module 9 (maybe also 8?) personal finance

Flexible Spending Account for Approved Medical Expenses

An employer may provide a flexible spending account for medical expenses, which helps employees take advantage of government tax deductions. In a flexible spending account for medical expenses, each employee can deduct up to $2,500 a year from his or her gross income for approved medical expenses. These expenses could include nearly all medical expenses, including payments of insurance deductibles and co-payments for doctor visits. The key is that the set-aside amounts are subtracted from an employee's gross income before taxes. As a result, this reduces the employee's total taxable income. For example, Carlos's mother sets aside money to pay for herself and her family members to visit the doctor and dentist. However, this money must be used by the end of the calendar year or she will lose it. So, she must carefully estimate her family's anticipated medical expenses each year.

Assets, Liabilities, and Net Worth—1

Assets are possessions that have economic value. Assets include cash and investments—such as checking and savings accounts—personal property (jewelry, a car, or a computer), stocks (shares in a corporation), real estate, and business equipment. Assets have economic value that can change over time. There are three ways to categorize your assets: At this point in your life, you most likely have only liquid or current assets. As you grow older, you will want to acquire a mixture of liquid, restricted, and fixed assets. Each type gains value at a different rate and involves a different level of risk. Over time, you hope that your assets will increase in value, which, in turn, will increase your net worth.

How to Buy a House

If one of your goals is to buy a house, you should start budgeting your money as soon as possible. After you start saving, it can take many years before you have enough money to buy a house, depending on your salary. Realistically, a starting salary will probably cover only your regular expenses. As you get older, however, your earning power probably will increase, which will allow you to save more money for large purchases, such as a house. Most people cannot afford to pay cash for a house. They normally pay part of the cost and take out a loan for the rest. These are the two types of expenses to keep in mind when planning to buy a house. The first is called a down payment, which is used to secure the property and the loan. A down payment costs usually around 20% of the negotiated price. If you have a good credit rating, it may be possible to get approved for a smaller down payment, perhaps as low as 10%. The smaller the down payment, however, the larger the loan will be. For the remainder of the price, you will need to take out a type of loan called a mortgage, where the lender uses the property—in this case, the house—as collateral. This means the lender has a lien on the property, which gives the lender the right to evict you from the property if you fail to make your mortgage payments or live up to other terms of the loan. This is important because even though you can live in or rent the house, you do not actually own it until you have paid off the entire mortgage. Mortgage payments must be made each month. If you fail to make your payments, the lender can take over the property in a process known as a foreclosure. Risks and Benefits Buying a house is a big responsibility. You must pay for the house itself, all repairs, insurance, and property taxes. Your mortgage payment will likely be higher than rent on a house or apartment would be. You also will have to spend much of or all your savings to make the down payment. However, there are many advantages in buying a home. First, you can alter your home as you wish—fix, remodel, or paint it however you like. Second, it offers stability—no one will raise your rent or ask you to move out as long as you make your mortgage payments. Third, a home is an investment. At some point, you will finish paying off the mortgage, and the home will be yours; then, you can continue living in it without making any more mortgage payments, rent it out, or leave it to someone in your will. One of the important concerns with buying a house is the risks you assume. If you default, or stop making your mortgage payments, the lender likely will foreclose on and repossess the house, which means the lender will evict you and most or all of the money you have invested will be lost. A foreclosure will negatively affect your credit rating, possibly for the rest of your life. It may also result in bankruptcy. People default for all sorts of legitimate reasons, including the loss of your job or other financial calamities. The other concern with buying real estate is whether it will hold or lose its value. You may need to sell your home if you are transferred or need to relocate for whatever reason. Depending on where you live, a house may hold its value, appreciate (gain value), or depreciate (lose value). During the Great Recession, houses all over the country lost value. Even in places with high demand for housing—such as the Florida or California coasts—houses can depreciate during a recession. On the other hand, falling house prices can be good news for buyers because lots of bargains are on the market. It may be easier to find a house you can afford. Remember, though, just as you might get a house for a bargain, you also might have to sell one at a bargain price, too.

What Gets Taxed?

property, wealth, purchases, earning s

Filing for an Extension and Avoiding a Tax Audit

Although taxes are withheld from your paycheck, you still need to file your taxes every year if you make more than a few thousand dollars. This involves filling out some IRS forms for your federal taxes and some Virginia Department of Taxation forms for your state taxes. By filling out these forms, you will determine whether you paid the correct amount in taxes during the previous year—typically through money withheld from your paychecks. If you paid too much, you will receive a tax refund. If you did not pay enough, you will owe taxes and need to make a payment. Sometimes, you may need more time to finish your taxes. In this module, you will learn how to file an extension when you need more time. You should always do your best to fill out your taxes clearly and accurately. The IRS may request more information, and you may be audited. During an audit, you will be asked to provide information, documents, and answer questions. In this module, you will learn what to do if you are audited.

Federal Income Tax

As you earn more money, you will pay more federal income tax. The federal income tax is considered a progressive tax, which means the tax rate increases as a person's taxable income increases. In other words, with a progressive tax, people who make more money are required to pay higher taxes. In each tax bracket, a higher tax on additional income is added to the lower tax from the previous bracket. Here is an example of how the federal income tax is progressive—based on a single person filing taxes for 2010:

Keeping Track of Your Budget

Below is Jessica's annual budget. Notice how the budget template separates her income and goals from her expenses. Also, notice the far-right column, which indicates whether Jessica spent more or less than she budgeted for each particular expense. Total income minus total actual expenses: $2,500 - $2,160 = $340 in savings You can see that Jessica sometimes spent more than she had planned and sometimes spent less. At the end of the year, Jessica had money left over. She could apply some of these savings to her short-term goal: buying a camera to use on her family vacations. She could dedicate some toward her long-term goal of buying a car. She could then save any leftover money to use in case of emergencies or unanticipated expenses. If Jessica wants more savings, she could do two things. She could cut back on her expenses. For example, she might find a cheaper Internet connection or cell phone service. She could try to increase her income. For example, she could ask for an increase in her allowance, or she could look for an after-school job.

Changes in Tax Regulations and Shifts in Tax Burden

By now, you know that if taxpayers take deductions when calculating their federal income tax returns, they can lower their taxable incomes and their tax liabilities. This means they pay less in taxes to the federal government. In Module 96, you learned that the federal government cannot balance its budget if it takes in less revenue than it spends. So, what happens when tax deductions reduce federal revenues? It sounds bad, but there are some benefits for taxpayers and state and local governments. The benefits described below illustrate just how interdependent the different levels of government are.

taxes on wealth

Estate taxes and inheritance taxes are two forms of taxation on wealth. An estate tax is a tax collected on a recently deceased person's assets (e.g., bank accounts, investments, property); however, these assets must be valued at a certain amount before the estate tax kicks in. This minimum amount changes periodically based on congressional legislation. For instance, in 2012, the minimum amount was $5.12 million; estates valued at less than this amount were not taxed. In 2013, the minimum amount was raised slightly to $5.25 million as a result of the American Taxpayer Relief Act.1 The federal government and some state governments levy estate taxes. An inheritance tax is similar to a property tax. It is collected by states based on the value of the property the deceased person passed down to his or her heirs; the heirs must pay an inheritance tax based on the value of this property. These taxes on wealth are not everyday taxes. Many people go through their entire lives without having to pay them.

Employer-Sponsored Retirement Plan

In a previous module, you learned about the importance of signing up for an employer's retirement plan. Given that many employers match contributions to the plan, it is a great way to boost your savings. An employer's retirement plan is also pretax. So once again, if Jessica is in the 15% tax bracket and she contributes 6% of her $35,000 salary to a 401(k), she will save $315 in federal taxes. Depending on his or her income and deductions, a person may qualify for other tax credits and tax deductions. Tax credits reduce the amount of overall taxes a person owes, while tax deductions reduce the amount of income that can be taxed.

An Annual Budget

Isabella has always had dreams of leaving her home and striking out to a big city. She would love to live near the water. She also plans on having a family and wants to live in a house where everyone has his or her own room. Isabella grew up in a cramped space and shared a room with her sisters. There was no extra space, and, though she loved her family, she does not want to raise her children the same way. Although Isabella has yet to go to college and start a career or a family, she already has researched some of the cities she might move to: Boston; Los Angeles; New York City or the suburbs surrounding it; Portland, Maine; Richmond, Virginia; and Tampa, Florida. However, buying a house in a major city is expensive. She realizes she needs to make a plan. Boston, MA Los Angeles, CA New York City, NY Richmond, VA Portland, ME Tampa, FL Throughout your life, you will have certain anticipated expenses that must be paid every week, month, or year—such as credit card bills, phone and utility bills, rent, insurance, grocery bills, income taxes, and transportation costs. You know in advance when they will crop up, and you must pay them. In addition, there will be unanticipated expenses, such as bills to help a sick pet, fix a broken tooth, repair a flat tire, replace a ruined pair of shoes, or pay off an unexpectedly high electricity bill. Unanticipated expenses may occur when you least want or expect them. Preparing and sticking to an annual budget can help make sure you have enough money to cover all of these expenses.

Long-Term Tax Planning

It is important to save for your financial goals and security. A good first step toward financial security is to create an emergency fund. Unexpected expenses and opportunities may arise at any time. The car you depend upon to get to school or work may need repairs. You might have a chance to take a course that will help you get a better job or get into the college of your choice. In these cases, an emergency fund could help you meet your expenses and take advantage of opportunities. After establishing an emergency fund, you will want to think about ways to meet your other financial goals. These may be short-term, intermediate-term, or long-term goals.

How We Pay Income Tax—1

Now you know that most Americans—including teenagers like you—pay taxes. People tend to think of April as "tax season" because the deadline for filing an income tax return or an extension is April 15. In truth, every day is tax day because many taxes are "paid as you go." Sales taxes are collected when a sale is made. Likewise, payroll taxes are deducted and income taxes are withheld from each paycheck. So, why is April 15 such a big deal? Even though the government has withheld income tax throughout the year, each taxpayer must prepare and file a tax return. These returns are often highly detailed documents that include information about the taxpayer's marital status, sources of income and investments, expenses, deductions, credits, and withholdings. All this information helps determine the taxpayer's tax liability—the amount of tax owed to the government in a given year. An income tax return is important because it is the only way to determine if the government withheld too little or too much in taxes. If too little tax was withheld, the taxpayer needs to pay the remaining amount by April 15 or be subject to penalties. If too much tax was withheld, the government will send a refund or apply the overpayment to next year's taxes, depending on the taxpayer's preference. In Module 95, you will learn the basics of completing a tax return. How does the government decide how much to deduct or withhold? Payroll deductions are simple. The federal government deducts 6.2% for Social Security and 1.45% for Medicare. These percentages have changed over time but have remained steady since 1990.1 Income tax withholdings are a little trickier to calculate. Fortunately, the government and employers work together to figure out the amount. The process begins with a W-4 form, also known as an Employee's Withholding Allowance Certificate. Each employee is entitled to a certain number of allowances or exemptions, which helps determine how much money to withhold. You learned how to fill out form W-4 in Module 90. Here is how it works. An employee usually claims at least one exemption for himself or herself. Employees can claim additional exemptions if they have a spouse and/or dependents, if they pay for child or dependent care, or if they can claim a Child Tax Credit on their annual income tax form. The more exemptions an employee has, the less money the government withholds from each paycheck. The reasoning is that people with children or other dependents need more money in each paycheck to cover their daily expenses; in addition, they will owe less in taxes at the end of the year because they have more deductions.

taxes on property

Property taxes usually refer to taxes on real estate, such as houses or land. Every year, municipalities calculate the value of local homes, office buildings, farms, land, and other real estate and send the owner a tax bill based on that value. These taxes often are billed quarterly (four times per year) or biannually (two times per year); although, homeowners with mortgages can arrange to contribute some of their monthly payments toward property taxes. Some municipalities also levy taxes on personal property. Owners of cars, boats, and farm equipment, for example, usually are taxed annually on the value of their vehicles. In some places, personal property, such as furniture, is taxed annually, too. Individuals must calculate the worth of their specific assets and pay taxes accordingly. You will learn more about evaluating assets in Module 103.

