into purchases you weren’t expecting.

55. Spend on the person you are, not the person you want to be. I love cooking, but I can’t justify $1000 of professional-grade kitchenware.

56. The bigger the purchase, the more time it deserves. Organic vs. normal peanut butter? Don’t spend 10 minutes thinking about it. $100K on a timeshare? Don’t pull the trigger when you’re three margaritas deep.

57. Use less than 30% of your available credit. Credit usage plays a major role in your credit score. Consistently maxing out your credit hurts your credit score. Aim to keep your usage low (paying off every month, preferably).

58. Unexpected windfall? Use 5% or less to treat yourself, but use the rest wisely (e.g. invest for later).

59. Aim to keep your student loans less than one year’s salary in your field.

The Mental Side of Personal Finance

At the end of the day, you are what you do. Psychology and behavior play an essential role in personal finance. That’s why these behavioral rules of thumb are vital.

60. Consider peace of mind. Paying off your mortgage isn’t always the optimum use of extra money. But the peace of mind that comes with eliminating debt—it’s huge.

61. Small habits build up to big impacts. It feels like a baby step now, but give yourself time.

62. Give your brain some time. Humans might rule the animal kingdom, but it doesn’t mean we aren’t impulsive. Give your brain some time to think before making big financial decisions.

63. The 30 Day Rule. Wait 30 days before you make a purchase of a “want” above a certain dollar amount. If you still want it after waiting and you can afford it, then buy it.  

64. Pay yourself first. Put money away (into savings or investment accounts) before you ever have a chance to spend it.

65. As a family, don’t fall into the two-income trap. If you can, try to support your lifestyle off of only one income. Should one spouse lose their job, the family finances will still be stable.

66. Every dollar counts. Money is fungible. There are plenty of ways to supplement your income stream.

67. Savor what you have before buying new stuff. Consider the fulfillment curve.

68. Negotiating your salary can be one of the most important financial moves you make. Increasing your income might be more important than anything else on this list.

69. Direct deposit is the nudge you need. If you don’t see your paycheck, you’re less likely to spend it.

70. Don’t let comparison steal your joy. Instead, use comparisons to set goals. (net worth).

71. Learning is earning. Education is 5x more impactful to work-life earnings than other demographics.

72. If you wouldn’t pay in cash, then don’t pay in credit. Swiping a credit card feels so easy compared to handing over a stack of cash. Don’t let your brain fool itself.

73. Envision a leaky bucket. Water leaking from the bottom is just as consequential as water entering the top. We often ignore financial leaks (e.g. fees), since they’re not as glamorous—but we shouldn’t.

74. Forget the Joneses. Use comparisons to motivate healthier habits, not useless spending.

75. Talk about money! I know it’s sometimes frowned upon (like politics or religion), but you can learn a ton from talking to your peers about money. Unsure where to start? You can talk to me!

The Last Personal Finance Rule of Thumb

Last but not least, an investment in knowledge pays the best interest.

Boom! Got ’em again! Ben Franklin streaks in for another meta appearance. Thanks Ben!

If you enjoyed this article and want to read more, I’d suggest checking out my Archive or Subscribing to get future articles emailed to your inbox.

This article—just like every other—is supported by readers like you.

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How This Former Zookeeper Paid Off Over $40,000 In Debt

Hey! Today, I have a great debt payoff story to share from Steffa Mantilla. She paid off $40,000 in debt so that she could be a stay at home mom and start a business. Enjoy!

My husband CJ and I have been married for over a decade.  You’d think with all that time married would come wisdom but it wasn’t until year 10 of our marriage before we really took stock in figuring out our financial life.

How This Former Zookeeper Paid Off Over $40,000 In Debt

How This Former Zookeeper Paid Off Over $40,000 In Debt

Like most people, we got into a routine and didn’t question what we thought was working.  We had surrounded ourselves with other couples who were living the same way we were. 

There was no impetus to change because we had created a comfortable echo chamber with a “Keeping up with the Jones’ mentality.”

