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A Simple Guide To Family Finances


Introduction 2

Basics 2

Intro 2

Invest For the Long Run 2

Passive vs Active Investing 3

Load vs No Load funds 4

ETF’s vs Mutual Funds 6

Saving For College 8

Intro 8

Educational IRA vs 529 Plan 8

Finding the Right 529 Plan 10

Gerber College Plan 12

Retirement 13

Intro 13

Roth vs. Traditional IRA 13

401(k) Rollover 15

Robo – Advisors 16

Taxes 17

Intro 17

Itemize vs Standard 17

Exemptions vs Deductions 18

Above the Line vs Below the Line 20

Deductions vs Credits 20

Products To Avoid 21


Raising a family is expensive. From diapers, clothes, toys and electronics up through saving for college and retirement the expenses never end. Factor in stagnant wages, increasing health care costs and dishonest financial planners and it’s no surprise that most families feel overwhelmed.

Though no magic cure exists to fix every family’s finances, having an understanding of the different financial products can help a family avoid making bad decisions.



For families to save for college or retirement, they will likely need to use the stock market. Savings accounts and certificate of deposit offer too little interest to accumulate meaningful returns. Investing in the stock market can be intimidating but it doesn’t have to be. By using low cost diversified investments families can generate meaningful returns over a long time horizon to help pay for college or retirement.

The next few chapters dive into investing basics that apply to both saving for college and retirement.

[] Invest For the Long Run

Before you invest in the stock market, remember that investing is for the long run. Forgot those silly ads you see promising to double your money in 5 months and never watch Jim Cramer. The only way to earn money in the stock market is to invest with a long time horizon.

The stock market experiences constant fluctuations. The market can rise one day and fall the next day. Over a long time horizon, at least 5 years, the stock market will normally rise faster than inflation. If you’re trying to save for a car or pay for vacation, the stock market is not for you. If you are trying to save your retirement that is 10 years away or college for your 5 year old child, then the stock market is the best place to put your money.

[] Passive vs Active Investing

For the majority of families, owning a mutual fund is a safer investment than owning a few stocks. Mutual funds offer immediate diversification to protect against a precipitous fall in a single stock. Remember all those [+ Enron employees+] that had their entire retirement savings in Enron stock?

The majority of mutual funds, like those offered by Fidelity, T. Rowe Price, etc are actively managed. A highly compensated fund manager and a team of analysts pick the stocks to buy and sell. These professionals are paid with a portion of the money you invest. For example, T Rowe Price’s Dividend Growth  fund has a 0.65% expense ratio. Every year, including years where the mutual fund is down, 0.65% of your money is being sent to the fund for management fees.

Passively managed funds don’t have an advisor that picks which stocks to buy and sell. Passively managed funds follow an index like the S&P 500. The composition of a passively managed fund is the same as the composition of the S&P 500. A passively managed index fund has a much smaller expense ratio since there is no expensive fund manager to pay. [+Vanguard’s S&P 500 index fund +] has a 0.17% expense ratio; one third of the actively managed fund above.

The S&P 500 is a list of the 500 largest US stocks. When you buy a share of an S&P 500 index fund, you are buying a small portion of the 500 largest US corporations. The S&P 500 is weighted meaning larger companies like Apple account for a larger portion of the index. If you purchase $1,000 in a S&P index fund, a portion of your money goes to Apple stock, a smaller portion goes to Microsoft, a smaller portion goes to Kellogg’s, etc. The index composition is updated once a quarter.

So passively managed funds are cheaper than actively managed one, but which one performs better?

[+ The New York Times+]  found that over a ten year period, low cost passive index funds beat 75% of actively managed mutual funds. The vast majority of people who invested in high cost actively managed funds would have earned higher returns with a low cost index fund.

Based on current history, low cost index funds are better than high cost actively managed funds. Vanguard offers some of the lowest cost index mutual funds and ETF’s. For further proof, the best investor in the world, Warren Buffett, told LeBron James to use Vanguard index funds.

Passively managed index funds come in many flavors. There are funds that track the S&P 500, other funds that track the Russell 2000, etc. If you want to keep it simple, use an index fund that tracks the S&P 500.