Calculating Growth of Assets Over Time

Remember, the point of an investment is to make a profit or to increase the value of the money you invested (the principal). The process is often slow. To calculate an investment's growth, use the rule of 72. The rule of 72 reveals how long it will take for an investment to double in value: 72 ÷ interest rate = the number of years it will take for the money to double. Max will invest $500 in an investment with a 2.51% interest rate over five years. How many years will it take for Max's investment to double in value? We will use the rule of 72: the number 72 divided by the interest rate (2.51) equals the years it will take the investment to double in value. Look at the math: 72 ÷ 2.51 = 28. It would take 28 years for Max's investment of $500 to grow to $1,000. That seems like a long time. Let's look at another scenario. Notice how the amount of Max's investment is not considered part of the equation. Also, the equation does not take into account compounded interest. Still, the rule of 72 is an easy and memorable equation for calculating how much money you could have in the future. So, Max does not want to wait nearly three decades to double his money. As a result, he may want to put the money in a savings account with a 9% interest rate. Let's look at the formula you learned earlier to calculate if Max will make money more quickly this way: 72 ÷ 9 = 8. Based on this formula, Max would approximately double his money in eight years, even without adding any more money into his account. A lot depends on the interest rate. Max's InvestmentsAnswer these two questions based on what you just learned. Use the drop-down menu to select an answer. o calculate your net worth, you must know the value of your investments. But because net worth is just a picture of your financial situation at the moment the assessment is made, you also need to look long term in order to meet your big goals, such as paying for college or buying a new car. Time value of money is a way of thinking about how money changes in value over time. Think of it this way: the value of a dollar is greater today than the value of any dollar you make in the future. This is true, in part, because of inflation. In addition, the dollar you have right now can be earning interest while you are acquiring that other dollar. Consider this example: Taylor's grandfather wins $48,000 in the lottery. He has two options for collecting his money. He can receive all $48,000 right now, or he can receive 12 monthly payments of $4,000. Based on the time value of money, the lump sum is better because he can invest and earn interest on it over the course of the year. At the end of the year, he will have more money, thanks to interest. The calculated value of his money at the end of the year is called its future value. Most people do not win the lottery, but they still need to think about the future value of the money they have right now. You already know something about this concept. Calculating the compound interest you will earn over time is actually a way to figure out the future value of your money. The formula should look familiar.1 FV = PV(1+ r/n)nt FV is the future value. PV is the present value—the amount of money you actually have right now. The interest rate is r. The number of times in which interest is compounded in a year is n. Let's say that Taylor's grandfather invests his $48,000 (present value) by putting it in a savings account with 2% interest that compounds quarterly, or four times a year. What is the future value of the money? Let's use the formula, FV = PV(1 + r)n FV = PV(1+ r/n)nt FV = 48,000(1+ .02/4)4(1) FV = 48,000(1.005)4 FV = 48,000(1.020) = 48,960.00. If Taylor's grandfather had taken the second option—receiving $4,000 a month for a year—at the end of the year, he would have had $48,000, or $960.00 less than if he had invested the full $48,000 for the entire year.

Exercise

Take a look at the line graphs below1 and notice how much each tax has contributed to the federal revenue since 1970 as a percentage of the gross domestic product. Also pay attention to the way the lines rise and fall. Think about possible reasons why revenues from individual income taxes seem to rise and fall so much through the years (hint: remember the business cycle)!

The Costs of Assets

There are several kinds of costs related to assets. Check the following bulleted list to learn about those costs. [Interactive placeholder: the cost of assets NOTE: Excluded because it was just a list of terms defined below] The historical cost of an asset is a starting point for calculating an asset's value over time. Historical cost is the price you paid for an asset at the time of the purchase or transaction. For example, if you bought a brand new car for $14,000.00, that would be its historical cost. If you bought a used car for $500.00, that would be its historical cost. Historical cost is the starting figure you would use when trying to calculate a car's value two, five, or ten years down the road. Historical cost helps financial planners and accountants distinguish between the price you paid for an asset in the past and its replacement cost, which is what you would pay if you had to replace the asset right now. It is important to consider these two kinds of costs when insuring your assets or when making an insurance claim if the asset, such as a car or house, gets damaged or destroyed. To determine the value of an asset, you must also consider depreciation. Depreciation is the decrease in an asset's value over time you own and use it. For most assets, depreciation is primarily caused by the wear and tear of regular use. For example, by driving a car or scooter, you wear out its parts—the tires, belts, pistons, brakes, and so on. This makes the vehicle less valuable. Wear and tear mostly affects mechanical or technological assets, such as cars or computers, but it can also affect real estate and business equipment. For some assets, such as art, depreciation is based on market value, not wear and tear. In addition, depreciation is measured differently for certain kinds of assets. New cars, for example, lose a lot of value the moment you drive them away from the dealership. After the first year, the rate of depreciation is slower. You will learn more about calculating depreciation later in this module. Operating costs are also associated with assets. These are the costs you pay to keep an asset working, in good condition, and in compliance with the law. For example, a car requires repairs, cleaning, fuel, registration, annual inspections, license plates or tags, personal property taxes, and insurance. These costs all add up and keep recurring; you pay them throughout the time you own an asset. Finally, some assets require additional costs. Real estate—such as land and the houses and buildings on the land—often requires the payment of property taxes. When you purchase a new car, you also pay local, state, and federal taxes in addition to the sales price. Calculating the historical cost of an asset is easy. You first look at what you paid for the asset. In some instances, the historical cost must be adjusted for inflation to determine the purchase price in current dollars. This adjustment is necessary when we are comparing the prices of goods and services produced or consumed in the past with the comparable current value of goods and services. Figuring operating costs and taxes is fairly straightforward, too. As an asset owner, you will receive a tax bill from the federal government or from your state or local government. Operating expenses include the gas and oil you put into your car, the ink you put into your printer, the batteries you put into your digital camera, and so on. As the property owner, it is your responsibility to track the operating costs of your assets. Knowing the operating costs will allow you to determine when the opportunity cost of owning an asset is too high. If it costs more to own than the asset is worth to you, then the cost of ownership is too high. Calculating depreciation is a little trickier. The salvage value is subtracted from the asset's historical cost, then divided over the life of the asset. (Salvage value, or scrap value, is basically the value of an asset's parts—what it is worth when it breaks down and is unusable.) Depreciation is usually spread over the life of the asset—the time during which you own or use it. It puts a value on how much wear and tear costs you pay each year over the lifetime of the asset. Here is an example: You purchase a one-year-old car for $5,000.00—its historical cost. The car depreciates over time because of wear and tear. After 10 years, the car is worth $500.00. That is its salvage value. In other words, over 10 years, the car loses $4,500.00 in value. Because the car was used when you bought it, its depreciation is $450 per year of the car's life. After having it five years, what is the depreciation? Do the math: 5 x $450.00 = $2,250.00. Keep in mind that the car continues to have value to you, the owner, while it is depreciating. As long as you can drive it safely, it has value to you. Often, the salvage value is much lower than the car is actually worth to the owner. The depreciation value is a helpful number to consider when calculating your net worth. At some point, an asset may cost more to own or operate than it is worth. If that 10-year-old car needs thousands of dollars in repairs to keep it running, it may be less expensive to trade it in and buy a replacement with the money you would have spent on repairs. In making choices about spending—on repairs or a replacement—consider your opportunity cost. For this reason, you will want to keep an eye on the depreciation and operating costs of your most valuable assets. Sometimes, an asset loses value or begins to cost more than it is worth in maintenance. Older cars, for example, depreciate and begin to cost more in operating costs (repairs, fuel, maintenance, etc.) than they are worth. In that case, it may be worthwhile to get rid of the car and invest in a new one or take public transportation. The next section explains how to know if an asset is worth keeping or if it costs more than it is worth

Your Filing Status and Exemptions

To see how federal taxation affects gross income, look at the following table based on single filing status and no exemptions. Notice the difference made by decreasing the number of exemptions from one to zero.

Proportional Taxes

A proportional tax, sometimes called a flat tax, levies the same rate on all income levels—everyone pays the same percentage, regardless of income. An example is a sales tax. Here is how it works. Suppose your city places a 5 percent sales tax on clothing. When buying a T-shirt, everyone would pay a 5 percent tax. Some proportional taxes can be tricky. They may be considered regressive taxes (see below) for people with lower incomes. Remember proportional taxes this way: One size fits all. Spend more, pay more.

Education Tax Credits

A tax credit allows you to decrease the income taxes you owe.

Four Tax Deductions—1

According to federal tax laws, taxpayers can deduct the costs of property taxes and income taxes when they calculate their taxable income. To do this, taxpayers must itemize their deductions, which means the taxpayer provides a detailed list of expenses that are eligible for deductions. They also have the option of deducting general sales taxes instead of state income taxes. Before discussing this further, let's go over the kinds of taxes that can be deducted.

Calculating Interest: Simple vs. Compound Interest

As you have learned, a bank savings account is an example of an asset. It is also an investment. The bank pays you interest on your principal. The principal is the money you deposit in the bank. In return for lending the bank your money, the bank pays you interest on the principal. Banks are very clear about their interest rates. Typically, the interest rate on a savings account is low, about 1% to 3%. In early 2013, however, most banks were offering much lower interest rates on savings accounts, ranging from .02% to .99%.1 Make sure to search for a bank with a high interest rate when looking to open a savings account. There are two types of interest: simple interest is interest paid on only the principal. It is a fixed amount paid at regular intervals (usually monthly or annually). It is based solely on the principal in the account and not on any interest that has accumulated. Compound interest is also paid periodically; however, it is paid on the principal plus any previously earned interest. In other words, your principal earns interest, and then, that combination of principal and interest also earns interest. Depending on the rate and the amount of principal, savings accounts with compound interest generally grow much faster than those that pay simple interest. Here is an example. Marie has $100 in a savings account that pays 2% simple interest each year. Then after one year the bank pays Marie $2. After one year, if Marie does not take any money out or put in more money, she will have $102 in her savings account. A year later, the bank will pay her another $2 on her $100 principal; so, she will have $104. This equation shows how to calculate the simple interest on Marie's account:P is Marie's principal of $100. P = 100r is the interest rate (2%). r = .02Interest is calculated by multiplying the principal by the interest rate: P•r = 2.00. So, when Marie opens her savings account, it equals P, or $100. At the end of a year, her savings account equals P + (P•r), or 100 + (100•.02) = 102. At the end of the next year, Marie's savings account equals P + (P•r) + (P•r), or 100 + 2 + 2 = 104.Another way to write this equation is P (1 + r•t), where t equals the number of years. See how it works? After three years, Marie's savings account equals the following: 100.00(1+ r•t), or 100.00(1 + .02•3), or 100.00(1 + .06.), or 100.00(1.06) = 106.00

Filling Out a W-4 Form

Do you see how the information filled out on a W-4 affects your paycheck? Based on the examples in the activities, there would be a $13.45 per week difference between exemptions. This would add up to $699.40 per year. Suppose you claimed an exemption because you did not expect to earn much money; however, suppose you then got a large raise or found out you were earning much more than you thought. At that point, you should complete a new W-4 form to avoid owing too much money at the end of the year. If you owe too much (as a percentage of your income) at the end of the year, you will be charged a fine. You can complete a new W-4 form anytime throughout your employment. This is true whether you want to increase or decrease your withholding. If your job happens to be interrupted for a while—for instance, maybe you worked for an employer during the summer, took a break for school during the fall, and came back to work during winter break—you would have to complete only one W-4 at the beginning of your employment, unless you wanted to make changes.

More Types of Goals

Intermediate-term goals often take two to five years to achieve. Think of what you will need within two to five years. Will you need a car, payments for college, furniture for an apartment, or something else? Once you have identified your highest priorities, you will need to research their costs. If your annual income is greater than your annual expenses, you can save for your intermediate-term goals. Long-term goals take at least five years. Long-term goals include saving for retirement, buying a home, or starting a business. Though it may seem odd at your age to think about retirement, the reality is that you need to plan and save now to have the life you want later. Living on Social Security alone might not allow you to pay all of your expenses during retirement. Most likely, you will need an additional source of income. It will be up to you to provide for your financial needs in retirement beyond what Social Security may cover.

Paying for Post-High School Education—1

It is easy to pay for college, is it not? After all, you hear a lot about financial aid—grants, scholarships, work-study, or loans. Sounds great! Now you can go to college, tuition-free, right? Well, wait. Before you agree to anything, it is important to know what you are getting. Grants and scholarships are awards of money students may receive to pursue higher education. Grants typically come directly from the institution and scholarships may come from many different sources. Grants and scholarships can both be awarded to a student based on academic merit, financial need or accomplishments (like athletic or music scholarships), or just meeting certain criteria (like being from a certain city or pursuing a type of study). Work-study programs allow students to work on campus in order to offset tuition costs. If you are offered one of these, you do not have to pay back anything. But student loans are money borrowed from an institution, usually the federal government or a bank. The institution provides a set amount of money at a price with an agreed-upon interest rate. Student loans are legal obligations that you must repay. Before you sign any loan documents, read the fine print. Some student loans have high interest rates. Often, graduates end up paying back student loans for years after they leave school. While education can increase your human capital and your ability to earn more income, you may be saddled with student loans that will affect your discretionary spending over a long period of time. Understanding your future expenses is key to effective planning. That involves considering what kind of college you want to attend, the cost of tuition, and what field you want to pursue. Starting this planning process early is one way to ensure that you are financially prepared for your future. A good way to start is to assess your skills and your interests. That way you can choose a career and an education that is right for you. Keep in mind that many people start one career and then change to another for various reasons, including changes in their circumstances or in the overall economy. But assessing your skills and interests early will help you plan your decisions regarding your future education.

How Much Can You Borrow?