Fast forward to today and we’ve paid off $100,000 in debt and are on track to pay off our mortgage within the next 3 years. 

While there’s no “easy button” on debt payoff, I hope that our story can help others see what’s possible and the steps we took to get there.  

More debt payoff stories:

Our Debts

In 2016, my husband and I were close to $200,000 in debt.  Around $165,000 was our mortgage, $12,000 in student loans, and $30,000 in consumer loans.  We were a dual income couple with no kids and lived like money was infinite.  Most of our friends had a similar lifestyle and seemed to be able to afford it.  

The problem was, we put our entire life on payments because we had the mistaken belief that we “deserved it” somehow.  Payments for already-experienced fancy vacations, new cars, and furniture ate up the majority of our paychecks.  

From the outside, we seemed like we were well off when in reality, we were one missed paycheck away from not being able to make the minimum payments on our bills.  

What Made Me Want To Change My Career

By the time 2016 rolled around, we had been married for 11 years and were ready to start a family.  I had also been in my zookeeping career for equally as long.

I had worked my way up from an Avian Intern all the way up through my ultimate goal of Senior Keeper for Carnivores.  While I had loved being a zookeeper all those years, I had reached the limit of upward mobility.  All higher positions were supervisory and were no longer working directly with the animals.  

When we were discussing our future family plans, it became apparent to me that my career wasn’t going to mesh well with my idea of motherhood.  Zookeepers work long hours, often starting at 6AM to get the exhibits ready by the time guests arrive.  They also work every weekend,  evening special events, and every holiday.  

I was also capped out on pay. 

Despite working a decade in this field, having advanced continuing education certifications, and the required degrees, I made merely $16 an hour (roughly $30,000/year).  The long, strenuous hours left me burnt out and wanting a change.

One day, my husband and I sat down to do our budget planning for a baby.  After looking at all of the costs, including childcare, if I continued to work in the same job, I would be making negative dollars. 

This, combined with rarely being able to have weekends or holidays off with my family, was a deal-breaker.  I’d essentially miss out on my child’s entire childhood if I stayed in this job.

I brought up the idea of becoming a stay at home mom and we set out to make a plan.

What Needed To Happen To Make This Work

In order for me to become a stay at home mom, our family budget had to be drastically altered.  Thankfully, while talking about finances was awkward in the beginning, we quickly set aside any embarrassment or feelings of guilt that we had.  

Open communication without judgement, finger pointing, or blame was the only way we were able to make a real plan that we could stick to.  While it was stressful since we were essentially broke despite both earning incomes, we instead used this to come together and strengthen our marriage instead of pull us apart.

By the end, we came to the conclusion that a few things needed to happen:

  • Pay off all our debt (except the mortgage)
  • Lower our frivolous household expenses
  • I’d need to get a job to make up the difference in our budget

Our Money Mindsets

As a wedding gift, we had received the book The Total Money Makeover.  Neither of us had heard of Dave Ramsey before and didn’t really have an interest in learning about him.  Thus, this book sat on our bookshelf for 10 years unopened.

It’s kind of interesting thinking back about how we had the tools for financial success right in front of our faces for literally 10 years without ever using them.  But, we weren’t mentally open to change at the time.  

I think the saying that “you can help someone who won’t help themselves” is especially true when talking about money.  Money is a personal topic that many people have hang ups about. In our case, I knew investing was good so we did that but never really had a problem with debt.  I assumed everyone had debt and all my friends confirmed that.

For CJ, he grew up in a household where you didn’t talk about money.  It was always a source of stress because there was never enough.  Then when he grew up and got his first adult job, there was a sigh of relief.  All restrictions were gone and he could spend how he wished instead of constantly being in a scarcity mindset.

Even though we came from very different money backgrounds, we both were missing solid financial knowledge.  Neither of us had been taught about building wealth or living a debt-free lifestyle.  

This was a huge paradigm shift that we each needed to overcome in order to truly get on the same page and work together.