[]Load vs No Load funds

The previous chapter described why index funds are better for the vast majority of investors. They are cheaper than actively managed mutual funds and often perform better. For families that insist on using an actively managed mutual fund, some are better than others. Mutual funds can either have a load or not have a load. The difference between load and no load mutual funds can save families a lot of money.

If you’d rather not read ahead, never buy a mutual with a load. Buy funds from Vanguard or T. Rowe Price only.

Mutual funds that have a load charge an upfront fee in addition to an ongoing annual fee. Think of this as a commission; it’s a percentage of what you put in. JP Morgan is one of the biggest offenders in charging loads.

Mutual funds without a load do not have an upfront fee. They do have an ongoing annual fee like all funds do. T Rowe Price and Vanguard are the leaders in no load mutual funds.

Let’s look at the [+JPMorgan Smart Retirement 2055 Fund +](there is nothing smart about it)

p<>{color:#000;}. 4.5% Load

p<>{color:#000;}. .94% Annual Expense Ratio

p<>{color:#00F;}. [+ 10.62% return per year for last 3 years +]

If you invest $5,000 into this fund, right off the top they take out $225. That is their 4.5% load. The annual return is without the 4.5% up front commission.


Let’s look at an equivalent fund, T Rowe Price 2055 Retirement fund.

p<>{color:#000;}. No Load

p<>{color:#000;}. .75% Expense Ratio

p<>{color:#00F;}. [+ 10.64% return per year for last 3 years +]

These two funds are essentially the same. JP Morgan charges you a 4.5% commission and has a high annual fee. T Rowe Price charges no commission and has a lower annual fee.

Two identical mutual funds with similar returns but one is cheaper than the other.

Why would you pay a commission with JP Morgan?

If you want to invest in the market:

p<>{color:#000;}. Index funds from Vanguard are the best

p<>{color:#000;}. No load mutual funds from T Rowe Price are the second best

p<>{color:#000;}. Mutual funds with a load (like JP Morgan) are the worst

[] ETF’s vs Mutual Funds

A mutual fund is purchased through a company like T Rowe Price, Vanguard, Fidelity, etc. A mutual fund offers instant diversification and can either be active or passive. The price of a mutual fund is set each night after the fund calculates the values of all the stocks it holds. Mutual funds can only be purchased once a day; all orders are pending until the fund is priced each night. Many mutual funds require at least $2,000 to open an account. Some mutual funds have a fee to purchase (a load); you should avoid these at all costs.

An exchange traded fund (ETF) is similar to a mutual fund but trades like a stock. An investor can purchase an ETF through any broker like eTrade or ShareBuilder. There is no minimum to purchase an ETF but you will pay a small commission to the broker (less than $20). An ETF trades like a stock; every second when the stock market is open its price is updated. An ETF typically tracks an index like the S&P 500 and is similar to a passive mutual fund. The key difference is an ETF can be bought and sold any time during the trading day.

When do you use an ETF vs. a mutual fund?

First, you should always use passive ETF’s or mutual funds since they are lower cost and outperform the majority of actively managed funds.

Second, if you cannot meet the minimum threshold for a mutual fund, an ETF is the best option. The only transaction cost will be the trading commission from your broker. ShareBuilder only charges $7 per trade.

The fact that an ETF trades throughout the day whereas a mutual fund is only priced at night is largely irrelevant. If you are saving for college or retirement this should have no impact.

If you meet the minimum threshold, what should you use?

If you are making consistent contributions, say $200 per month, a mutual fund is the best option. With an ETF you’ll pay a commission every month you place an order. Those commissions will take away from your returns. For most mutual funds, once you open an account you can make additional investments as low as $100.

A mutual fund that tracks an index like the S&P 500 will perform the same as an ETF that tracks the S&P 500. Before you buy either an ETF or mutual fund, be sure to check the annual fees. Vanguard usually has the lowest cost funds.


[]Saving For College


After the purchase of home, paying for college will likely be the second largest expense a family will ever have. We all have personal knowledge or have read about recent graduates with $50,000 or more of debt entering a job market with stagnant wages.

This trend of continuous increases in college tuition will likely not stop. Families will have to save more and more money to help their children earn a degree.

