Your Money: A yearly financial checkup

Feb. 1, 2001
The process of filing taxes probably provides the year's most comprehensive look at personal finances. There's much you can learn from the experience.

Think of it as a yearly financial checkup. If you're like many Americans, preparing your taxes - the last-minute calculations, the W-2 forms, and that eleventh-hour dash to the post office - may make you feel a little under the weather. However, tax time may provide the most accurate annual barometer of your financial health.

For many, the process of filing taxes probably provides the year's most comprehensive look at personal finances. There's much you can learn from the experience. When filing your taxes, you should devote particular attention to the following issues.

  • The right time to budget. Tax preparation forces you to analyze how much money you made and how you spent it. You can track how much you spent on housing interest, taxes, and personal property taxes.

If you take time to assess other regular expenses not required to complete the tax form - such as consumer credit, food, and clothing - you can assemble a pretty complete picture of where the money is going. Tax time is the right time to ask questions to determine if your current spending practices are working. And, because you have an assessment of your regular expenses, it's a good time to set realistic financial goals.

  • Good debt and bad debt. For most people, any kind of debt is bad. However, there is a difference between debt interest that's tax-deductible (such as mortgage or home equity loans) and interest that's not (such as consumer loans and credit cards). A house payment, in a sense, is an investment in your future financial security. On the other hand, credit card debt is only costing you money and does nothing to reduce your taxes.
  • Is your investment strategy working? Any income - interest or dividends - that you received during the year may be taxed at the full rate. But a municipal bond or municipal bond fund pays dividends that are generally free from federal income tax.

When filing your taxes, you can see how your money is meeting your financial goals. After all, you have short- (one to five years), intermediate- (five to 10 years), and long-term (10 or more years) financial goals, and each may require different types of investments. In the process, you may learn that you're exposing yourself to additional taxes by putting long-term money in a short-term investment.

Obviously you need some money in liquid, interest-bearing investments. But if you don't need the income today, you might consider investments that defer or eliminate the needless tax "hit" altogether.

Consolidating investments may even simplify the tax-preparation process. If your money is spread between several financial institutions, you just may be creating unnecessary paperwork for yourself.

  • What about retirement? For starters, you can see how much your IRA, Keogh, or 401(k) plan is worth this year compared to last year. You'll learn firsthand the value of tax deferral. Also, are you contributing the maximum amount to your IRA, Keogh, or 401(k)? You may be surprised at how much you can contribute by law. Finally, by completing your taxes, you'll get a better idea ofhow diversified your retirement investments are. Of course, the right mix of investments may change over time.
  • Is your withholding appropriate? The ideal situation is to neither owe nor get an income tax refund. If you have too much tax withheld, you are, in effect, giving Uncle Sam an interest-free loan and sacrificing potential interest or dividends you could earn from the money that's withheld. If you aren't withholding enough, you may end up owing a lot at the end of the year.

Paperwork with a purpose

The significance of "the basics" perhaps never is clearer than it is at this time of year, when preparation of tax returns is at hand. It's now we're reminded that tax management is largely a function of record management. Straight and simple, it is: What's important? What do we keep? What do we pitch?

  • Income records - W-2 forms (showing salary), W-2P forms (showing payments from a pension), 1099 forms (reflecting interest and investment income), and all documents related to personal income should be retained.
  • Banking - Likewise, canceled checks, monthly statements, money order receipts, and any paperwork related to savings accounts, certificates, and loans.
  • Housing - For most people, mortgage interest and selected home-buying fees continue to be deductible. This is one of the few remaining tax havens.
  • Credit card receipts - Credit card receipts and records can be helpful in tracking deductible expenses such as medical bills and charitable contributions.
  • Deductions - Some out-of-the-ordinary expenses (cash contributions to charities, fees for continuing professional education, etc.) are potentially deductible and, sometimes, hard to track unless they're logged separately. Remember that the IRS requires you to have a receipt from the charity to take a charitable deduction for contributions over $250.
  • Investments - Records showing costs, dates of transactions, shares received, and commissions paid all are important, both for the current tax year and in the year an investment is liquidated.
  • Self-employment - It's crucial that income and cost-of-business documentation be kept. Those with at-home offices can prorate some expenses, such as telephone and other utilities.

The rule-of-thumb on how long tax records should be kept is three years. Many authorities advise seven years as optimal. The prospect of an IRS audit is justifiable motivation.

But there are other, certainly more positive, reasons as well. Com prehensive records put the taxpayer on solid footing for claiming the maximum, legally allowed deductions. But beyond the legalities involved, recordkeeping can help ensure that legitimate deductions aren't overlooked or simply forgotten. In this way, organized records can help the taxpayer minimize taxes.

When it comes to taxes, a lot of people care only about the bottom line: Do I owe, or do I get some money back? However, as a yearly financial assessment, filing your taxes can be a valuable lesson. Just remember that your homework is due on April 15.

Kathleen Adams, RDH, BS, is a financial adviser with Waddell and Reed ( She is currently trying to initiate money-management workshops for hygiene students and specializes in working with dental professionals. She can be reached at (800) 210-1357.