How We Got On The Same Page As A Couple

I love reading so I quickly devoured The Total Money Makeover in one day.  But no matter what, I couldn’t convince CJ to read the book.  He thought of it as “work” and he’d rather read for relaxation.

So I used my training in operant conditioning to subtly leave hints and clues about.  CJ and I now joke how I “clicker trained” him into getting on board. 

During car rides together we’d listen to the Dave Ramsey Podcast. I’d talk about how neat it was hearing other’s debt-free screams and then we’d discuss what we’d do if that were us.  Could we ever achieve that?  How are these people able to do this and we can’t when we’re earning more money than them?  

The best persuasion was learning about others achieving their financial dreams.  Dreaming together and making plans for our financial future was instrumental in giving us an achievable goal.  

Now it wasn’t just some vague idea; we had concrete plans for how we wanted the next 20 years to go.  We could eliminate financial stress and truly live a life we never thought was possible.

Our Plan To Pay Off Debt

So back to the debt.  We had around $42,000 that needed to be paid off before I could become a stay at home mom.  We weren’t a brand new couple so we did have some savings and investments.  Everything was disjointed and not well organized though.

After looking at our current financial state, we saw that a lot of the debt could be wiped out fairly quickly with the money we had in various places.  

Here’s where we took money from:

  • Sold stock from my childhood mutual funds that my parents had set up as a teaching tool. (~ $2,000)
  • Sold company stock from CJ’s job that was bonus compensation. (~$3,000)
  • Emptied out our $15k Emergency Fund down to $1,000 ($14,000)

These were the immediate quick wins that we could do.  We now had $23,000 left in debt to tackle.  

Rearranging our budget was where we found our largest consistent monthly savings.  After tracking our spending for a few months, we saw that we were spending an insane $800 a month on eating out and for entertainment purposes.  This was on top of the $600 we already spent on groceries for two people.

While we do live in a city where things cost more, it wasn’t enough to justify hundreds of dollars every month.  We were going out for dinner or drinks with friends whenever we were invited.  We never said “no” and our bank account was weeping.  

I also started to take any overtime that was offered.  I’d either come in to work on my days off when coverage was needed or I’d volunteer to work extra evening special events.  This also made it easier to save because a lot of my free time was being used up so I couldn’t go out with friends.

After rearranging our budget and adding in overtime pay, we were able to free up around $1800/month to go directly towards debt. It took 12 months for us to pay off the remaining debt.  During this time I got pregnant and now had to figure out what to do about my soon to be eliminated income.

Making Up The Deficit In Our Budget

Fast forward to me having a baby and being out on maternity leave.  During this time I was still being paid since I had sick days accumulated from the past 5 years.  I was working with my boss to try and see if a part-time or few days a week position could be created.  

Ultimately, while they were willing to work with me somewhat, it still wouldn’t have been financially viable due to the cost of childcare.  

After switching gears, I started talking to other zookeepers who did pet sitting as a side job.  They mainly did weekend pet sits or before and after work drop-ins.  I picked their brains a bit and then decided to offer up my services on Rover.

The reason I chose Rover was that there was already a built-in client base.  I knew I could get clients by highlighting my experience with animals.  Who wouldn’t trust their dog with someone who worked with cheetahs and lions?  By using Rover, I didn’t have to do any outside marketing and ended up having a client wait list.

I also made it clear that I’d be bringing my baby along with me to all dog walks or cat sits so I only took on small or elderly dogs and cats.  I met all clients ahead of time to do behavioral observations and stroller testing to ensure it would be safe. 

In the end, I took on 2 mid-day dog walk clients and numerous cat sitting clients. Our budget was going to be $500 short once my maternity pay ended but with these pet sitting clients I was making $500 a month bare minimum.  And I didn’t need to worry about childcare.  

Paying Down The Mortgage

As I got into the hang of mom life and my child grew older, I started looking into creating my own business.  I was now a self-taught personal finance enthusiast  and Certified Financial Education Instructor (CFEI) so I started my blog Money Tamer.  I was able to write blog posts during my son’s nap time and learned as much as I could about online business.  