There are numerous investment products to help pay for college. Many of them are useful and some are outright fraudulent. The chapters in this section review the college savings products families should use and also one they should avoid.

[] Educational IRA vs 529 Plan

There are two tax advantaged options available to most parents: 529’s or Educational IRA’s. Each is slightly different and can be used for different goals.

Educational IRA

Similar to its cousins ROTH or Traditional, an educational IRA is a tax advantaged account that can be used for primary and secondary schooling expenses. The money you put in is after tax but the investment grows tax free, just like a ROTH IRA. Similar to other IRA’s, an Educational IRA can invest in stocks, mutual funds, etc. The best option for parents is to use a low cost Vanguard index fund.

Parents can open an Educational IRA if their Modified Gross Income is less than $110,000; the maximum they can contribute per child is $2,000 per year.

529 Plan

Relatively new, 529 plans are the preferred educational savings vehicles for parents. Unlike Educational IRA, 529’s cannot be used for private primary schooling; they can only be used for secondary (college) expenses. The [+contribution limits +]for 529 plans are higher; usually around $14,000 per year but five years of contributions ($70,000) can be made at once.

Every state offers a different 529 plan; finding the right one can be difficult.

Go to [+US News 529 finder +]and choose your state.

Check if your state offers a state income tax deductions for contributions.

Most states offer two types of 529 plans: advisor and direct sold. Direct sold have lower costs since they are passive investments. A direct sold plan is almost always the better option.

You can open a 529 plan with any state; regardless of where you live or where your child goes to college.  If your state does not offer an income tax deduction, find the state with the lowest expense ratio and use that one.

Different plans have different investment options. Some states only offer low return low risk money market funds; others offer index funds. Before choosing a plan, make sure it offers Vanguard mutual funds as investment options.

529’s or Educational IRA’s Which One To Use?

If you are saving only for college, the 529 plan is the winner. The contribution limit is significantly higher and most states offer an income tax deduction.

If you are saving for private school, the Educational IRA is your only option. These funds can also be used to pay college expenses.

Parents can use both but may hit the gift tax penalty if they do so. Contributions to both accounts count as a gift to child; if the cumulative gifts to a child in one year exceed $14,000, you will have to file a gift tax return form. If you are able to do this, you should consult with a tax attorney.

[] Finding the Right 529 Plan

If your state offers a tax deduction, contribute only up to the maximum tax deduction. For example, [+Idaho residents can only deduct $4,000 +]in contributions each year from their state income taxes. After reaching the maximum tax deduction, parents should contribute to any of the 529 plans listed below. They have the lowest expense ratios meaning more money will be available for your kids to use for college.

1) Maryland College Investment Plan

With a super low expense ratio of less than 1%, the Maryland College Investment Plan is one of the best plans available. The plan invests exclusively in T Rowe Price mutual funds which are very low cost and highly rated.

2) Utah Educational Savings Plan

Another super low cost 529 Plan, the Utah Educational Savings Plan has an expense ratio less way than 1% and invests in super low cost Vanguard Index Funds. The Utah 529 Plan has numerous investment options available based on risk type; I would go with the moderate option.

3) Nevada Vanguard 529 Plan

The Nevada Vanguard 529 Plan also has an expense ratio of less than 1% and offers parents two categories of options: your typical age based plan and a static option. The static option invests only in an S&P 500 Index Fund. The age based plan is probably more suitable for most families.

There are a lot of 529 plans available; every state has at least one.

My recommendation for families is simple:

p<>{color:#000;}. Contribute to your state plan until you maximize the state income tax deduction each year. After that, use one of the plans above.

p<>{color:#000;}. If your state does not offer a tax deduction, use one of the plans above

p<>{color:#000;}. Never buy an advisor sold plan; buy a direct sold plan. Advisor plans are too expensive

[]Gerber College Plan

The Gerber College Plan is a combination parental life insurance plan and college savings plan. A parent would specify how much benefit they wish to receive at maturity (for college costs) and how long they will wait to collect that benefit. Gerber then tells you how much your monthly payments are. The company emphasizes you are guaranteed to receive your benefit amount. They also state the benefit amount will be more than the premiums you paid. So there is no investment risk. If the parent passes away before the plan hits maturity, the family would receive the cash value not the full amount.