Lenders are concerned with how much you should borrow—or, more specifically, how much you will be able to afford to pay each month. They typically consider your usual monthly expenses and the amounts of your monthly mortgage payment, property taxes, and insurance. Generally, they will lend up to 35% of your monthly gross income, assuming that your credit rating is good and that you do not have any significant debt. You should also think about what you can afford. After making the down payment, will you still have enough money in your savings account? You should still have enough left in savings in case of an emergency. Then, think about the monthly payments. Can you afford to pay the mortgage every month even if your work situation changes? When you initially buy the house, your salary might be enough to cover the monthly payments, but, sometimes, the unexpected occurs. If the economy gets worse, you might lose your job. Or, if you decide to start a family, your monthly expenses will increase. In addition, added expenses, such as property taxes, come with home ownership. In the United States, property taxes average 1.04% of the property's value. Property tax rates vary widely, depending on the city and county. In Virginia, rates range from 0.46% in Augusta and Bedford counties to 1.14% in Loudoun County. Property taxes as a percentage of household income vary from 0.3% to nearly 10% in some suburbs of New York City.1

The Federal Budget in a Market Economy

Many people wonder if it really should be the federal government's job to fund so many expensive programs and services. They suggest that, in a market economy, private businesses could probably provide many of the same programs and services more efficiently and cheaply. Privatization, they argue, would reduce federal spending, stop deficit spending, and pay down the national debt. Let's look at the different qualities of the private sector versus the federal government. Private SectorFederal Governmentoften innovative sometimes bureaucraticquick to respond to the market often slow to changecompetitive stableprofit based—must generate profits to survive need based—increased needs often increase deficit spendingoften focused on the short term often focused on the long termobligated to clients/customers and, in some cases, shareholders obligated to all citizens, including nonvoters At a glance, the private sector seems to be a good option for running many public programs and services. The private sector is always concerned with profits, which means it might be less likely than the federal government to waste money. It also might be more likely to eliminate bureaucratic problems and provide programs and services that customers want. This is a traditional argument against big government. However, the private sector cannot run a deficit for long periods of time, because investors expect returns, not losses. The government can spend money today to cover the citizens' needs, even if the money is not available, and pay for it at a much later date. The federal government, however, is incredibly stable even during tough economic times. It has been around for more than 200 years, and Americans know it will be there—in good and bad times, regardless of what the market does. Supporters of higher government spending argue that many government programs and services—such as national defense and "safety net" programs for the elderly, poor, disabled, and young—do not generate profits and likely would suffer or be eliminated in the hands of the private sector. It may not be efficient or make everyone happy, and it may operate at a deficit, but the federal government provides programs and services that support all American citizens. Even if you never use any federal government programs or services (which is almost impossible), you still benefit from living in a society in which government helps people. Let's consider a couple examples where the private sector would not easily replace the government. Imagine if private companies took over responsibility for national defense. How would they generate revenues? They would need to appeal to investors and customers who think that national defense is worth paying for. Investors would expect to have a say in how the companies are run, and customers would expect services in return for their purchases. Would these companies be more likely to provide national defense services to their own investors and customers than those who do not have stakes in the companies? Furthermore, if revenues declined, would the companies cut back their services? What if a national crisis arose? Could everyone count on an army run by private companies and motivated by profits? In our current system, tax dollars support national defense, and, as a result, all citizens receive protection. The Pentagon, the headquarters for the U.S. Department of Defense, is located in Arlington County, Virginia. Here is another example. What if only people with children paid for schools? What if you stopped paying taxes to support education as soon as you graduated from high school or college? After all, you would not need school anymore, and it costs so much to send other people to school. As a result, only a small and constantly changing segment of the population would pay for education. But, guess what? All Americans, even if they are not in school, benefit from good education systems. How does a middle-aged college graduate benefit from the education of another person's child? That child could grow up to become his or her doctor. Society is better off when everyone is educated, and that is why most people pay taxes to support education. The federal, state, and local governments all support education in different ways.

Progressive Taxes

Progressive taxes require people with more money to pay higher taxes than people who have less. With this type of tax, people who are wealthy or who earn higher incomes must pay a larger percentage of their wealth or earnings in taxes than people who earn less. Income tax is an example of a progressive tax. People who earn more pay a higher percentage of their wealth or earnings in taxes. Here is an example from the 2010 tax code: People with a taxable income of $8,375 or less per year were in the 10 percent tax bracket; they were taxed at 10 percent. So, a person with a taxable income of $8,000 would have paid the government $800. People with taxable income between $82,400 and $171,850 per year were in the 28 percent tax bracket. So, a person with a taxable income of $95,000 would have paid the government $26,600. A person with $95,000 in taxable income would have paid more than 25 times as much in taxes as someone with $8,000 in taxable income—even though $95,000 is not even 12 times more than $8,000.1 The logic behind progressive taxes is that people who earn more can afford to pay more in taxes. These taxes, in turn, fund programs and services that help people who earn very little. Remember progressive taxes this way: Earn more, pay more.

Long-Term Tax Planning

When Carlos started his new job, he completed a W-4 form. The W-4 is a brief form that helps employers determine how much money to withhold from their employees' paychecks. On this form, workers indicate whether they are single or married and how many people they support. For example, if Carlos was a single father with two children, he would declare three dependents—himself and his two children. However, because he does not have any children, he declares only himself. Now that Carlos has started his job, it is important for him to take advantage of tax benefits. More than likely, he will find some ways to save on taxes and keep more money in his pocket. You will learn more about these kinds of benefits later in the module.

Tax Deductions and Tax Credits—1

Warning! At some point in your life, you will most likely have to stop using the 1040EZ form. When you graduate from high school and college or trade school, big changes may take place in your life. You probably will make more money. You might get married and have children or need to take care of your parents when they get older (making them dependents). You might buy a house or other property and start a retirement fund. One thing is for certain—you will definitely have new expenses. As you earn and own more, the government will collect more money from you. It's only fair, right? But, it is nice to keep some of the money if you can. That is why you will want to start thinking about ways to reduce your taxable income and your tax liability legally. Total income, or gross income, refers to most of your sources of income, including earned, unearned, and investment income. It is important to understand that not all sources of income are subject to taxes or even to the same tax rates. That makes calculating your tax liability a little tricky. The first step is to determine your adjusted gross income—your total, or gross, income minus any adjustments. These adjustments include IRAs, student loan interest, and tuition and fees. You learned about these adjustments in Module 92. The next step is to calculate your taxable income. Step 3: How do you calculate your taxable income? First, you take your adjusted gross income and subtract deductions, credits, and taxes. Let's focus on tax deductions first. Every taxpayer is eligible to take a standard deduction. The standard deduction is kind of like a free pass—you do not have to pay taxes on this amount. How much is a standard deduction? It depends on your filing status and the current rates set by the government. In 2010, the standard deduction for a single taxpayer was $5,700.00 and double that amount for married couples.1 The federal government regularly changes the amount of standard deductions. You can find the information in your tax form instructions or online. Not everyone uses a standard deduction, however. Some people's financial lives are more complicated, and they qualify for other kinds of deductions. If these deductions add up to more than the amount of the standard deduction, the taxpayer will want to itemize, or list, them individually, on a tax return. These are called itemized deductions. Some deductions that a taxpayer may itemize include medical expenses, donations (made to approved charities/institutions), interest payments (for example, interest paid on a home mortgage loan), state and local taxes, and in certain cases theft or loss of property. If you want to itemize your deductions, you have to be very organized. You can keep track of all your income and expenses by using personal accounting software, such as Quicken®. Normally, this software can link with tax preparation software, such as TurboTax®, which makes it easier to prepare your taxes. You must keep good records and save all receipts, bills, and paperwork related to potential deductions, especially if you start your own business. Then, you can deduct exact amounts based on your records and receipts. If they add up to more than the standard deduction, great! Subtract the amount from your adjusted gross income to determine your taxable income. Here is an example: In 2011, Taylor's older cousin Franklin had an adjusted gross income of $36,400. He could have taken the standard deduction ($5,700.00), but he thought that itemizing would work in his favor. Here is a list of his tax deductions for the year:

What Is a 529 Plan?

A 529 Plan is a higher education savings plan, typically sponsored by a state, designed to help families plan and invest for future college expenses. Its name comes from Section 529 of the Internal Revenue Code, which created these types of tax-advantaged college savings plans in 1996. The Commonwealth of Virginia offers four different programs—one prepaid education program and three savings programs. The Virginia Prepaid Education ProgramSM (VPEP) allows parents and students to prepay their cost of tuition and mandatory fees at Virginia's public colleges and universities (but benefits may be used at any qualified higher education institution). The Virginia Education Savings TrustSM (VEST), is a savings program that offers a selection of investment options to help pay for college costs. CollegeAmerica,® is another savings program, available only through a financial advisor, which provides investment options in mutual funds to build a college savings account that meets their specific needs. Finally, CollegeWealth® offers FDIC-insured bank savings accounts popular with more conservative investors. VEST and CollegeAmerica investments are subject to financial markets and have the potential for investment losses as well as gains; VPEP carries a statutory guarantee from the state and CollegeWealth is guaranteed by federal deposit insurance. All 529 plans offer tax advantages—they grow tax-free—and some offer additional state tax advantages. The earlier you start saving, the better.

Wage and Tax Statement—W-2 Form: Overview

A Wage and Tax Statement, issued by the Internal Revenue Service, is commonly called a W-2 form. Each January—the start of the calendar year—Carlos' employer issues a W-2 for each employee. Carlos' W-2 shows exactly how much money was withheld from his paycheck during the previous year. The amount withheld is based on the information Carlos filled out on his W-4. Carlos will use the information on the W-2 when preparing to file his income tax. The W-2 also details the amount of money withheld from his paycheck to support his future Social Security benefits.Employers must distribute W-2 forms by the end of January each year so that employees will have time to prepare and file their tax returns before the April 15 filing deadline. As you learned earlier, when Carlos started the job, his employer gave him a W-4. In completing this form, Carlos indicated his number of exemptions. His employer would use this information to calculate how much to withhold from his paycheck each pay period. With each paycheck, Carlos also would receive a pay stub listing his gross income, taxes withheld, tax deductions, and net income (his pay after deductions). His last pay stub of the year would show his gross income, deductions, and net income for the year in the "year to date" column. After receiving his W-2, it is important for Carlos to confirm that it matches the "year to date" column from his last pay stub of the calendar year. If they are not the same, Carlos needs to contact his employer to correct the error. It is also important for Carlos to check his Social Security statement—distributed by the U.S. government—to make sure his annual income for that calendar year matches the amount shown on his W-2. If not, Carlos has three years to correct it.

Electronic Filing

According to the IRS, people make many more mistakes when they file their tax returns on paper rather than electronically. People have been filing electronically for a relatively short amount of time. In 1986, the first electronic transmission of a tax return was sent to the IRS. By 1989, taxpayers in 36 states could file their taxes electronically. By 1990, all taxpayers in the country who expected a refund could file electronically. Today, people can file electronically whether they owe taxes or expect a refund.

Tax Breaks: What They Mean for the Federal Government and You

Another way that the government helps citizens is by providing tax breaks. As you learned in Module 95, tax deductions allow taxpayers to reduce their taxable income, which lowers their taxes. They may also take advantage of tax credits, which reduce the amount of taxes owed. During tough times, the government may also cut taxes. Tax breaks and tax cuts mean that taxpayers get to keep more money in their pockets. Although they reduce government revenues, the hope is that taxpayers will either spend that extra money, which helps the economy grow, or invest it, which increases their assets. So, even though the government actually collects less revenue, many people benefit from consumer spending or investment. Are there any drawbacks to tax breaks and tax cuts? Absolutely. Two things can happen when the federal government does not collect enough revenue. First, it may have to cut back on programs or services. This response, however, may hurt low-income families or elderly retirees who depend on those programs or services. Second, it could respond with deficit spending—borrowing money to make up for the missed revenue. In this case, public services might not get cut, but the deficit spending will increase the national debt. In turn, interest payments on the debt will go up, driving up the debt amount even more. No one likes the feeling of being in debt, and, when the entire country is in debt, all Americans share that feeling and the burden of paying it back. In 2012, the national debt had grown to nearly $16 trillion, alarming many government leaders that the debt is bankrupting the nation. For years, a fierce political fight has been occurring in Congress about methods for reducing the national debt. In general, some leaders favor reducing—or, in some cases, eliminating—federal spending on many programs and services while imposing no new taxes on Americans. Their opponents on the other side want to maintainmany of these programs and services at their current, or only slightly reduced, funding levels by raising taxes on wealthier Americans. This disagreement is ongoing and is one of the defining issues of 21st century America. Examine each argument and decide what strategy sounds best for addressing the national debt. Does one strategy work better than the other? If not, can you determine a combination of each plan that may provide the best option? Discuss some of your ideas with your classmates and listen to their opinions.