My blog is now monetized and the income I take from it goes directly towards our mortgage principle.  Any extra money that CJ earns also goes towards paying off our house early.  We’ve sold things we no longer want or need to consignment stores or used online marketplaces.  

Over the past three years, we’ve been able to put close to $55,000 towards paying down our home making our total debt payoff close to $100,000. 

Our next goal is to have our house paid off in an additional 3 years or so.  

Final Thoughts

Getting out of debt is possible even when you feel lost.  So many people grow up in households where money is taboo and many schools barely touch upon the subject.  Even if you think you’re too far gone, I’m here to tell you it’s never too late.

We had been married and spending with abandon for over 10 years before we got our act together.  The biggest factor in our success was our change in mindset.  We started seeing money as a way to build freedom into our lives rather than surrounding ourself with consumer goods.

If you’re in a couple, it’s paramount that you have meetings to dream together.  You both need to create a dream you’re both working towards so that you aren’t tempted to derail one another.  When one of you is struggling, the other is there to help keep you on course and vice versa.  

This is the route we took, and while it’s not complete yet, we’re well on our way to being able to reach our goal of financial freedom.

Author bio:  Steffa is a Certified Financial Education Instructor (CFEI) and founder of the personal finance website Money Tamer.  She is an online entrepreneur who built her business while being a stay at home mom to her toddler.  Steffa has paid off over $100,000 in debt and now teaches others how they can get their finances under control to do the same.

Are you trying to pay off your debt? What are your dreams for life after debt?

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1099-C: What You Need to Know about the Cancellation of Debt Tax Form

January 6, 2021 &• 5 min read by Brooke Niemeyer Comments 4 Comments

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Disclaimer

From early January to mid-February, you might receive a number of tax documents in the mail. They can range from expected W-2s from your employer to forms about mortgage interest you paid. One form that many people don’t expect is the 1099-C. Discover why you would receive such a form and what the IRS expects you to do with it. Make sure to consult with your tax professional for your specific situation.

What Is a 1099-C Form?

A 1099-C is a tax form required by the IRS in certain situations where your debts have been forgiven or canceled. The IRS requires a 1099-C form for certain acts of debt forgiveness because it sees that forgiven debt as a form of income.

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For example, if you borrowed $12,000 for a personal loan and only paid back $6,000, you still received the original $12,000. Not paying back the other half of the loan means you got the benefit of that money without paying for it. The IRS considers that to be income in many cases.

Why Did You Get a 1099-C Form?

Not every debt cancellation involves a 1099-C form. But if you received this form in the mail, it’s because of a debt cancellation that occurred at some point during the tax year.

Box 6 on the 1099-C form should have a code to help you determine why you received the form. You can also learn more about 1099-C cancellation of debt processes and the reasons you might receive such a form if you’re not sure whether yours is accurate.

The IRS provides instructions and information about 1099-C forms and cancellation of debt in general. That includes a list of potential codes that might be found in Box 6:

  • A—Bankruptcy (Title 11)
  • B—Other judicial debt relief
  • C—Statute of limitations or expiration of deficiency period
  • D—Foreclosure election
  • E—Debt relief from probate or similar proceeding
  • F—By agreement
  • G—Decision or policy to discontinue collection
  • H—Other actual discharge before identifiable event

What Should You Do with a 1099-C Form?

You should never ignore any tax form you receive, as each might have positive or negative implications on your tax return. But you should also not panic if you receive a 1099-C form indicating a large amount of income. It doesn’t necessarily mean that you will owe a lot more in taxes.

First, find out whether the type of debt cancellation on the 1099-C form is excluded from taxable income. The IRS provides a list of exclusions, which include debts that were forgiven because you were insolvent or involved in certain types of bankruptcies. It’s a good idea to double check with your bankruptcy lawyer about whether you need to claim 1099-C income relevant to your bankruptcy discharge.