A guaranteed benefit sounds good but the Gerber College Plan is not a wise investment.

First, unlike [+529 plans or Educational IRA’s +]there is no tax benefit with the Gerber College Plan. There is no state income tax deduction for contributions like there is for many 529’s. Even worse, at maturity the benefits received from the Gerber College Plan are subject to tax. Distributions from 529’s and educational IRA’s are tax free if used for educational purposes. With Gerber, a large portion of your benefit will be sent to Uncle Sam.

The second downside is the consistency required. In 529 plans and Educational IRA’s parents set their own contribution schedule. If you miss one payment with the Gerber College Plan you will likely lose your benefits. 529 Plans and Educational IRA’s are significantly more flexible for contributions. There is a higher level of responsibility required for 529’s and Educational IRA’s, but that comes with being a parent.

Parents may be drawn to the Gerber College Plan for the combination life insurance and guaranteed benefit amount. With the lack of tax savings and flexibility, a combination of term life insurance and 529 plan is a superior option. Here is another viewpoint with a similar conclusion on Gerber’s College Plan.



With all the costs associated with raising a child and then saving for their college education, many parents neglect their retirement savings. This is a huge mistake. At some point the majority of people are unable to work due to age and need to retire. Social Security provides a small payment to retirees but that small benefit may be reduced in the future. Parent cannot forget about their retirement savings and must be proactive about their investment selections.

The chapters in this section go through the different investment options available for retirement savings.

[] Roth vs. Traditional IRA

In addition to 401k plans, Individual Retirement Accounts (IRA) are a widely used investment tool to save for college. An IRA can be either traditional or ROTH. Depending on a family’s financial situation, tax bracket and age, one IRA may be better than the other.

In a traditional IRA, any contributions you make are before federal income tax. Let’s say your gross income is $100,000 and you contribute $5,000 to an IRA. Your taxable income falls to $95,000. Contributions to a traditional IRA are an above the line deduction. They reduce your taxable income regardless if you itemize or use the standard deduction.

When you make a withdrawal from a Traditional IRA, you pay income tax on the amount withdrawn. If a withdrawal is made before age 59.5, there is a 10% penalty in addition to income tax on the amount withdrawn. A traditional IRA makes sense if you are in a high tax bracket today. When you retire you’ll be in a lower tax bracket and then pay lower tax on the withdrawals.

In a Roth IRA, contributions you make are after tax. If you contribute $5,000 to a ROTH IRA, you do not receive a tax deduction as you would with a traditional IRA. When money in withdrawn from a ROTH IRA there is no income tax paid. In a ROTH IRA, you money grows tax free.

Money invested in a ROTH IRA can be withdrawn tax free and penalty free before age 59.5 only up to the amount you deposited. If you deposited a total of $20,000 over 5 years and it grows to $23,000, you can withdraw the original $20,000 tax free and penalty free. If you withdraw more than $20,000 you’ll pay a penalty and tax on that amount. Your original contribution can be withdrawn tax and penalty free any time but your investment gains cannot be withdrawn tax and penalty free until age 59.5.

ROTH or Traditional?

A Roth IRA is generally better since your investment grows tax free. ROTH IRA’s are only available if you [+ income is below a certain amount+]. Traditional IRA’s have no income limits but the tax deduction phases out for higher incomes.

If you are able to contribute to a ROTH IRA, then you should do so. You’ll pay tax upfront but your investment will grow tax free. Additionally you can withdraw the original amount you deposited tax free and penalty free. A third benefit of a ROTH IRA is you pay the tax now and don’t have to worry about tax rates in the future. If taxes dramatically increase when you retire and take money out, it will not affect you.

How To Invest

Similar to all investment accounts, passive low cost index funds are ideal for ROTH or traditional IRA’s. Always avoid mutual funds with a load. IRA’s can be opened with any broker like ShareBuilder or Vanguard.

[]401(k) Rollover

The majority of employers offer a 401(k) plan. When you leave an employer to take a new job, stay at home with the kids or retire, you have an option to roll your 401(k) plan into a traditional IRA. This type of rollover can be completed tax and penalty free.