Sales Tax

As a consumer, sales tax is the tax you pay most often—almost every time you make a purchase. As you have learned, state and local governments depend on sales taxes to help pay for various state and local services. Each state determines its own base sales tax percentages. Local governments can impose an additional sales tax, usually much smaller than the base tax. For example, in Virginia, the base sales tax for most items is 4%, which goes to the state. An additional 1% for most items goes to local revenue. So, the total Virginia sales tax for most items is 5%. However, Virginia uses a lower tax rate, 2.5%, for fresh produce and most groceries. Some cities and counties in Virginia also levy a meal tax on restaurant food. This tax may be as much as 6.5% in addition to the 5% sales tax. While many other states collect sales tax for postage stamps, Virginia does not tax these goods. How much is the sales tax in your community? It is easy to find out. Next time you go shopping, save the receipt. It will show you the price of each purchase—the "sticker price." At the bottom of the receipt, you will see the sales tax. You might have to do some math to figure out the exact amount of the tax. Let's take a look at a receipt Isabella saved from a trip to the pet store. This receipt is pretty straightforward. Isabella bought dog food and a new leash, both of which were subject to a sales tax. Where she lives, the sales tax is 5%. If you take 5% of $35.98, it comes to $1.80, which brings her total to $37.78.

Politics: Interplay between Local and Federal Taxes

As you learned earlier in Unit 8, local and state governments rely heavily on property and income taxes for revenue. To ease taxpayers' tax liability, the federal government allows them to deduct taxes paid at state and local levels when calculating their federal taxable incomes. Taxpayers may deduct income taxes, real property taxes, and personal property taxes that they have already paid to state and local governments. Those state and local taxes add up, so these deductions can be really helpful in reducing a taxpayer's taxable income. Since 2005, sales taxes have been deductible; before this law went into effect, taxpayers could not deduct sales taxes from their federal income taxes.1 Individuals can deduct state and local income taxes paid, or they can deduct sales taxes paid. This allows taxpayers to choose which deduction they want to take, depending on which one is larger. Generally speaking, the deduction works best for people who live in a state with no income tax or where the sales tax deduction is larger than their state income tax deduction. Since taxes reduce people's income and wealth, the subject is a hot-button issue for many Americans. Some people feel like they do not get the best or most-efficient programs and services for their tax dollars; on the other hand, some people think that paying taxes is a good trade off for these same programs and services. Yet, everyone relies on government services, including roads, mail delivery, food safety, police and fire departments, public schools, hospitals, and libraries. This is where politics enters the picture. Americans have different views on how tax dollars should be spent and tend to vote for politicians who represent those views. This is why government officials often disagree on how to spend tax revenue. For example, should the town spend money on a new water treatment plant or repair the roads? Should the federal government provide health insurance for everyone or make it easier to buy privately? Both sides have valid points. It is Complicated! Deciding how to allocate tax revenue is a big responsibility. Government officials must consider the needs of constituents and the greater good. They do not always get it right. As a result, one group may benefit from tax laws more than another, and government programs and services sometimes are overly expensive and inefficient. Despite some of these flaws, the overall process has worked well.

Assets, Liabilities, and Net Worth—2

Now you understand what assets are. Next, you will learn about liabilities. Liabilities are financial obligations, or amounts of money you owe. Liabilities include outstanding bills and debts of any kind, such as student loans, car loans, money borrowed from friends or family, mortgages (and rent, if you have a lease), and taxes. To calculate your net worth, first identify and add up your assets. Then, identify and add up your liabilities. Finally, subtract your liabilities from your assets. This gives you your net worth.

Why You Should Evaluate the Value of Your Assets Over Time

Consider the following situation. You were just hired at $7.50 an hour for 15 hours a week at a coffee shop across town. A friend has offered to sell you his 10-year-old car for $1,000. You need the car to drive to the job. Even if you have enough savings to buy the car, you will have additional car-related expenses, such as the car's registration, monthly insurance costs, gas, and oil. Known as operating costs, maintenance such as repairs, fuel, or insurance policies add up over the life of an asset. Suppose you earn $73.12 a week in net pay (pay after taxes). If it costs more than $73 a week to maintain the car, you will lose money on your asset. Most people would not intentially choose this option, but they might not realize they are actually losing money. This is because many people do not know the true costs of their assets. Even new cars lose a lot of their value—through depreciation—as soon as they are bought and driven off the lot. Sometimes, it makes more sense to sell an asset and to reinvest the money in a different asset. Take a minute to review the different types of assets. As a teenager, you probably do not have any fixed assets, such as real estate, factory equipment, or antiques. Most of your assets are likely liquid, or current. You might have cash and perhaps a checking or savings account; you might also have property, like Marie's books, that can be sold for cash. In the future, though, you may acquire fixed assets, such as a house or a piece of land. You will need to be able to calculate the value of all your assets over time so that you can keep track of your net worth. Those values may be affected by historical costs, depreciation, and operating costs.

Short-term and Long-term Financial Goals—1

Effective financial planning requires short-term and long-term goals. These goals reflect where you are in life. Teens, for example, are rarely ready to buy a house or to plan for retirement. These are long-term goals, which require a lot of planning, money, and time—often years—to reach. Short-term goals can be reached in less time—weeks or months instead of years. Examples of short-term goals include paying a credit card bill, saving up for a road trip during spring break, or buying a new winter coat. Short-term goals generally require less money, planning, and time to set aside money. To begin setting goals, think about what you need or want to pay for in the long term (a year or more from now) and the short term (in the coming weeks or months). These goals should include not only dream purchases, such as a new computer or smartphone, but also your regular day-to-day purchases, such as bus fare, food, and clothing. In fact, necessities, food, clothing, and shelter—the things you must have to survive—are the first things to plan for in a budget.

Maximizing Investments

First, you need to think about investments. Investments are similar to savings; you put a little money into them now with the hope that your money will grow in value. A "good" investment is worth buying because it will become more valuable over time—and increase your net worth. Generally, people do not invest unless they believe they will gain financially. Not all investments result in gains, though. Still, people invest their money as a way to generate additional income. Income is the money you earn by working; investments allow your money to earn more money for you. There are several kinds of investments.1 There are other risks, too. Objects can be stolen or damaged or lose value. Stocks can lose value if the corporation experiences financial trouble. Also, inflation will decrease the value of your savings. The goal of investing is to gain financially over time. People who invest need to calculate net worth statements periodically. They need to determine if their assets are increasing in value and outpacing their liabilities as well as inflation.

Weekly Budgets

For those who get paid weekly, a weekly budget is easier to manage. A weekly budget helps you determine exactly how much you make each week and how much you can spend. This makes paying bills and keeping up with your spending a lot easier. As much as possible, people who get paid weekly should pay their bills on a weekly, too. If that is not practical, they should use weekly budgets to calculate and set aside enough money each week to cover their monthly bills. This is what Taylor does. Taylor makes about $100 each week for tutoring math students. He does not always make that amount. During spring break or during the summer months, he might make less. During finals, he might make more. This is one reason why Taylor uses a weekly budget. During the week of April 1-7, he made $90. All of Taylor's expenses are weekly, except for one. To simplify things, he set up his monthly cell phone and Internet connection bills so that he pays them automatically by credit card. So he pays only one monthly bill—his credit card bill—usually on the 15th of the month. This is a monthly anticipated expense of $50. Every month, Taylor has to make sure that he has the money to pay that bill on the second week of every month. Taylor's initial budget set aside $12.50 each week to cover the bill ($12.50 x 4 weeks = $50). But, by the second week of the month, when the bill was due, he had only $25—half the bill—set aside. Taylor remembered that a weekly budget is more flexible than a monthly budget. Now, he budgets $25 a week for the first two weeks of the month and $0 a week for the second two weeks.

Gross Income and Net Income

Gross pay is the amount you earn before paying any income taxes. Net pay is the amount you receive after all income taxes are deducted. To see how federal taxes affect gross income, look at the table below based on Single filing status and one exemption. FICA OASDI is the deduction for Social Security's Old Age, Survivor's, and Disability Insurance. FICA Medicare is the deduction for Medicare premiums, which is set aside to cover a portion of health care costs for U.S. residents who are at least 65 years old or who are under 65 and disabled. Social Security payments also may be made to your dependents if you die. Additionally, if you become disabled and cannot work, Social Security can provide money to offset your health care costs and as compensation for your lost earnings. How much of your gross income do you pay in payroll taxes? It varies from year to year because the U.S. government changes these rates occasionally to provide tax relief or to infuse more money into these programs. If you worked for an employer in 2010, you would have contributed 6.2% for Social Security and 1.45% for Medicare. Your employer would have matched these contributions—doubling the amount paid into Social Security and Medicare. However, if you did not work for an employer and were self-employed, you would have paid both halves of the contribution—or 14.4% for Social Security and 2.9% for Medicare. In 2010, Congress passed a tax-relief bill, which lowered the employee contribution for Social Security to 4.2% for 2011 and 2012. The employer contribution remained at 6.2%; all the other rates stayed the same as well. So, if you were self-employed in 2011 or 2012, you would have paid 10.4% (4.2% as employee and 6.2% as employer) in Social Security and 2.9% (1.45% as employee and 1.45% as employer) in Medicare. FICA taxes are not charged on wages that exceed a certain amount. In 2011, this amount was $106,800; in 2012, it was raised to $110,100. So, even if an employee makes much more than this, he or she will still pay Social Security only on that maximum amount ($110,100 in 2012). On the other hand, there is no maximum amount for Medicare contributions. So, someone who makes $200,000 a year will pay more into Medicare than someone who makes $110,100. Since the maximum amount a person paid into Social Security in 2011 was capped at 110,100, the 2011 Social Security tax was regressivebecause people that made below $110,100 contributed a higher percentage of their income than people who made above $110,100. On the other hand, the 2011 Medicare tax was proportional because everybody contributed the same percentage of their income to Medicare. Let's see how much would be deducted from paychecks for different gross incomes. These numbers are based on the 2012 tax rates.

Is an Asset Worth Keeping?—1

How do you know if an asset costs you more than it is worth? You need to consider all your costs and think about other alternatives. Here is an example: Max uses his motor scooter to get to school and to his weekend job. He is trying to decide if he should sell it and replace it with something else. As you learned, motor scooters, like cars, are affected by depreciation. They also have operating costs. Now, look at Max's numbers. Max has had the scooter for two years. It currently is worth $385.72 because of depreciation. His operating costs are much higher than that—$941.00. By selling the scooter now, he could get $385.72. (Selling it next year, he might get only $328.58 after more depreciation.) Max has looked at his budget. He can still afford to run his motor scooter, but he has better options. Taking the bus, for example, would cost him only $500 a year. That is less than his scooter's operating costs, plus he would not have to worry about repairs or parking fees. Max decides to put more money in his pocket by selling the scooter now. By doing so, he replaces a depreciating asset with an asset potentially worth more: if he puts the money in a savings account, it will earn compounded interest. As a result, his money will gain value over time, whereas the scooter will only lose value over time.

Savings and Loans

How much can you realistically save per month? Keep in mind that you will have to give up some expenses to save that money. For instance, you may have to cut back on your cell phone plan or cut out another optional expense, like eating at restaurants or seeing concerts. Make sure you are realistic—otherwise, you could set yourself up for failure. The safest place to save your money is in a savings account, checking account, or a certificate of deposit—even though it will probably not increase your savings significantly. The current average yearly percentage is at much less than 1%, which means you would not gain much on your investment. Still, you would have the satisfaction of seeing your savings grow at least some with every deposit. Keep in mind that you always have the option of taking out a loan. On average, you will need 20% of the car's price as a down payment and you will have to pay at least 3% to 5% in interest on the loan, which means it will take you longer to pay off. Taking out a car loan also means that you must have the discipline to pay off the required amount each month. Not doing so can affect your credit rating for years and could make it difficult for you to secure a loan later in life. If you miss too many payments, your car could also be repossessed, or taken back, and you will lose any money that you have already paid. You could also ask a family member to loan you the money. Remember, although the money is from a relative, you need to treat the loan as a business. This requires you to sign a loan agreement and make payments in a timely manner. Yet another option is to lease a car. When you lease, you make monthly payments for a specific time—often one, two, or three years—and then you return the car to the leasing company. Leasing makes sense for people who drive company cars or for business executives who move often. With leasing, the monthly payments are high, and, in the end, you give the car back. For most people, this is not a wise use of money.