Once you know whether you need to claim the income or not, you must incorporate the 1099-C into your federal tax filing. If the canceled debt doesn’t fall under an exclusion, you report it as “other income” on your tax return.

That income will be included with your other income in determining how much tax you must pay for the year. In short, you’ll have to pay taxes on the extra income. That might mean your refund is reduced or that you owe more taxes than you would otherwise.

In cases where the 1099-C canceled debt falls under an IRS exclusion—which means you don’t have to pay taxes on all or some of the income—you still may need to file a form. The creditor that sent you the 1099-C also sent a copy to the IRS. If you don’t acknowledge the form and income on your own tax filing, it could raise a red flag. Red flags could result in an audit or having to prove to the IRS later that you didn’t owe taxes on that money.

Luckily, the IRS provides a form for this purpose. It’s Form 982, the Reduction of Tax Attributes Due to Discharge of Indebtedness.

What to Do if You Received a 1099-C Form After Filing Your Taxes

If you don’t know a 1099-C form is coming—and many people don’t realize they might receive one—you could file your taxes before it arrives. You should file an amended return if this happens. That’s true even if the 1099-C doesn’t change your tax obligation, as you might want to get the Form 982 on record for documentation purposes. 

What’s the 1099-C Statute of Limitations?

There aren’t really statutes of limitations on cancellation of debt, though the IRS does have rules about when these forms should be filed. The creditor must file a 1099-C the year following the calendar year when a qualifying event occurs. That just means the creditor must file the next year if they discharge or forgive a debt.

If the creditor files a 1099-C with the IRS, then typically it must provide you with a copy by January 31 so you have it for tax filing purposes that year. This is similar to the rule for W-2s from employers.

However, there is no rule for how long a creditor can carry debt on its books before it decides it’s uncollectible. So, if your debt isn’t canceled via repossession, bankruptcy, or other processes, cancellation could happen at any time. The creditor doesn’t have to tell you about it other than sending the 1099-C.

Is a 1099-C Form Good or Bad for Your Credit?

The 1099-C form shouldn’t have any impact on your credit. However, the activity that led to the 1099-C probably does impact your credit. Typically, by the time a creditor forgives a debt, you’ve engaged in at least one of the following activities:

  • Failed to make payments for an extended period of time
  • Negotiated a settlement on the debt
  • Entered into a program with the creditor because you can’t pay the debt, such as a home short sale or voluntary repossession
  • Been sent to collections
  • Had a foreclosure or repossession
  • Gone through a bankruptcy

All of those are negative items that can impact your credit report and score for years. So, while getting a 1099-C itself doesn’t change your credit at all, you’ve probably already experienced a negative hit to your score.

Get Tax Help if You Receive a 1099-C

As with other tax topics, the 1099-C can be complicated. It’s a good idea to work with a professional when dealing with complicated tax matters or trying to reduce your tax burden legally.

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Wealth Tax: Definition, Examples, Pros and Cons

Wealth Tax: Definition, Examples, Pros and Cons – SmartAsset

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A wealth tax is a type of tax that’s imposed on the net wealth of an individual. This is different from income tax, which is the type of tax you’re likely most used to paying. The U.S. currently doesn’t have a wealth tax, though the idea has been proposed more than once by lawmakers. Instituting a wealth tax could help generate revenue for the government but only a handful of countries actually impose one.

Wealth Tax, Definition

A wealth tax is what it sounds like: a tax on wealth. This can also be referred to as an equity tax or a capital tax and it applies to individuals.

More specifically, a wealth tax is applied to someone’s net worth, meaning their total assets minus their total liabilities. The types of assets that may be subject to inclusion in wealth tax calculations might include real estate, investment accounts, liquid savings and trust accounts.

A wealth tax isn’t the same as other types of tax you’re probably familiar with paying. For example, you might be used to paying income tax on the money you earn each year, self-employment tax if you run a business or work as an independent contractor, property taxes on your home or vehicles and sales tax on the things you buy.