If you do leave an employer, I recommend your rollover your 401k into an IRA. This rollover can be done at any brokerage or mutual fund company like Vanguard. The best option is roll your 401(k) into a traditional IRA and invest the money in a target date retirement fund. Vanguard offers some of the lowest cost target date funds available.

To summarize, when leaving an employer:

p<>{color:#000;}. Rollover your 401(k) into a traditional IRA at Vanguard or another fund company

p<>{color:#000;}. Invest the money into a Target Date Retirement Fund.

Vanguard has some the lowest cost Target Date Retirement Funds available; T. Rowe Price is another good option.

[]Robo – Advisors

Robotic advisors often referred to as robo advisors, have become very popular the past few years. A robo advisor manages your investments through a computer algorithm. When you sign up for a robo advisor, you’ll complete a series of questions that determine your risk tolerance and investment goals. Using this data the algorithms will allocate your investments between various ETF’s and rebalance that allocation over time.

Robo advisors are significantly cheaper than traditional investment advisors and the majority of actively managed mutual funds. Betterment is the most popular robo followed by Wealth Front and a host of smaller companies.

I do not think families should use robo advisors due to their high cost.

While robo’s are cheaper than investment advisors they are significantly more expensive than Vanguard Target Retirement Funds. A robo advisor like Wealth Front invests your money into a collection of ETF’s. Each of those ETF’s has a small expense ratio. The robo will then charge a small fee (0.25%) on top of that as well. This combined fee is less than what an investment advisor will charge but larger than a low cost target date retirement fund.

[+ Vanguard’s Target 2055 Retirement Fund+] has a combined expense ratio of 0.18%. This retirement fund also allocates your investments into a collection of Vanguard ETF’s and rebalances your investment as you age. The combined expense ratio for the Vanguard 2055 Retirement Fund includes the expenses for the underlying ETF’s.

With Wealth Front your expense ratio will be 0.25% plus the expenses for the underlying ETFs.

With Vanguard your expense ratio will be 0.18% in total.

You’ll save a lot of money over time with a Vanguard Target Retirement Fund.



Death and taxes; the two things that cannot be avoided. You can argue that taxes is the more complicated one. The federal tax code in the United States is insane. It’s thousands of pages long with numerous exemptions, carve outs, etc.

Even though the majority of American will use a tax prep software to complete their returns, it’s important to understand some of the basic aspects of federal income taxes. Knowing how deductions, credits and exemptions work can help you make wise financial decisions to help your family.

[]Itemize vs Standard

Taxpayers in the United States have the option to itemize their deductions or use the standard deduction. Since most people utilize tax software like H&R Block, they are told which deduction option to use. Regardless, learning the difference between the itemize vs standard deduction is pretty important for families.

The standard deduction is available to all tax payers. In 2015, a couple filing together receive a standard deduction of $12,600. Please note this amount changes every year.

For couples who own a home they are likely better off using the itemized deduction. In the itemized deduction, a tax payer adds up all their deductions (state and local income taxes paid, interest on a mortgage for your primary home, property taxes, charitable donations, etc) and that is their deduction.

Your tax software will recommend using the itemized deduction if the deductions for you and your spouse are greater than $12,600.

I recommend couples spend some time in September adding up their deductions for the year. If the couple is going to itemize this year but use the standard deduction next year, it may be a good time to increase their charitable contributions. If you use the standard deduction, charitable contributions don’t lower your taxes.

By bringing forward next year’s charitable contribution to this year, you’ll receive an additional tax benefit since you are itemizing this year that you would not receive next year when you use the standard deduction.

 The tax code in the United States is complicated; it can be stressful to try and understand. At very least, every tax payer should know if they use the standard deduction or if they itemize. If you have a child, you receive a tax credit not a deduction.

[] Exemptions vs Deductions

Every tax payer in the United States is allowed to take a personal exemption for themselves and one for each of their dependents. To take an exemption for yourself, no one else can claim you as a dependent. The personal exemption amount in 2015 is $4,000.



If you are married and have two children, you can take four exemptions; one for you and your spouse and one for each of your children for a total of $16,000. Similar to deductions, the personal exemption begins to phase out for higher incomes.