Preparing an Annual Budget: Income Greater Than or Equal to Expenses

Ideally, your income should be more than enough to cover your expenses. Creating an annual budget helps you do two things. First, it helps ensure that you have or can make more money than you spend. Second, if you spend more money than you make, an annual budget can help you find areas where you can reduce spending. An annual budget may seem like long-term thinking, but it is the best way to set financial goals and see where your money likely will be spent over the course of an entire year. What information do you need to create a budget? You need the following: a calculation of your annual income (sources include jobs, scholarships, gifts, and, perhaps, interest on bank accounts and other investments) a list of your short- and long-term goals and their calculated costs a list of your anticipated monthly or yearly expenses, such as rent, car insurance, gas, groceries, clothing, transportation, entertainment, sports, books, monthly bills, and so on

Flexible Spending Account for Approved Dependent Care Expenses

If Jessica has children, she may benefit from another tax-saving deduction. A flexible spending account for approved dependent care expenses allows parents to set aside money each year to help pay for their children's needs. It works the same as the flexible spending account for approved health expenses. An employee completes a yearly form with a chosen amount for dependent care expenses. Money is deducted from the employee's paychecks before taxes are taken out. This leaves the employee with a smaller tax bill at the end of the year. For example, suppose that Jessica deducts $2,000 from her paycheck for dependent care expenditures. If she is in the 15% federal tax bracket, she would save $300 in federal taxes because the $2,000 was deducted before taxes were taken out.

Preparing Income Tax Returns

If you are a teenager who receives a regular paycheck, congratulations! It feels good to earn your own money, right? In addition to the excitement of having your own source of income comes the responsibility of paying taxes. Even though the federal government withholds money from each of your paychecks (some states, like Virginia, do, too), you may still owe taxes. On the bright side, the government might have withheld too much and will owe you a refund. That would be great! But, you will not know for certain until you complete the tax return forms and find your tax liability. So, what forms and information do you need? Step 1: First, you need the right tax return forms. Most teens need the 1040EZ. It is the simpler (or "EZ-ier") version of the 1040 tax form, which most Americans use. You can find all the federal forms and their instructions online at the Internal Revenue Service Web site. Use the search term IRS forms and publications. You may not use the 1040EZ if you plan to itemize deductions, make adjustments to your income, or claim tax credits. You will learn more about deductions and credits later in this module. 1040EZ tax form

Monthly Budgets

If you are paid monthly, a monthly budget will work better for you. A monthly budget keeps you from overspending or living beyond your means. It helps you plan for essential and anticipated expenses, such as rent payments, loan repayments, insurance payments, phone bills, groceries, and credit card bills. It also lets you know how much discretionary income you will have. Because the majority of people are paid at the end or in the middle of the month, most monthly bills are due then, too. Many companies—including electric, gas, phone, and credit card companies—allow customers to choose their "pay by" dates. Rents are almost always due at the first of the month. Paying your bills right after you get paid may seem disappointing. It is no fun to watch your paycheck shrink, but there is an upside. When you pay your bills right after you get paid, you have already met most of your monthly financial obligations. After setting aside money for other expenses, such as for buying groceries and purchasing gas, any leftover money is your discretionary (or disposable) income, which you can spend or save. Discretionary income is what you have to spend for the rest of the month. Your goal is to not spend more than your discretionary income. You want to avoid debt and begin to save. When creating a monthly budget, it helps to categorize your expenses. By breaking your expenses into categories, you can better plan for expenses and track the way you spend your money. Categorizing means that you "lump" together similar kinds of expenses. For example, Carlos spends a lot of his money on sports-related items—equipment, fees, clothing, shoes, and tickets to games. When he adds up all the expenses, the category of "sports" seems to take up a lot of his discretionary income. It is hard to see where he can cut back. Sometimes it is easier to identify how to cut expenses with a simple data management tactic. Carlos can categorize his sports expenses into different, more precise categories to help identify and cut back on certain nonessentials. For example, he can put his sports equipment under Recreation. He can put his fees under Dues and Subscriptions. Clothes and shoes can be considered items for Daily Living, and tickets to sports games can go under Entertainment. In this light, Carlos can see that maybe he should spend less on tickets to sports games, since he categorized this expense as Entertainment. By looking at his expenses differently, Carlos can then make choices about cutting back on certain nonessentials. Although you should try to adhere to your monthly budget when at all possible, you should remember that monthly budgets can be flexible, too. At certain points in the year, you may want to purchase gifts for friends and family members or give to certain charities. During these times, you should try to increase the money you set aside for gifts or charitable giving—as long as you decrease the money in other budget categories. You can then reduce the amount budgeted for gifts and charities the next month and increase the amount you spend on another category. If you remember that monthly budgets can be flexible, you can maintain a balanced budget while accommodating for such monthly adjustments.

W-4 and Withholding

If you earn a paycheck, your employer will withhold, or keep, a percentage for taxes and then pay that amount to the federal and state governments. This practice is called withholding. If your employer withholds more income tax than you owe, you will receive a refund at the end of the year. By doing this, you will have lent the government your money—however, the government will not pay you any interest on the loan. On the other hand, if you choose a withholding level that is too low, you might owe a lot in taxes when you file your return at the end of the year. If you owe a large amount, the government may also add a fine. The best way to avoid either of these situations is to complete your W-4 form correctly. When you start a new job, an employer will give you two forms: an I-9 form and a W-4 form. An I-9 establishes your employment eligibility, and a W-4 informs your employer about how much to withhold from your paycheck. The Internal Revenue Service (IRS) issues the W-4 form. If your employer does not give you a W-4, you are considered "working under the table." This is illegal because it means your employer is not telling the government about your work. Your employer is also asking you to break the law, which requires you to report your total income to the government. For further information, roll your mouse over the different sections of the W-4 below. As a high school student, you would typically check the "Single" box or claim an exemption. An exemption means that you do not expect to earn enough money to owe any taxes at all. In 2010, a person who earned $5,700 or less a year would not have to file a federal income tax return and would not need to have money withheld. But if your estimation is low, and you are going to earn more than $5,700 in a year, you do not want to claim an exemption on the W-4. You must be careful because if you do not have enough taxes withheld, you will have to pay them when your taxes are due at the end of the year. If you owe a significant amount, you can be fined for not having enough withheld. You can claim an exemption if you did not owe any taxes last year AND if you expect a refund of all your withholding this year. To review, no federal income taxes will be withheld if you claim an exemption or if you fill in "Single" on your W-4. You can visit the IRS Web site to see if you need to file a federal tax return: www.irs.gov (Links to an external site.). Most high school students will not need to file a return. However, if you had taxes withheld and earned wages lower than the taxable limit, you might want to file so you can get a refund.

760 tax form

If you live in a state that requires you to pay income tax, you will also need that state's tax return form. Each state has its own forms and labels them with unique names and numbers. For example, Virginia's state individual income tax form for residents is called a 760. Also, the forms are updated each year, and you definitely need the most recent one. The Virginia Department of Taxation has its own Web site with links to Virginia's specific tax forms. Try these search terms to find the current year's tax forms: Virginia state tax form, [year]. You can use the computers at public libraries to print tax forms. Step 2: Now you need to collect the documents that contain information about your earnings. To complete a federal income tax form, you will need the following: Your earnings statement(s) (W-2) Interest statement(s) from your bank (1099-INT) Your employer sends the W-2 form to you, while your banking institution sends your 1099-INT form. These forms may arrive in the mail or via e-mail and are sent just after the beginning of the year. This gives taxpayers plenty of time to prepare and submit their tax returns by mid-April. People with more complicated financial situations will also need documents that state their earnings from investments or from the sale of assets. In addition, people who itemize their business or medical expenses need copies of all receipts for major purchases, business expenses, or medical and childcare expenses. You will learn more about itemizing in Module 97. Let's focus on the W-2 form. As you know from Module 92, employers are required to generate W-2 forms for their employees. This form contains all the information about an employee's earnings and withholdings over the course of a year. By law, an employer must send that information to the Internal Revenue Service. When you receive this form, hang on to it. It is important! Not only do you need the information on it, if you file a paper return, you will need to submit the actual W-2 form to the government with your completed tax form. In Module 94, you learned about payroll taxes (withholdings for FICA and Medicare) and income tax withholding. These taxes reduce the amount of money in your paycheck. The W-2 form shows you just how much money was deducted or withheld over the past year. The amount withheld is key because this amount will help you determine your tax liability.

Taxes on Earnings

If you work and receive a regular paycheck, you also pay taxes on your earnings. Payroll taxes—deductions for Social Security and Medicare—are deducted from each of your paychecks. Look at your pay stub, and you will see the word FICA under the deductions column. FICA stands for Federal Insurance Contributions Act—the 1935 legislation that created Social Security, an entitlement program for retirees. Workers who contribute for a set number of years are eligible to receive regular Social Security checks after they retire. You will also find the word Medicare on your pay stub. Medicare is a medical insurance benefit provided by Social Security. Current retirees are eligible to use Medicare to help pay medical bills. You do not have a choice about paying payroll taxes; by law, employers deduct them automatically. Income tax is yet another deduction from your paycheck. The federal government and most states collect income taxes by withholding some of your pay. You will learn more about this later in the module.

Individual Retirement Plans

Individual Retirement Accounts (or IRAs) are personal retirement plans. You can open an IRA as soon as you have earned income. Each year, the Internal Revenue Service determines the maximum amount you can contribute to an IRA. For 2012, the IRS allowed up to $5,000 per year for people under 50 and up to $6,000 per year for people 50 and older.1 There are several types of IRAs for business owners and employees—simple, traditional, SEP, Roth, and others. With the traditional IRA, you pay taxes on the money you contribute to the plan when you withdraw it. With a Roth IRA, you pay taxes on the money you save before you deposit it. The benefit of a traditional IRA is that it allows you to save money for your retirement even if your employer does not offer you this option. It is important to note that if you take money out of your IRA prior to age 59½, you will be charged a 10% penalty when you file your tax return that year. Ten percent may not sound like much. But, if you withdrew $50,000 before age 59½, you would pay $5,000 in penalties. There are some exceptions to this rule. For example, money can be withdrawn without a penalty if the IRA money is used to pay for higher-education expenses or to buy your first home. With the Roth IRA, you pay taxes on the money that you contribute to the IRA during that year. For this reason, the Roth IRA does not have an immediate tax advantage. But, in the future, there may be tax savings: when you withdraw the money from a Roth IRA, there are no additional taxes to pay. Like the traditional IRA, there is a 10% penalty if the withdrawal occurs prior to age 59½. But, also like the traditional IRA, money can be withdrawn without penalty if the Roth IRA money is used to pay for higher-education expenses or to buy a first home. During your working years, you are earning income and can often adjust your expenditures to save for your future. You may feel like there is something you need now and that withdrawing money from your IRA or 401(k) is the answer, but it usually is not. Think of your retirement account as a long-term goal, and only withdraw money from it truly as a last resort.

Revisit the Federal Budget

In 2010, the federal government spent about $3.5 trillion dollars.1 How can the government keep track of so much money? It relies on a federal budget. On its most basic level, the federal budget is not that different from a person's or a family's annual budget, which you will learn about in Module 101. Just like these, the federal budget identifies short-term and long-term financial goals and maps out spending for the next fiscal year. Unlike an individual's or family's budget, however, the federal budget is a really long document—often hundreds of pages—that covers thousands of expenditures. The federal budget is also based on a proposal from the U.S. president to Congress about how federal dollars should be spent. The president suggests goals and spending allotments based on recommendations from several federal agencies, including the Office of Management and Budget (OMB). In the end, Congress has the final say on how much of the federal revenue—Americans' tax dollars—will get spent. The federal budget is a public document that anyone can read. The budget overview section outlines the president's goals and priorities for the next fiscal year. For example, in the overview of his 2012 federal budget proposal, President Obama outlined a list of specific goals, including cutting the deficit, eliminating specific tax breaks in an effort to raise revenues, reforming public school funding, building a nationwide wireless broadband network, and cutting billions of dollars in government administrative costs. The president sends this budget proposal to Congress, which then reviews and develops its own version of the budget, outlining goals congressional members may suggest. After Congress reviews and produces their version, the budget goes to the House and Senate floors for a vote. While the President's budget proposal is often much longer and more detailed than the congressional version, each budget covers and tracks an immense volume of expenditures.2 To find the hard funding data, you need to look deep into the budget document for the sections on itemized expenditures. The numbers can be overwhelming, so let's look at the budget from a broader perspective—the percentage of federal spending. How is the federal revenue spent? You might be surprised to learn that most federal revenues pay for only a few items—Social Security, Medicare, defense and security, "safety net" programs, and interest on the national debt. These five budget items absorb about 80 percent of federal revenue. Take a look at the pie chart below for a breakdown of the spending.

Redistribution of Wealth

In addition to providing important programs and services, the federal government also helps to redistribute wealth in the nation. Many low-income Americans depend on the government to provide a "safety net" and to alleviate problems caused by poverty. How does the government redistribute wealth? It often does this directly through social programs, such as Medicare and Social Security, or through progressive taxes, which impose a higher percentage of taxes on wealthier Americans. In addition to easing the tax burdens of low-income Americans, progressive taxes also are intended to shift wealth from the "haves" to the "have nots." Let's take a closer look at progressive taxes and two other types—proportional and regressive taxes.

Other Taxes

In addition, you may need to pay other taxes at different times. For example, the federal government and many states collect excise taxes and fees. Excise taxes are imposed on certain goods or services, such as tobacco products and alcoholic beverages, gasoline and tires, air travel, and cell phone service. When you pay for gas, you pay an excise tax on top of any sales tax. If you have a cell phone, you probably pay an excise tax. Given that so many people buy gasoline for their cars, travel on airplanes, or use a cell phone, excise taxes are a regular and dependable source of revenue for governments. Tariffs are special taxes on imported products, such as steel and sugar. These taxes are usually paid by businesses rather than by individuals.

