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Post by uhuh on Mar 2, 2011 10:04:58 GMT -5
Hi,
I was at a local branch recently. The banker specialist has a proposal and I have questions about this.
Here is the proposal.
Open a 5 years CD at 2.25 % which is far better rate than Money Market account which gives 0.45 %. After 1.5 years, I should break the CD if the rates do improve. I only would have to pay 6 months penalties.
I know we have to report the interest earned on our tax returns. But from what she was telling me that I can use the penalties to offset other interest that I earn. This way I can earn 4 times the amount of interest in one year.
Here are my questions: 1) Will the penalties that I have to pay in order to break be recognized as income earned? 2) Can I offset penalties against other interest earned? If so, how? 3) If this is a valid proposal, then I'm shocked that no one has discussed this on MSN Money Board or here.
Please share your opinions.
thanks
I posted on the Tax board but I think Your Money gets more traffic.
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Post by Savoir Faire-Demogague in NJ on Mar 2, 2011 10:19:42 GMT -5
Paying a penalty for breaking a CD would not be income, but an expense. I do not know if this could be claimed as an investment expense or not, which would subject to a percent of AGI, I think it is 2% of AGI, anything over that can be deducted. You would have to check the IRS instruction booklet for that particular form.
I would take the approach of laddering CDs, with maturities of no more than two or three years.
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schildi
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Post by schildi on Mar 2, 2011 10:21:40 GMT -5
I am confused about what you are proposing, and I don't think that this can get you in any way to earning 4x interest. If you "break" that CD after 1.5 years and pay a 6 months interest penalty, then that CD earned you only around 1.5% interest effectively. I don't think there is anything "magic" about the bankers proposal, and no reason to be "shocked"!
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Post by Savoir Faire-Demogague in NJ on Mar 2, 2011 10:30:36 GMT -5
I don't think there is anything "magic" about the bankers proposal, and no reason to be "shocked"!
It may be possible the bank employees who work on the platform get some sort of incentive for each CD(or account) they open.
Just speculating.
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Deleted
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Post by Deleted on Mar 2, 2011 10:32:50 GMT -5
I think the 4 times the amount of interest is the 5 year cd versus the money market.
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runewell
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Post by runewell on Mar 2, 2011 10:43:52 GMT -5
THink about it this way: Even if you withdrew the money after one year you and paid the penalty you would still have 1.13% which is better than the 0.45% money market.
If your interest accrues monthly at about 0.19%/mo, the break-even point is probably 9 months. You would earn 0.19% x 3 = 0.57% and the remaining six months would be forfeited.
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Post by uhuh on Mar 2, 2011 11:22:45 GMT -5
Savior Faire is absolutely correct. There is always pressure from management up above pushing the folks at the branch to sell the products to the customers. No question about this and I recognize this sale pitch.
runewell, I went to bankrate.com website and use one of their calculators. Let's assume that the initial amount is $10,000. After one year, it would have grown to $10,225 if it was parked at 5 years CD. After 1.5 years, it would have grown to $10,343 and after paying 6 months penalties, my interest earned after 1.5 years is $225.
If I kept at .45 % money market account, after 1.5 years, the account would have grown to $10,068.
Basically after 1.5 years, the 5 years CD earned me three times more interest than money market. Does this make sense?
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Post by uhuh on Mar 2, 2011 11:24:01 GMT -5
It's been a while since did my own taxes, but I'm pretty sure there's a place to "deduct" the expense of breaking the CD. DH and I broke one last year, I'll check my forms when they come back from the accountant.... Let me know what your accountant say. I'm curious to know.
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phil5185
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Post by phil5185 on Mar 2, 2011 12:07:41 GMT -5
If I kept at .45 % money market account, after 1.5 years, the account would have grown to $10,068. Basically after 1.5 years, the 5 years CD earned me three times more interest than money market. Does this make sense? Well, it probably makes sense to somebody - but after 1 1/2 years you will have $225 of taxable income, leaving you with about $10,175 after 1 1/2 years. Meanwhile the purchasing power of the $10,175 will have dropped to about $9875. You are only age 40 - why not invest the $10,000 for 5 yrs with a goal of a nominal $16,000? And pay the preferred 15% MAX tax on the $6000 profit? That at least gives you an opportunity to outpace inflation and get some tax deferred growth - it may not work out, but it gives you a chance - the 2.25% rate guarantees that you will lose purchasing power.
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Post by uhuh on Mar 2, 2011 12:13:17 GMT -5
If I kept at .45 % money market account, after 1.5 years, the account would have grown to $10,068. Basically after 1.5 years, the 5 years CD earned me three times more interest than money market. Does this make sense? Well, it probably makes sense to somebody - but after 1 1/2 years you will have $225 of taxable income, leaving you with about $10,175 after 1 1/2 years. Meanwhile the purchasing power of the $10,175 will have dropped to about $9875. You are only age 40 - why not invest the $10,000 for 5 yrs with a goal of a nominal $16,000? And pay the preferred 15% MAX tax on the $6000 profit? That at least gives you an opportunity to outpace inflation and get some tax deferred growth - it may not work out, but it gives you a chance - the 2.25% rate guarantees that you will lose purchasing power. Phil, you are absolutely correct that either 0.45 or 2.25 guarantee losing purchase power. However 0.45 is worse than 2.25 no doubt about it. The real question is how much risk am I willing to take to invest same $10,000 into something that is NOT guaranteed to be $16,000 after five years? Unless you know of a stock that guarantee to be $16,00 after five years and you don't want to share with rest of us so that we can enjoy same success as you?