Instead, a wealth tax has just one focus: taxing a person’s wealth. According to the Tax Foundation, only Norway, Spain and Switzerland currently have a net wealth tax on assets. But a handful of other European countries, including Belgium, Italy and the Netherlands, levy a wealth tax on selected assets.

How a Wealth Tax Works

Generally, a wealth tax works by taxing a person’s net worth, rather than the income they earn in a given year. In countries that impose a wealth tax, the tax is only levied once assets reach a certain minimum threshold. In Norway, for instance, the net wealth tax is 0.85% on stocks exceeding $164,000 USD in value.

Wealth taxes can be applied to all of the assets someone owns or just some of them. For example, the wealth tax can include securities and investment accounts while excluding real property or vice versa.

Every country that imposes a wealth tax, whether it’s a net tax or a tax on selected assets, can set the tax rate differently. It’s not uncommon for there to be exemptions or exclusions to who and what can be taxed this way.

A wealth tax can be charged alongside an income tax to help generate revenue for the government. The wealth tax rates are typically lower than income tax rates, in terms of the actual percentage rate, but that doesn’t necessarily mean paying less in taxes. Someone who has substantial assets that are subject to a wealth tax, for instance, may end up paying more toward that tax than income tax if they’re able to reduce their taxable income by claiming tax breaks.

Is a Wealth Tax a Good Idea?

In countries that use a wealth tax, the revenue helps to fund government programs and organizations. In some places, such as Norway, revenue from the wealth tax is split between the central government and municipal governments. It would be up to the federal government to decide how wealth tax revenue should be allocated if one were introduced here.

In the U.S., the concept of a wealth tax has been used to argue for a redistribution of wealth. Or more specifically, lawmakers who back the tax have suggested that it could be used to more fairly tax the wealthy while relieving some of the tax burdens on lower and middle-income earners. While wealthier taxpayers may take advantage of loopholes to minimize income taxes, a wealth tax would be harder to work around, at least in theory. That could yield benefits for less wealthy Americans if it means they’d owe fewer taxes.

That sounds good but implementing and collecting a wealth tax may be easier said than done. It’s possible that even with a wealth tax in place, high-net-worth and ultra-high-net-worth taxpayers could still find ways to minimize the amount of tax they’d owe. And the tax itself could be seen as unfairly penalizing wealthier individuals who own charities or foundations, invest heavily in businesses or save and invest their money instead of using it to buy things like luxury cars, expensive homes or other physical assets.

It’s important to keep in mind that a wealth tax is targeted at people above certain wealth thresholds, so most everyday Americans wouldn’t have to pay it. But it could cause problems for someone who unexpectedly receives a large inheritance that increases his wealth, even if his income remains at the lower end of the scale.

The Bottom Line

In the U.S., the wealth tax is still just an idea that’s being floated by progressive politicians and lawmakers. Whether a wealth tax is ever implemented remains to be seen and it’s likely that debate over it may continue for years to come. And enforcing one could be difficult if it were ever introduced, if for no other reason than there are many ways for the extremely wealthy to avoid taxes. In the meantime, talking with a tax professional may be the best way to manage your own personal tax liability.

Tips on Taxes

  • Consider talking to your financial advisor about the best ways to handle taxes as you grow an investment portfolio. If you don’t have a financial advisor yet, finding one doesn’t have to be complicated. SmartAsset’s financial advisor matching tool can help you connect with professional advisors online. It takes just a few minutes to get your personalized financial advisor recommendations. If you’re ready, get started now.
  • Managing taxes is an important part of growing wealth and creating an estate plan. The less you pay in taxes, the more money you have to save and invest toward establishing a legacy of wealth. A free income tax calculator is a good way to start figuring what you owe or to get confirmation that  your calculations are correct.