Module Overview

In previous modules, you learned that local, state, and federal governments depend on taxes for their revenues. In turn, each level of government is responsible for providing different programs and services—or, sometimes, different levels of the same programs and services. For example: Local governments - education (public schools and community colleges), libraries, police and fire departments, city and county roads, trash collection, street cleaning, animal control, public utilities State governments - education (public schools, including community colleges, state colleges and universities), libraries, public welfare agencies, health care (state hospitals), state roads, state police, motor vehicle agencies, state prisons The federal government - entitlement programs (Social Security, Medicare, Medicaid); national defense and security; agriculture (subsidies and research); health services (food and drug safety, workplace safety, medical research); justice system (federal courts, prisons, law enforcement); national resources (environmental protection, conservation, pollution control, flood control); technology and space exploration; energy regulation and conservation; interest on the national debt; transportation (interstate highways, air traffic control); benefits for federal retirees and veterans; support for education (grants and research); research institutions (Library of Congress, National Archives, National Centers for Disease Control) Each level of government is responsible for important services and programs, but the federal government's responsibilities are much broader and affect all Americans. The federal budget reflects the government's long-term commitment to provide these programs and services, which millions of Americans depend upon every day.

State Taxes

In the Commonwealth of Virginia and most other states, workers also pay state income taxes. This tax is withheld from your pay and paid directly to the state when you receive a paycheck. Most states also have sales taxes. A sales tax is collected when consumers buy taxable items. The seller must then pay those taxes to their state and local governments. In Virginia, the sales tax is composed of both state and local sales taxes. The state sales tax is the same throughout the state, but local governments can impose their own sales taxes on top of the state sales tax. This is why the overall sales tax may vary from one city to another. Since sales taxes are the same for everyone, they are considered regressive taxes. This means that people who make less money pay a higher percentage of their incomes in taxes. This is important because people who make less money tend to spend more of their incomes and save less. On the other hand, people with higher incomes tend to save larger portions of their incomes. For example, a person earning $10,000 a year and spending $5,000 on taxable items would pay $250 in Virginia sales taxes. As a result, this person would pay 2.5% of his or her income toward sales taxes. A person earning $50,000 a year and spending the same $5,000 on taxable items would pay the same $250 in sales taxes. This would account for only 0.5% of his or her income. Even if the person earning $50,000 a year spent twice as much as the person earning $10,000 a year, the sales taxes would still represent a smaller percentage (only 1.0%) of his or her income. So, you can see how a sales tax is regressive. As a person's income increases, the percentage of that income spent on sales taxes decreases.

Paying for College: What Are Your Options?

It is rare that students pay the entire bill for college by themselves because financial aid is available in many forms. In fact, the average financial aid package for a full-time student at the University of Virginia in 2009-2010 was $12,500.1 Depending on your income and your grades, colleges offer financial aid that can help cover some of the cost of your education. Some colleges have over 70% of their student body on some type of financial aid. Financial aid generally is a package of grants, work-study options, and loans. With work-study, you might work a campus job, such as in food service, to help pay for your education. Usually, financial aid requires that you maintain a grade-point average determined by your school. Only the student loan part of a financial aid package must be repaid. Scholarships and grants are a form of financial aid earned through good grades, high performance, financial need, or athletic ability. Scholarships and grants do not need to be repaid. Though financial aid can make a difference in your ability to afford the college of your choice, planning ahead and saving for college can make a difference as well. The earlier you start planning and saving for college, the better. Most states offer tax-advantaged college savings plans, called 529 plans, that with consistent contributions, can help pay for your college education. While it helps to start early—many programs recommend starting at birth (which means your parents have to be aware of these opportunities)—starting at any point can provide needed help.

Who Collects Taxes?

It is true that most people do not like to pay taxes. When you give your money to the government, you have less to spend or put in your bank account. But without tax revenues, the federal, state, and local governments would not have funding to provide essential goods and services that affect people's quality of life. Most taxes collected by each level of government affect individuals. As you move forward in your life, land a full-time job, and acquire assets (such as a house or a car), you will have to pay more in taxes. Let's take a look at the taxes most Americans pay.

A Closer Look at Sales Receipts

Let's take a minute to review. To calculate sales tax, it is important to change the percentage to a decimal. So, a 2.5% sales tax rate is expressed as 0.025 after being changed to a decimal. To calculate 2.5% of a number, multiply by 0.025. You can round answers to the nearest cent. Not all products and services are subject to a sales tax. For example, some states do not charge sales taxes for medicine or health products. For groceries and produce, many states do not apply sales taxes or charge a reduced rate. Why? These exceptions help ease the tax burden on people who earn less income because a large portion of their earnings are spent on food and medicine. However, not all items from the supermarket or drug store are exempt from sales tax. Here is a sample receipt from a trip Marie made to a Virginia grocery store, where she bought some snacks and school supplies. Remember, Virginia charges 2.5% sales tax on produce and groceries. Notice, there are two different calculations for sales taxes: the fruit and yogurt are taxed at 2.5%, and the notebooks and bag of candy are taxed at 5%. Even though Marie purchased the notebooks and candy at a grocery store, these items do not fall into the category of "produce and most groceries." Some municipalities also add sales taxes to particular goods or services. For example, cities that are tourist destinations often impose hospitality taxes or meal taxes. These taxes mostly affect out-of-town visitors who stay in hotels and eat in restaurants—most local residents do not pay for hotels and eat out only occasionally. So, local residents benefit from out-of-town visitors who pay these taxes.

Employer-Sponsored Retirement Plans

Many companies offer employer-sponsored retirement plans to which their employees can contribute. The type of plan varies with the type of employer. For-profit companies offer 401(k) plans. Nonprofit companies and organizations, as well as local and state government employers, offer 403(b) and 457(b) plans. According to the Internal Revenue Service (IRS): A 401(k) Plan is a contribution plan where an employee can make contributions from his or her paycheck before taxes are taken out. The contributions go into a 401(k) account and are invested and managed by the 401(k) company, with the employee often choosing the types of investments based on options provided under the plan. In some plans, the employer also makes contributions—that is, the employer matches the employee's contributions up to a certain percentage.1 A 403(b) plan, also known as a tax-sheltered annuity (TSA) plan, is a retirement plan for certain employees of public schools and other educational institutions. It is also available to employees of certain tax-exempt organizations such as religious organizations.2 A 457(b) plan is available to state or local governments and to tax-exempt non-profit organizations. Employers or employees, through salary reductions, contribute up to a certain annual limit ($16,500 in 2011 and $17,000 for 2012) on behalf of participants under the plan.3 Though there are annual limits on how much you can contribute to an employer-sponsored retirement plan, some employers will match your retirement contributions. This means that employers will contribute to your retirement fund along with you. For example, you might contribute 3% of your salary, and the company might also contribute 3%. In effect, this doubles your savings. Or your employer may partially match your contribution. For example, you might contribute 5% of your salary, and the company might contribute 2.5%. But, if you do not contribute anything to your 401(k), you will not benefit from the employer's matching contributions. If you do not sign up for the employer-sponsored retirement plan that matches your contributions, it is like throwing away money! Employers will help you save for retirement—but only if you sign up for the employer-sponsored plans and contribute to your retirement account. When you retire, you will receive retirement income from the employer-sponsored plan. Sometimes, you may need to remove your savings from the plan before you retire. For instance, if you switch jobs, you can roll over the funds to the employer-sponsored retirement plan at your new job. If you "cash out" your account—taking out your money and not placing it into another retirement account—you will have to pay taxes and penalties. This is not a good idea. You should always roll over your retirement funds and keep contributing what you can so you can retire comfortably

Filing for an Extension

Max thought his parents were going to file his tax return, but they expected him to file his own. He does not have time to complete his tax return before the deadline. Luckily, he can file for an extension. Taxes are due each year on April 15. (If the 15th falls on a Saturday or Sunday, taxes are due the following Monday.) If a need arises to ask the IRS for more time, this request for an extension also must be done by April 15. To apply for an extension, you must fill out and submit IRS Form 4868 by the April 15 deadline. Filing an extension does not automatically mean that you can pay your taxes later without a penalty. To avoid a penalty and/or interest, estimate how much you owe the federal government and pay that amount when you file Form 4868 on or before April 15. Once you get the extension, you have six months to file your return. That means you can file it any time as long as it is postmarked by October 15. Even with the extension, if you owe taxes that have not already been paid, you will owe the government interest. So, it is best to file your taxes on time, or as soon as possible.

An Annual Budget

Money is a resource, and, like any valuable resource, it is in limited supply. As a result, you have to be careful about how to spend it. If you spend it all on one thing, you will not have enough left over to pay for other things. A budget can help you keep track of what you spend and how you spend it. It can help you determine if you need to make any changes to your spending habits so you can reach your financial goals. An annual budget is an excellent tool to help you identify short- and long-term financial goals and to plan for paying for them. Before you can create a budget, you must first figure out your income and expenses. Income is the money you earn. Most people receive income from working at a job; this is known as earned income. Income may also be unearned. Inheritance and interest from investments are examples of unearned income. Expenses are the things on which you spend money, such as food, clothing, rent, and transportation. For most people, income is mostly fixed or anticipated income. Most people work at a regular job and can anticipate how much they will be paid each week, month, or year. This is known as a fixed income because it generally does not change much, if at all, over a period of time. As a result, people on fixed incomes can budget and spend their money based on a fairly accurate estimate of how much they will earn over time. Unanticipated income is unexpected. It might come in the form of an inheritance or a winning lottery ticket. It cannot be counted on in the same way as anticipated income. Discretionary income is the money you have left over after paying for the essentials, such as food, clothing, utilities, insurance, and shelter. Discretionary income is used to pay for nonessentials—dinners at restaurants, movie tickets, music downloads, gifts, computer gadgets, video games, and so on. Discretionary income is usually spent on "fun stuff"; however, it can also cover emergencies or unexpected expenses or be saved. As with income, you will have anticipated and unanticipated expenses. Anticipated expenses include the regular bills that you must pay every week, month, or year. Credit card bills, phone and utility bills, rent, insurance, grocery bills, income taxes, and transportation costs are examples of anticipated expenses. You know they will crop up and must pay them. Unanticipated expenses could result from emergencies—such as a sick pet, a broken tooth, a flat tire, or a ruined pair of shoes—which cannot be ignored. Unanticipated expenses can occur when you least want them. However, an annual budget can help make sure you have money to cover them.

Car Insurance

Nobody likes to pay for car insurance, especially since most people never have to use it. But, most states mandate that people buy car insurance, and driving without it can be grounds for revoking your license. However, if you have an accident, insurance comes in handy as long as your claim is covered. So, what different kinds of insurance are available? Property damage liability, which is required by nearly every state, is one of the most important kinds of car insurance. It covers damages caused to another vehicle if you are responsible for an accident—if you have adequate property damage liability coverage, you will not have to pay for the other vehicle's damages from your own pocket. What do you think would happen if you hit an expensive luxury automobile and did not have property damage liability coverage? It could easily bankrupt you. Bodily injury liability insurance covers an injury to or the death of another person that results from an accident you caused. It covers the victim's medical expenses and can also pay for your legal defense costs, if needed. Medical payment insurance is optional in most states. It covers your medical expenses—and those of any passengers in your vehicle—whether or not an accident was your fault. Uninsured motorist coverage pays for damages if you are the victim of an accident caused by an uninsured driver. In a "hit and run" situation, you would need this coverage to pay for your medical expenses. Even though most states require proof of automobile insurance to register a vehicle, many drivers still do not carry it. In Virginia, registering a vehicle without insurance costs $500 a year. The purpose of this fee is to encourage motorists to insure their vehicles. Collision coverage pays for damages to your car in case you are in an accident. When pricing collision insurance, consider the cost of your vehicle. There is no point in getting collision insurance that costs more than your car is worth. Comprehensive coverage pays for damages from theft, vandalism, acts of nature, fire, and collisions with animals. Many lenders require comprehensive coverage as part of a car loan. It also covers the cost of these damages to victims in case you cause an accident. You will learn more about the details associated with car insurance in Module 159.

Regressive Taxes

Not all taxes redistribute wealth from the "haves" to the "have nots." Regressive taxes have a greater negative impact on people with lower incomes. Some people consider sales taxes, which theoretically are proportional taxes, to be regressive because people with smaller incomes spend most of their disposable income on taxable items. A person who makes several hundred-thousand dollars per year usually does not spend it all, but a person who makes $25,000 spends nearly all of it. As a result, the person who makes $25,000 will spend a higher percentage of his or her income on sales taxes. Sometimes, the government imposes higher sales taxes on certain items to discourage people from using so much of them; examples can include gasoline, tobacco, and alcoholic beverages. Just like a base sales tax, these sin taxes, as they are called, affect people with lower incomes more negatively—and, due to the higher tax rates, take an even higher percentage of income. Similarly, FICA taxes are charged only on the first $106,800 of wages.2 A person who makes a million dollars per year pays exactly the same amount for Social Security and Medicare as a family that earns $106,800. FICA also does not apply to income from investments, and people with large incomes tend to have much more income from investments. Remember regressive taxes this way: Earn less, pay more.