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schildi
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Post by schildi on Mar 2, 2011 12:17:17 GMT -5
If I kept at .45 % money market account, after 1.5 years, the account would have grown to $10,068. Basically after 1.5 years, the 5 years CD earned me three times more interest than money market. Does this make sense? Well, it probably makes sense to somebody - but after 1 1/2 years you will have $225 of taxable income, leaving you with about $10,175 after 1 1/2 years. Meanwhile the purchasing power of the $10,175 will have dropped to about $9875. You are only age 40 - why not invest the $10,000 for 5 yrs with a goal of a nominal $16,000? And pay the preferred 15% MAX tax on the $6000 profit? That at least gives you an opportunity to outpace inflation and get some tax deferred growth - it may not work out, but it gives you a chance - the 2.25% rate guarantees that you will lose purchasing power. Phil, you are absolutely correct that either 0.45 or 2.25 guarantee losing purchase power. However 0.45 is worse than 2.25 no doubt about it. The real question is how much risk am I willing to take to invest same $10,000 into something that is NOT guaranteed to be $16,000 after five years? Unless you know of a stock that guarantee to be $16,00 after five years and you don't want to share with rest of us so that we can enjoy same success as you? Phil already said that there is no guarantee. Got to support Phil here this time, because he did say it! :-)
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runewell
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Post by runewell on Mar 2, 2011 12:24:17 GMT -5
Savior Faire is absolutely correct. There is always pressure from management up above pushing the folks at the branch to sell the products to the customers. No question about this and I recognize this sale pitch. runewell, I went to bankrate.com website and use one of their calculators. Let's assume that the initial amount is $10,000. After one year, it would have grown to $10,225 if it was parked at 5 years CD. After 1.5 years, it would have grown to $10,343 and after paying 6 months penalties, my interest earned after 1.5 years is $225. If I kept at .45 % money market account, after 1.5 years, the account would have grown to $10,068. Basically after 1.5 years, the 5 years CD earned me three times more interest than money market. Does this make sense? Well you are comparing a rate of 2.25% x 1 yr = 2.25% against 0.45% x 1.5 yr = 0.68% so yes the ratio is approx. 2.25/0.68 = 3.38. The point is that the interest rate is so much more it doesn't take long for the CD to outgain the money market even when a penalty is priced in. I have done this before even with CD rates alone. Here's an example using Wells Fargo rates in Iowa: The 1-yr rate is a paltry 0.25% or 0.02%/mo. The 5-yr rate is 1.65% or 0.1375%/mo. There are 1-month and 6-month penalties for early withdrawal. Since the interest rates are pitiful let's forgo the compound interest and just add dollars. On a $10,000 CD you get $2.08/mo with the 1-yr rate and $13.75/mo with the 5- yr rate. If you were to withdraw after 7 months, you would get 6 months of interest @ $2.08 = $12.48 or 1 month of interest @ $13.75. If you were to withdraw after 8 months, you would get 7 months of interest @ $2.08 = $14.56 or 2 month of interest @ $13.75 = $27.50. So as you can see, the break-even point in this scenario is 7 months. If you think you might need the money sooner, you might end up with no interest using a 5-yr term. But if you make it to 7 months, you will always come out ahead with the 5-yr investment, even if your time horizon is much shorter than that. Having done this quick calculation, I opted for a 5-yr CD # 3.XX% right around the time the recession was in full swing, even though I only held it for about a year because I knew I would come out ahead. As a miniscule bonus the penalty you pay is tax deductible. In the example above the penalty on $10,000 would be $13.75 x 6 = $82.50 which reduces your taxes by about $82.5 x 15% = $12 in the lower tax bracket. So with the reduction in taxable income the break even point might be less than 7 months! Getting NO interest and a small tax deduction might still be worth more than the 1-yr rate LOL.
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phil5185
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Post by phil5185 on Mar 2, 2011 13:07:22 GMT -5
The real question is how much risk am I willing to take to invest same $10,000 into something that is NOT guaranteed to be $16,000 after five years? Unless you know of a stock that guarantee to be $16,00 after five years and you don't want to share with rest of us so that we can enjoy same success as you? LOL - no, I don't know of a magic guaranteed 10%/yr stock. But you don't have to make an either/or decision. Long term, stock funds earn about 10%, bond funds earn about 5%, and CDs earn near 0%. So you can select any risk level that you like - eg, a 50/50 mix of bonds/CD would get about 2.5%. Or 100% bonds is about 5%. And 50/50 stocks/bonds is about 7.5%.
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runewell
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Post by runewell on Mar 2, 2011 16:43:46 GMT -5
On the other hand, if your 5-yr timeframe had started Feb 2004, your $10,000 would have plummted to $6,420 in the S&P (excl dividends).
Nobody here denies that long-term stocks have outpaced CD's. But the fact that CD's exist means they serve sort of purpose, namely safety of principal.
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Plain Old Petunia
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Post by Plain Old Petunia on Mar 2, 2011 19:39:25 GMT -5
I think that a 6 month penalty is very steep. Have you shopped around? For example, right now AllyBank has a 60 mo CD paying 2.37%, early withdrawal penalty is 60 days interest.
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