An exemption is defined as the amount of money the IRS says you are entitled to that is free from federal taxes. Similar to a deduction, exemptions reduce the amount of income that is taxed. If the family of four above has $100,000 in income, after taking personal exemptions their taxable income will be reduced to $84,000.



How is an exemption different than a deduction?

The majority of deductions, like a charitable contribution, only reduces your taxable income if you itemize your return. An exemption reduces your taxable income regardless if you itemize or use the standard deduction.



How is an exemption different than a child tax credit?

You can only take the federal child tax credit if your child is 17 years of age or younger. You can take the exemption regardless of age if they are your dependent.



Bottom line is that exemptions lower your taxable income regardless if you use the standard deduction or if you itemize. Some deductions are above the line which lowers your income regardless if you itemize or use the standard deduction.



[] Above the Line vs Below the Line

A previous chapter discussed the differences between using the standard deductions and itemizing deductions. As with everything tax related, there are certain deductions you can use regardless if you itemize or use the standard. These are called above the line deductions.




Above the line deductions are also referred to as adjustments to income. Let’s say if your gross income is $100,000 and you have above the line deductions of $5,000, then your adjusted gross income is $95,000. Above the line deductions include contributions to a Traditional IRA and Health Savings Account, interest on student loans, alimony payments, etc.



A below the line deduction is a deduction you take after calculating your adjusted gross income. Below the line deductions include state and local income taxes, mortgage interest, charitable donations , etc. Any tax payer can take an above the line deduction regardless if they itemize or if they use the standard deduction. Below the line deductions are only available to tax payers that itemize their returns.



An above the line deduction is better than a below the line deduction since it’s lowers your Adjusted Gross Income (AGI). Some benefits, like the personal exemption, phase out for tax payers with high adjusted gross income. Above the line deductions reduce the AGI thus making it more likely a tax payer will qualify for a benefit.



Regardless if you itemize or use the standard deduction, above the line deductions like contributions to a traditional IRA or Health Savings account will reduce your taxable income.


[]Deductions vs Credits

For many couples, having a child makes them eligible for a tax credit for the first time. A tax credit is very different from a tax deduction. All new parents need to understand the differences between deductions vs credits since it has a large impact on your tax liability.

A tax deduction in the United States lowers the amount of income you are taxed on. Tax deductions are available for state and local incomes you paid, property tax and mortgage interest on your primary home, charitable donations, contributions to health savings accounts and traditional IRAs, and various other items.

A tax credit is an amount you can use to offset your tax liability. Think of it as a credit you receive at a department store.

Let’s assume you and your spouse have a combined gross income of $100,000 and your federal tax liability on this income is $10,000. If you have a child, you are eligible for a tax credit of $1,000 (way less than the cost of raising a child). Your tax liability will be reduced from $10,000 to $9,0000.

A tax credit applies whether you itemize your deductions or use the standard deduction.

The child tax credit phases out for higher incomes; the threshold increases every year. Your child also has to be no older than seventeen years of age to qualify.

Even though most tax prep software like Intuit or H&R Block will walk you through the steps for using a child tax credit, it’s important to know the difference of deductions vs credits.

[]Products To Avoid

The preceding chapters discussed many of the good and bad aspects of numerous financial products available. To get a free complete list of products to avoid and products to use, including many not listed here, join our newsletter at MommyWord.

After you join we’ll email you a list of 101 financial products to avoid what to avoid, the reason to avoid it and a better alternative.

A Simple Guide To Family Finances

Raising a family is expensive. From diapers, clothes, toys and electronics up through saving for college and retirement the expenses never end. Factor in stagnant wages, increasing health care costs and dishonest financial planners and it’s no surprise that most families feel overwhelmed. Though no magic cure exists to fix every family’s finances, having an understanding of the different financial products can help a family avoid making bad decisions.This free e-book walk through how families should save for college and retirement, different tax strategies and the financial products they should avoid using.

  • ISBN: 9781310207679
  • Author: Mommy Word
  • Published: 2016-01-07 19:05:07
  • Words: 5025
A Simple Guide To Family Finances A Simple Guide To Family Finances