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Rebecca Lake Rebecca Lake is a retirement, investing and estate planning expert who has been writing about personal finance for a decade. Her expertise in the finance niche also extends to home buying, credit cards, banking and small business. She’s worked directly with several major financial and insurance brands, including Citibank, Discover and AIG and her writing has appeared online at U.S. News and World Report, CreditCards.com and Investopedia. Rebecca is a graduate of the University of South Carolina and she also attended Charleston Southern University as a graduate student. Originally from central Virginia, she now lives on the North Carolina coast along with her two children.
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5 Options for Your Retirement Account When Leaving a Job

Not sure what to do with a retirement account from an old employer? Laura covers five options for managing your retirement funds when your job ends. Handling your nest egg the right way is critical for preserving what you’ve worked so hard to save.

By

Laura Adams, MBA
September 16, 2020

Retirement Account Comparison Chart (PDF)—a handy one-page download to see the retirement account rules at a glance.

What is a retirement account rollover?

Don’t make the mistake of thinking that once you leave a job with a 401(k) or a 403(b) you can’t continue getting tax breaks. Doing a rollover allows you to withdraw funds from a retirement plan with an old employer and transfer them to another eligible retirement account.

When you roll over a workplace retirement account, you don’t lose your contributions or investment earnings. And if you’re vested, you don’t lose any money that your employer may have put into your account as matching funds.

The main rule you must follow when doing a retirement rollover is that you must complete it within 60 days once you begin the process.

The main rule you must follow when doing a retirement rollover is that you must complete it within 60 days once you begin the process. If you miss this deadline and are younger than age 59½, the transaction becomes an early withdrawal. That means it is subject to income tax, plus an additional 10% early withdrawal penalty.

If you’re a regular Money Girl podcast listener or reader, you know that I don’t recommend taking early withdrawals from retirement accounts. Paying income tax and a penalty is expensive and reduces your nest egg.

If you complete a traditional rollover within the allowable 60-day window, you maintain all the funds’ tax-deferred status until you make withdrawals in the future. And with a Roth rollover, you retain the tax-free status of your funds.

What are your retirement account options when leaving a job?

Once you’re no longer employed by a company that sponsors your retirement plan, there are four options for managing the account. 

1. Cash out your account

Cashing out a retirement plan when you leave a job is the easiest option, but it’s also the worst option. As I mentioned, taking an early withdrawal means you must pay income tax and a 10% penalty. 

Cashing out a retirement plan when you leave a job is the easiest option, but it’s also the worst option.

Let’s say you have a $100,000 account balance that you cash out. If your average rate for federal and state income taxes is 30%, and you have an additional 10% penalty, you lose 40%. Cracking open your $100,000 nest egg could mean only having $60,000 left, depending on how much you earn.

Note that if your retirement plan has a low balance, such as $1,000 or less, the custodian may automatically cash you out. If so, they’re required to withhold 20% for taxes (although you may owe more), file Form 1099-R to document the distribution, and pay you the balance. 

2. Maintain your existing account

Most retirement plans allow you to keep money in the account after you’re no longer employed if you maintain a minimum balance, such as more than $5,000. If you don’t have the minimum, but you have more than the cash-out threshold, the custodian typically has the authority to deposit your money into an IRA in your name.

The downside to leaving money in an old retirement account is that you can’t make additional contributions because you’re not an employee. However, your funds can continue to grow there. You can manage them any way you like by selling or buying investments from a set menu of options.

The downside to leaving money in an old retirement account is that you can’t make additional contributions.

Leaving money in an old retirement plan is certainly better than cashing out and paying taxes and a penalty, but it doesn’t give you as much flexibility as you you would get with the next two options I’m going to talk about.

I only recommend leaving money in an old employer’s retirement plan if you’re happy with the investment choices and the fund and account fees are low. Just make sure that the plan doesn’t charge you higher fees once you’re no longer an active employee.

Another reason you might want to leave retirement money in an old employer’s plan is if you’re unemployed or have a job that doesn’t offer a retirement account. I’ll cover some special legal protections you’ll get in just a moment.