Is an Asset Worth Keeping?—2

Not every asset depreciates rapidly or has huge operating costs. Sometimes, due to your financial situation, you will need to consider getting rid of an asset even if it is gaining in value. Here is an example: Max's father bought a piece of land 10 years ago for $50,000. Now, Max is getting ready to go to college, so his father is checking on the value of his assets. Looking at his net worth statement, he sees that a lot of money is tied up in the form of a fixed asset—that piece of land. He cannot use that fixed asset to pay for Max's college tuition, so he thinks it may be time to sell the land. That way, he would turn a fixed asset into a liquid one. As a result, he would have more cash. Is this a wise decision? Now, look at the numbers. We know that the historical cost is $50,000. In addition, there have been some small operating and other costs: Max's father has to pay someone to mow the grass on the property and fix the fences around it. These costs have been small: about $200.00 each year. In addition, he has paid property taxes on the land: about $500.00 per year. So over the course of 10 years, Max's father has paid $2,000.00 in operating costs and $5,000.00 on taxes. After checking with a real estate agent, Max's father learns that the land has increased in value, not depreciated. It is worth around $75,000. Even subtracting the operating costs and taxes, Max's father's investment in the land has increased in value over time. The land could, of course, continue to increase in value. That would be one good reason to keep it as an asset. Still, Max's father wants to have the cash to pay for his son's tuition. So, he decides to sell the land. By doing so, he turns a fixed asset into a liquid one.

Tax Deductions and Tax Credits—2

Now that you have taken all your deductions and figured your taxable income, it is time to calculate what you owe in taxes. You can do this by checking the tax tables that come with your income tax form. This part is surprisingly easy. Take a look at the federal 2010 Taxable Income Table below. This is how Franklin calculated what he owed on a taxable income of $29,800. As you can see in this table, a single person with a taxable income of $29,800 must pay $4,055 in taxes. Before Franklin wrote a check to the U.S. Treasury, though, he considered tax credits. Tax credits further reduce a person's tax liability. Not all income is taxed at the same rate. Tax rates, or tax brackets, change depending on how much a person earns. Higher incomes are subject to higher tax rates. Here are the brackets for 2010: Incomes up to $8,375 were taxed at 10 percent. Incomes between $8,375 and $34,000 were taxed at 15 percent. Incomes between $34,000 and $82,400 were taxed at 25 percent. Incomes between $82,400 and $171,850 were taxed at 28 percent. Incomes between $171,850 and $373,650 were taxed at 33 percent. Incomes of $373,650 and higher were taxed at 35 percent.1 Tax tables do the math for you. Franklin's taxable income of $29,800 was taxed at 15 percent: $4,055 is nearly 15 percent of $29,800. Tax credits are different from deductions. Deductions reduce the amount of your taxable income. Tax credits reduce the amount of taxes you owe. In other words, you subtract deductions from your adjusted gross income, but you subtract credits from the amount of taxes you owe. Think of a tax credit as the government repaying you for some of your expenses. Read the list and description of the tax credits below Child care and dependent expenses - money spent to provide for children or other dependents (elderly or disabled family members) Foreign taxes - taxes paid on income earned in countries outside the United States (so you do not have to pay taxes twice on the same earnings-in the United States and the other country) Retirement - investments in retirement funds Other - adopting a child, participating in college education plans, installing eco-friendly windows or appliances, and numerous other expenses Let's pretend that Taylor's cousin Franklin qualified for a tax credit on foreign taxes. Suppose he worked for a month in a foreign country and paid $400 in taxes on his earnings to that country's government. That means Franklin could deduct $400 from what he owed in taxes in 2010—that is, $4,055 - $400 = $3,655. Tax credits are not something you can claim lightly. Tax credit rules are strict and can change from year to year. If you have questions about qualifying for a tax credit, you should seek help from a tax expert. One credit that helps low-income workers is the earned-income credit, also called the EIC. It allows working parents whose income is less than a certain amount to get a tax credit. For example, in 2007, a parent making less than $39,783, filing a "married filing jointly" tax return with more than one child, could get an EIC of $2,950.2

What Kind of Mortgage Is Right for You?

Once a lender determines how much you can borrow, you will need to decide what kind of mortgage is right for you. First, you will need to determine the term of the mortgage. Most mortgages are for 15 or 30 years—meaning you will have either 15 or 30 years to pay it off. If you choose 30 years, the monthly payments will be lower; however, because you are paying interest over a longer period of time, you will end up paying much more altogether. You pay interest on the amount you borrow. The amount of interest will depend on the interest rates that banks, credit unions, or other mortgage lenders offer at your time of purchase. Sometimes, interest rates are low, which is to your advantage. Sometimes, they are higher. There are basically two kinds of mortgages: fixed rate and adjustable. Fixed-rate mortgages are based on interest rates that do not change as you repay the loan. If interest rates are low, it is to your advantage to choose a fixed-rate mortgage. Interest on an adjustable-rate mortgage (ARM, for short) varies, depending on the current interest rate—also known as the prime rate. This means the rate will increase or decrease based on the current prime rate, which, in turn, means you could end up paying more or less interest over the course of the loan. There are risks associated with both kinds of loans. If you get a fixed-rate mortgage, the overall interest rates could decrease, in which case you would be stuck paying the original higher interest rate. With an ARM, you might initially get a good interest rate, but your payments would go up if the overall interest rates increase. A good gauge is to look at your projected monthly payments with both kinds of loans. Determine if that amount is at the top range of what you can afford. With an ARM, your payments could easily go up at some point, and you might have to pay more than you can afford. The safest approach is to seek a fixed-rate loan. If you cannot afford the property with a fixed-rate loan, you should probably find another piece of property that you can afford more comfortably. Plus, if interest rates decrease, you could still try to "refinance," or get a new mortgage at the lower rate. So, a fixed-rate mortgage is safer and, through refinancing, offers the potential benefits of an ARM. Points There is another expense related to purchasing a house: points. A point is a fee levied by the lender when you have a closing (when you sign the documents related to buying the house). The lender charges you these points for lending you its money. A point is 1% of the amount you borrow. Many lenders charge 1.5 points for a home mortgage—this means, if you borrow $100,000, you will pay an additional $1,500 in points. Sometimes, you can get the seller to pay the points, but traditionally, the buyer pays them. In a fixed-rate loan, the lender usually reveals the number of points involved in the transaction. Some lenders offer mortgages with lower interest rates if you pay higher points. Other mortgages are available without paying any points at closing.

How We Pay Income Tax—2

Once an employee identifies the number of exemptions on the W-4 form, it is up to the employer to calculate how much money is withheld from each paycheck. The government provides tables that help with the calculations. These tables reflect different pay periods, wages, and exemptions. Here is an example from 2011: Source: "Publication 15 - Main Content." www.irs.gov (Links to an external site.). IRS, n.d. Web. 2 Dec. 2011. States that withhold income taxes follow formulas similar to that for federal income taxes. For example, Virginia considers the number of exemptions and the employee's taxable income bracket. The Commonwealth also considers the length of the pay period (usually weekly or biweekly) when calculating withholding. Everyone's tax situation is different, and that is why too much or too little money is often withheld. When Jessica files her annual income tax return next year, she will know if the right amount of money was withheld. If she owes a lot of taxes, or if she has a large refund, she can make adjustments the next year by filling out a new W-4 form and changing the amount of withholding. Exceptions to the Rule — The government does not deduct payroll taxes or withhold income taxes from people who are self-employed, such as farmers, independent contractors, and small business owners. However, self-employed people are still responsible for paying these taxes. They must pay taxes to the government four times a year based on their earnings from the previous year and estimates of their income for the current year.

developing a savings plan

Once you have decided what kind of car you want, you should set your savings goals, as Carlos did. If you have a job, you need to analyze how to spend those paychecks and what expenses you can do without. You can also rely on money you may have saved from gifts or special occasions. Carlos decides he can make his money multiply faster by investing in stocks. He chooses a stock and buys $2,000 in shares. He makes deposits in his savings account with the remaining money from his paycheck. Even though Carlos was careful in choosing a stock, it did not prove to be a good investment, especially in such a short time period. If he had kept the stock for several months or years, the investment may have worked. Then again, there is no guarantee that any stock will be worth more in the future. After 10 months, Carlos is about $300 short to purchase a car. He needs to save for a few more months before he can get his car. Carlos should have kept his money in the safest place possible, especially since he gave himself a deadline of 10 months. You can lose money in the stock market. Even trusted stocks can be questionable investments in the short term. Plus, when you make short-term investments, you need to pay attention to how the stock does every day. Savings accounts, despite offering a fairly low annual percentage of interest, are the safest place to keep money that you will definitely need in the future.

Evaluating Discretionary Spending

Remember, discretionary income is the money left over after you have paid your essential expenses. What do you do with discretionary income? Do you spend it all or save it? What about your short-term financial goals? Remember what you learned about short- and long-term financial goals? Long-term goals involve saving money over many months to pay for something expensive and important, such as college tuition or a car. Short-term goals involve saving money over weeks or months for less expensive items, like a new bicycle or a touch-screen device. In a perfect world, you would put all your discretionary income into savings. In real life, however, you can use discretionary income to pay for short-term goals. Both Carlos and Taylor had some discretionary income in April. Carlos had $40.25 left over at the end of the month. Taylor had $4 in savings at the end of the first week. If he saved at least that much each week in April, his discretionary income would be $16 ($4 x 4 weeks = $16) for the month. When Carlos and Taylor stood outside the sporting goods shop, they had short-term goals in mind. Could they afford their short-term goals? Complete the activity on the next page to find out.

Taxes on Purchases (Sales Tax)

Sales tax is the most common tax that people encounter on a daily basis. Each time you buy most items, such as meals, books, or laptop computers, a sales tax is added to your bill. Sales taxes are especially important sources of revenue for states and local governments. As you will learn later, sales taxes do not always apply to all purchased items.

Short-Term Tax Planning

Short-term goals can be achieved within one to two years. When thinking about your goals, it is important not to confuse your wants with your needs. Money is limited. Once money is spent, it is gone. For example, if you spend $25 on a new shirt you like but do not actually need, you will not have that money to buy a pair of shoes when your current ones wear out. In this example, the shoes are a need, and the shirt is a want. When setting goals, think carefully about what you need most. Once you have identified your highest-priority needs, start doing research to determine the cost of the items. If your annual income is greater than your annual expenses, you can save for your short-term goals.

Your Guide to an IRS Audit

Sometimes, the IRS may ask you to appear in person and provide more information about your tax return. This process is called an audit. If all information is accurate and clear on your tax return, you probably will not be audited. If some of the information appears incorrect, you could receive either a phone call or a letter from the IRS stating what is wrong with your tax return, what you need to do to correct it, and contact information for the auditor assigned to you. Sometimes, the IRS computer system flags tax returns simply because something seems incorrect. The auditor will contact you and provide more details. Sometimes, an auditor may request to see you in person to go over issues and to get any applicable paperwork from you. This meeting could last 30 minutes or a few hours. Other times, you can send in applicable paperwork and forms to the auditor by mail. If you are audited, you must pay the amount the auditor determines that you owe. It is very important that you follow all the directions and do what is asked by the deadline. Remember that if the auditor finds that you owe the government additional taxes, interest will start accruing on that money from the day your tax return and any taxes owed were due, not the day you first meet with your auditor. For most taxpayers, this means that interest will begin to accrue on any unpaid taxes starting April 15, the deadline to file your tax return. Therefore, the sooner you can meet with your auditor and help them to resolve your case, the cheaper your final tax bill will be. If you have any questions, call and speak to your assigned auditor at the IRS. This conversation should help you understand why you were audited.

What Levels of Government Benefit from Tax Deductions?