3. Rollover to an Individual Retirement Arrangement (IRA)

Another option for your old workplace retirement plan is to roll it into an existing or new traditional IRA. If you have a Roth 401(k) or 403(b), you can roll it over into a Roth IRA. The deadline to complete an IRA rollover is 60 days.

Your earnings in a traditional IRA would continue to grow tax-deferred, just like in your old workplace plan. And earnings grow tax-free in a Roth IRA, like a Roth account at work. 

Here are a couple of advantages to moving a workplace plan to an IRA:

  • Getting more control. You choose the financial institution and the investments for your IRA.  
  • Having more flexibility. With an IRA, there are more ways to tap your funds before age 59½ and avoid an early withdrawal penalty than with a workplace account. That rule applies to several exceptions, including using withdrawals for medical bills, college expenses, and buying or building your first home.

Here are some downsides to rolling over a workplace plan to an IRA:

  • Having fewer legal protections. Depending on your home state, assets in an IRA may not be protected from creditors.  
  • Being ineligible for a Roth IRA. When you’re a high earner, you may not be allowed to contribute to a Roth IRA. However, you can still manage the account and have tax-free investment earnings.

If you want more control over your investment choices, think you’ll need to make withdrawals before retirement, are self-employed, or don’t have a job with a retirement plan to roll your account into, having an IRA is a great option.

4. Rollover to a new workplace plan

If you land a new job with a retirement plan, it may allow a rollover from your old plan once you’re eligible to participate. While the IRS allows rollovers into most retirement accounts, employer plans aren’t required to accept incoming rollovers. So be sure to check with your new plan administrator about what’s possible. 

Once you initiate a transfer from one workplace plan to another, you must complete it within 60 days to avoid taxes and a penalty.

Here are some advantages of doing a workplace-to-workplace rollover:

  • More convenience. Having all your retirement savings in one place may make it easier to manage and track.  
  • Taking early withdrawals. Retirees can begin taking penalty-free withdrawals from workplace plans as early as age 55.  
  • Avoiding Roth income limits. Unlike a Roth IRA, there are no income restrictions for participating in a Roth workplace retirement account.  
  • Getting more legal protections. Workplace retirement plans are covered by the Employee Retirement Income Security Act of 1974 (ERISA), a federal regulation. It doesn’t allow creditors (except the federal government) to touch your account balance.

Some downsides to transferring money from one workplace plan to another include:

  • Having less flexibility. You can’t take money out of a 401(k) or a 403(b) until you leave the company or qualify for an allowable hardship. It doesn’t come with as many withdrawal exceptions compared to an IRA. 
  • Getting less control. You may have fewer investment choices or higher fees than an IRA, depending on the brokerage firm. 

5. Rollover to an account for the self-employed

If you left a job to become self-employed, having an IRA is a great option. However, there are other types of retirement accounts that you might consider, such as a solo 401(k) or a SEP-IRA, based on whether you have employees and on your business income. 

Read 4 Ways to Start a Retirement Account as a Self-Employed Freelancer or 5 Retirement Options When You’re Self-Employed for more information. 

When is a Roth rollover allowed?

For a rollover to be tax-free, you must use a like account. For example, if you have a traditional 403(b), you must rollover to another traditional retirement account at work or to a traditional IRA.

If you move traditional, pre-tax funds into a post-tax, Roth account, you must pay income tax on any amount that wasn’t previously taxed. That could leave you with a massive tax liability. If you want a Roth, a better move would be to open a Roth account at your new job or to start a Roth IRA (if your income doesn’t make you ineligible to contribute). 

Where should you move an old retirement account?

The best place for your old retirement account depends on the flexibility and legal protections you want. Other considerations include the quality of your old plan, your income, and whether you have a new job with a retirement plan that accepts rollovers.

The best place for your old retirement account depends on the flexibility and legal protections you want.

The goal is to position your retirement money where you can keep it safe and allow it to grow using low-cost, diversified investment options. If you have questions about doing a rollover, get advice from your retirement plan custodian. They can walk you through the process to make sure you choose the best investments and don’t break the rollover rules.