State and local governments benefit because taxpayers face a smaller overall tax burden. Taxpayers are able to keep more of their income, which is often spent or invested in their local communities. As a result, state and local governments collect more revenue. The federal government deliberately assists taxpayers, which indirectly benefits state and local governments. These governments would not benefit nearly as much if the federal tax policy allowed deductions for estate taxes. The reason is that the number of taxpayers subject to estate taxes is smaller compared to the number who pay state and local taxes. Therefore, state and local governments have a larger tax base from which to collect. Allowing state and local governments to collect more revenue also benefits the country as a whole. The money taxpayers save from paying fewer taxes is often spent or invested. These activities help return money to circulate in the economy, which is good for everyone. Furthermore, as these governments collect more revenue, they can fund programs and services that can improve the quality of life in the area. This can attract new residents, which grows the tax base, and provide more revenues for state and local governments. In addition, the deductions help ease tax burdens on taxpayers who live in high-tax states. Tax burden reflects not the actual taxes you pay but the overall impact of paying those taxes. People who pay a larger percentage of their incomes in taxes bear greater tax burdens. Tax burdens vary across the country because each state has a different tax policy. People who live in states with no or low state income tax rates, or no sales taxes, have lighter tax burdens than people who live in places with high state income or sales taxes. The federal deductions for state income and sales taxes help reduce the tax burden for citizens living in high-tax states. What would happen if the tax laws were changed so that state and local taxes could not be deducted? State and local governments may see their revenues decrease, which could lead to cuts in expenditures, including public programs and services. Canceling the deductions would shift tax burdens on individuals, too. Without federal tax deductions, people in high-tax states would once again bear the weight of paying higher federal income taxes on top of their other taxes.

Planning Ahead in the Short Term

Taxes are needed to run the federal, state, and local governments. After all, these governments provide many goods and services, which cost money. Federal and state services are funded mostly through the federal income tax and state income taxes. Income taxes are based on how much money a person earns. In the Commonwealth of Virginia, there is also a sales tax, which is based on how much money a person spends. Sales taxes pay for many state and local services. Local governments mainly rely on property taxes, which are paid by businesses and individuals who own property, such as real estate. Federal payroll taxes pay for Social Security and Medicare, and they are based on the wages a person earns.

Understanding Federal Tax Credits for Education

The Internal Revenue Service (IRS) Web site includes online tutorials on a variety of topics related to income taxes, deductions, and credits. According to the IRS, The American Opportunity and Lifetime Learning Credits are credits that allow taxpayers to claim all or a portion of qualified tuition and related expenses paid for higher education or job-related skills. A taxpayer cannot claim: A deduction for higher education expenses and also claim an American Opportunity or Lifetime Learning Credit based on those same expenses Both an American Opportunity Credit and a Lifetime Learning Credit for the same student in the same year A credit based on expenses paid with a tax-free scholarship, a grant, or employer-provided educational assistance These tax credits encourage people to pursue various educational opportunities. However, when it comes time to file taxes, consult a tax adviser or carefully read the IRS publications because tax rules can be complicated.

Tax Brackets

The U.S. income tax is a progressive tax. People who earn more money pay higher tax rates. The tax rate on the first dollar of taxable income is 10%. The maximum tax rate is 35%, as shown in the table. Carlos is in the 15% tax bracket because his taxable income is more than $8,375 but less than $34,000. The tax rate for taxable income over $8,375 is 15%.

Preparing Throughout the Year

The amount of taxes you pay depends upon your income. Generally, the higher your income, the higher your tax obligation will be. However, tax credits and deductions can lower the income taxes you pay. A tax deduction is an amount of money the government allows you to subtract from your taxable income. The remaining income is then taxed. A tax credit is a reduction in your taxes based on your expenses. Expenses can include your education fees or a home mortgage. People also are allowed deductions for each child they have. These children are called dependents. Many businesses have programs that help their employees take advantage of government tax credits and deductions.

Choosing Tax Software

The first time you pay federal taxes, the forms may seem confusing, even if you use the 1040EZ. Some people pay licensed tax preparers to do the paperwork. The downside to using a tax preparer is that you still have to gather all the paperwork and are still responsible for all the information that goes on the forms. You also need to pay that person for doing the work. (That payment is tax deductible next year, though!) Another option is to use tax software, which is designed to save you time. Most tax software programs contain all the forms you might need. They also help you select the proper forms and input the information into the correct places. Pop-up windows help guide you through the process by asking questions and providing feedback. For example, if you skip a box or enter information incorrectly, a pop-up window will let you know you to correct it. "Help" buttons also provide guidance. If you do not know where to find a piece of information, you can click on the help button and search the menu for the appropriate topic. How do you choose which tax software to use? Not all tax software programs have the same features or are user friendly. For example, some software programs assume that users are already familiar with tax-related terminology and forms. Other tax programs are basic versions for those with simple returns. Some software is free and available online, but it might not do everything you need, like provide explanations of forms or other help. Before you buy a program, check the description to make sure it provides tips and hotlines for free advice from experts—either by phone or online—and tech support. If you really do not want to do your own taxes, go ahead and get help from a professional tax preparer. Be a savvy consumer! Choose someone who is certified and who works for a reliable business. Ask people you trust for recommendations, then shop around and ask questions. Ask any potential tax preparers about their training and fees and if they will stand by their work if you are audited. Do NOT take your business to anyone who offers you a refund in advance of completing your return. If it turns out that you are not eligible for a refund, you will have to pay back that money with interest. Avoid anyone who guarantees that you will get a refund. Think twice about people who ask you to pay them a fee up front, too. Reliable tax preparers usually bill by the hour or by the form since they would not know how much to charge until after they do the work. Also, be suspicious of anyone who asks for a fee based on the amount of your refund. You worked hard for that money. Your tax preparer deserves only his or her fee, not a cut of your refund.

Short-Term and Long-Term Financial Goals—2

The next step in thinking about budgets is to determine the costs of short- and long-term goals. The math is simple, but you may have to do some research to find the actual costs of the things you want to buy. For example, Marie needs a new winter coat. It is August, and, if she looks online, she can find last year's coats on sale for under $100. If Marie wants a coat in the latest style, however, she will need to wait a few months before the new coats show up in stores. In addition, the price of those coats will likely be more than $100. Marie decides to go online to buy a coat from last season. The one she likes is $89. The Web site provides free shipping and charges no sales tax. Her budget calculation is simple. She needs one coat at a price of $89. She will buy only one coat this year. PriceHow Many Items?How Many Times Per Year?Annual Expense$891 coat1 time$89 What about other short-term expenses? For example, Marie is a serious ballet dancer. She needs several new pairs of ballet slippers each year because she wears them out quickly. She has looked online for the best prices, but a local shop offers a discount because she is a dance student. As a result, the prices are about the same. In addition to ballet shoes, Marie gets a monthly bill for her cell phone service. What do these items cost over the course of a year?

Tax Deduction for College Education

There are a number of federal tax deductions. Two that apply directly to college students are the student loan interest deduction and the tuition and fees deduction. In other words, when you pay tuition and other fees for post-high school education or when you pay interest on a student loan, you can deduct these costs from your taxable income.

Section 125 Cafeteria Plans

There are ways to lower the amount of federal income taxes a person pays. For example, Carlos' mother receives benefits from her employer that allow her to take advantage of tax credits. This type of employer program is called a Section 125 cafeteria plan. As the name suggests, a cafeteria plan allows employees to choose different benefit options just as they might choose different types of food in a cafeteria. An employer might offer flexible spending accounts, life insurance plans, disability insurance plans, or health insurance plans. Let's take a closer look at some of these benefits.

How to Make Deductions

To itemize or not to itemize, that is the question. If you want to take advantage of the tax deductions described in the previous section, you must itemize your deductions on your federal income tax form. Itemizing seems like a lot of work. Should you bother or just take the standard deduction? Think back to what you learned about standard deductions and tax credits in Lesson 95. Remember, a standard deduction is like a free pass. You do not have to pay federal taxes on the amount of your standard deduction. To find the standard deduction, you identify your income and filing status in an IRS tax table. Here is why you might want to itemize your deductions: Your deductions may add up to more than the standard deduction. That means you can reduce your taxable income and your tax liability. Saving money on your taxes may be worth the effort to itemize. It is really not that much more work to itemize. Look at the form Schedule A (Form 1040). This is where you itemize some of your deductions. You need to focus only on lines 5-8 in the section called Taxes You Paid. Line 5: Look closely at line 5. This is where you choose whether to deduct state income taxes (5a) or general sales taxes (5b). Remember, you want to deduct the one that is greater. Choose one and then enter the amount of the taxes paid. Where do you find that information? Check the W-2 form you receive from your employer each year. It includes the amount deducted from your paycheck over the past year for state income taxes. To calculate your general sales tax deduction, you either add up the sales taxes on your receipts from the previous year or you go to the IRS table provided with your tax forms. Find your state, your income level, and your number of exemptions. This is the number you plug in on line 5b. If you live in Virginia, your income is between $20,000 and 30,000, and you have one exemption, your general sales tax deduction would be $276. Source: "Instructions for Schedule A (Form 1040): Itemized Deductions." www.irs.gov (Links to an external site.). Internal Revenue Service, 21 Jan. 2011. Web. 19 Dec. 2011. Line 6: This is where you input the real property taxes you paid in the previous year. Where do you find that number? Check your records. Look for the cancelled check you sent to the city for real property taxes. Or, find the assessment and bill the city sent you. If you pay property tax as part of your mortgage, check the last mortgage statement of the year. It will say how much went toward real property tax. Line 7: This line applies only if you bought a new vehicle that meets certain criteria, which may change from year to year. The state and local sales and excise taxes paid at the point of purchase of a new car go here. Note: You cannot deduct these taxes if you deducted general sales taxes on line 5b. If you deduct general sales taxes, the sales taxes you paid on the car would be included there. Line 8: Personal property taxes are listed here. Also, this is the line where you would list any income taxes you paid to foreign countries.

Simple and Compound Interest

Unless you have a large principal, simple interest does not pay much over time. Marie thinks she can earn more money if she moves it into an account that pays compound interest. Compound interest is paid periodically. It is paid on the principal plus all interest earned in the past. Marie takes her $100 and puts it in an account that pays 2% interest compounded annually. So, at the end of the first year, Marie has $102 in her account, the same as her account that paid simple interest with a 2% rate. Because compound interest involves the principal plus the interest from the previous period, the bank calculates Marie's interest this way: P(1 + r)t Remember, Marie's principal is $100, so P = 100.00. The interest rate is 2%, so r = .02. P × r = 2.00. t is the number of years. Here is the math: Year 1: 100.00(1+.02)1 = 100.00(1.02)1 = 100.00(1.02) = 102.00 Year 2: 100.00(1+.02)2 = 100.00(1.02)2 = 100.00(1.0404) = 104.04 Year 3: 100.00(1+.02)3 = 100.00(1.02)3 = 100.00(1.061208) = 106.12 Now, suppose Marie moves her money again, this time to an account that pays compound interest every quarter, or four times a year. How would this change affect the equation for calculating her interest? Let's use this equation: P(1+ r/n)n Marie's principal is $100.00, so P = 100.00 for the 1st Quarter. Because of the compounded interest her original principal earns, Marie's principal grows in the following quarters, and thus P changes. The interest rate is 2%, so r = .02. The number of investment periods, or the number of times the interest is compounded, is n. Because she moved her money to an account that compounds interest four times a year, n = 4. For banks that compound interest bi-annually, n would equal 2. Let's look at the math to see how much money Marie will have in a quarterly-compounded interest account after just one year: Q1: 100.00(1+.02/4)4 = 100.00(1.05)4 = 100.00(1.2155) = 121.55 Q2: 121.55(1+.02/4)4 = 121.55(1.05)4 = 121.55(1.2155) = 147.74 Q3: 147.74(1+.02/4)4 = 147.74(1.05)4 = 147.74(1.2155) = 179.58 Q4: 179.58(1+.02/4)4 = 179.58(1.05)4 = 179.58(1.2155) = 218.28 Marie would be wise to continue adding money to her account, or she could start with a larger principal (more than $100). In either case, if the principal is the same, compound interest will earn more money over time than simple interest. Prudent investors put their money in accounts that pay compound interest. Knowing your interest rates and how to calculate them can help you determine the value of your assets, including bank accounts. With interest, the value of your money will increase over time, which increases your net worth.

Which Path Do You Want to Pursue?

What are the opportunities for education after high school? Though many students see a four-year college as the ultimate option for post-high school education, there are lots of other opportunities, and many are cheaper alternatives to a traditional four-year school. Your choice depends on what you want to achieve in your career and your financial plan. If you want to pursue a post-graduate professional degree in medicine or law, a four-year college is the best option for you. If instead you are looking for a different type of degree, such as in computer technology or web design, then you may want to pursue a different option, like a technical school or a community college. (You can usually transfer your credits to a four-year college if you change your mind.) Some universities have dual enrollment programs that allow you to take introductory courses at a community college and more advanced courses at the university. If you are not sure, you can always start with a community college or technical school and take courses that may help you make up your mind about the career you want to pursue. In addition, some institutions can help you find internships at various companies. Internships can help you make decisions about your career, as well as valuable professional connections. Whatever schooling you pursue will likely increase your human capital, which, in turn, will allow you to increase your income and wealth.

1040EZ Tax Form

When you first start earning money, your taxes may be simple. Depending on how simple or complicated your taxes are, you may need to fill out a different form. For instance, Marie can file her federal taxes with a Form 1040, Form 1040A, or Form 1040EZ. Marie's income is less than $100,000, and her filing status is single. She is under age 65 and not blind, and she will not claim any dependents. Given that her interest income from banks is $1,500 or less, she can use Form 1040EZ. This is the least complicated tax return form.